McAfee Inc. Q2 2008 Earnings Call Transcript

| About: McAfee Inc. (MFE)

McAfee Inc. (MFE) Q2 2008 Earnings Call July 31, 2008 4:30 PM ET


Kelsey Doherty - VP of IR

Dave DeWalt - President and CEO

Rocky Pimentel - COO and CFO

Todd Gebhart - SVP and General Manager


Frederick Grieb - Goldman Sachs

Heather Bellini - UBS

Rob Owens - Pacific Crest

Walter Pritchard - Cowen

Tim Klasell - Thomas Weisel Partners

Michael Turits - Raymond James

Brent Thill - Citi

Todd Raker - Deutsche Bank

Philip Rueppel - Wachovia Securities


Good afternoon, ladies and gentlemen. My name is Tina and I will be your conference operator today. At this time, I would like to welcome everyone to the McAfee second quarter 2008 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. Miss Doherty, you may begin your conference.

Kelsey Doherty

Thank you so much, Tina. Good afternoon and thank you for joining us. Today's conference call is being recorded and will be available for replay on McAfee's Investor Relations' homepage at On today's call are our Chief Executive Officer and President Dave DeWalt, and our Chief Operating Officer and Chief Financial Officer, Rocky Pimentel. Welcome, Rocky.

Dave will open the call with an overview of the quarter, a discussion of our growth drivers and overview of our acquisition of Reconnex. Then Rocky will provide the financial details of the quarter and guidance. Dave will close the call with a quick wrap up and we will take your questions.

You will find in our press release and on the Investor Relations section of our website a GAAP to non-GAAP reconciliation of the second quarter 2008 financial results discussed in this conference call.

The link is, and our results are posted under quarterly results. We will post our prepared remarks to the website following the conclusion of today's call. This conference call, including the question-and-answer session, will contain forward-looking statements.

These statements include, among others, those regarding market trends, our strategic positioning, guidance on revenue, operating income margins and earnings levels for the third quarter of 2008 and full fiscal year; expectations regarding the benefits of our pending acquisition of Reconnex, including those regarding future plans for the Reconnex's business, the expected closing date of the acquisition, the expected level and scope of security threats in future periods; expectations regarding the industry shift to security suites; expected industry growth rates of the market segments in which McAfee participates; expected new and future product introductions and the revenue opportunity associated with them; expected integrations of products from our pending acquisition of Reconnex and recent acquisitions with existing McAfee product lines; expectations regarding McAfee's business momentum, market position, business segments, statements regarding future partnership opportunities and our future growth opportunities, specific growth initiatives and strategies outlined for 2008 in McAfee's business; plans regarding investments in our global systems and infrastructure and future strategic acquisitions and other uses of cash by McAfee.

Forward-looking statements are based on management's current expectations and are subject to risks and uncertainties, including that McAfee may not achieve its planned revenue realization rates, succeed in its efforts to grow its business or effectively combat the security threats of the future, build upon its technology leadership or capture market share, or benefit from its acquisitions, strategic relationships or partnerships or its partner distribution network as anticipated.

We may not benefit from our investments and systems personnel and infrastructure as anticipated, McAfee customers may not respond as favorably as anticipated to the company's product or technical support offerings, the company may not satisfactorily anticipate or meet its customer's needs or expectations and the industry shift to security suites may not be adopted to the extent anticipated.

The company's product and service offerings may not continue to interoperate effectively with newly developed operating systems, the company may experience delays in product development or the release of previously announced products, the company may choose not to deliver a previously announced product, the company may experience delays or losses in revenue resulting from outages in the integrated systems on which it is highly dependent.

In addition, a number of operational and other factors, including new product introductions, the mix of products and services sold, the size of deals closed in a quarter, the amount of revenue deferred in a quarter, the integration of acquired businesses and products, changes in senior management, the competition we face in the market, currency fluctuations, and the greater macroeconomic environment to name a few may cause our revenue, gross margins and operating results to fluctuate significantly from period to period.

We caution listeners that actual results may vary perhaps materially from the forward-looking statements referenced in this call, including any forward-looking statements made during the question-and-answer session. We encourage listeners to review the risk factors contained in today's press release, as well as the company's filings with the Securities and Exchange Commission, including the company's annual report on Form 10-K filed February 27, 2008 and most recently filed quarterly report filed on Form 10-Q filed May 12, 2008 for more detailed information on the risks and uncertainties related to the company and its business. We do not undertake to update any forward-looking statements.

Now, with all of that, it's my pleasure to turn the call over to our CEO and President, Dave DeWalt. Dave?

Dave DeWalt

Okay. Thank you, Kelsey, and good afternoon and welcome, everybody. Thank you for joining us today. The second quarter of 2008 was one of the strongest quarters in the company's history. With record highs set in a variety of metrics throughout the business. I would like to thank all of the McAfee employees and our partners for their hard work and extraordinary efforts in the first half of 2008. These are exciting times to be at McAfee.

To summarize our progress to date, I would like to emphasize three things for today. First of all, our strategy is working. The combination of our strong products and our powerful go-to-market model is really helping us deliver our goals in taking market share and this could not be more evident than the two to three times growth we are experiencing over our primary competitors.

Secondly, our operating and financial models are really beginning to create significant leverage for the company. Q2 is back on track with a 350 basis point improvement in operating margins.

And third, we are positioning ourselves for future growth through strategic investments such as the acquisition today of Reconnex, the increased sales capacity we added in Q2 and the significant partner investment wins we have made at Hewlett-Packard, Acer, Toshiba and Yahoo just to name a few.

Overall, McAfee is outgrowing not only the major security competitors, but also most other vendors in the technology market. So what is our growth opportunity? During this past quarter, I spent considerable time traveling. The goal was to touch as many customers, partners and employees as possible.

I had the opportunity to visit more than 15 countries. I met with more than 500 corporate customers in person and shared the McAfee story with more than 10,000 people through 11 executive keynote addresses.

