UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

Form 10-Q

 

 

 

 

 

Registrant’s telephone number, including area code:

(408) 517-8000

 

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  þ      No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  þ      Accelerated Filer  o      Non-accelerated filer  o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o      No  þ

 

Shares of Symantec common stock, $0.01 par value per share, outstanding as of July 27, 2007: 882,521,613 shares.

 

SYMANTEC CORPORATION

 

FORM 10-Q

 

Quarterly Period Ended June 30, 2007

 

TABLE OF CONTENTS

 

 

 

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

 

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

SYMANTEC CORPORATION

 

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Recent accounting pronouncements

 

In February 2007, the FASB, issued Statement of Financial Accounting Standards, or SFAS, No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of SFAS No. 115. SFAS No. 159 permits companies to choose to measure certain financial instruments and certain other items at fair value and requires unrealized gains and losses on items for which the fair value option has been elected to be reported in earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We are currently in the process of evaluating the impact of SFAS No. 159 on our consolidated financial statements.

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. SFAS No. 157 establishes a framework for measuring the fair value of assets and liabilities. This framework is intended to provide increased consistency in how fair value determinations are made under various existing accounting standards which permit, or in some cases require, estimates of fair market value. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. We are currently in the process of evaluating the impact of SFAS No. 157 on our consolidated financial statements.

 

In September 2006, the FASB issued Emerging Issues Task Force Issue, or EITF, No. 06-1, Accounting for Consideration Given by a Service Provider to a Manufacturer or Reseller of Equipment Necessary for an End-Customer to Receive Service from the Service Provider. EITF No. 06-1 requires that we provide disclosures regarding the nature of arrangements in which we provide consideration to manufacturers or resellers of equipment necessary for an end-customer to receive service from us, including the amounts recognized in the Consolidated Statements of Income. EITF No. 06-1 is effective for fiscal years beginning after June 15, 2007. We do not expect the adoption of EITF No. 06-1 to have a material impact on our consolidated financial statements.

 

In March 2006, the FASB issued Emerging Issues Task Force Issue 06-03 – How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (“EITF 06-03”). Pursuant to this issue we elected to present taxes collected from customers and remitted to governmental authorities net in our financial statements. This treatment is consistent with our historical presentation. EITF 06-03 is effective for interim and annual reporting periods beginning after December 15, 2006, with earlier application permitted. We do not expect the adoption of EITF 06-03 to have any impact on our consolidated financial statements.

 

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments , which amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities , and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. SFAS No. 155 simplifies the accounting for certain derivatives embedded in other financial instruments by allowing them to be accounted for as a whole, if the holder elects to account for the entire instrument on a fair value basis. SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133 and SFAS No. 140. SFAS No. 155 is effective for all financial instruments acquired, issued, or subject to a re-measurement event occurring in fiscal years beginning after September 15, 2006. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We do not expect the adoption of SFAS No. 155 to have a material impact on our consolidated financial statements.

 

 

 

Accumulated other comprehensive income as of June 30, 2007 and 2006 consists primarily of foreign currency translation adjustments, net of taxes. Unrealized gains and losses on available-for-sale investments, net of taxes, were immaterial for all periods presented.

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Company-i

 

On December 1, 2006, we completed our acquisition of Company-i Limited, or Company-i, a UK-based professional services firm that specialized in addressing key challenges associated with operating and managing a data center in the financial services industry, for $26 million in cash, including an immaterial amount for acquisition related expenses. The aggregate purchase price was allocated as follows, based on the currency exchange rate on the date of acquisition: goodwill, $22 million; other intangible assets, $6 million; net deferred tax liabilities, $2 million; and an immaterial amount to net tangible assets. Goodwill resulted primarily from our expectation of synergies from the integration of Company-i’s service offerings with our service offerings. The amount allocated to Other intangible assets is being amortized to Operating expenses in the Condensed Consolidated Statements of Income over its estimated useful life of eight years. The results of operations of Company-i have been included in our results of operations since its acquisition date. The financial results of this acquisition are considered immaterial for purposes of pro forma financial disclosures. Company-i is included in our Services segment. Goodwill is not deductible for tax purposes.

