UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x
|
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|
For the Quarterly Period Ended September 30, 2008
or
¨
|
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|
For the Transition Period From
to
.
Commission file number 0-27074
SECURE COMPUTING CORPORATION
(Exact name of registrant as specified in its
charter)
|
|
|
Delaware
|
|
52-1637226
|
(State or other jurisdiction of
incorporation or organization)
|
|
(I.R.S. employer
identification no.)
|
|
|
55 Almaden Boulevard
San Jose, California
|
|
95113
|
(Address of principal executive offices)
|
|
(Zip code)
|
(408) 494-2020
Registrants telephone number, including area code
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days. Yes
x
No
¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated filer,
accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
¨
Accelerated filer
x
Non-accelerated filer
¨
Smaller reporting company
¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act.): Yes
¨
No
x
Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practical date: Common Stock, $.01 par
value 68,505,007 shares issued and outstanding as of October 31, 2008.
SECURE COMPUTING CORPORATION
TABLE OF CONTENTS
2
PART IFINANCIAL INFORMATION
Item 1.
|
Financial Statements
|
SECURE COMPUTING CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share amounts)
|
|
|
|
|
|
|
|
|
|
|
September 30,
2008
(Unaudited)
|
|
|
December 31,
2007
(See Note)
|
|
ASSETS
|
|
|
|
|
|
|
|
|
Current assets
|
|
|
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
40,633
|
|
|
$
|
12,084
|
|
Restricted cash
|
|
|
9,664
|
|
|
|
507
|
|
Accounts receivable, net
|
|
|
53,851
|
|
|
|
64,056
|
|
Inventory, net
|
|
|
5,505
|
|
|
|
6,725
|
|
Other current assets
|
|
|
16,737
|
|
|
|
16,464
|
|
|
|
|
|
|
|
|
|
|
Total current assets
|
|
|
126,390
|
|
|
|
99,836
|
|
Property and equipment, net
|
|
|
20,013
|
|
|
|
18,595
|
|
Goodwill
|
|
|
512,865
|
|
|
|
528,264
|
|
Intangibles, net
|
|
|
49,262
|
|
|
|
61,494
|
|
Other assets, net of current portion
|
|
|
12,209
|
|
|
|
10,560
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
720,739
|
|
|
$
|
718,749
|
|
|
|
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
|
|
|
Current liabilities
|
|
|
|
|
|
|
|
|
Accounts payable
|
|
$
|
9,243
|
|
|
$
|
12,567
|
|
Accrued payroll
|
|
|
9,829
|
|
|
|
9,886
|
|
Accrued expenses
|
|
|
15,725
|
|
|
|
7,891
|
|
Acquisition reserves
|
|
|
464
|
|
|
|
1,012
|
|
Deferred revenue
|
|
|
118,716
|
|
|
|
98,751
|
|
|
|
|
|
|
|
|
|
|
Total current liabilities
|
|
|
153,977
|
|
|
|
130,107
|
|
Acquisition reserves, net of current portion
|
|
|
569
|
|
|
|
721
|
|
Deferred revenue, net of current portion
|
|
|
56,380
|
|
|
|
69,429
|
|
Deferred tax liability
|
|
|
9,957
|
|
|
|
8,729
|
|
Debt, net of fees
|
|
|
|
|
|
|
41,461
|
|
Other liabilities
|
|
|
2,583
|
|
|
|
1,359
|
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
223,466
|
|
|
|
251,806
|
|
Convertible preferred stock, par value $.01 per share:
|
|
|
|
|
|
|
|
|
Authorized 2,000,000; issued and outstanding 700,000 at September 30, 2008 and December 31, 2007
|
|
|
72,202
|
|
|
|
69,281
|
|
Stockholders equity
|
|
|
|
|
|
|
|
|
Common stock, par value $.01 per share:
|
|
|
|
|
|
|
|
|
Authorized 100,000,000; issued and outstanding 68,467,611 at September 30, 2008 and 67,178,668 at December 31, 2007
|
|
|
685
|
|
|
|
673
|
|
Additional paid-in capital
|
|
|
576,641
|
|
|
|
564,108
|
|
Accumulated deficit
|
|
|
(151,020
|
)
|
|
|
(166,028
|
)
|
Accumulated other comprehensive loss
|
|
|
(1,235
|
)
|
|
|
(1,091
|
)
|
|
|
|
|
|
|
|
|
|
Total stockholders equity
|
|
|
425,071
|
|
|
|
397,662
|
|
|
|
|
|
|
|
|
|
|
Total liabilities and stockholders equity
|
|
$
|
720,739
|
|
|
$
|
718,749
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE:
|
|
The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by U.S.
generally accepted accounting principles for complete financial statements.
|
See accompanying notes to the financial statements.
3
SECURE COMPUTING CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(Unaudited, in thousands, except per share amounts)
|
|
|
|
|
|
|
|
|
|
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|
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|
|
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|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
$
|
30,244
|
|
|
$
|
31,006
|
|
|
$
|
88,011
|
|
|
$
|
91,899
|
|
Services
|
|
|
19,462
|
|
|
|
18,992
|
|
|
|
60,435
|
|
|
|
54,901
|
|
Other (See Note)
|
|
|
13,250
|
|
|
|
10,020
|
|
|
|
36,917
|
|
|
|
24,638
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
62,956
|
|
|
|
60,018
|
|
|
|
185,363
|
|
|
|
171,438
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
|
11,150
|
|
|
|
9,570
|
|
|
|
32,902
|
|
|
|
28,127
|
|
Services
|
|
|
3,968
|
|
|
|
4,020
|
|
|
|
12,604
|
|
|
|
12,151
|
|
Other (See Note)
|
|
|
2,168
|
|
|
|
1,446
|
|
|
|
5,985
|
|
|
|
3,934
|
|
Amortization of purchased intangibles
|
|
|
1,923
|
|
|
|
1,924
|
|
|
|
5,771
|
|
|
|
5,905
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
|
19,209
|
|
|
|
16,960
|
|
|
|
57,262
|
|
|
|
50,117
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
|
43,747
|
|
|
|
43,058
|
|
|
|
128,101
|
|
|
|
121,321
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
|
26,673
|
|
|
|
29,692
|
|
|
|
88,036
|
|
|
|
87,794
|
|
Research and development
|
|
|
12,432
|
|
|
|
11,207
|
|
|
|
37,163
|
|
|
|
32,932
|
|
General and administrative
|
|
|
4,670
|
|
|
|
4,310
|
|
|
|
15,619
|
|
|
|
11,702
|
|
Amortization of purchased intangibles
|
|
|
2,197
|
|
|
|
2,712
|
|
|
|
6,711
|
|
|
|
8,265
|
|
Litigation settlement
|
|
|
|
|
|
|
|
|
|
|
9,180
|
|
|
|
|
|
Goodwill impairment
|
|
|
15,424
|
|
|
|
|
|
|
|
15,424
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
|
61,396
|
|
|
|
47,921
|
|
|
|
172,133
|
|
|
|
140,693
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
|
(17,649
|
)
|
|
|
(4,863
|
)
|
|
|
(44,032
|
)
|
|
|
(19,372
|
)
|
Gain on divestiture of SafeWord product line
|
|
|
70,701
|
|
|
|
|
|
|
|
70,701
|
|
|
|
|
|
Other expense
|
|
|
(2,866
|
)
|
|
|
(1,576
|
)
|
|
|
(4,722
|
)
|
|
|
(5,593
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income/(loss) before taxes
|
|
|
50,186
|
|
|
|
(6,439
|
)
|
|
|
21,947
|
|
|
|
(24,965
|
)
|
Income tax expense
|
|
|
(2,832
|
)
|
|
|
(3,613
|
)
|
|
|
(4,018
|
)
|
|
|
(6,610
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income/(loss)
|
|
|
47,354
|
|
|
|
(10,052
|
)
|
|
|
17,929
|
|
|
|
(31,575
|
)
|
Preferred stock accretion
|
|
|
(989
|
)
|
|
|
(943
|
)
|
|
|
(2,921
|
)
|
|
|
(2,781
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income/(loss) applicable to common shareholders
|
|
$
|
46,365
|
|
|
$
|
(10,995
|
)
|
|
$
|
15,008
|
|
|
$
|
(34,356
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic income/(loss) per share
|
|
$
|
0.68
|
|
|
$
|
(0.17
|
)
|
|
$
|
0.22
|
|
|
$
|
(0.52
|
)
|
Weighted average shares outstandingbasic
|
|
|
68,241
|
|
|
|
66,268
|
|
|
|
67,859
|
|
|
|
65,772
|
|
Diluted income/(loss) per share
|
|
$
|
0.63
|
|
|
$
|
(0.17
|
)
|
|
$
|
0.24
|
|
|
$
|
(0.52
|
)
|
Weighted average shares outstandingdiluted
|
|
|
74,803
|
|
|
|
66,268
|
|
|
|
74,843
|
|
|
|
65,772
|
|
NOTE
: For certain multiple-element arrangements we are unable to establish vendor specific objective evidence (VSOE) of fair value for the undelivered bundled elements and, therefore, are unable to allocate the value of the
arrangement between Products and Services Revenue and have reported these revenues and corresponding cost of revenues as Other.
See accompanying notes to the financial statements.
4
SECURE COMPUTING CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited, in thousands)
|
|
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
Operating activities
|
|
|
|
|
|
|
|
|
Net income/(loss)
|
|
$
|
17,929
|
|
|
$
|
(31,575
|
)
|
Adjustments to reconcile net income/(loss) to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
7,567
|
|
|
|
5,327
|
|
Amortization of intangible assets
|
|
|
13,110
|
|
|
|
14,768
|
|
Loss on disposals of property and equipment and intangible assets
|
|
|
104
|
|
|
|
160
|
|
Gain on divestiture of SafeWord product line
|
|
|
(70,701
|
)
|
|
|
|
|
Amortization of debt fees
|
|
|
2,539
|
|
|
|
348
|
|
Deferred income taxes
|
|
|
(290
|
)
|
|
|
3,701
|
|
Share-based compensation
|
|
|
9,783
|
|
|
|
12,361
|
|
Goodwill impairment
|
|
|
15,424
|
|
|
|
|
|
Changes in operating assets and liabilities, excluding effects of acquisitions:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
10,195
|
|
|
|
4,007
|
|
Inventories
|
|
|
7
|
|
|
|
(1,291
|
)
|
Other operating assets
|
|
|
(2,379
|
)
|
|
|
(2,103
|
)
|
Accounts payable
|
|
|
(2,927
|
)
|
|
|
272
|
|
Accrued payroll
|
|
|
(57
|
)
|
|
|
(1,440
|
)
|
Accrued expenses
|
|
|
8,888
|
|
|
|
2,281
|
|
Acquisition reserves
|
|
|
(255
|
)
|
|
|
(867
|
)
|
Deferred revenue
|
|
|
18,233
|
|
|
|
31,487
|
|
|
|
|
|
|
|
|
|
|
Net cash provided by operating activities
|
|
|
27,170
|
|
|
|
37,436
|
|
Investing activities
|
|
|
|
|
|
|
|
|
Proceeds from the divestiture of the SafeWord product line
|
|
|
63,020
|
|
|
|
|
|
Purchase of property and equipment, net
|
|
|
(9,828
|
)
|
|
|
(8,896
|
)
|
Increase in intangibles and other assets, net
|
|
|
(1,127
|
)
|
|
|
(3,400
|
)
|
Change in restricted cash, net
|
|
|
(9,163
|
)
|
|
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
Net cash provided by/(used for) investing activities
|
|
|
42,902
|
|
|
|
(12,304
|
)
|
Financing activities
|
|
|
|
|
|
|
|
|
Proceeds from issuance of common stock
|
|
|
2,580
|
|
|
|
7,344
|
|
Repayment of term debt
|
|
|
(44,000
|
)
|
|
|
(32,000
|
)
|
|
|
|
|
|
|
|
|
|
Net cash used for financing activities
|
|
|
(41,420
|
)
|
|
|
(24,656
|
)
|
Effect of exchange rates
|
|
|
(103
|
)
|
|
|
1,445
|
|
|
|
|
|
|
|
|
|
|
Net increase in cash and cash equivalents
|
|
|
28,549
|
|
|
|
1,921
|
|
Cash and cash equivalents, beginning of period
|
|
|
12,084
|
|
|
|
8,249
|
|
|
|
|
|
|
|
|
|
|
Cash and cash equivalents, end of period
|
|
$
|
40,633
|
|
|
$
|
10,170
|
|
|
|
|
|
|
|
|
|
|
Supplemental Cash Flow Disclosure
|
|
|
|
|
|
|
|
|
Interest paid
|
|
$
|
1,973
|
|
|
$
|
5,011
|
|
Release of deferred tax asset valuation allowance as a reduction to goodwill
|
|
$
|
469
|
|
|
$
|
1,367
|
|
See accompanying notes to the financial statements.