My overall impression coming away from that experience was wow. McAfee is an opportunity of a lifetime. First of all, security market is growing. Substantiated by industry analysts who see the market growing at about 15% compounded growth rates between now and 2011.

And most importantly, this growth is being driven by customers who are making strategic consolidation decisions about their security vendors and who want to make those decisions soon to save money.

We are in the right market at the right time. We believe that our products offer the highest protection with the greatest compliance controls at the lowest total cost of ownership. I am more convinced now than ever that the three trends dominating the security market, first, customers are looking for more comprehensive protection from increased threats, malware is up more than 60% year-over-year, and we now see well over 350 net new pieces of malware every day.

Secondly, customers are facing greater compliance requirements and higher risks and costs of non-compliance. Some companies face upwards to 50 different compliance mandates around the world making their security requirements very complex.

And finally, they are looking to optimize their security environments at the total cost of ownership. So at mid-year, this evolution in customers' requirements is consistent with what we saw beginning of the year and it's the basis for the strategy we have outlined for you before.

First, to own the endpoint from the consumer to the enterprise, through conversions of our antivirus franchise to our ToPS for Endpoint, then to interlock the Endpoint suites with our new suites for data protection, network protection and risk in compliance, and then to secure the emerging platforms, such as the web safe searching, safe shopping, virtual environments such as VMware, Microsoft and Citrics. Our results show they are right on target with all of these initiatives.

So now let's talk about the second quarter results. The programs that we embarked on in the first part of the year to improve our business processes and operating efficiencies have showed significant results in this quarter. We executed in the second quarter of 2008 and delivered record quarterly revenue and non-GAAP EPS results.

Revenue for the second quarter was $397 million, up 26% year-over-year and an all-time record for the company. This is the largest year-over-year increase in revenue McAfee has reported since we completed the divesture of non-security businesses in 2005. This was also the tenth consecutive quarter of double-digit year-over-year revenue growth.

McAfee has also delivered record deferred revenue this quarter of $1.09 billion and record non-GAAP earnings per share of $0.52. Our business is balanced and the team continues to deliver double-digit growth across our consumer and corporate businesses, our systems, network and risk compliance product lines and all of our geographies. North American revenue was $204 million, an increase of 25% from last year's second quarter and accounted for 51% of the business.

International revenue was $193 million, an increase of 27% from last year's second quarter, and accounted for 49% of the business. We had double-digit growth across all of our international segments including Europe, the Middle East and Africa growing at 28%, Asia-Pacific growing at 31%, Latin America growing at 44% and Japan growing at 13%.

Corporate revenue was $240 million, up 32% year-over-year; $240 million is a record revenue for our corporate business, which includes mid-market and enterprise customers. This marks the tenth consecutive quarter of more than double-digit year-over-year growth in our corporate business.

Highlights included one of the most successful product upgrades ever with the release of ePO 4.0. We now have more than 40% of our ePO customers deploying version 4.0 since its release in 2007 September.

Our large customer installations are extremely pleased with the advantages of the openness and scalability of the platform, the ability to manage virtual endpoints, and its web-based management console.

During the quarter, we closed 346 deals over $100,000, 45 deals over 500,000 and a record 21 deals over a $1 million. We have more than 90% year-over-year growth in deals over $1 million to a record 21, demonstrating the power of our improved go-to-market model. This success in large deal execution is further validation that customers are looking to consolidate vendors and are doing so with McAfee.

Total Protection solutions for Endpoint or ToPS was a major driver in many of our competitor displacements and larger transactions during the second quarter. As a result, McAfee took a larger portion of our customer's IT spend by becoming a security standard in more enterprises around the globe.

Q2 was the best quarter ever for ToPS with year-over-year sales increasing more than 40%.Customers are moving to the best-of- suite, improving their protection manageability and overall return on our security investment. This evolution of requirement fits right in the McAfee's strategy and strengths.

On the consumer side, revenue was $157 million, up 18% year-over-year. This is the 13th of 14 consecutive quarters that we have grown our consumer revenue double-digits year-over-year and we continue to grow faster than our competition.

Highlights in this segment include our high-end consumer suite; Total Protection had a great quarter with more than 100% increase in sales year-over-year. Consumers continue to migrate to our higher functionality suites. We signed or extended 14 consumer partner agreements and launched 68 newer enhanced consumer online partnerships during the quarter.

With the recent announcements, we now have more than 175 global consumer partners with many of the industry's leading players including banks, Telcos, ISPs, PC OEMs, retailers and universities and we estimate that we are now shipping on at least 50% of the PC shipments from the top-ten PC OEMs.

In addition, the consumer team announced the two new web security services, the first called McAfee Secure, a combination of our SiteAdvisor and ScanAlert technology, driving monetization opportunities in this multibillion dollar e-commerce and search marketplace.

McAfee Secure Web Certification will create a more secured internet experience for millions of consumers. To-date, McAfee Secure now protects more than 8,800 e-commerce resellers worldwide and creates more than $6.5 billion impressions of the McAfee trust mark each month.

Our second announcement, Yahoo SearchScan utilizes McAfee's safe search technology to provide more than 47 million people, who use Yahoo each day and conduct 2.4 billion searches each month, a safe search experience.

We also announced our new McAfee Anti-Theft product leveraging the technology we acquired from SafeBoot. Anti-Theft is an innovative easy-to-use security solution that provides data and personal information protection for 80% of consumers that store valuable files and personal identity information on their PC.

McAfee Anti-Theft can run in conjunction with any security software in the market. Successfully released online last month, the product should be available in retail shelves later this quarter.

And finally, we are very excited about our upcoming major refresh of our consumer security suites. Our new solutions are expected to include enhanced features, improved performance and better user experiences. We are on track to deliver this major product update early this fall.

Turning to growth driver investments, our foundation is strong and the opportunity ahead of us is really exciting. We're already beginning to see the benefits from the implementation of our strategy that we believe will drive growth in our business, enable us to capitalize on the opportunities ahead of us in the security market.