 

In addition, the purchase price was subject to an adjustment of up to $11 million in cash if Company-i achieved certain billings targets by March 31 or September 30, 2007, or September 30, 2008. During the June quarter, we determined that the billing targets were met as of June 29, 2007 and therefore recorded a liability of approximately $12 million, including the effects of foreign exchange and booked an adjustment to goodwill, in accordance with SFAS No. 141, Business Combinations.

 

Altiris

 

On April 6, 2007, we completed our acquisition of 100% of the equity interest of Altiris Inc., or Altiris, a leading provider of information technology management software that enables businesses to easily manage and service network-based endpoints. The aggregate purchase price, including acquisition related costs, was approximately $1,045 million, of which approximately $841 million was paid in cash, which amount was net of Altiris’ cash and cash equivalents balance. We believe this acquisition will enable us to help customers better manage and enforce security policies at the endpoint, identify and protect against threats, and repair and service assets. The aggregate purchase price was preliminarily allocated as follows: goodwill, $633 million; other intangible assets, $223 million; net income tax liabilities, $139 million; developed technology, $90 million; and net tangible assets, $238 million. Goodwill resulted primarily from our expectation of synergies from the integration of Altiris’ service offerings with our service offerings. The amount allocated to Developed technology is being amortized to Cost of revenues in the Condensed Consolidated Statements of Income over its estimated useful life of one to six years. The amount allocated to Other intangible assets is being amortized to Operating expenses in the Condensed Consolidated Statements of Income over its estimated useful life of three to eight years. The results of operations of Altiris have been included in our results of operations since its acquisition date. The financial results of this acquisition are considered immaterial for purposes of pro forma financial disclosures. Altiris is included in the new Altiris segment. Goodwill is not deductible for tax purposes.

 

Huawei Technologies Joint Venture

 

In May 2007, we signed an agreement to form a joint venture with Huawei Technologies Co., Ltd., or the joint venture. The joint venture will develop, manufacture, market and support security and storage appliances to global telecommunications carriers and enterprise customers. We will contribute storage and security software and $150 million in cash in return for a 49% interest in the joint venture. The joint venture is expected to close late in calendar year 2007, pending required regulatory and governmental approvals.

 

 

 

 

Goodwill is tested for impairment on an annual basis during the March quarter, or earlier if indicators of impairment exist. Based on our review at June 30, 2007, no indicators of impairment existed.

 

Acquired product rights, net

 

Acquired product rights, net subject to amortization are as follows:

 

 

 

 

 

Amortization expense for other intangible assets was $57 million and $51 million for the three-month periods ended June 30, 2007 and 2006, respectively. Amortization of other intangible assets is included in Operating expenses in the Condensed Consolidated Statements of Income. The weighted-average remaining estimated lives for other intangible assets are approximately six years for customer base, approximately eight years for trade name, and approximately one year for partnership agreements. The weighted-average remaining estimated life of other intangible assets is approximately six years. Amortization expense for other intangible assets, based upon our existing other intangible assets and their current useful lives as of June 30, 2007, is estimated to be as follows (in thousands) :

 

 

 

Convertible senior notes

 

In June 2006, we issued $1.1 billion principal amount of 0.75% Convertible Senior Notes due June 15, 2011, or the 0.75% Notes, and $1.0 billion principal amount of 1.00% Convertible Senior Notes due June 15, 2013, or the 1.00% Notes, to initial purchasers in a private offering for resale to qualified institutional buyers pursuant to SEC

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Rule 144A. We refer to the 0.75% Notes and the 1.00% Notes collectively as the Senior Notes. We received proceeds of $2.1 billion from the Senior Notes and incurred net transaction costs of approximately $33 million, which were allocated proportionately to the 0.75% Notes and the 1.00% Notes. The transaction costs were primarily recorded in Other long-term assets and are being amortized to interest expense using the effective interest method over five years for the 0.75% Notes and seven years for the 1.00% Notes. The 0.75% Notes and 1.00% Notes were each issued at par and bear interest at 0.75% and 1.00% per annum, respectively. Interest is payable semiannually in arrears on June 15 and December 15, beginning December 15, 2006.