5
SECURE COMPUTING CORPORATION
NOTES TO THE FINANCIAL STATEMENTS
(Unaudited)
1. Organization
Secure Computing Corporation (we, us, our or Secure Computing) is a global leader in enterprise security solutions. Powered by TrustedSource technology, our award-winning solutions
proactively protect our customers mission-critical business applications from all manner of Internet-borne threats. Our comprehensive portfolio of Secure Web, Secure Mail, and Secure Firewall solutions provide unmatched
protection for the enterprise.
On September 21, 2008, we entered into an Agreement and Plan of Merger (Merger Agreement) with McAfee,
Inc. (McAfee) and Seabiscuit Acquisition Corporation, a wholly owned subsidiary of McAfee, pursuant to which McAfee has agreed to acquire all of the outstanding common stock of Secure Computing for $5.75 per share in cash, without interest,
representing an equity value for our common stock of approximately $412.5 million in the aggregate. In addition, pursuant to the Merger Agreement, our outstanding shares of preferred stock will be redeemed for cash as part of the proposed
transaction, which would represent approximately an additional $84.8 million calculated as of September 21, 2008. In total, the proposed transaction would be valued at approximately $497.3 million. In connection with the Merger Agreement we
will hold a special meeting with our stockholders, scheduled for November 14, 2008, to consider and vote upon the adoption of the Merger Agreement. After careful consideration, our board of directors has unanimously approved and declared the
merger, the Merger Agreement and the transactions contemplated by the Merger Agreement to be advisable, and has determined that it is in the best interests of our stockholders that we enter into the Merger Agreement and consummate the merger on the
terms and conditions set forth in the Merger Agreement.
2. Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared by us without audit and reflect all adjustments (consisting of normal
recurring adjustments and accruals) which are, in our opinion, necessary to present a fair statement of the results for the interim periods presented. The consolidated financial statements include our accounts and those of our subsidiaries. All
intercompany balances and transactions have been eliminated in consolidation. The statements have been prepared in accordance with the instructions for Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission, and,
as permitted, omit certain information and footnote disclosures necessary to present the statements in accordance with U.S. generally accepted accounting principles. The results of operations for the interim periods presented are not necessarily
indicative of the results to be expected for the full fiscal year. The December 31, 2007 condensed consolidated balance sheet is derived from our audited consolidated balance sheet as of December 31, 2007. These condensed financial
statements should be read in conjunction with the Consolidated Financial Statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2007, as filed with the Securities and Exchange Commission
(SEC).
3. Summary of Significant Accounting Policies
Revenue Recognition
We derive our revenue primarily from two sources: (i) sales of products, including hardware,
subscriptions, software licenses, and royalties and (ii) sales of services, including maintenance arrangements to provide upgrades and customer support, professional services, and contracted development work. We recognize revenue in accordance
with Statement of Position (SOP) 97-2, Software Revenue Recognition, as modified by SOP 98-9. Revenue from products is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and
determinable, and collection is probable. Subscription-based contracts are generally for 12, 24 or 36 months in duration. Subscription revenue along with maintenance revenue for providing product upgrades and customer support are deferred and
recognized ratably over the service period beginning with the month the subscription or service begins.
When arrangements contain multiple
elements and vendor specific objective evidence (VSOE) of fair value exists for all undelivered elements, we recognize revenue for the delivered elements using the residual method. For arrangements containing multiple elements where VSOE of fair
value does not exist for all undelivered elements, we defer revenue for the delivered and undelivered elements and then recognize revenue on all elements over the service period. In instances where an entire arrangement is deferred due to lack of
VSOE of fair value on an undelivered element, the revenue recognized over the service period is identified as other revenue on the condensed consolidated statements of operations because we are unable to allocate the value of the arrangement between
products and services revenue. We also identify costs (primarily hardware component costs) that are directly associated with product revenues that have been deferred due to lack of VSOE of fair value on an undelivered element. We defer these costs
at the time of shipment and recognize them as cost of sales in proportion to the product revenue as it is recognized over the service period. These costs are identified as other cost of revenues on the condensed consolidated statements of
operations.
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We sell our products either directly to an end-user or indirectly through our channel of resellers and
distributors (our channel partners). When selling through our channel we require our channel partners to provide evidence of end-user sell-through. If we are unable to obtain end-user sell-through evidence at the time we fulfill the order from a
channel partner, we do not recognize revenue until the channel partner supplies end-user sell-through information, the product has been shipped, and all other criteria of SOP 97-2 have been met, with the exception of sales to our distributors who
stock our SnapGear product line. We recognize revenue, net of estimated returns, upon shipment of our SnapGear product line as we have sufficient return history to establish a reserve and we are not able to receive end-user evidence due to the
high-volume sales of this low-price point product.
Income Taxes
We account for income taxes under Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, which requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of events that have been included in our financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax
basis of assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. SFAS No. 109 requires the consideration of a valuation allowance for deferred tax assets if it is more
likely than not that some component or all of the benefits of deferred tax assets will not be realized.
We adopted the provisions of
Financial Accounting Standards Board Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS No. 109 on January 1, 2007. FIN 48 creates a single model to address uncertainty in
tax positions and clarifies the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48 also provides guidance on derecognition,
measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. At the adoption date, January 1, 2007, we did not have a material liability under FIN 48 for unrecognized tax benefits. Upon
implementation of FIN 48 we have recognized a liability of $2.6 million for unrecognized income tax benefits as of September 30, 2008. Included in the $2.6 million is the recognition of a $1.1 million increase in the liability for unrecognized
income tax benefits in the three month period ended September 30, 2008. If the benefit had been recognized, the $1.1 million would be offset by an increase in the valuation allowance and thus have no impact on the effective tax rate. Our
continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. We do not expect the amount of unrecognized tax benefits to significantly change within the next 12 months.
Our company is subject to U.S. Federal income tax as well as income tax in multiple state jurisdictions. Generally, tax years from 2004 through the
present remain open under the statute of limitations. However, due to net operating loss (NOL) carryforwards from prior periods, the Internal Revenue Service could potentially review the losses related to NOL-generating years back to 1989. Our
foreign subsidiaries are also subject to income tax in several foreign jurisdictions which have open tax years varying by jurisdiction back to 2002.
Recently Issued Accounting Standards
In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS
No. 157, Fair Value Measurements. SFAS No. 157 which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and establishes a hierarchy that categorizes and prioritizes
the sources to be used to estimate fair value. SFAS No. 157 also expands disclosures about fair value measurements. SFAS No. 157 is intended to increase consistency and comparability among fair value estimates used in financial reporting.
As such, SFAS No. 157 applies to all other accounting pronouncements that require (or permit) fair value measurements, except for the measurement of share-based payments. SFAS No. 157 does not apply to accounting standards that require (or
permit) measurements that are similar to, but not intended to represent, fair value. SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer the liability (an exit price) in an orderly
transaction between market participants and also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. SFAS No. 157 is
effective for financial assets and financial liabilities for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. FSP 157-2 Partial Deferral of the Effective Date of Statement 157 (FSP
157-2), deferred the effective date of SFAS No. 157 for all non-financial assets and non-financial liabilities to fiscal years beginning after November 15, 2008. FSP 157-3 Determining the Fair Value of a Financial Asset When the
Market for That Asset is Not Active (FSP 157-3), clarified the application of SFAS No. 157
,
in a market that is not active. The implementation of SFAS No. 157 for financial assets and financial liabilities, effective
January 1, 2008, did not have an impact on our condensed consolidated financial statements. We are currently assessing the impact of SFAS No. 157 for non-financial assets and non-financial liabilities on our consolidated financial
statements.
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In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities. SFAS No. 159 allows entities to voluntarily choose, at specified election dates, to measure many financial assets and financial liabilities at fair value. The election is made on an instrument-by-instrument basis
and is irrevocable. If the fair value option is elected for an instrument, SFAS No. 159 specifies that all subsequent changes in fair value for that instrument shall be reported in earnings. SFAS No. 159 is effective for fiscal years
beginning after November 15, 2007. We did not elect the fair value option for any financial assets or liabilities.
In December 2007,
the FASB issued SFAS No. 141(R), Business Combinations. SFAS No. 141(R) establishes principles and requirements for determining how an enterprise recognizes and measures the fair value of certain assets and liabilities acquired
in a business combination, including noncontrolling interests, contingent consideration, in-process research and development and certain acquired contingencies. SFAS No. 141(R) requires acquisition-related transaction expenses and restructuring
costs to be expensed as incurred rather than capitalized as a component of the business combination. In addition, under SFAS No. 141(R), changes in an acquired entitys deferred tax assets and uncertain tax positions after the measurement
period will impact income tax expense. Following the adoption of SFAS No. 141(R) any change in an acquisition-related valuation allowance will be reversed to income tax expense rather than goodwill. SFAS No. 141(R) is effective for fiscal
years beginning on or after December 15, 2008. This standard will change our accounting treatment for business combinations on a prospective basis, when adopted.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activitiesan amendment of FASB Statement No. 133 (SFAS No. 161). SFAS No. 161
expands quarterly disclosure requirements in SFAS No. 133 about an entitys derivative instruments and hedging activities. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. This standard will change
our disclosures of any future derivative instruments and hedging activities on a prospective basis, when adopted.
In April 2008, the FASB
issued FASB Staff Position (FSP) No. 142-3, Determination of the Useful Life of Intangible Assets. FSP No. 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the
useful life of a recognized intangible asset under SFAS No. 142, Goodwill and Other Intangible Assets. FSP No. 142-3 is effective for fiscal years beginning after December 15, 2008. We are currently assessing the impact of
FSP No. 142-3 on our consolidated financial position and results of operations.
4. Goodwill Impairment
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Balance as of December 31, 2007
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$
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528,264
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Goodwill impairment
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(15,424
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)
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Recognition of acquired deferred tax assets
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469
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Other
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(444
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)
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Balance as of December 31, 2007
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$
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512,865
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We test the carrying amount of goodwill and other indefinite-lived intangible assets annually
during our fourth quarter ending December 31 and at other times when events or circumstances indicate that impairment may have occurred. Impairment testing is performed in accordance with SFAS No. 142, Goodwill and Other Intangible
Assets (SFAS No. 142). We are annually required to complete Step 1 of the impairment test, determining and comparing the fair value of our reporting unit to our carrying value. Step 2 is required to be completed if Step 1 indicates that
the carrying value of the reporting unit exceeds the fair value and involves the calculation of the implied fair value of the goodwill.
We
determined that the announced merger with McAfee was a triggering event under SFAS No. 142, requiring us to further evaluate the carrying value of our goodwill. As a result of this evaluation, we recorded an impairment charge to reduce the book
value of our equity to its implied fair value as of the merger announcement date. Based on the cash price stated in the merger agreement of $5.75 per share multiplied by the projected number of shares outstanding on the transaction close date, plus
the outstanding shares of preferred stock which will be redeemed for cash as part of the proposed transaction, the implied fair value of our equity was $497.3 million. This implied fair value calculation resulted in recording a goodwill impairment
charge of $15.4 million as of September 30, 2008.
Due to the limited time available between the merger announcement date and our Form
10-Q filing date, there was insufficient time to complete Step 2 of the goodwill impairment test and calculate the implied fair value of goodwill as described in SFAS No. 142. Once Step 2 of the goodwill impairment test is completed during our
fourth quarter, the amount of impairment recorded could increase or decrease by a material amount.
8
5. Divestiture of SafeWord product line
On September 4, 2008, we completed the divestiture of our identity and access management (IAM) product line and certain other assets, leases and
contracts relating to the IAM product line (collectively, the IAM assets) to Aladdin Knowledge Systems Ltd. (Aladdin) pursuant to the Asset Purchase Agreement dated as of July 29, 2008. The purchase price for the IAM Assets was $63.0 million,
after inventory-related adjustments and the payment by Aladdin of certain transaction costs. Of the purchase price, $8.6 million was classified as restricted cash on our condensed consolidated balance sheet and deposited with an escrow agent to be
available to satisfy amounts owed by us to Aladdin under the Asset Purchase Agreement in accordance with the terms of an escrow agreement. The financial statements escrow account is equal to $1.0 million with a release date on or before
December 31, 2008 with the delivery of the audited SafeWord financial statements to Aladdin. The indemnity escrow account is equal to 12% of the purchase price, $7.5 million, to be held on behalf of Secure Computing to secure the
indemnification obligations of Secure Computing related to the SafeWord divestiture, with a release date of September 4, 2009.
The
IAM assets consisted of $1.2 million in inventory, $902,000 in other assets, $730,000 in property and equipment and $423,000 in intangible assets. In addition, $11.3 million in deferred revenue was transferred to Aladdin. We recognized a gain on the
divestiture of the IAM product line of $70.7 million on our condensed consolidated statement of operations. The gain consisted of the $63.0 million purchase price, $8.0 million net liabilities transferred and $312,000 bonuses paid to exiting
employees.