Specifically, we have made investments in the go-to-market model, we have added new talent to the sales-force, the increase in the number of unique account reps in the field with a better coverage model and allowing compensation structures that are paying off and we expect to make even more progress as we head to the year end.

And in the mid-market, we are empowering the channel and providing best-in-class support for McAfee. In the enterprise space, we approached the market with high touch model supported by internal sales resources while partnering with the channel at all levels to close transactions.

We expect to optimize the segments based on how we see the sales cycles work, and we continue to make investments in the team to capture the opportunity we see. A better than 30% year-over-year growth rate in corporate revenue highlights that the opportunity in security is now, and the resources we have put in place to take advantage of that opportunity are delivering the results.

Our next major growth area has been investments and sustainable and profitable global partnerships. These include partnerships with ISPs, financial institution, PC OEMs and others. PartnerSelect security is a subscriber acquisition and retention tool, or is a revenue generation opportunity for their business.

PartnerSelect McAfee, because of our industry-leading security as a service technology called SAS and a subscriber management process that drives attach rates, retention rates and revenue opportunities better than our competition.

Over the years, these partnerships have proven to change the game in consumer security as evidenced by our growth rates, and we believe this will continue to drive for future growth.

I am very pleased to announce that McAfee has secured some major new agreements with the following strategic PC OEM partners, Dell, Hewlett-Packard, Lenovo, Toshiba, Acer and Sony.

We estimate the McAfee will now ship more than 50% of all PC shipments worldwide for the top-ten PC manufacturers. Specifically on Dell, we are the default security partner worldwide from May 2008 through October 2009. At the same time, we have recommended positioning in North America, Latin America and Asia-Pac through October 2008 and then recommended positioning worldwide through October 2009.

Also at Dell, McAfee will have recommended placement in North America on SMB [Lostro] systems beginning in May 2008 through 2008 October, shipping ToPS preinstalled. And finally at Dell, McAfee has been chosen the recommended security vendor for system sold to the consumer retail channel globally through October 2009.

And on Hewlett-Packard, McAfee is providing a 60-day trial of preinstalled McAfee ToPS on HP commercial desktop computers and notebooks. This offering just now is shipping and is targeted at small business customers. And finally on Lenovo, McAfee entered into an agreement as Lenovo is a worldwide go-to-market partner for new Lenovo ThinkPad notebooks and ThinkCentre Desktop PCs. Shipments are expected to begin in early August.

We plan to continue building our partner distribution network. Operating cash flow for the second quarter would have been more than $100 million, but we chose instead to invest some of that cash making strategic investments in the consumer business.

We believe these partnerships are essential to broadening our consumer reach, driving new and profitable customers to McAfee while positioning us for the future growth in the business.

And finally, we are investing in building out the product portfolio. We believe that our ability to strategically use the cash on our balance sheet to make smart, small-to-medium size security-focused technology acquisitions will be the key to McAfee's ongoing success.

The acquisition of SafeBoot and the creation of McAfee's data protection business unit are a good example of this strategy in action. Data protection remains the number one concern of customers around the world and these concerns are driving spending.

During the second quarter, we closed the largest deal in SafeBoot's history and grew sales for that business 73% year-over-year. Results illustrate that we can scale SafeBoot's data protection technology through McAfee's distribution channel.

Our recently finalized integration into ePO 4.0 have accelerated growth and competitive displacements during the quarter which was 15% of our sales being displacements, and we expect this to continue in the back half of 2008 and beyond.

We are particularly pleased with how successful the team has been selling Data Protection in combination with other McAfee products, particularly ToPS for Endpoint. These are very important proof points against our base strategy that come standardized in customer's environments and continue to grow the customer spend with McAfee through the sale of incremental technologies.

Turning now to Reconnex: Well, that strategy is the heart of our approach. I am very pleased to announce it today we have signed a definitive agreement to purchase privately owned Reconnex, a leading data loss prevention provider as recognized by both Gartner and Forrester. Their unique technology learns and adapts to automate the outgoing and ongoing protection of data.

With this pending acquisition, McAfee expects to redefine the entire data protection market by bringing together a leader in data loss prevention with our comprehensive portfolio of data protection technologies and this is planned to be managed with a single-agent, single-console ePO.

We are paying approximately $46 million for Reconnex funded by cash from our balance sheet. The acquisition is expected to close in the third quarter of 2008. We anticipate that after closing, Reconnex will be incorporated McAfee's data protection business unit.

Today, Reconnex has more than 1.5 million managed users. According to industry analysts, the worldwide content monitoring, filtering and data loss prevention market is expected to grow through 2009 by a compounded annual rate of 59%.

Reconnex's products aligned with McAfee's vision provide a complete data protection and compliance solution. With more than 60 million notes managed by ePO today, the addition of Reconnex will enable McAfee to bring automated centrally managed adaptive protection to our existing customers and further enhance the value of our customers in McAfee's investment in ePO.

So in closing, we are very pleased with our second quarter results, reflecting execution in every geography, in every business segment and further validating the strategy our team has been developing and implementing.

With that, I'll turn it over to Rocky. Rocky welcome to the team and after Rocky is done; I will answer a few questions and a brief conclusion. Rocky?

Rocky Pimentel

Thank you, Dave. Good afternoon, everyone, I am very pleased to be joining you this afternoon. First, I would like to thank all the organizations in the company for their support in making my transition smooth and I would really particularly like to thank Keith Krzeminski for his help and support during this period.

This week marks my 11th week with McAfee and I thought I would start this afternoon by providing you a very quick overview of my reasons for joining the company and my initial impressions.

First, I believe there is a great opportunity in the security market due to the risks and vulnerabilities are ever-changing world presents. The second quarter marked McAfee's tenth consecutive quarter of double-digit year-over-year revenue growth. Nowhere else in the IT sector can you find an industry with that continuous growth, and I do not see that subsiding any time soon. The threat landscape drives the need for security across consumer and commercial platforms.