 

Each $1,000 of principal of the Senior Notes will initially be convertible into 52.2951 shares of Symantec common stock, which is the equivalent of $19.12 per share, subject to adjustment upon the occurrence of specified events. Holders of the Senior Notes may convert their Senior Notes prior to maturity during specified periods as follows: (1) during any calendar quarter beginning after June 30, 2006, if the closing price of our common stock for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is more than 130% of the applicable conversion price per share; (2) if specified corporate transactions, including a change in control, occur; (3) with respect to the 0.75% Notes, at any time on or after April 5, 2011, and with respect to the 1.00% Notes, at any time on or after April 5, 2013; or (4) during the five business-day period after any five consecutive trading-day period during which the trading price of the Senior Notes falls below a certain threshold. Upon conversion, we would pay the holder the cash value of the applicable number of shares of Symantec common stock, up to the principal amount of the note. Amounts in excess of the principal amount, if any, may be paid in cash or in stock at our option. Holders who convert their Senior Notes in connection with a change in control may be entitled to a “make whole” premium in the form of an increase in the conversion rate. As of June 30, 2007, none of the conditions allowing holders of the Senior Notes to convert had been met. In addition, upon a change in control of Symantec, the holders of the Senior Notes may require us to repurchase for cash all or any portion of their Senior Notes for 100% of the principal amount.

 

Under the terms of the Senior Notes, we were required to use reasonable efforts to file a shelf registration statement regarding the Senior Notes with the SEC and cause the shelf registration statement to be declared effective within 180 days of the closing of the offering of the Senior Notes. In addition, we must maintain the effectiveness of the shelf registration statement for a period of two years after the closing of the offering of the Senior Notes. If we fail to meet these terms, we will be required to pay additional interest on the Senior Notes in the amount of 0.25% per annum. We have filed the shelf registration statement with the SEC and it became effective on December 11, 2006.

 

Concurrently with the issuance of the Senior Notes, we entered into note hedge transactions with affiliates of certain of the initial purchasers whereby we have the option to purchase up to 110 million shares of our common stock at a price of $19.12 per share. The options as to 58 million shares expire on June 15, 2011 and the options as to 52 million shares expire on June 15, 2013. The options must be settled in net shares. The cost of the note hedge transactions to us was approximately $592 million. In addition, we sold warrants to affiliates of certain of the initial purchasers whereby they have the option to purchase up to 110 million shares of our common stock at a price of $27.3175 per share. The warrants expire on various dates from July 2011 through August 2013 and must be settled in net shares. We received approximately $326 million in cash proceeds from the sale of these warrants.

 

The cost incurred in connection with the note hedge transactions, net of the related tax benefit and the proceeds from the sale of the warrants, is included as a net reduction in Capital in excess of par value in the accompanying Consolidated Balance Sheet as of June 30, 2007, in accordance with the guidance in Emerging Issues Task Force, or EITF, No. 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.

 

In accordance with SFAS No. 128, Earnings per Share , the Senior Notes will have no impact on diluted earnings per share until the price of our common stock exceeds the conversion price of $19.12 per share because the principal amount of the Senior Notes will be settled in cash upon conversion. Prior to conversion we will include the effect of the additional shares that may be issued if our common stock price exceeds $19.12 per share using the

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

treasury stock method. As a result, for the first $1.00 by which the price of our common stock exceeds $19.12 per share there would be dilution of approximately 5.4 million shares. As the share price continues to increase, additional dilution would occur at a declining rate such that a price of $27.3175 per share would yield cumulative dilution of approximately 32.9 million shares. If our common stock exceeds $27.3175 per share we will also include the effect of the additional potential shares that may be issued related to the warrants using the treasury stock method. The Senior Notes along with the warrants have a combined dilutive effect such that for the first $1.00 by which the price exceeds $27.3175 per share there would be cumulative dilution of approximately 39.5 million shares prior to conversion. As the share price continues to increase, additional dilution would occur but at a declining rate.