6. Debt
Debt consisted of
the following at the dates indicated (in thousands):
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As of
September 30, 2008
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As of
December 31, 2007
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Secured term loan, due August 31, 2013
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$
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$
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44,000
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Deferred financing fees, amortized through August 31, 2013
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(2,539
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)
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Total debt, net of fees
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$
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$
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41,461
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Senior Secured Credit Facility
On August 31, 2006, we entered into a senior secured credit facility with a syndicate of banks led by Citigroup and UBS Investment Bank. The credit
facility provided for a $90.0 million term loan facility, a $20.0 million revolving credit facility, and a swingline loan sub-facility. The obligations under the senior secured credit facility were secured by a perfected security interest in
substantially all of our assets. The proceeds from the $90.0 million term loan were used to finance a portion of the CipherTrust, Inc. (CipherTrust) acquisition. The term loan was to mature on August 31, 2013 and was payable in
scheduled quarterly installments of $225,000, which began in December 2006 with the remaining balance due at maturity. In prior periods, we had been making accelerated payments on the debt with excess cash from operations. Interest was payable
quarterly on the term loan at the London Interbank Offered Rate (LIBOR) +3.00%. The interest rate on the term loan was adjusted quarterly based on our Leverage Ratio (as defined below) and could range from LIBOR +3.25% to LIBOR +3.00%. The interest
rate in effect as of September 8, 2008 was 5.80%. Including amortization of deferred financing fees, we incurred $2.8 million and $1.6 million of interest expense in the three months ended September 30, 2008 and 2007, respectively, and
$4.5 and $5.5 million in the nine months ended September 30, 2008 and 2007, respectively.
The sale of the SafeWord product line to
Aladdin (see Note 5) triggered a covenant of the senior secured credit facility requiring that the outstanding balance on the term debt and any related fees be paid in full upon closing of the sale. On September 8, 2008, Aladdin paid $44.5
million directly to Citigroup, on our behalf, for repayment in full of the debt, interest due and additional fees outstanding under the term loan, and the senior secured credit facility was terminated.
The $20.0 million revolving credit facility was to expire on August 31, 2012 with interest payable quarterly at LIBOR + 2.75%. The interest rate on
the revolving credit facility was adjusted quarterly based on our Leverage Ratio and could range from LIBOR +3.25% to LIBOR +2.75%. The revolving credit facility required that we pay an annual commitment fee of .375%. The annual commitment fee,
based on our Leverage Ratio and ranging from .5% to .375%, was payable quarterly in arrears. The Leverage Ratio was defined as the ratio of (a) consolidated indebtedness to (b) consolidated adjusted EBITDA (earnings before interest, taxes,
depreciation, amortization and other adjustments as defined in the agreement). The Leverage Ratio was calculated quarterly on a pro forma basis that included the four preceding quarters. There were no outstanding amounts on either the revolving
credit facility or the swingline loan sub-facility as of September 30, 2008 and December 31, 2007. The revolving credit facility and the swingline loan sub-facility were terminated at the same time as the senior secured credit facility.
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The letter of credit under the revolving credit facility was terminated with Citigroup on
September 4, 2008 and a new standby letter of credit was issued by Wells Fargo, NA, which expires on June 25, 2012. As of September 30, 2008, there was $800,000 outstanding under the standby letter of credit related to the expansion
of our St. Paul, MN facility. This amount is classified as restricted cash on our condensed consolidated balance sheet.
Financing fees
incurred in connection with the credit facility were deferred and were included as a reduction to our long-term debt. These fees were being amortized to interest expense over the term of the term loan using the effective interest rate method. Upon
repayment of the term debt in September 2008, the outstanding balance of the deferred financing fees was fully recognized in interest expense on our condensed consolidated statement of operations.
Derivative Instrument
On September 29,
2006, we entered into a 3-month LIBOR interest rate cap agreement to cap the interest rate at 5.5% on $60.0 million, or approximately 67% of the aggregate term loan. The notional amount of the agreement decreased $10.0 million each quarter beginning
on March 30, 2007. The agreement terminated on June 30, 2008. The interest rate cap agreement was designated as a cash flow hedge and was reflected at fair value in our condensed consolidated balance sheet. The related gains or losses on
this contract were deferred in stockholders equity as a component of other comprehensive loss. Deferred gains and losses were amortized as an adjustment to expense over the same period in which the related items being hedged were recognized in
income. The unrealized gain on the interest rate cap agreement on our condensed consolidated balance sheet was $0 and $1,000 as of September 30, 2008 and 2007, respectively.
7. Equity Financing
On January 12, 2006, we received from Warburg Pincus Private Equity IX,
L.P., a global private equity fund, $70.0 million in gross proceeds from the issuance of 700,000 shares of Series A Convertible Preferred Stock (the preferred stock) and a warrant to acquire 1.0 million shares of our common stock. Based on the
quoted market price of $14.40 on January 12, 2006 and the fair value of the warrant as determined using the Black-Scholes model, we valued the preferred stock at $62.0 million and the warrant at $8.0 million. The proceeds from this transaction
were used to finance most of the cash portion of the CyberGuard Corporation acquisition.
On August 31, 2006, the conversion price for
the preferred stock was adjusted from the original price of $13.51 to $12.75 per share in accordance with an anti-dilution adjustment triggered by the CipherTrust acquisition. Holders of our preferred stock will be entitled to receive benefits not
available to holders of our common stock. These benefits include, but are not limited to, the following: (i) if the proposed merger with McAfee did not close, beginning in July 2010, shares of preferred stock would be entitled to receive
semi-annual dividends, which could be paid in cash or added to the preferred stock liquidation preference, equal to 5% of the preferred stock liquidation preference per year and (ii) each share of preferred stock has an initial liquidation
preference of $100 which accretes daily at an annual rate of 5%, compounded semi-annually, until July 2010.
On August 31, 2006, the
exercise price for the warrant was adjusted from the original price of $14.74 to $13.85 per share also in accordance with an anti-dilution adjustment triggered by the CipherTrust acquisition. The warrant expires on January 12, 2013 but will be
terminated at the closing of the proposed merger with McAfee if the merger occurs. If the market price of our common stock rose above the exercise price, the warrant would become dilutive and 1.0 million shares will be immediately included in
the computation of diluted earnings per share as if the warrant is exercised using the treasury stock method.
The preferred stock was
initially recorded at $62.0 million, which is a discount of $8.0 million from its initial liquidation value of $70.0 million due to the fair value of warrants on the effective date. The liquidation value of the preferred stock accretes daily at an
annual rate of 5%, compounded semi-annually. This accretion is recorded as a reduction of earnings attributable to common shareholders ratably for a period of 54 months after date of issuance.
The preferred stock is considered to be contingently redeemable shares and is classified as temporary equity on our condensed consolidated balance sheets
as the change in control of our company is uncertain and because there is a cash settlement feature of the preferred stock upon a change of control. As of September 30, 2008 and December 31, 2007, none of the preferred stock had been
converted.
As a part of the announced merger with McAfee, each share of preferred stock, issued and outstanding immediately prior to the
effective time of the merger, will be converted into the right to receive a cash amount of $100, plus (i) an amount
10
of interest on such amount accreting daily at the annual rate of 5%, compounded semi-annually, computed on the basis of a 360 day year of 12 30-day months
from January 12, 2006 to the date the merger closes, as well as an amount equal to any accrued but unpaid dividends on a preferred share as of the date the merger closes (the Series A Liquidation Amount), plus (ii) an amount equal to 5% of
the Series A Liquidation amount.
8. Comprehensive Income/(Loss)
During the three months ended September 30, 2008, total comprehensive income amounted to $47.0 million. During the three months ended September 30, 2007, total comprehensive loss amounted to $10.1 million.
During the nine months ended September 30, 2008, total comprehensive income amounted to $17.8 million. During the nine months ended September 30, 2007, total comprehensive loss amounted to $30.0 million. The components of our comprehensive
income/(loss) are net income/(loss), foreign currency translation adjustments, and the change in the fair market value of our interest rate hedge. Results of operations were translated using average exchange rates throughout the period. Translation
gains or losses are accumulated as a separate component of stockholders equity and included in comprehensive income/(loss).
9. Contingencies
Finjan Software Litigation
On
June 5, 2006, Finjan Software, Ltd. filed a complaint entitled Finjan Software, Ltd. v. Secure Computing Corporation in the United States District Court for the District of Delaware against Secure Computing Corporation, CyberGuard Corporation,
and Webwasher AG. The complaint alleged that Secure Computing and its named subsidiaries infringe U.S. Patent No. 6,092,194 (194 Patent) based on the manufacture, use, and sale of the Webwasher Secure Content Management suite and
CyberGuard TSP. On April 10, 2007, Finjan amended its Complaint to allege that Secure Computing and its named subsidiaries infringe U.S. Patent No. 6,804,780 (780 Patent) and U.S. Patent No. 7,058,822 (822 Patent) based on
the manufacture, use, and sale of the Webwasher Secure Content Management suite. Secure Computing denies infringing any valid claims of the 194 Patent, the 780 Patent, or the 822 Patent. The answer and counterclaims to
Finjans amended complaint were filed on April 20, 2007. In its counterclaims, Secure Computing alleges that Finjan infringes two Secure Computing patents-U.S. Patent No. 6,357,010 and U.S. Patent No. 7,185,361.
The case was tried before a jury in Delaware in March 2008. The jury entered a verdict in favor of the plaintiff on March 12, 2008 and the District
Court entered judgment on March 28, 2008. The jury found that Secure Computing infringed certain claims of Finjans patents and awarded damages in favor of Finjan in the amount of $9.2 million. The jury also found that the patents asserted
by Secure Computing are valid but that Finjan has no liability to Secure Computing under our asserted patents. As a result of the jury verdict in the case, we recorded a $9.2 million pre-tax charge, which is a reasonable estimate of the probable
loss, if the jury verdict is not reduced, set aside or overturned. The jurys verdict, including the damage award, is subject to the outcome of the post-verdict motions described below.
On March 27, 2008, Secure Computing filed a combined motion for judgment as a matter of law, new trial, and/or remittitur, asking the trial court to
set aside the jurys verdict, to reduce or eliminate the damages award, and/or for a new trial, which motions were renewed on April 10, 2008. On April 4, 2008, Finjan filed amended motions for an injunction, enhanced damages,
interest, attorneys fees, costs, expenses and an accounting of damages. Finjan also filed a motion for judgment as a matter of law to set aside the jurys verdict that Secure Computings patents are valid. On April 7, 2008,
Secure Computing filed a motion to stay execution of the judgment pending the post-trial motions. Briefing for these motions was completed on May 16, 2008. All of the motions remain pending. At this time, it is not possible to predict the
timing or outcome of these motions or reasonably estimate the additional amount of loss, if any, that Secure Computing might suffer. We believe that the allegations included in the complaint are wholly without merit and intend to defend this
litigation vigorously. If necessary, we will appeal the trial courts decision to the Federal Circuit Court of Appeals.
Rosenbaum Capital Class
Action Litigation
On January 19, 2007, Rosenbaum Capital, LLC filed a putative securities class action complaint in the United
States District Court for the Northern District of California against Secure Computing and certain officers of Secure Computing. The alleged plaintiff class includes persons who acquired our stock between May 4, 2006 and July 11, 2006. The
complaint alleged generally that defendants made false and misleading statements about our business condition and prospects for the fiscal quarter ended June 30, 2006, in violation of Section 10(b) and 20(a) of the Securities Exchange Act
of 1934 and SEC Rule 10b-5. The complaint sought unspecified monetary damages. After plaintiff filed an amended complaint on July 2, 2007, the defendants filed a motion to dismiss. The trial court denied that motion on March 4, 2008. The
defendants filed answers to the amended complaint on April 25, 2008.
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On October 14, 2008, the parties participated in a mediation of plaintiffs claims. At the
mediation, the parties agreed, subject to formal documentation in mutually agreeable form and to court approval after notice to the settlement class, to a settlement of all claims in the case in exchange for a payment of $3.6 million. Under the
terms of the tentative agreement, our primary director and officer liability insurance carrier will pay the entire settlement amount. Both Secure Computing and the individual defendants have denied and continue to deny plaintiffs substantive
allegations and any wrongdoing.
Josifovich Litigation
On September 21, 2007, Diane Josifovich filed a complaint against Secure Computing in the Superior Court of New Jersey, Somerset County. The complaint alleges that Secure Computing breached its contract with
Ms. Josifovich with respect to payment for commission sales. The complaint also asserts claims of promissory estoppel, equitable estoppel, misrepresentation, and breach of the covenant of good faith and fair dealing. The complaint also alleges
that Secure Computing retaliated against Ms. Josifovich and created a hostile work environment on the basis of Ms. Josifovichs gender. The complaint seeks unspecified monetary damages. The case was removed to the United States
District Court for the District of New Jersey. In February 2008, the plaintiff amended her complaint to add some additional allegations, including a claim that she was allegedly retaliated against by being placed on a performance improvement plan
and terminated. Secure Computing has answered the complaint, denying all of Ms. Josifovichs claims and denying any liability. This matter is pending, with the parties conducting depositions and documentary discovery. We intend to
vigorously defend the claims against us.