Second, McAfee has market-leading solutions as recognized by industry analysts, customers and partners and McAfee has been visionary in its product development being the first, among other things, to develop software as a service security model and the first to introduce integrated management under ePO more than seven years ago.

I am impressed by our R&D organization and believe that through internal development and thoughtful strategic acquisitions, we will enhance our leadership position in this market.

Third, the company has a strong brand franchise, recognized globally by both consumers and businesses. We have over 60 million corporate users managed under ePO, more than 60 million mobile devices shipped with McAfee protection, more than 170 million users who have downloaded McAfee SiteAdvisor and thousands of partners and points of distribution which sell our solutions worldwide. Having had prior experience with both global and consumer businesses, I am very excited by this worldwide reach, which firmly positions us for future growth.

Fourth, McAfee has attracted many outstanding people. My initial impressions have been reinforced over the past several weeks and I look forward to working closely with our team worldwide.

As some of you who are familiar with me now, I love business operations. Though my background is from the finance side and my main role is to serve as Chief Financial Officer, I have a passion for business operations. I believe this makes Dave and I a great compliment in working with the rest of the management team to create a positive energy that will drive the company forward.

And finally, McAfee operates a very attractive business model with roughly 80% of revenue every quarter being recognized from the balance sheet. We have an admirable cash generation profile and a strong balance sheet having no debt and a cash balance of $1.13 billion all of which we believe gives us the ability to take advantage of opportunities to enhance McAfee's leadership position.

So where do we go from here? Though I am in the early stages of developing priorities at McAfee, I have learned over the years that one of the most important aspects of any company is operational excellence, which promotes productivity, scalability and improves profitability.

One thing we are focused on is our expense profile and a desire to create more leverage in our business going forward. We will continue to invest in our global systems and infrastructure to support our growth goals worldwide. Initially, we are focused to make improvements in business applications, customer relationship management systems and our web infrastructure.

We believe, we can improve the management of our information for enhanced decision support worldwide. Simplifying our sales processes and utilizing the web to more effectively communicate and support our organizations internally, our channel partners and our customers should provide us more capacity to sell and sell effectively in the future.

We believe there are many areas throughout the business where we can improve. and I am currently working with a management team and employees to prioritize those opportunities.

Ultimately, our goal is to continue to develop McAfee into a high-performance world-class organization enabling us to be the leader in the markets we serve. I look forward to meeting or reacquainting myself with many of you during the quarter, and now I would like to turn to a review of the second quarter financial results.

Our second quarter 2008 revenue was better than expected. Revenue for the quarter reached an all-time high of $397 million, up 26% year-over-year. 80% of total revenue came from deferred revenue on the balance sheet. The increase in in-period revenue reflects the positive impact of our product mix and improved in-period sales contract structures.

Included in the second quarter 2008 results was the favorable year-over-year revenue impact due to foreign exchange of approximately $27 million. We have been able to improve in-period realization rates as compared to the first quarter of 2008 for transactions featuring solutions, which include newly acquired technologies for which there is no established vendor specific objective evidence or VSOE, such as SafeBoot as well as for our large enterprise transactions.

We accomplished this through an improved sales business process and focus on sales contract structure. We believe these improvements will continue to provide us benefit in our business operations on a go forward basis. Please note that generally revenue from SafeBoot will continue to be recognized ratably until the establishment of VSOE next year.

Moving to the income statement, GAAP gross profit margin for the second quarter was 77.4%, compared with first quarter 2008, 75.7% and second quarter 2007 of 77.3%.

Non-GAAP gross profit margin for the second quarter was 81%, compared with last quarter's 79.5%, and year ago quarter gross profit margin of 80.2%. Gross margin trended slightly higher due to the mix in volume of products sold during the quarter.

Total GAAP operating expenses in the second quarter 2008 were $253 million, up 23% from last year's $205 million for Q2. Total operating expenses on a non-GAAP basis in Q2, 2008 were $220 million, compared with $179 million for Q2 2007. This year-over-year increase in operating expenses reflects the acquisitions of SafeBoot and ScanAlert and personnel added to the core McAfee team, particularly in sales and marketing in the back half of last year and earlier this year and the impact of new consumer OEM relationships, where certain OEM payments are classified as sales and marketing expense rather than contra-revenue.

GAAP sales and marketing expenses for Q2 were $129 million. Sales and marketing expenses on a non-GAAP basis for Q2 were $120 million, or 30.1% of revenue. This slight sequential increase on a non-GAAP basis, compared to $114 million for the first quarter reflects the OEM partner $214 million for the first quarter reflects the OEM partner program costs incurred in Q2.

Otherwise, we were successful in holding our sales and marketing investments flat for the quarter.Q2 GAAP research and development costs were $62 million. Second quarter R&D costs on a non-GAAP basis were $57 million, or 14.5% of revenue. This slight sequential increase on a non-GAAP basis, compared to $55 million for the first quarter reflects a small addition to personnel in our research and development team.

Our R&D efforts are continuing to be fruitful. During Q2 2008, seven new patents were granted, bringing McAfee's total patent portfolio to 322. We also completed a number of planned major product releases including the new Content Security Blade Server, McAfee Secure and McAfee Anti-Theft.

GAAP G&A expenses for Q2 on the attached press release schedule were $48 million. On a non-GAAP basis, G&A expenses for Q2 were $43 million, or 10.7% of revenue. GAAP expense in absolute dollars was flat when compared with the first quarter of 2008.

Please note that our annual merit increases were made during the second quarter of 2008 and impacted all operating expense totals. Our GAAP operating income for second quarter was $54 million resulting in an operating margin for the period on a GAAP basis of 13.7%.