 

Prior to conversion, the note hedge transactions are not considered for purposes of the earnings per share, or EPS, calculation as their effect would be anti-dilutive. Upon conversion, the note hedge will automatically serve to neutralize the dilutive effect of the Senior Notes when the stock price is above $19.12 per share. For example, if upon conversion the price of our common stock was $28.3175 per share, the cumulative effect of approximately 39.5 million shares in the example above would be reduced to approximately 3.9 million shares.

 

The preceding calculations assume that the average price of our common stock exceeds the respective conversion prices during the period for which EPS is calculated and exclude any potential adjustments to the conversion ratio provided under the terms of the Senior Notes. See Note 10 for information regarding the impact on EPS of the Senior Notes and warrants in the current period.

 

Line of credit

 

In July 2006, we entered into a five-year $1 billion senior unsecured revolving credit facility that expires in July 2011. Borrowings under the facility bear interest, at our option, at either a rate equal to the bank’s base rate or a rate equal to LIBOR plus a margin based on our leverage ratio, as defined in the credit facility agreement. In connection with the credit facility, we must maintain certain covenants, including a specified ratio of debt to earnings before interest, taxes, depreciation, and amortization as defined, or EBITDA, as well as various other non-financial covenants. No borrowings are outstanding at June 30, 2007.

 

 

Stock repurchases

 

During the quarter ended June 30, 2007, we completed the $1 billion share repurchase program announced in January 2007. In June 2007, we announced that our Board of Directors authorized the repurchase of an additional $2 billion of Symantec common stock. The repurchase authorization does not have a scheduled expiration date.

 

During the three-month period ended June 30, 2007, we repurchased 25 million shares of our common stock at prices ranging from $19.40 to $20.14 per share for an aggregate amount of $500 million. As of June 30, 2007, an aggregate of $2 billion remained authorized for future repurchases under our authorized stock repurchase programs.

 

 

We currently have in effect certain stock purchase plans, stock award plans, and equity incentive plans, as described in detail in Note 11 of Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended March 31, 2007.

 

 

The expected life of options is based on an analysis of our historical experience of employee exercise and post-vesting termination behavior considered in relation to the contractual life of the option. Expected volatility is based on the average of the historical volatility for the period commensurate with the expected life of the option and the implied volatility of traded options. The risk free interest rate is equal to the U.S. Treasury constant maturity rates for the period equal to the expected life. We do not currently pay cash dividends on our common stock and do not anticipate doing so in the foreseeable future. Accordingly, our expected dividend yield is zero. The fair value of each Restricted Stock Unit, or RSU, is equal to the market value of Symantec’s common stock on the date of grant. The fair value of each Employee stock purchase plan, or ESPP, purchase right granted from July 1, 2005 onwards is equal to the 15% discount on shares purchased. We estimate forfeitures of options, RSUs, and ESPP purchase rights at the time of grant based on historical experience and record compensation expense only for those awards that are expected to vest.

 

Stock-based compensation expense

 

Stock-based compensation is classified in the Condensed Consolidated Statements of Income in the same expense line items as cash compensation. The following table sets forth the total stock-based compensation expense recognized in our Condensed Consolidated Statements of Income for the three-month periods ended June 30, 2007 and 2006.

 

 

As of June 30, 2007, total unrecognized compensation cost related to unvested stock options, RSUs, and Restricted Stock Agreements, or RSAs, was $201 million, $78 million, and $4 million, respectively, which is

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

expected to be recognized over the remaining weighted-average vesting periods of 2.8 years for stock options, 2.1 years for RSUs, and 1 year for RSAs.