Class Action relating to Proposed Sale to McAfee
Following the announcement on September 22, 2008 of the proposed sale of Secure Computing to McAfee, Inc., four class action complaints were filed in
the Superior Court of the State of California Santa Clara County, and one class action complaint was filed in the Superior Court of the State of California Los Angeles County. The four Santa Clara complaints were consolidated into an amended
complaint that was filed in Santa Clara County on October 17, 2008. On October 14, 2008, the defendants moved to transfer the Los Angeles complaint to Santa Clara County. On October 20, 2008, the Los Angeles County Court granted the
defendants motion, and the case is being transferred to Santa Clara. The Santa Clara County consolidation order provides that all actions filed in, removed to or transferred to Santa Clara County must be consolidated with the other four cases
already in Santa Clara County. The defendants response to the consolidated amended complaint is currently scheduled to be due on or about November 17, 2008.
The consolidated amended complaint makes numerous allegations against Secure Computing, our board of directors, and McAfee. The complaint alleges various breaches of fiduciary duty by the members of our board of
directors relating to the proposed sale of Secure Computing. In particular, the complaint alleges breaches of the individual directors duties of due care, loyalty and good faith by failing to fully inform themselves of potential competing
proposals, failing to disclose material information regarding the transaction to our stockholders, and favoring their interests over the interests of our stockholders. The complaint further alleges that Secure Computing and McAfee aided and abetted
the alleged breaches of fiduciary duty. We believe these claims to be wholly without merit and intend to defend this litigation vigorously.
The consolidated amended complaint seeks an order declaring our merger agreement with McAfee to be unlawful and unenforceable, enjoining the proposed sale, requiring the individual defendants to conduct a more extensive auction process for
Secure Computing, rescinding the merger agreement, requiring us to provide additional disclosure to our stockholders regarding the proposed transaction, imposing a constructive trust on any benefits improperly received by the individual defendants
in the proposed transaction, and awarding plaintiffs costs and disbursements in pursuing their claims.
On October 22, 2008, the
court granted plaintiffs request for limited expedited discovery and ordered the parties to negotiate the scope of appropriate discovery. The parties are negotiating the scope of appropriate discovery and providing the agreed-upon information.
Additional Litigation
From time to
time we may be engaged in certain other legal proceedings and claims arising in the ordinary course of our business. The ultimate liabilities, if any, which may result from these or other pending or threatened legal actions against us cannot be
determined at this time. However, in the opinion of management, the facts known at the present time do not indicate that such litigation will have a material effect on our consolidated financial position or results of operations.
12
10. Income Taxes
During the three months ended September 30, 2008, we recorded income tax expense of $2.8 million. Income taxes related to the gain on the divestiture of the SafeWord product line were substantially offset by the
release of valuation allowance on NOLs where the benefit of the release is recorded in the condensed consolidated statement of operations. The $2.8 million income tax expense consists of $213,000 of non-cash foreign tax expense associated primarily
with the release of valuation allowance on utilized acquired NOLs where the benefit of the release is offset to goodwill, $51,000 of non-cash U.S. tax expense related to deferred tax liabilities, $54,000 of cash tax expense for various foreign
taxes, and $2.5 million is related to U. S. federal and state income tax expense. This is compared with an income tax expense of $3.6 million in the same period of 2007. Of this $3.6 million of income tax expense, $2.4 million is related to non-cash
foreign tax expense associated primarily with the release of valuation allowance on utilized acquired NOLs where the benefit of the release is offset to goodwill, $875,000 is related to various other foreign income taxes, and $338,000 is related to
U.S. federal and state income tax expense.
During the nine months ended September 30, 2008, we recorded income tax expense of $4.0
million. Income taxes related to the gain on the divestiture of the SafeWord product line were substantially offset by the release of valuation allowance on NOLs where the benefit of the release is recorded in the condensed consolidated statement of
operations. The $4.0 million of income tax expense consists of $874,000 of non-cash foreign tax expense associated primarily with the release of valuation allowance on utilized acquired NOLs where the benefit of the release is offset to goodwill,
$321,000 of non-cash U.S. tax expense of which a portion relates to deferred tax liabilities, $239,000 of tax expense for various foreign taxes, and $2.6 million is related to U. S. federal and state income tax expense. This is compared with an
income tax expense of $6.6 million in the same period of 2007. Of this $6.6 million of income tax expense, $1.4 million is related to non-cash foreign tax expense associated primarily with the release of valuation allowance on utilized acquired NOLs
where the benefit of the release is offset to goodwill, $2.4 million is related to various other foreign income taxes, $2.4 million is related to non-cash U.S. tax expense associated with the need to provide additional tax expense for valuation
allowance on net operating losses, and $440,000 is related to U.S. federal and state income tax expense.
In accordance with SFAS
No. 109, Accounting for Income Taxes, we have assessed the likelihood that the net deferred tax assets will be realized. SFAS No. 109 requires the consideration of a valuation allowance in all circumstances, if the conclusion
is not more likely than not a valuation allowance is required. We have recorded a deferred tax liability in our condensed consolidated balance sheet for indefinite lived intangible assets that are not deductible for tax purposes and therefore cannot
be used to realize additional reversing deferred tax assets. We also have a deferred tax asset that is able to be recognized as a result of the FIN 48 liabilities that are recorded. In accordance with SFAS No. 109, our remaining noncurrent
deferred tax liabilities are netted with our noncurrent deferred tax assets and are presented as a single amount in our condensed consolidated balance sheet. We have determined that primarily all of our net deferred tax assets are not more likely
than not to be realized, and as such a full valuation allowance has been placed on this amount.
11. Related Party Transaction
In February 2005, we made a strategic investment in a privately-held technology company of $2.7 million. In July 2007, we made an additional $500,000
investment. As a result of this $3.2 million investment, we have a 15% ownership stake in this company. This investment is reported in other assets on our condensed consolidated balance sheets and is evaluated for impairment quarterly. There have
been no impairment charges recorded against this strategic investment.
One of our board members is currently an individual investor of the
investee. At the time that the decisions were made to make both investments, a former board member was also involved with the investee and these two board members recused themselves from the decisions.
12. Net Income/(Loss) Per Share
The following table
represents the calculation of basic and diluted net income/(loss) per share (in thousands, except per share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Net income/(loss)
|
|
$
|
47,354
|
|
|
$
|
(10,052
|
)
|
|
$
|
17,929
|
|
|
$
|
(31,575
|
)
|
Preferred stock accretion
|
|
|
(989
|
)
|
|
|
(943
|
)
|
|
|
(2,921
|
)
|
|
|
(2,781
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income/(loss) applicable to common stockholders
|
|
$
|
46,365
|
|
|
$
|
(10,995
|
)
|
|
$
|
15,008
|
|
|
$
|
(34,356
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
13
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2008
|
|
2007
|
|
|
2008
|
|
2007
|
|
Shares used in computing basic net income/(loss) per share
|
|
|
68,241
|
|
|
66,268
|
|
|
|
67,859
|
|
|
65,772
|
|
Preferred stock as-if converted
|
|
|
6,290
|
|
|
|
|
|
|
6,290
|
|
|
|
|
Common stock equivalents
|
|
|
272
|
|
|
|
|
|
|
694
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shares used in computing diluted net income/(loss) per share
|
|
|
74,803
|
|
|
66,268
|
|
|
|
74,843
|
|
|
65,772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic net income/(loss) per share
|
|
$
|
0.68
|
|
$
|
(0.17
|
)
|
|
$
|
0.22
|
|
$
|
(0.52
|
)
|
Diluted net income/(loss) per share
|
|
$
|
0.63
|
|
$
|
(0.17
|
)
|
|
$
|
0.24
|
|
$
|
(0.52
|
)
|
All potential common stock equivalents for the three and nine months ended September 30, 2007
were excluded from the computation of diluted earnings per share as inclusion of these shares would have been anti-dilutive. Additionally, 6.0 million shares of common stock issuable upon conversion of our preferred stock were excluded from the
effect of dilutive securities for the three and nine months ended September 30, 2007 because we reported a net loss for those periods. Potential common shares of 10.2 million and 8.8 million related to our outstanding stock options
were excluded from the computation of diluted earnings per share for the three and nine months ended September 30, 2008, respectively, as inclusion of these shares would have been anti-dilutive.
13. Segment Information
We view our operations and
manage our business as one segment called Enterprise Security Solutions. Major foreign markets for our products and services include Europe, Japan, China, the Pacific Rim, the Middle East, Australia, and Latin America. In each market, we have
independent channel partners who are responsible for marketing, selling and supporting our products and services to resellers and end-users within their defined territories. International sales accounted for 28% and 31% of total revenue for the
three months ended September 30, 2008 and 2007, respectively, and 35% and 34% of total revenue for the nine months ended September 30, 2008 and 2007, respectively. The following table summarizes our domestic and international revenues (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Domestic
|
|
$
|
45,369
|
|
$
|
41,660
|
|
$
|
120,204
|
|
$
|
113,257
|
International
|
|
|
17,587
|
|
|
18,358
|
|
|
65,159
|
|
|
58,181
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
62,956
|
|
$
|
60,018
|
|
$
|
185,363
|
|
$
|
171,438
|
|
|
|
|
|
|
|
|
|
|
|
|
|
14. Share-Based Compensation
Description of Plans
Under our 2002 Stock Incentive Plan (2002 Plan), we are permitted to
grant incentive and non-qualified stock options, restricted stock awards, restricted stock units, stock appreciation rights, and other similar types of stock awards, such as phantom stock rights, to our employees and non-employee directors. There
were a total of 10.0 million shares authorized under the 2002 Plan at September 30, 2008. All options granted under the 2002 Plan through September 30, 2008 have exercise prices equal to the fair market value of our stock on the date
of grant. Options granted under the 2002 Plan have ten-year terms and typically vest 25% after the first year and then monthly over the following three years. Restricted stock awards granted under the 2002 Plan typically vest 25% after the first
year and then quarterly over the following three years. Outstanding awards that were originally granted under several predecessor plans also remain in effect in accordance with their terms.
Our 1995 Omnibus Stock Plan along with the N2H2 Stock Option Plans, the CyberGuard Stock Option Plans, and the Secure Computing 2000 Stock Plan (formerly
the CipherTrust 2000 Stock Option Plan), which were assumed in connection with our acquisitions, are described more fully in Note 10 of the Notes to the Consolidated Financial Statements in our Annual Report on Form 10-K for the year ended
December 31, 2007, as filed with the SEC. No additional awards may be granted under the 1995 Omnibus Stock Plan.
14
We have an employee stock purchase plan (ESPP), which enables employees to contribute up to 10% of their
compensation toward the purchase of our common stock at the end of the participation period at a purchase price equal to 85% of the lower of the fair market value of the common stock on the first or last day of the participation period.
Share-Based Compensation Expense
A
summary of the share-based compensation expense that we recorded in accordance with SFAS No. 123(R) for stock options, restricted stock awards and shares purchased under our ESPP for the periods shown is as follows (in thousands, except per
share amounts):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
Nine Months Ended
September 30,
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
Cost of product revenues
|
|
$
|
72
|
|
$
|
57
|
|
$
|
227
|
|
$
|
268
|
Cost of service revenues
|
|
|
203
|
|
|
220
|
|
|
442
|
|
|
613
|
Selling and marketing
|
|
|
1,133
|
|
|
2,490
|
|
|
4,653
|
|
|
6,907
|
Research and development
|
|
|
769
|
|
|
838
|
|
|
2,723
|
|
|
2,773
|
General and administrative
|
|
|
648
|
|
|
699
|
|
|
1,738
|
|
|
1,800
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect on income/(loss) before taxes
|
|
$
|
2,825
|
|
$
|
4,304
|
|
$
|
9,783
|
|
$
|
12,361
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Effect on basic income/(loss) per share
|
|
$
|
0.04
|
|
$
|
0.06
|
|
$
|
0.14
|
|
$
|
0.19
|
Effect on diluted income/(loss) per share
|
|
$
|
0.04
|
|
$
|
0.06
|
|
$
|
0.13
|
|
$
|
0.19
|
As of September 30, 2008, there was $27.1 million of total unrecognized compensation cost
related to non-vested share-based compensation arrangements granted under all equity compensation plans. Total unrecognized compensation cost will be adjusted for future changes in estimated forfeitures. We expect to recognize that cost over a
weighted average period of 2.5 years.