Our operating income for second quarter on a non-GAAP basis was $102 million resulting in a non-GAAP operating margin of 25.7%. GAAP other income for the quarter was $10 million. This GAAP figure includes a $2.6 million impairment loss on a marketable security.

Non-GAAP other income was $13 million, compared with $15 million in Q1 2008 and $19 million in Q2 2007. The sequential decrease was related primarily to the lost interest income associated with the SafeBoot and ScanAlert acquisitions and the repurchase of common stock.

Total employee headcount at the end of the quarter was 4,558. This is up 86 employees from the 4,472 that we reported at the end of first quarter 2008, which reflected additions made to the R&D and sales organizations. The GAAP tax rate for the quarter was 26%. On a non-GAAP basis our tax rate was unchanged from a year ago at 27%.

In Q2, 2008, we reported net income on a GAAP basis of $48 million, or $0.30 per share on a diluted basis. Our second quarter net income on a non-GAAP basis was $84 million, or $0.52 per share on a diluted basis, up 25% year-over-year. Non-GAAP earnings per share of $0.52, is an all-time quarterly high record for McAfee.

Turning to the balance sheet, our net accounts receivable balance at the end of second quarter 2008 was $202 million compared to the balance at the end of second quarter 2007, which was $162 million. Days sales outstanding were 46 days for Q2 2008, unchanged from the second quarter of last year and compared to 48 days in the first quarter of 2008.

The slight quarter-over-quarter decrease in days sales outstanding was primarily due to favorable cash collections during the second quarter. We posted a record level of deferred revenue at the end of second quarter 2008, totaling $1.09 billion, up 20% on a year-over-year basis.

We ended second quarter with $843 million in short-term deferred revenue, up $6 million, when compared with the first quarter 2008. Long-term deferred revenue was flat in the second quarter compared to the first quarter of 2008, ending the quarter at $243 million.

We did not see unusual contract extensions during the quarter or unusual discounting. We ended the quarter with cash and marketable securities of $1.13 billion, a 20% reduction year-over-year.

During the second quarter, we repurchased 7.7 million shares of our common stock for $275 million of which $256 million had been paid as of June 30th. In addition, subsequent to June 30th, we repurchased 3.4 million shares for $113 million. This brings the total shares repurchased since announcing the repurchase program earlier this year to 14.5 million shares representing an aggregate cost of approximately $500 million.

As of today, we have a total of approximately $250 million in authorization available for share repurchases through July 2009. In the second quarter 2008, we generated a total GAAP operating cash flow of $80 million. Year-over-year cash flow was down due to the additional use of cash for working capital requirements resulting from approximately $22 million increase year-over-year for investments in OEM partnerships.

Please note that a full cash flow statement has been included with the financial tables attached to our press release issued this afternoon. We expect operating cash flow for the third quarter of 2008 will include the impact of approximately $40 million related to both the legal settlement and investments associated with new PC OEM partnerships recently announced. The composition of our deferred revenue balance as of the end of the second quarter 2008 was 62% related to corporate sales and 38% for consumer.

Now, turning to guidance. The following updated guidance replaces and supersedes any previous guidance with respect to future periods and is valid as of today only. I would like to remind our listeners that guidance is based upon management's current judgments and that actual results may vary, perhaps materially, from those results anticipated in this guidance. Please see the footnotes to our press release for further details.

For the third quarter of 2008, we expect a revenue range of $390 million to $400 million. We expect the GAAP operating income margin of 9% to 13%. We expect an operating income margin on a non-GAAP basis of 22% to 24%. We expect a diluted share count in the range of 156 million to 159 million shares.

Also for the third quarter of 2008, we expect GAAP earnings per share of $0.27 to $0.32 per share on a diluted basis. On a non-GAAP basis, we expect earnings per share of $0.46 to $0.50 per share on a diluted basis.

For the full year 2008, we expect revenue with a range of $1.535 billion to $1.585 billion. We expect the GAAP operating income margin of 12% to 16%. We expect a non-GAAP operating income margin of 23% to 25%. We assume a GAAP tax rate of 29% and a non-GAAP tax rate of 27% for the full year 2008.

Also for the full year 2008, we expect full year 2008 GAAP earnings per share of $1.12 to $1.22 per share on a diluted basis. On a non-GAAP basis for the full year, we expect earnings per share of $1.90 to $2 per share on a diluted basis.

Please note the following. Our expectations regarding Reconnex contribution to our sales for the remainder of the year post-closing is approximately $4 million to $8 million. We have stated for previous acquisitions Reconnex revenues will be treated as fully ratable by McAfee until the establishment of VSOE.

Guidance for the remainder of 2008 outlined this afternoon contains our current expectations regarding the impact of the acquisition of Reconnex. We are assuming GAAP EPS dilution of approximately $0.05 per share for 2008, which $0.01 per share will occur in the third quarter and $0.04 per share is estimated to occur in the fourth quarter and non-GAAP EPS dilution of approximately $0.03 for 2008, $0.01 of which is in the third quarter and $0.02 of which is estimated for the fourth quarter. On a non-GAAP basis, this dilution is the result of lack of established VSOE.

Today's guidance also reflects the impact of new consumer OEM relationships where certain OEM payments are classified as sales and marketing expense rather than contract revenue. This has a negative impact on operating margin.

In addition, guidance does not include any impact from future stock repurchases. We are not forecasting the timing, expected average purchase price or total stock to be repurchased. We plan to provide updates on the program on a quarterly basis and adjust guidance based on actual repurchase program results.

At this point, I will turn the call now back to Dave to conclude. Thank you very much.

Dave DeWalt

All right, Rocky. Thank you very much. We are really excited to have you here, love having a CFO named Rocky. It's great. All right. The team has made a great deal of progress over the five quarters since I have joined the company. As we conclude today's call, I would like to leave you with just a few thoughts.

First, the security-focused strategy is working. We are taking market share. Second, we are executing well in Q2 with record quarterly revenue and non-GAAP EPS results. And third, we continue to make strategic investments in the business and we believe will ensure that we maintain our market leading position and drive long-term growth.

Thank you for joining us this afternoon. We look forward to answering your questions and I will turn the call back over to Kelsey.

Kelsey Doherty

Thanks, Dave and Rocky. As the operator polls for questions, I would like to inform you that McAfee will be attending the Citigroup Conference on Wednesday, September 3rd in New York City.

Operator, you may now poll for questions. Please limit yourself to one question. Thanks a lot.

Question-and-Answer Session


(Operator Instructions) Our first question will come from the line of Sarah Friar with Goldman Sachs.

Fred Grieb - Goldman Sachs

Fred Grieb for Sarah Friar. One question on your margins, they were terrific this quarter and looking forward can we expect these types of levels to be sustainable? And then what would be the split between margin growth coming from top-line leverage versus continuing cost controls?

Dave DeWalt

Thank you, Fred. This is Dave. I will just take the first part of it. Yeah, we had an excellent quarter. Rocky talked a little bit about some of the efficiencies we really put in place and on the first part of the year. Obviously, we resolved a lot of the acquisition-oriented challenges we had where we had some of the content that we sold from SafeBoot and other acquisitions affecting some of the core McAfee products, those things are past us. We did a nice job with big deals and making sure we structured those rights.

So, obviously all those things from a business process point of view and operating controls helped the company improve our margins, we do have an effect going forward. We'll show you some guidance there on the margins moving forward into Q3, some of which are affected by Rhino, and what we call Reconnex, sorry for the project name there, but Reconnex is the company. We are really excited about this technology, but being that we have known VSOE established on that, we knew this. That's going to have at least a penny impact and obviously some gross margin impact and operating margin impacts moving forward and then product mixes.

We are starting to really see our network products really gain some momentum. We had a really strong quarter with our Network Security Platform called Intrushield. That product has been great and we see a lot more of that moving forward.

So, just as we look at making investments in the business, i.e. sales and R&D and the partner investments, and then coupled with some of the product mix and things, we like what we see out there, but certainly we are cautious a little bit, too on the operating margin.


Our next question will come from the line of Heather Bellini with UBS.

Heather Bellini - UBS

Hi. Thank you, Dave. You guys had a great quarter in large deal signings in the second quarter. And I guess I was just wondering if you could walk us through what do you think is driving that. And if you look at the environment for large deals potentially getting tougher in the second half, how do you think you are positioned to handle that right now?

Dave DeWalt

Heather, thank you. Yeah. We had a strong quarter in big deals, although, quite honestly, we haven't even hit our stride yet with this. I am very pleased with some of the strategies we have put in place. I said this in the script a bit, but when you look at what's happening is we are in a consolidating phase for security, customers are trying to reduce the spend in security and they are spending more on single vendors than they ever have before. I think McAfee is perfectly positioned for that.

I quite honestly have never seen a pipeline as big as we have got now for big deals. We have closed several already, we've been really making some progress in other theaters outside the United States.

Our Europe, Middle East had a very strong, number of big deals over a million. We are beginning to take that into other theaters now, and the progress of our go-to-market model, high touch, number of unique account managers is beginning to take shape.

And some of those investments in Q4 and Q1 we made in sales people, they just weren't ramped yet in Q4 and Q1. They are beginning to get ramped and quite honestly, we see a lot of opportunity downstream with what we have got.

And then lastly, the partners are helping us. We see a great channel that has emerged, that has really become friendly to McAfee. Some of our competitors have stumbled in this area and it is played right into our hands in terms of focus. We are 100% channel, the channel likes us, we help them drive business too.

And then when you combine an aggressive sales force with a motivated channel, it drives business.


Our next question will come from the line of John Difucci with JPMorgan.

Unidentified Analyst

[Gordon] for John, thank you very much. Question on these OEM deals and I know you guys are continuing to invest in them, but can you talk a little bit about when we will see incremental cash flow associated with these deals and when they are going to be added to the business versus just being kind of a land grab with limited margin opportunity?

Dave DeWalt

I think you are asking a really good question. This is Dave. Rocky, feel free to add on here

Rocky Pimentel


Dave DeWalt

But what we saw was, these partner investments are very important. I am hoping you are picking up on a little bit of the numbers, we were trying to show you this quarter.

I mean we are now shipping on 50% or more of all shipments of PCs now. And, if you knew us from a year ago, this is in the top-ten PC manufacturers now, and. If you look at the deals we did with Acer and HP and Toshiba and Sony, we have made a lot of progress here getting our products on. But what happens is, pay for some of that, sometimes upfront, sometimes rev share, sometimes these things don't payoff for a couple of quarters and but eventually these things are very powerful, and we have proven that with Dell and our other models.

So, I am very excited about it. We mentioned numbers like 175 global partners now, many of which our consumer team have signed up in the last six months. We've got a lot of momentum here and I am very optimistic about what the consumer business can do downstream to drive McAfee. So, it just takes a little time.

It's like an acquisition. In some cases, it takes us time to establish these. So we in an acquisition and in the partner model for consumer, it takes us a little time to get the trials loaded and the trials converted and it has a little effect on cash flow in the short-term. Do you want to comment, Rocky?

Rocky Pimentel

Yes, I think it's always difficult to judge the cycle time to get to the harvest period on these OEM relations, but I can tell you that based on the take rates that we've had historically and the useful life of our consumers and then you add on top the complexity and the robustness of the security solutions that consumers now have to purchase in their decision making, it limits the competitive playing field in our favor.

And I think that the tail of the value that we are going to generate from these consumer OEM relationships is going to be pretty compelling certainly as we go out into 2009.

As you know at the end of this quarter and going into fourth quarter, we will have our new consumer release available. It will be, clearly a very successful release we think and hopefully we are being cautiously optimistic with our outlook given the environment we are in, but we certainly have more positives than negatives working for us at this point.

Unidentified Analyst

That is great, Rocky.