As a part of the merger with McAfee, each vested or unvested option to purchase shares of Secure
Computing common stock outstanding at the effective time of the merger will be cancelled automatically, and at the effective time of the merger, converted into the right to receive a lump sum cash payment (less any applicable withholding) equal to
the product obtained by multiplying the total number of shares granted as a result of exercising the option immediately prior to the effective time of the merger by the excess, if any, of $5.75 per share over the exercise price per share. Unvested
restricted stock units and restricted shares outstanding at the effective time of the merger (after taking into account waivers of acceleration of vesting by certain Secure Computing executive officers) will be assumed by McAfee, and, at the
effective time of the merger, converted into the right to receive McAfee restricted stock units or restricted shares, as the case may be, based on an exchange ratio specified in the merger agreement.
15. Fair Value Measurement
In September 2006, the
FASB issued SFAS No. 157 which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and establishes a hierarchy that categorizes and prioritizes the sources to be used to estimate fair
value. SFAS No. 157 also expands disclosures about fair-value measurements. We adopted SFAS No. 157 effective January 1, 2008 for all financial assets and liabilities and any other assets and liabilities that are recognized or
disclosed at fair value on a recurring basis. Although the adoption of SFAS No. 157 did not impact our financial condition, results of operations or cash flows, we are required to provide additional disclosures within our condensed consolidated
financial statements.
SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer the
liability (an exit price) in an orderly transaction between market participants and also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring
fair value. The fair value hierarchy within SFAS No. 157 distinguishes between three levels of inputs that may be utilized when measuring fair value including level 1 inputs (using quoted prices in active markets for identical assets or
liabilities), level 2 inputs (using inputs other than level 1 prices such as quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability) and level 3 inputs (unobservable inputs
supported by little or no market activity based on our own assumptions used to measure assets and liabilities). A financial asset or liabilitys classification within the above hierarchy is determined based on the lowest level input that is
significant to the fair value measurement.
Our financial assets measured at fair value on a recurring basis of $32.3 million as of
September 30, 2008 consisted of money market funds and commercial paper. We used level 1 inputs to determine the fair value of our financial assets.
15
16. Subsequent Event
On October 1, 2008, we closed the acquisition of Securify, Inc. (Securify), a privately-held company based in Cupertino, CA, for $15.0 million plus an earn-out of up to $5.0 million. Securify provides an
innovative and easy-to-use solution for monitoring and controlling user access to applications with complex and rapidly changing networks. Its plug-and-play appliance offers automatic discovery and policy development in intuitive
business terms of users, groups and applications. Securify sells primarily into federal government and other high-assurance markets, including financial services. This is consistent with our core firewall market, and it will provide a significant
opportunity to deliver complementary value across existing and future customers both domestically and internationally.
Item 2.
|
Managements Discussion and Analysis of Financial Condition and Results of Operations
|
EXECUTIVE OVERVIEW
We are a global leader in enterprise security solutions that proactively protect
our customers mission-critical business applications and desktop users from all manner of Internet-borne and internal threats. Our comprehensive portfolio of Secure Web, Secure Mail, and Secure Firewall solutions provide unmatched protection
for the enterprise.
Our specialized solutions are designed to meet customers needs to balance security and accessibility, and to
help them create trusted environments both inside and outside their organizations. We have developed a vision for comprehensive security on the enterprise gateway that embodies the following core design principles: hybrid delivery via appliances,
security as a service, and virtual appliances; real-time, reputation-driven intelligence; application and content awareness; centralized policy, management and reporting; bi-directional protection; user management and education; performance; and
resiliency.
We continue to evolve all of our products to meet the needs of our
customers either through maintenance or feature releases each quarter. In addition, we introduced the following major product and/or service releases in 2008. In the first quarter of 2008, we released SafeWord
®
2008, a new version of our award-winning two-factor authentication solution, which is designed for the latest 64-bit Windows environments, including Vista and Windows 2008 Server, with seamless integration to
Microsoft Active Directory. In the second quarter of 2008 we announced the availability of Secure Web Protection Service, the industrys first software-as-a-service (SaaS) Web security solution providing reputation-based protection from malware
and other Web-borne threats. We also unveiled Secure Firewall Geo-Location, a new service that allows organizations to create policies that block connections by an IP address (for any network protocol/application) based on country code information.
In the third quarter of 2008 we announced the availability of Secure Web Reporter, a highly scalable reporting solution that provides instantaneous views of important Web activity, focusing on security, compliance monitoring and performance
assessment.
In April 2008, we took actions to reduce company expenses by approximately 10%. In support of this, we incurred $1.5 million
in severance and related costs by eliminating 75 positions throughout the company.
During the second quarter of 2008, we also increased
our focus and investments in the enterprise gateway areas of our business with an emphasis on Web and hosted security. We believe that this plan will allow us to better capitalize on the market opportunities in these areas, expand our operational
leverage and ultimately provide stronger top and bottom line growth for the company.
On April 22, 2008, John McNulty resigned as our
Chief Executive Officer and Chairman of the board of directors. As a result, we incurred $719,000 in severance and related costs. The board of directors has since appointed Richard Scott, a director since January 2006, as Chairman. Mr. McNulty
will continue to serve as a director. On July 15, 2008, the board of directors appointed Daniel Ryan as our Chief Executive Officer and he continues to serve as our President.
On July 30, 2008 we announced the sale of the SafeWord product line to Aladdin Knowledge Systems, Ltd. (Aladdin) for $64.3 million in cash,
including acquisition costs. In connection with the proposed sale, certain employees from our SafeWord research and development group and our corporate sales team were hired by Aladdin. The transaction closed on September 4, 2008. The
divestiture of SafeWord enables us to focus on our areas of greatest strength and expertisedelivering comprehensive and integrated Web, mail and network gateway appliances.
On September 21, 2008, we entered into an Agreement and Plan of Merger (Merger Agreement) with McAfee, Inc. (McAfee) and Seabiscuit Acquisition
Corporation, a wholly owned subsidiary of McAfee, pursuant to which McAfee has agreed to acquire all of the outstanding common stock of Secure Computing for $5.75 per share in cash, without interest, representing an equity value for our common stock
of approximately of $412.5 million in the aggregate. In addition, pursuant to the Merger Agreement, our outstanding shares of preferred stock will be redeemed for cash as part of the proposed transaction, which would represent approximately an
additional $84.8 million calculated as of September 21, 2008. In total, the proposed transaction would be valued at approximately $497.3 million. In connection with the Merger
16
Agreement we will hold a special meeting with our stockholders, scheduled for November 14, 2008, to consider and vote upon the adoption of the Merger
Agreement. After careful consideration, our board of directors has unanimously approved and declared the merger, the Merger Agreement and the transactions contemplated by the Merger Agreement to be advisable, and has determined that it is in the
best interests of our stockholders that we enter into the Merger Agreement and consummate the merger on the terms and conditions set forth in the Merger Agreement.
On October 1, 2008, we closed the acquisition of Securify, Inc. (Securify), a privately-held company based in Cupertino, CA for $15.0 million, net of cash received, plus an earn-out of up to $5.0 million.
Securify provides an innovative and easy-to-use solution for monitoring and controlling user access to applications with complex and rapidly changing networks. Its plug-and-play appliance offers automatic discovery and policy development
in intuitive business terms of users, groups and applications. Securify sells primarily into federal government and other high-assurance markets, including financial services. This is consistent with our core firewall market, and it will provide a
significant opportunity to deliver complementary value across existing and future customers both domestically and internationally.
Our Enterprise Security Solutions revenue represented 93% of total revenue in the third quarter of
2008, a 13% or $6.9 million increase over the prior year. The increase was driven by sustained demand for network security solutions. Our SafeWord revenue represented 7% of total revenue in the third quarter of 2008, a 47% or $3.9 million decrease
over the prior year. This decrease was primarily driven by the divestiture of our SafeWord
®
product line in the third quarter of 2008.
Our Enterprise Security Solutions revenue represented 89% of total revenue for the nine months
ending September 30, 2008, a 13% or $19.7 million increase over the prior year. The increase was driven by sustained demand for network security solutions. Our SafeWord revenue represented 11% of total revenue for the nine months ending
September 30, 2008, a 23% or $5.7 million decrease over the prior year. This decrease was primarily driven by the divestiture of our SafeWord
®
product line in the third quarter of
2008. To a lesser extent, revenue decreased due to fewer significant sized purchases in this period compared to the same period of the prior year.
Our global footprint now encompasses more than 22,000 customers operating some of the largest and most sensitive networks and applications in the world. Our partners and customers include the majority of the Dow Jones Global 50 Titans and
numerous organizations in the Fortune 1,000, as well as banking, financial services, healthcare, real estate, telecommunications, manufacturing, public utilities, schools and federal, state and local governments. We also have close relationships
with the largest agencies in the U.S. government.
International sales accounted for 28% and 35% of total revenue for the three months and
nine months ended September 30, 2008, respectively. Major foreign markets for our products include Europe, Japan, China, the Pacific Rim, the Middle East, Australia and Latin America. In each market, we have independent channel partners
responsible for marketing, selling and supporting our products to resellers and end-users. Our market presence has continued to expand through our extensive worldwide channel of value-added resellers, distributors, and original equipment
manufacturer (OEM) partners. These channel partners generated 91% and 90% of our sales for the three months and nine months ended September 30, 2008, respectively, compared to 81% and 84% for the same periods ended September 30, 2007,
respectively.
Each of our individual products competes with a different group of competitors and products. In this highly competitive
market characterized by rapid technological change, our customers purchasing decisions are based heavily upon the quality of the security our products provide, the ease of installation and management, and the scalability and flexibility of our
software.
Specific challenges and risks that our product lines face include, but are not limited to: responding to competitor pricing
policies and competitive features; rapid technological change in the network security market; and risk of bugs and other errors in our software.
We recognized net income of $47.4 million in the three months ended September 30, 2008 compared to a net loss of $10.1 million in the same period of 2007. For the nine months ended September 30, 2008, we recognized net income of
$17.9 million compared to a net loss of $31.6 million for the same period in 2007.
As of September 30, 2008, we had $50.3 million in
cash, cash equivalents and restricted cash. We generated $27.2 million in cash from operations for the nine months ended September 30, 2008. As a result of the divestiture of our SafeWord product line in September 2008 we paid the outstanding
balance on our term debt.
17
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the condensed consolidated statements of operations of our company expressed as a percentage of revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
Nine Months Ended
September 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
48
|
%
|
|
52
|
%
|
|
47
|
%
|
|
54
|
%
|
Services
|
|
31
|
|
|
31
|
|
|
33
|
|
|
32
|
|
Other (See Note)
|
|
21
|
|
|
17
|
|
|
20
|
|
|
14
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
100
|
|
|
100
|
|
|
100
|
|
|
100
|
|
|
|
|
|
|
Cost of revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Products
|
|
18
|
|
|
16
|
|
|
18
|
|
|
16
|
|
Services
|
|
6
|
|
|
7
|
|
|
7
|
|
|
7
|
|
Other (See Note)
|
|
4
|
|
|
2
|
|
|
3
|
|
|
2
|
|
Amortization of purchased intangibles
|
|
3
|
|
|
3
|
|
|
3
|
|
|
4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of revenues
|
|
31
|
|
|
28
|
|
|
31
|
|
|
29
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
69
|
|
|
72
|
|
|
69
|
|
|
71
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and marketing
|
|
42
|
|
|
49
|
|
|
48
|
|
|
51
|
|
Research and development
|
|
20
|
|
|
19
|
|
|
20
|
|
|
19
|
|
General and administrative
|
|
8
|
|
|
7
|
|
|
8
|
|
|
7
|
|
Amortization of purchased intangibles
|
|
3
|
|
|
5
|
|
|
4
|
|
|
5
|
|
Litigation settlement
|
|
|
|
|
|
|
|
5
|
|
|
|
|
Goodwill impairment
|
|
24
|
|
|
|
|
|
8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total operating expenses
|
|
97
|
|
|
80
|
|
|
93
|
|
|
82
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating loss
|
|
(28
|
)
|
|
(8
|
)
|
|
(24
|
)
|
|
(11
|
)
|
Gain on divestiture of SafeWord product line
|
|
112
|
|
|
|
|
|
38
|
|
|
|
|
Other expense
|
|
(4
|
)
|
|
(3
|
)
|
|
(2
|
)
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income/(loss) before taxes
|
|
80
|
|
|
(11
|
)
|
|
12
|
|
|
(15
|
)
|
Income tax expense
|
|
(5
|
)
|
|
(6
|
)
|
|
(2
|
)
|
|
(4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income/(loss)
|
|
75
|
|
|
(17
|
)
|
|
10
|
|
|
(19
|
)
|
Preferred stock accretion
|
|
(1
|
)
|
|
(1
|
)
|
|
(2
|
)
|
|
(1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income/(loss) applicable to common shareholders
|
|
74
|
%
|
|
(18
|
)%
|
|
8
|
%
|
|
(20
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOTE:
|
|
For certain multiple-element arrangements we are unable to establish vendor specific objective evidence (VSOE) of fair value for the undelivered bundled elements and are therefore unable to
allocate the value of the arrangement between Products and Services Revenue and have reported these revenues and corresponding cost of revenues as Other.
|
Comparison of Three Months Ended September 30, 2008 and 2007.
Revenues.
Our total revenues increased 5% to $63.0 million for the three months ended September 30, 2008 up from $60.0 million in the same
period of 2007. Our products revenues decreased 2% to $30.2 million for the three months ended September 30, 2008 down from $31.0 million in the same period of 2007. Our services revenues increased 2% to $19.5 million for the three months ended
September 30, 2008 up from $19.0 million in the same period of 2007. Other revenues increased 32% to $13.3 million for the three months ended September 30, 2008 up from $10.0 million in the same period of 2007. Other revenue represents
multiple element sales that lacked VSOE in the prior periods and became recognizable as services were provided in 2008 and 2007, respectively. This revenue is primarily from our Secure Mail product line revenues. Because we are unable to establish
VSOE of fair value on the undelivered elements, the majority of the revenue from that product line has been deferred and is being recognized as revenue over the service period. The total revenue growth was
18
driven by a 13% or $6.9 million increase in Enterprise Security Solutions revenue, which was primarily driven by sustained demand for network security
solutions, and was offset by a 47% or $3.9 million decrease in the SafeWord revenue due to the divestiture of the SafeWord product line in September 2008.
Cost of Revenues and Gross Profit.
Total cost of revenues increased 13% to $19.2 million for the three months ended September 30, 2008, up from $17.0 million in the same period of 2007. This increase is
primarily the result of the increase in total revenues. Gross profit as a percentage of revenue was 69% for the quarter compared to 72% in the same period of 2007. For the three months ended September 30, 2008, gross profit for products
decreased to 63% for the quarter compared to 69% in the same period of 2007, primarily due to increased sales volume of products containing a hardware component, which have a lower gross profit than our software products, and an increase in related
manufacturing and overhead costs. Gross profit for services increased to 80% for the quarter compared to 79% in the same period of 2007. This improvement was primarily driven by the growth of our support revenue outpacing increases in support costs.
Operating Expenses.
Operating expenses consist of selling and marketing, research and development, general and administrative
expenses, amortization of purchased intangible assets, and litigation judgment costs. Total operating expenses increased 28% to $61.4 million for the three months ended September 30, 2008 up from $47.9 million in the same period of 2007. This
increase was driven primarily by the goodwill impairment charge of $15.4 million resulting from our announced merger with McAfee. This increase was offset by decreases in salaries and stock-based compensation as a result of the workforce reduction
that occurred in April 2008 and the divestiture of our SafeWord product line in September 2008. As a percentage of revenue, total operating expenses were 97% for the quarter compared to 80% in the same period of 2007.
Selling and Marketing.
Selling and marketing expenses consist primarily of salaries, commissions, share-based compensation and benefits related to
personnel engaged in selling, marketing, and customer support functions, along with costs related to advertising, promotions, public relations, travel and allocations of corporate costs, which include information technology, facilities and human
resources expenses. Our customer support function, which provides support, training and installation services, is also responsible for supporting our sales representatives and sales engineers throughout the sales cycle by providing them and our
prospective customers with technical assistance and, as such, a portion of these costs are included here. Selling and marketing expenses decreased 10% to $26.7 million for the three months ended September 30, 2008 down from $29.7 million in the
same period of 2007. This decrease was driven primarily by the April 2008 workforce reduction. As a percentage of revenue, selling and marketing expense was 42% for the quarter compared to 49% in the same period of 2007. This improvement was
primarily driven by the decrease in selling and marketing expense.
Research and Development.
Research and development expenses
consist primarily of salaries, share-based compensation and benefits for our product development and advanced technology personnel, and allocations of corporate costs, which include information technology, facilities and human resources expenses.
Research and development expenses increased 11% to $12.4 million for the three months ended September 30, 2008 up from $11.2 million in the same period of 2007. This increase was driven primarily by increased research and development headcount
and related costs in support of our revenue growth and to a lesser extent inflationary increases in payroll and related costs. As a percentage of revenue, research and development expenses were 20% for the three months ended September 30, 2008
compared to 19% in the same period of 2007. This increase was primarily driven by the increased amount of dollars invested in research and development to support our revenue growth.
General and Administrative.
General and administrative expenses consist primarily of salaries, share-based compensation, benefits and related
expenses for our executive, finance and legal personnel, directors and officers insurance, and allocations of corporate costs, which include information technology, facilities and human resources expenses. General and administrative expenses
increased 8% to $4.7 million for the three months ended September 30, 2008 up from $4.3 million in the same period of 2007. This increase was driven primarily by increased legal fees with defending the complaints described in Note 9 of the
Notes to the Financial Statements, and to a lesser extent inflationary increases in payroll and related costs and allocated corporate costs. As a percentage of revenue, general and administrative expenses were 8% for the three months ended
September 30, 2008 compared to 7% in the same period of 2007. This increase was primarily due to increased legal fees incurred defending the previously mentioned lawsuits.
Amortization of Purchased Intangible Assets.
Amortization of purchased intangible assets consists of the amortization of tradenames and customer
lists acquired in the CipherTrust and CyberGuard acquisitions. Amortization expense for these acquired tradenames and customer lists was $2.2 million for the three months ended September 30, 2008 compared to $2.7 million in the same period of
2007. This decrease was primarily driven by certain assets being fully amortized.
19
Share-Based Compensation Expense
. Share-based compensation expense related to stock options,
restricted stock awards and shares purchased under our employee stock purchase plan (ESPP) under Statement of Financial Accounting Standards (SFAS) No. 123(R) was allocated as follows for the periods indicated (in thousands):
|
|
|
|
|
|
|
|
|
Three Months Ended
September 30,
|
|
|
2008
|
|
2007
|
Cost of product revenues
|
|
$
|
72
|
|
$
|
57
|
Cost of service revenues
|
|
|
203
|
|
|
220
|
Selling and marketing
|
|
|
1,133
|
|
|
2,490
|
Research and development
|
|
|
769
|
|
|
838
|
General and administrative
|
|
|
648
|
|
|
699
|
|
|
|
|
|
|
|
Total share-based compensation expense
|
|
$
|
2,825
|
|
$
|
4,304
|
|
|
|
|
|
|
|
The decrease in share-based compensation expense in selling and marketing and in total is
primarily due to the departure of former CipherTrust employees, along with the workforce reduction in April 2008.
Goodwill.
Goodwill impairment charge reduced the book value of our equity to its implied fair value, which was determined based on the announced merger with McAfee. The implied fair value calculation resulted in recording a goodwill impairment charge of $15.4
million for the three months ended September 30, 2008 (see Note 4). There was not a similar charge in the same period of 2007.
Gain on Divestiture of SafeWord Product Line.
We recorded a gain on the divestiture of the SafeWord product line of $70.7 million for the three months ended September 30, 2008 (see Note 5). There was not a similar benefit in the
same period of 2007.
Other Expense.
Other expense of $2.9 million for the three months ended September 30, 2008, consists
primarily of interest expense, including the write-off of the deferred financing costs, related to the term debt, compared to $1.6 million in the same period of 2007.
Income Taxes.
During the three months ended September 30, 2008, we recorded income tax expense of $2.8 million. Income taxes related to the gain on the divestiture of the SafeWord product line were
substantially offset by the release of valuation allowance on NOLs where the benefit of the release is recorded in the condensed consolidated statement of operations. The $2.8 million income tax expense consists of $213,000 of non-cash foreign tax
expense associated primarily with the release of valuation allowance on utilized acquired net operating losses (NOLs) where the benefit of the release is offset to goodwill, $51,000 of non-cash U.S. tax expense related to deferred tax liabilities,
$54,000 of cash tax expense for various foreign taxes, and $2.5 million is related to U. S. federal and state income tax expense. This is compared with an income tax expense of $3.6 million in the same period of 2007. Of this $3.6 million of income
tax expense, $2.4 million is related to non-cash foreign tax expense associated primarily with the release of valuation allowance on utilized acquired NOLs where the benefit of the release is offset to goodwill, $875,000 is related to various other
foreign income taxes, and $338,000 is related to U.S. federal and state income tax expense.
In accordance with Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes, we have assessed the likelihood that the net deferred tax assets will be realized. SFAS No. 109 requires the consideration of a valuation allowance in all
circumstances, if the conclusion is not more likely than not a valuation allowance is required. We have recorded a deferred tax liability in our consolidated balance sheet for indefinite lived intangible assets that are not deductible for tax
purposes and therefore cannot be used to realize additional reversing deferred tax assets. We also have a deferred tax asset that is able to be recognized as a result of the FASB Interpretation (FIN) 48 liabilities that are recorded. In accordance
with SFAS No. 109, our remaining noncurrent deferred tax liabilities are netted with our noncurrent deferred tax assets and are presented as a single amount in our condensed consolidated balance sheet. We have determined that primarily all of
our net deferred tax assets are not more likely than not to be realized, and as such a full valuation allowance has been placed on this amount.
Estimates were used in the determination of our provision for income taxes, current income taxes payable, as well as in our deferred tax asset and liability analysis. These estimates take into account current tax laws and our interpretation
of these current tax laws within the various taxing jurisdictions within which we operate. Changes in the tax laws or our interpretation of tax laws and the resolution of future audits could impact our provision for income taxes.
Comparison of Nine Months Ended September 30, 2008 and 2007.
Revenues.
Our total revenues increased 8% to $185.4 million for the nine months ended September 30, 2008 up from $171.4 million in the same period of 2007. Our products revenues decreased 4% to $88.0
million for the nine months ended September 30, 2008 down from $91.9 million in the same period of 2007. Our services revenues increased 10% to $60.4 million for the nine months ended September 30, 2008 up from $54.9 million in the same
period of 2007. Other revenues
20
increased 50% to $36.9 million for the nine months ended September 30, 2008 up from $24.6 million in the same period of 2007. Other revenue represents
multiple element sales that lacked VSOE in the prior periods and became recognizable as services were provided in 2008 and 2007, respectively. This revenue is primarily from our Secure Mail product line revenues. Because we are unable to establish
VSOE of fair value on the undelivered elements, the majority of the revenue from that product line has been deferred and is being recognized as revenue over the service period. The total revenue growth was driven by a 13% or $19.7 million increase
in Enterprise Security Solutions revenue which was primarily driven by sustained demand for network security solutions, and was offset by a 23% or $5.7 million decrease in the SafeWord revenue due to the divestiture of the SafeWord product line in
September 2008.
Cost of Revenues and Gross Profit.
Total cost of revenues increased 14% to $57.3 million for the nine months ended
September 30, 2008, up from $50.1 million in the same period of 2007. This increase is the direct result of the increase in total revenues. Gross profit as a percentage of revenue was 69% for the nine months ended September 30, 2008
compared to 71% in the same period of 2007. For the nine months ended September 30, 2008, gross profit for products decreased to 63% compared to 69% in the same period of 2007, primarily due to increased sales volume of products containing a
hardware component, which have a lower gross profit than our software products, and an increase in related manufacturing and overhead costs. Gross profit for services increased to 79% for the nine months ended September 30, 2008 compared to 78%
for the same period in 2007. This improvement was primarily driven by the growth of our support revenue outpacing increases in support costs.
Operating Expenses.
Total operating expenses increased 22% to $172.1 million for the nine months ended September 30, 2008 up from $140.7 million in the same period of 2007. This increase was driven primarily by goodwill
impairment of $15.4 million, litigation settlement expense of $9.2 million and increased legal fees of $2.1 million associated with defending the complaints described in Note 9 of the Notes to the Financial Statements, severance incurred of $2.5
million for the reduction in force in April 2008 and the resignation of two executive officers, increased headcount and related costs which is in line with the growth of our business, and increased depreciation expense due to capital additions for
computer hardware and software throughout the prior year as a result of the expansion of our TrustedSource data centers and customer evaluation equipment. To a lesser extent, operating expenses increased as a result of inflationary increases in
payroll and related costs. As a percentage of revenue, total operating expenses were 93% for the nine months ended September 30, 2008 compared to 82% in the same period of 2007. This increase was primarily driven by the goodwill impairment in
September 2008 and the litigation accrual in March 2008 related to the Finjan lawsuit, which is offset by growth in revenue outpacing the increase in operating expense.
Selling and Marketing.
Selling and marketing expenses remained relatively flat at $88.0 million for the nine months ended September 30, 2008 compared with $87.8 million in the same period of
2007. As a percentage of revenue, selling and marketing expenses were 48% for the nine months ended September 30, 2008 compared to 51% in the same period of 2007. This improvement was primarily driven by the growth in revenue outpacing the
increase in selling and marketing expense.
Research and Development.