Our next question will come from the line of Rob Owens with Pacific Crest.

Rob Owens - Pacific Crest

Given the environment, Dave, could you address the velocity of business throughout the quarter. And more importantly, what the exit rate look like? Maybe give us a little view on your feelings about the pipeline for Q3 and how that has impacted guidance. Thanks.

Dave DeWalt

Hey, Rob. Yeah. I mean the velocity was very strong whole quarter. As I mentioned, we felt like the pipeline has just continued to build as percentage of what we have to do in bookings and revenues, the multipliers are very strong and growing. I think we have gotten a lot of our capacity that we put in the model up to speed, a lot of the products, the new products we have got are beginning to pay off.

I talked a little bit about one of the feelings that we had in our business model was we now have over 40% of our customers converted already to ePO 4.0. As you know a major release of a big management console is never easy for customers to deploy and it takes time, but we have only had that thing out for 7 - 8 months and we have got nearly half of our customer base already deployed on it.

So, what does that do for us? It gives us cross-selling. It helps us with SafeBoot. It helps us with risk and compliance products, it will help us with our new Reconnex acquisition. It just creates cross selling and whenever you can keep incrementally adding products in a cross-sell model, it really just continues to drive business for us and we see big deals growing.

We had North America up to 25% now in growth, we had international at 27%, we had double-digit growth across all the segments and 73% growth on SafeBoot and most of our challenges last quarter, quite honestly, was just getting revenue accounting and getting our operating expenses inline with that revenue. I think we solved a lot of that and hopefully this really bodes well for the company in the second half.


Our next question will come from the line of Walter Pritchard with Cowen.

Walter Pritchard - Cowen

Cash flow, that's helpful. My one question is on the cash payments to the OEMs. You talked about $40 million next quarter between the legal settlement, which I think is roughly $9 million and then the OEMs. Does that OEM stuff, is that end after September and December and March, we see those payments sort of subside and maybe even decline year-over-year?

Dave DeWalt

So, on the cash payments, thank you. So, we did want to kind of guide a little bit to what's going on, on this. So, just for clarification, we sent out an 8-K today, so that you know we have kind of put all the legal elements behind us at this stage.

We have a $25 million settlement payment, which will be due in the third quarter, which will affect cash flow from operations that's in the 8-K. This was a part of the jury verdict come settlement that we made and that's completed at this stage.

We also have the remainder of that really in partner investments, so that's why we gave you about a $40 million number. We feel that this was kind of the end of our partner investments in terms of where we are at. Many of the cycles are complete at this stage, and we are really entering into another phase to harvest the bookings, then revenue, then profitability off those models.

So, yes, you should anticipate kind of Q3 being, the tail end of all this and we are really hoping to drive more cash flow in Q4 and beyond.


Our next question will come from the line of Tim Klasell with Thomas Weisel Partners.

Tim Klasell - Thomas Weisel Partners

Just a quick question on the ToPS penetration, I don't know if I heard that on the call or not, but can you give us an idea of how far you think you penetrated into your market today?

Rocky Pimentel

Yeah, Tim. So, we had some great success in this quarter. I called out again this ToPS strategy has been outstanding for us. Remember what's called ToPS is total protection suite for everybody, but we have total protection suite in the enterprise, which we have done a great job converting. We had 40% year-over-year growth in the ToPS for the enterprise area. We had over 100% growth in the high-end suites on the consumer side on ToPS.

So, just think about the suite approach from best-of-breed, single products like antivirus and spy converted to a suite from a single consumer all the way through the enterprise beginning to take shape. We didn't really talk about what percent we are through the install base yet, but we clearly made a lot of progress.

You can see the large deals we did and we are analyzing that and talking that through, but, again, the progress is significant, the big deals are significant and the model is working for us. We also announced the ToPS for network stuff, so now we are attacking the area of the network. I think there is a lot of consolidation opportunity just like we had in the Endpoint where we can bring together now everything from e-mail filtering, web filtering, IPS and now DLP that we are getting from Reconnex all into a combined appliance and begin to play the same type of consolidating cost game in the network that many of our competitors cannot. So, some of that was working of us and we are investing more with the Reconnex acquisition to make that happen.

So this ToPS model plays out again with another suite. We talked about ToPS for data. We are doing that with a combination of products. So, suite is working versus point products. There is just no doubt about it in security and we are trying to lead that


Our next question will come from the line of Michael Turits with Raymond James.

Michael Turits - Raymond James

Hey, guys, good afternoon. Two questions, one is the general size of what SafeBoot was in the quarter, so we can get some organic growth And then secondly, on the partner investments you have made this year, which of those are actually driving revenue at this point and are you amortizing costs, how much of the revenue costs are coming out of that at this point?

Dave DeWalt

Thanks, Michael. Do you want to take some of that, Rocky?

Rocky Pimentel

Sure. SafeBoot as a standalone value is still modest; however, it grew at a substantial growth rate, 73% and so, we are very encouraged by that. Obviously SafeBoot is also being incorporated in our suite, so really you have to be careful about asking how much value, because the way we value and price suites and things like that, all the elements come into play. So we are clearly encouraged with a high double-digit growth.

Dave DeWalt

The thing I would add, too, Michael, just so you remember, all the SafeBoot business is still taken ratably, not all of it. There are some service elements that are still taking a little bit revenue, but remember the bulk of this is taken ratable. We do not get a large share of revenue off of this yet.

What we did resolve is when SafeBoot or Data Protection is sold with other McAfee products that was what really helped us. We resolved some of the VSOE challenges there, those are long since gone with the company. We got that done quickly and it will take us a few quarters to get all of that SafeBoot, but we talked last year that when we acquired SafeBoot, it was about a $60 million business in 2007 and you can see some of the growth rates that we have got, 73% growth rate this quarter. It gives you a little sense of the booking size or the sale size that we are getting.

So hopefully that answers you there. On the partner investments, we are early days on many of the new partnerships that we announced, I mean early days. In some cases, these have not even shipped yet.