Research and development expenses increased 13% to
$37.2 million for the nine months ended September 30, 2008 up from $32.9 million in the same period of 2007. This increase was driven primarily by increased research and development headcount and related costs in support of our revenue growth
and to a lesser extent severance incurred and inflationary increases in payroll and related costs. As a percentage of revenue, research and development expenses were 20% for the nine months ended September 30, 2008 compared to 19% in the same
period of 2007. This increase was primarily driven by the increased amount of dollars invested in research and development to support our revenue growth and severance incurred.
General and Administrative.
General and administrative expenses increased 33% to $15.6 million for the nine months ended September 30, 2008
up from $11.7 million in the same period of 2007. This increase was driven primarily by increased legal fees of $2.1 million incurred with defending the complaints described in Note 9 of the Notes to the Financial Statements and severance incurred
of $1.3 million. As a percentage of revenue, general and administrative expenses were 8% for the nine months ended September 30, 2008 compared to 7% in the same period of 2007. This increase was primarily due to the increased legal fees
incurred defending the previously mentioned lawsuits and severance incurred.
Amortization of Purchased Intangible Assets.
Amortization expense for these acquired tradenames and customer lists was $6.7 million for the nine months ended September 30, 2008 compared to $8.3 million in the same period of 2007. This decrease was primarily driven by certain assets
being fully amortized.
21
Share-Based Compensation Expense
. Share-based compensation expense related to stock options,
restricted stock awards and shares purchased under our ESPP under SFAS No. 123(R) was allocated as follows for the periods indicated (in thousands):
|
|
|
|
|
|
|
|
|
Nine Months Ended
September 30,
|
|
|
2008
|
|
2007
|
Cost of product revenues
|
|
$
|
227
|
|
$
|
268
|
Cost of service revenues
|
|
|
442
|
|
|
613
|
Selling and marketing
|
|
|
4,653
|
|
|
6,907
|
Research and development
|
|
|
2,723
|
|
|
2,773
|
General and administrative
|
|
|
1,738
|
|
|
1,800
|
|
|
|
|
|
|
|
Total share-based compensation expense
|
|
$
|
9,783
|
|
$
|
12,361
|
|
|
|
|
|
|
|
The decrease in share-based compensation expense in selling and marketing and in total is
primarily due to the departure of former CipherTrust employees, along with the workforce reduction in April 2008.
Litigation.
The
litigation settlement expense of $9.2 million in the nine months ended September 30, 2008 pertained to a charge related to litigation brought by Finjan Software Ltd. This expense represents a jury verdict in favor of the plaintiff for $9.2
million. We have asked the trial court to set aside the jurys verdict. The motion remains pending and has not been ruled on by the trial court. Therefore, the timing and amount of total payment have not been finalized. For further details
regarding this lawsuit, see Note 9 in the Notes to the Financial Statements.
Goodwill.
Goodwill impairment charge reduced the book
value of our equity to its implied fair value, which was determined based on the announced merger with McAfee. The implied fair value calculation resulted in recording a goodwill impairment charge of $15.4 million for the nine months ended
September 30, 2008 (see Note 4). There was not a similar charge in the same period of 2007.
Gain on Divestiture of SafeWord
Product Line.
We recorded a gain on the divestiture of the SafeWord product line of $70.7 million for the nine months ended September 30, 2008 (see Note 5). There was not a similar benefit in the same period of 2007.
Other Expense.
Other expense of $4.7 million for the nine months ended September 30, 2008, consists primarily of interest expense, including
the write-off of the deferred financing costs, related to the term debt, compared to $5.6 million in the same period of 2007.
Income
Taxes.
During the nine months ended September 30, 2008, we recorded income tax expense of $4.0 million. Income taxes related to the gain on the divestiture of the SafeWord product line were substantially offset by the release of valuation
allowance on NOLs where the benefit of the release is recorded in the condensed consolidated statement of operations. The $4.0 million of income tax expense consists of $874,000 of non-cash foreign tax expense associated primarily with the release
of valuation allowance on utilized acquired NOLs where the benefit of the release is offset to goodwill, $321,000 of non-cash U.S. tax expense of which a portion relates to deferred tax liabilities, $239,000 of tax expense for various foreign taxes,
and $2.6 million is related to U. S. federal and state income tax expense. This is compared with an income tax expense of $6.6 million in the same period of 2007. Of this $6.6 million of income tax expense, $1.4 million is related to non-cash
foreign tax expense associated primarily with the release of valuation allowance on utilized acquired NOLs where the benefit of the release is offset to goodwill, $2.4 million is related to various other foreign income taxes, $2.4 million is related
to non-cash U.S. tax expense associated with the need to provide additional tax expense for valuation allowance on net operating losses, and $440,000 is related to U.S. federal and state income tax expense.
In accordance with SFAS No. 109, we have assessed the likelihood that the net deferred tax assets will be realized. SFAS No. 109 requires the
consideration of a valuation allowance in all circumstances, if the conclusion is not more likely than not a valuation allowance is required. We have recorded a deferred tax liability in our consolidated balance sheet for indefinite lived intangible
assets that are not deductible for tax purposes and therefore cannot be used to realize additional reversing deferred tax assets. We also have a deferred tax asset that is able to be recognized as a result of the FIN 48 liabilities that are
recorded. In accordance with SFAS No. 109, our remaining noncurrent deferred tax liabilities are netted with our noncurrent deferred tax assets and are presented as a single amount in our condensed consolidated balance sheet. We have determined
that primarily all of our net deferred tax assets are not more likely than not to be realized, and as such a full valuation allowance has been placed on this amount.
Estimates were used in the determination of our provision for income taxes, current income taxes payable, as well as in our deferred tax asset and liability analysis. These estimates take into account current tax laws
and our interpretation of these current tax laws within the various taxing jurisdictions within which we operate. Changes in the tax laws or our interpretation of tax laws and the resolution of future audits could impact our provision for income
taxes.
22
LIQUIDITY AND CAPITAL RESOURCES
Our cash and cash equivalents increased by $28.5 million from $12.1 million at December 31, 2007 to $40.6 million at September 30, 2008. For the nine months ended September 30, 2008 we generated $27.2
million from operating activities and $2.6 million from the exercise of stock options and the sale of common stock through our ESPP. We generated $63.0 million of proceeds from the divestiture of SafeWord product line of which we used $44.0 million
to repay the outstanding balance on our term debt and $8.6 million was transferred to restricted cash to be held in escrow according to the terms of the agreement. We also utilized $9.8 million for capital purchases.
Net cash provided by operating activities of $27.2 million for the nine months ended September 30, 2008 was generated by our net income adjusted for
non-cash expenses and our collections outpacing our operating expenses. Terms for cash collections received from customers and cash payments made to vendors were consistent with normal business practices.
Net cash provided by investing activities of $42.9 million during the nine months ended September 30, 2008 consisted primarily of $63.0 million
provided by the divestiture of SafeWord product line, offset by $9.8 million for capital additions, which were primarily for leasehold improvements and furniture for our St. Paul, MN office expansion and San Jose, CA office relocation and customer
evaluation appliances along with $9.2 million held as restricted cash related primarily to the divestiture of our SafeWord product line.
Net cash used for financing activities of $41.4 million for the nine months ended September 30, 2008 consisted of $44.0 million for the repayment of the outstanding balance on our term debt, offset by $2.6 million in proceeds related
to the exercise of stock options and the sale of common stock through our ESPP.
We believe that we have sufficient financial resources
available to fund our current working capital and capital expenditure requirements for at least the next twelve months. We have a standby letter of credit at Wells Fargo of $800,000 related to the expansion of our St. Paul, MN facility. We have two
restricted escrow accounts at Wells Fargo, a stipulation of the sale of SafeWord to Aladdin. The financial statements escrow account is equal to $1.0 million with a release date on or before December 31, 2008 with the delivery of the audited
SafeWord financial statements to Aladdin. The indemnity escrow account is equal to 12% of the purchase price, $7.5 million, to be held on behalf of Secure Computing to secure the indemnification obligations of Secure Computing related to the
SafeWord divestiture, with a release date of September 4, 2009.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our discussion of the financial condition and results of operations is based upon the condensed consolidated financial statements, which have been
prepared in conformity with U.S. generally accepted accounting principles. The preparation of our financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and
expenses, and related disclosure of any contingent assets and liabilities at the date of the financial statements. Management regularly reviews its estimates and assumptions, which are based on historical factors and other factors that are believed
to be relevant under the circumstances. Actual results may differ from these estimates under different assumptions, estimates, or conditions. We believe that the estimates, assumptions and judgments involved in the accounting policies described in
Managements Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2007 have the greatest potential impact on our financial statements, so we consider
them to be our critical accounting policies and estimates. During the nine months ended September 30, 2008, there were no significant changes to those critical policies and estimates.
23
CAUTIONARY STATEMENTS
In this Quarterly Report on Form 10-Q and in other written or oral statements made from time to time, we have included and may include statements that constitute forward-looking statements with respect to
the financial condition, results of operations, plans, objectives, new products, future performance and business of Secure Computing Corporation and its subsidiaries. Statements preceded by, followed by or that include words such as may,
will, expect, anticipate, continue, estimate, forecast, project, believe or similar expressions are intended to identify some of the forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are included, along with this statement, for purposes of complying with the safe harbor provisions of that Act. These forward-looking statements involve risks
and uncertainties. By identifying these statements for you in this manner, we are alerting you to the possibility that actual results may differ, possibly materially, from the results indicated by these forward-looking statements. We undertake no
obligation to update any forward-looking statements. Actual results may differ materially from those contemplated by the forward-looking statements due to, among others, the risks and uncertainties discussed in Part I, Item 1A of our Annual
Report on Form 10-K for the year ended December 31, 2007, in Part II, Item IA of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, and in Part II, Item 1A of this Quarterly Report on Form 10-Q. Since it is not
possible to foresee all such factors, you should not consider these factors to be a complete list of all risks or uncertainties. We believe the most significant factors that could affect our future operations and results are set forth in the list
below.
|
1.
|
Inability to achieve operating profits and remain cash flow positive.
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|
2.
|
Influences of our Series A Preferred Stockholders and other large stockholders.
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|
3.
|
Requirements to provide volume price discounts and other allowances and significant costs incurred in customizing our products.
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4.
|
Consolidation among competitors and product introductions by competitors that have advanced technology, better features or lower pricing.
|
|
5.
|
The lack of diversification among our product lines and the inclusion of products similar to ours in vendors hardware or software rendering our products obsolete.
|
|
6.
|
Inability to obtain and maintain patents on our devices and concepts.
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|
7.
|
Adverse developments in litigation, including patent or other intellectual property litigation.
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|
8.
|
Disclosure of our trade secrets or proprietary information.
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|
9.
|
Inability to receive hardware components and subassemblies from third party manufacturers on a timely basis.
|
|
10.
|
Functional and design failures of our products.
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|
11.
|
Loss of one or more significant customers.
|
|
12.
|
Failure to collect on a timely basis amounts owed to us by our customers.
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|
13.
|
The volatility of our quarterly operating results.
|
|
14.
|
Inability to attract and retain highly qualified personnel to develop our products and manage our business.
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15.
|
A substantial decline in one or more of our major foreign markets.
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16.
|
Failure to complete the merger with McAfee, Inc.
|
Item 3.
|
Quantitative and Qualitative Disclosures About Market Risk
|
None.
Item 4.
|
Controls and Procedures
|
Evaluation of
Disclosure Controls and Procedures
Management of our company is responsible for establishing and maintaining effective disclosure
controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of September 30, 2008 an evaluation was performed, under the supervision and with the participation of management, including our
Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that as of
September 30, 2008, our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information required to be disclosed in the Quarterly Report on Form 10-Q was recorded, processed, summarized and
reported within the time period required by the Securities and Exchange Commissions rules and forms and accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions
regarding required disclosure.
24
Changes in Internal Control Over Financial Reporting
During the quarter ended September 30, 2008, there were no changes in our internal control over financial reporting that materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting.
25
PART IIOTHER INFORMATION
Item 1.
|
Legal Proceedings
|
Finjan Software Litigation
On June 5, 2006, Finjan Software, Ltd. filed a complaint entitled Finjan Software, Ltd. v. Secure Computing Corporation in the United States District
Court for the District of Delaware against Secure Computing Corporation, CyberGuard Corporation, and Webwasher AG. The complaint alleged that Secure Computing and its named subsidiaries infringe U.S. Patent No. 6,092,194 (194 Patent)
based on the manufacture, use, and sale of the Webwasher Secure Content Management suite and CyberGuard TSP. On April 10, 2007, Finjan amended its Complaint to allege that Secure Computing and its named subsidiaries infringe U.S. Patent
No. 6,804,780 (780 Patent) and U.S. Patent No. 7,058,822 (822 Patent) based on the manufacture, use, and sale of the Webwasher Secure Content Management suite. Secure Computing denies infringing any valid claims of the
194 Patent, the 780 Patent, or the 822 Patent. The answer and counterclaims to Finjans amended complaint were filed on April 20, 2007. In its counterclaims, Secure Computing alleges that Finjan infringes two Secure
Computing patents-U.S. Patent No. 6,357,010 and U.S. Patent No. 7,185,361.
The case was tried before a jury in Delaware in March
2008. The jury entered a verdict in favor of the plaintiff on March 12, 2008 and the District Court entered judgment on March 28, 2008. The jury found that Secure Computing infringed certain claims of Finjans patents and awarded
damages in favor of Finjan in the amount of $9.2 million. The jury also found that the patents asserted by Secure Computing are valid but that Finjan has no liability to Secure Computing under our asserted patents. As a result of the jury verdict in
the case, we recorded a $9.2 million pre-tax charge, which is a reasonable estimate of the probable loss, if the jury verdict is not reduced, set aside or overturned. The jurys verdict, including the damage award, is subject to the outcome of
the post-verdict motions described below.
On March 27, 2008, Secure Computing filed a combined motion for judgment as a matter of
law, new trial, and/or remittitur, asking the trial court to set aside the jurys verdict, to reduce or eliminate the damages award, and/or for a new trial, which motions were renewed on April 10, 2008. On April 4, 2008, Finjan filed
amended motions for an injunction, enhanced damages, interest, attorneys fees, costs, expenses and an accounting of damages. Finjan also filed a motion for judgment as a matter of law to set aside the jurys verdict that Secure
Computings patents are valid. On April 7, 2008, Secure Computing filed a motion to stay execution of the judgment pending the post-trial motions. Briefing for these motions was completed on May 16, 2008. All of the motions remain
pending. At this time, it is not possible to predict the timing or outcome of these motions or reasonably estimate the additional amount of loss, if any, that Secure Computing might suffer. We believe that the allegations included in the complaint
are wholly without merit and intend to defend this litigation vigorously. If necessary, we will appeal the trial courts decision to the Federal Circuit Court of Appeals.
Rosenbaum Capital Class Action Litigation
On January 19, 2007, Rosenbaum Capital, LLC filed a
putative securities class action complaint in the United States District Court for the Northern District of California against Secure Computing and certain officers of Secure Computing. The alleged plaintiff class includes persons who acquired our
stock between May 4, 2006 and July 11, 2006. The complaint alleged generally that defendants made false and misleading statements about our business condition and prospects for the fiscal quarter ended June 30, 2006, in violation of
Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. The complaint sought unspecified monetary damages. After plaintiff filed an amended complaint on July 2, 2007, the defendants filed a motion to dismiss. The
trial court denied that motion on March 4, 2008. The defendants filed answers to the amended complaint on April 25, 2008.
On
October 14, 2008, the parties participated in a mediation of plaintiffs claims. At the mediation, the parties agreed, subject to formal documentation in mutually agreeable form and to court approval after notice to the settlement class,
to a settlement of all claims in the case in exchange for a payment of $3.6 million. Under the terms of the tentative agreement, our primary director and officer liability insurance carrier will pay the entire settlement amount. Both Secure
Computing and the individual defendants have denied and continue to deny plaintiffs substantive allegations and any wrongdoing.
Josifovich
Litigation
On September 21, 2007, Diane Josifovich filed a complaint against Secure Computing in the Superior Court of New Jersey,
Somerset County. The complaint alleges that Secure Computing breached its contract with Ms. Josifovich with respect to payment for commission sales. The complaint also asserts claims of promissory estoppel, equitable estoppel,
misrepresentation, and breach of the covenant of good faith and fair dealing. The complaint also alleges that Secure Computing retaliated against Ms. Josifovich and created a hostile work environment on the basis of Ms. Josifovichs
gender. The complaint seeks unspecified monetary damages. The case was removed to the United States District Court for the
26
District of New Jersey. In February 2008, the plaintiff amended her complaint to add some additional allegations, including a claim that she was allegedly
retaliated against by being placed on a performance improvement plan and terminated. Secure Computing has answered the complaint, denying all of Ms. Josifovichs claims and denying any liability. This matter is pending, with the parties
conducting depositions and documentary discovery. We intend to vigorously defend the claims against us.
Class Action relating to Proposed Sale to
McAfee
Following the announcement on September 22, 2008 of the proposed sale of Secure Computing to McAfee, Inc., four class
action complaints were filed in the Superior Court of the State of California Santa Clara County, and one class action complaint was filed in the Superior Court of the State of California Los Angeles County. The four Santa Clara complaints were
consolidated into an amended complaint that was filed in Santa Clara County on October 17, 2008. On October 14, 2008, the defendants moved to transfer the Los Angeles complaint to Santa Clara County. On October 20, 2008, the Los
Angeles County Court granted the defendants motion, and the case is being transferred to Santa Clara. The Santa Clara County consolidation order provides that all actions filed in, removed to or transferred to Santa Clara County must be
consolidated with the other four cases already in Santa Clara County. The defendants response to the consolidated amended complaint is currently scheduled to be due on or about November 17, 2008.
The consolidated amended complaint makes numerous allegations against Secure Computing, our board of directors, and McAfee. The complaint alleges various
breaches of fiduciary duty by the members of our board of directors relating to the proposed sale of Secure Computing. In particular, the complaint alleges breaches of the individual directors duties of due care, loyalty and good faith by
failing to fully inform themselves of potential competing proposals, failing to disclose material information regarding the transaction to our stockholders, and favoring their interests over the interests of our stockholders. The complaint further
alleges that Secure Computing and McAfee aided and abetted the alleged breaches of fiduciary duty. We believe these claims to be wholly without merit and intend to defend this litigation vigorously.
The consolidated amended complaint seeks an order declaring our merger agreement with McAfee to be unlawful and unenforceable, enjoining the proposed
sale, requiring the individual defendants to conduct a more extensive auction process for Secure Computing, rescinding the merger agreement, requiring us to provide additional disclosure to our stockholders regarding the proposed transaction,
imposing a constructive trust on any benefits improperly received by the individual defendants in the proposed transaction, and awarding plaintiffs costs and disbursements in pursuing their claims.
On October 22, 2008, the court granted plaintiffs request for limited expedited discovery and ordered the parties to negotiate the scope of
appropriate discovery. The parties are negotiating the scope of appropriate discovery and providing the agreed-upon information.
Additional Litigation
From time to time we may be engaged in certain other legal proceedings and claims arising in the ordinary course of our business. The
ultimate liabilities, if any, which may result from these or other pending or threatened legal actions against us cannot be determined at this time. However, in the opinion of management, the facts known at the present time do not indicate that such
litigation will have a material effect on our consolidated financial position or results of operations.
Failure to complete the merger for
any reason other than acceptance of a superior proposal could adversely affect our stock price and our future business and financial results.
Completion of the merger is conditioned upon, among other things, adoption of the merger agreement by
our stockholders, the absence of any injunction making the merger illegal or otherwise preventing the closing of the merger, and other customary closing conditions. There is no assurance that we will satisfy the conditions necessary for completion
of the merger. Failure to complete the merger would prevent us and our stockholders from realizing its anticipated benefits. We will also incur significant transaction costs, whether or not the merger is completed and, under certain circumstances,
may be required to pay up to $16.1 million to McAfee, Inc. if the merger agreement is terminated. In addition, the current market price of our common stock likely reflects a market assumption that the merger or another change in control transaction
will occur, and a failure to complete the merger for reasons other than the acceptance of a superior proposal could result in a significant decline in the market price of our common stock.
Our business could be adversely impacted by uncertainty related to the proposed merger, whether or not the merger is completed.
Whether or not the
merger is completed, the announcement and pendency of the merger could negatively impact or cause disruptions in our business, which could have an adverse effect on our results of operations, financial condition and success of the merger. In
particular:
|
|
|
our employees may experience uncertainty about their future roles with the current and/or combined company, which might adversely affect our ability to retain and
hire managers and other employees;
|
27
|
|
|
the attention of our management may be directed toward the completion of the merger and transaction-related considerations and diverted away from the day-to-day
business operations of the Company; and
|
|
|
|
existing and future litigation related to the merger may result in additional expense and management distraction.
|
Other than the changes to our risk factors discussed above and in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2008, there have
been no material changes in the risk factors set forth in our 2007 Annual Report on Form 10-K. For further information, see Part I, Item 1A, Risk Factors in our 2007 Annual Report on Form 10-K and Part II, Item 1A, Risk Factors in our
Quarterly Report on Form 10-Q for the period ended June 30, 2008.
Item 2.
|
Unregistered Sales of Equity Securities and Use of Proceeds
|
During the quarter ended September 30, 2008, 18,726 shares of our common stock were surrendered to Secure Computing by participants in our stock-based compensation plans to satisfy the tax obligations related to the vesting of
restricted stock awards. Information regarding the surrendered shares follows:
|
|
|
|
|
|
|
|
|
|
Period
|
|
Total Number of
Shares Purchased
|
|
Average Price
Paid per Share
|
|
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
|
|
Maximum
Number of Shares
that May Yet Be
Purchased Under
the Plans or
Programs
|
July
|
|
|
|
|
|
|
|
|
|
August
|
|
6,463
|
|
$
|
4.34
|
|
|
|
|
September
|
|
12,263
|
|
$
|
4.13
|
|
|
|
|
Total
|
|
18,726
|
|
$
|
4.20
|
|
|
|
|
Item 3.
|
Defaults Upon Senior Securities
|
Not applicable
Item 4.
|
Submission of Matters to a Vote of Security Holders
|
None
Item 5.
|
Other Information
|
None
|
|
|
Exhibit
|
|
Description
|
2.1
|
|
Asset Purchase Agreement by and between Secure Computing Corporation and Aladdin Knowledge Systems Ltd., dated as of July 29, 2008, is incorporated by reference to Exhibit 2.1 to our
Current Report on Form 8-K filed with the SEC on July 31, 2008.
|
|
|
2.2
|
|
Agreement and Plan of Merger by and among McAfee, Inc., Seabiscuit Acquisition Corporation and Secure Computing Corporation, dated as of September 21, 2008, is incorporated by reference to
Exhibit 2.1 to our Current Report on Form 8-K filed with the SEC on September 25, 2008.
|
|
|
2.3
|
|
Voting Agreement (Series A) by and among McAfee, Inc., Warburg Pincus Private Equity IX, L.P. and Cary Davis, dated as of September 21, 2008, is incorporated by reference to Exhibit 2.2 to our
Current Report on Form 8-K filed with the SEC on September 25, 2008.
|
28
|
|
|
Exhibit
|
|
Description
|
2.4
|
|
Voting Agreement by and between McAfee, Inc. and certain stockholders, option holders and warrant holders of Secure Computing Corporation, dated as September 21, 2008, is incorporated by
reference to Exhibit 2.3 to our Current Report on Form 8-K filed with the SEC on September 25, 2008.
|
|
|
3.1
|
|
Restated Certificate of Incorporation, effective March 6, 1996, as amended by the Certificate of Amendment of Certificate of Incorporation effective December 11, 1998, is incorporated by
reference to Exhibit 3.1 to our Amended Quarterly Report on Form 10-Q/A for the period ended June 30, 2000.
|
|
|
3.2
|
|
Certificate of Designations, Preferences and Rights of Series A Convertible Preferred Stock is incorporated by reference to Exhibit 3.1 to our Current Report on Form 8-K filed with the SEC on
August 19, 2005.
|
|
|
3.3
|
|
By-Laws are incorporated by reference to Exhibit 3.3 to our Quarterly Report on Form 10-Q for the quarter ended June 30, 2008.
|
|
|
10.1
|
|
Employment Agreement with Daniel Ryan, effective as of July 1, 2008, is incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed with the SEC on July 18,
2008.
|
|
|
10.2
|
|
Description of severance arrangements with certain executive officers is incorporated by reference to Item 5.02 of our Current Report on Form 8-K filed with the SEC on July 25,
2008.
|
|
|
10.3
|
|
Separation and Release Agreement with Vincent Schiavo, effective as of October 1, 2007.
|
|
|
31.1
|
|
Certification of Chief Executive Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
|
|
|
31.2
|
|
Certification of Chief Financial Officer Pursuant to Section 302 of Sarbanes-Oxley Act of 2002.
|
|
|
32.1
|
|
Certification by Chief Executive Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
|
|
|
32.2
|
|
Certification by Chief Financial Officer Pursuant to Section 906 of Sarbanes-Oxley Act of 2002.
|
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
|
|
|
|
|
|
|
SECURE COMPUTING CORPORATION
|
|
|
|
|
|
By:
|
|
/s/ Timothy J. Steinkopf
|
Date: November 4, 2008
|
|
|
|
Timothy J. Steinkopf
|
|
|
|
|
Senior Vice President of Operations and Chief Financial Officer
|
|
|
|
|
(Duly authorized officer and Principal Financial Officer)
|
30
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