In the case of Hewlett-Packard, it's just shipping now. We are just getting loaded on all the HP computers and what's called the HP Commercial market segment and, nice market opportunity for us there.

We have had some new partnerships with Lenovo and Acer who are just getting going as well, Lenovo just shipping in August, Acer just shipping in Q2. And remember, they ship a trial, then the trial converts to a booking, then the booking will eventually convert to revenue and profitability.

So there is a cycle here and with now the amount of PC shipments we are on, again, you can get a glimpse of what's going on for 2009 in our consumer model with the investments we made.

Then, of course, just one last element was with Dell. Dell was very significant for us, not only ousting some of the competitors in the retail side, but really locking down Dell for a long period of time here and really getting a much more strategic relationship there, five-year relationship and cutting across all the theaters, really puts us in position now with Dell and Acer and others to take some significant market share. Next question?


Our next question will come from the line of Brent Thill with Citi.

Brent Thill - Citi

Thanks. Dave, one of the concerns has been the consumer market with the overall economy slowing down, but it seems and correct me if I'm wrong, that there is just so much low-hanging fruit in the consumer business that you don't feel that would have as big impact on the core business?

Dave DeWalt

Hi, Brent. Yeah, you surmised our situation really well. I know you know this market quite well. What we see is, we have a chance to take a lot of market share from our competitors. The PC OEM particularly is a well-known model. We know conversion rates, we know how to do this.

We know how to get the renewals. If we can displace competitors on there, it's straight market share gains for the company. And this is in many cases an easy model for us to look at. We are not really affected by changes in economy on that model while maybe consumers spending a little bit less overall in certain regions, international is very strong, many of the contracts we announced are in EMEA and Asia Pacific, all over the emerging markets.

And, of course, some of the takeaways we had from our competitors in North America it's just straight market share gains for the company, so I am really happy with what we have done on the consumer team. Todd Gebhart, who is the head of my consumer business, really has taken these partner models on and we are announcing, major, major wins all over the industry with a lot of banks, Telcos, ISPs and PC OEMs.

Now, just what we wanted to do was get balanced on the distribution channel and consumer and maximize our reach and we are launching a lot of these. You talked about Yahoo. I mean that thing is just getting going and we are starting to see a lot of success there and hopefully these things really payoff for the company.


Our next question will come from the line of Todd Raker with Deutsche Bank.

Todd Raker - Deutsche Bank

Hey, guys, two quick questions on the consumer side. You mentioned that some of, I think new relationships are going to be sales and marketing, sort of contra-revenue. Are any of the existing relationships shifting to that in any sense for kind of the revenue impact here as we look in the back half of the year, and is there anyway for you guys to potentially size some of the opportunities around the Yahoo and some of the new consumer products for us.

Dave DeWalt

Hey, Todd, this is Dave. Rocky, feel free to add on here, but no, the existing contracts, we didn't handled the same way. Some of the newer contracts, which is the shift to sort of a OpEx model versus a contra model is really about point-of-sale versus who the partner.

So, this was kind of traditional, we have got some new partnership models now, which will drive us more revenue, which has a little effect on operating margin, mind you, and we talked about that on the script. But generally speaking this is built into our guidance, you can get a sense of it, but it's not significantly material here, but overtime, hopefully these things really start to take off for us.

And then on the Yahoo side, we are just getting started with that. We had a little bit of a delay of getting it into production. Obviously with a gigantic application the size of Yahoo and the reach they have got, we are really trying to get mainstream with that here in the third quarter.

We had that all out in data in the second quarter. And pretty optimistic, you saw some of the reach, 40 million plus viewers of this. Some of the impressions are pretty amazing just with the ScanAlert model, we are starting to see 6.5 billion impressions a month on the ScanAlert with McAfee Secure, and just marketing, marketing, marketing, with that kind of thing, helping our consumer business.

So, we are hoping to drive annotation with that, which drive to sales and the model begins to go, so, again, optimistic, but we got to go execute and some of these things are the building blocks for the company.

Kelsey Doherty

We have time for one more question.


And our final question will come from the line of Philip Rueppel with Wachovia Securities.

Philip Rueppel - Wachovia Securities

Thanks very much. Again on the consumer front, you have now had some experience with partner renewals. Are you generally able to being successful in up selling there, or at least maintaining contract value, or is that an area where pricing becomes an issue.

And then one clarification, just on the consumer OEM cash flow that you expect in Q3, are all those related to the consumer deals you announced already, or are they in anticipation of other deals that you might close in the period? Thanks.

Rocky Pimentel

Yeah, Philip, this is Rocky Pimentel. The announcement that we have made in the second, those are what relate to the cash flows in the third quarter. So, at this point a number of the major PC OEM partnership opportunities pretty much have been addressed by us we think at this point.

So, again, as Dave, I think, mentioned, Q3 looking at maybe a high water mark at this point on cash flow impacts from PC OEM relations, but obviously opportunity continue to come up. So, we will keep you updated as we go forward.

But in terms of up-selling and value creation, I will turn it over to Todd Gebhart, who runs our Consumer Business, so he can give some color on this.

Todd Gebhart

In the customer model, the renewal rates we have are pretty high because of our subscriber and the programs we run with consumers, and we do also maintain a very active cross-sell and migration program at the higher end suites.

And the nice thing about the models is that as we get into renewals, the price is actually higher than what they pay for the initial subscription. So, we increment not only the product they have, but the price that they are paying process.

Dave DeWalt

All right, Todd. Thank you. So, I think this will wrap it up for us today and all the questions. Thank you so much for attending our second quarter 2008. As you can tell, we are very excited about our results here. I think we have really got the second quarter back on track. Our strategy is working. We are optimistic about the future and looking forward to talking again soon. Thanks very much.


Ladies and gentlemen, this concludes McAfee's second quarter 2008 earnings conference call. You may now disconnect.

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