 

The weighted-average fair value per share of options granted during the three months ended June 30, 2007 and 2006 was $5.72 and $4.77, respectively. The total intrinsic value of options exercised during the three months ended June 30, 2007 and 2006 was $61 million and $21 million, respectively.

 

The weighted-average fair value per share of RSUs granted during the three months ended June 30, 2007 and 2006 was $19.45 and $16.31, respectively. The total fair value of RSUs that vested during the three months ended June 30, 2007 and 2006 was $12 million and an immaterial amount respectively.

 

Assumed Altiris Stock Options and Awards

 

In connection with our acquisition of Altiris, we assumed all of the outstanding options to purchase Altiris common stock. Each option assumed was converted into an option to purchase Symantec common stock after applying the exchange ratio of 1.9075 shares of Symantec common stock for each share of Altiris common stock. In total, we assumed and converted Altiris options into options to purchase approximately 3 million shares of Symantec common stock. In addition, we assumed and converted all outstanding Altiris RSUs into approximately 320,000 Symantec RSUs, based on the same exchange ratio. Furthermore, we assumed all outstanding Altiris RSAs which were converted into the right to receive cash of $33.00 per share upon vesting. The total value of the assumed RSAs on the date of acquisition was approximately $9 million, assuming no RSAs are forfeited prior to vesting. The total unrecognized compensation cost as of June 30, 2007 related to the Altiris unvested stock options, RSUs and RSAs, was $5 million, $3 million, and $4 million, respectively.

 

The assumed options, RSUs, and RSAs retained all applicable terms and vesting periods, except for certain options, RSAs and RSUs that were accelerated according to the executive vesting plan and will generally vest over a four to twelve month period from the date of acquisition and certain other options that vested in full as of the acquisition date. In general, the assumed options typically vest over a period of three to four years from the original date of grant and have a maximum term of ten years. The assumed RSUs and RSAs typically vest over a period of two to three years from the original date of grant.

 

 

As of June 30, 2007, we had a restructuring and employee termination benefit reserve of $23 million, of which $17 million was included in Other accrued expenses and $6 million was included in Other long-term liabilities on the Condensed Consolidated Balance Sheet. The restructuring reserve consists of $16 million related to reserves established for the fiscal year 2007 plans, $4 million related to restructuring reserves established for the fiscal 2006 plan, and $3 million related to a restructuring reserve assumed from the Veritas acquisition.

 

Restructuring charges

 

In fiscal 2007, we implemented restructuring plans to better align our expenses with our revenue expectations. The costs included amounts for severance, associated benefits, outplacement services, and termination of excess facilities. As of March 31, 2007, $46 million remained related to this reserve. In the June 2007 quarter we increased this reserve by approximately $19 million and paid approximately $49 million related to this reserve. As of June 30, 2007, $16 million remained in this reserve, which we expect to be paid by the end of fiscal 2013.

 

In fiscal 2006, we recorded restructuring costs related to severance, associated benefits, and outplacement services, and related excess facilities. As of March 31, 2007, $5 million remained related to this reserve, the majority of which relates to excess facilities. During the June 2007 quarter, we paid an immaterial amount related to this reserve. As of June 30, 2007, $4 million remained in this reserve, which we expect to be paid by the end of fiscal 2018.

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Amounts related to restructuring expense are included in Restructuring on the Condensed Consolidated Statements of Income.

 

Acquisition-related restructuring

 

In connection with the Veritas acquisition, we assumed a restructuring reserve related to the 2002 Veritas facilities restructuring plan. As of March 31, 2007, $4 million remained related to this reserve. In the June 2007 quarter, we paid an immaterial amount related to this reserve and increased this reserve by an immaterial amount as we determined that the costs related to certain facilities would be greater than originally accrued. The remaining reserve amount of $3 million will be paid over the remaining lease terms, ending at various dates through 2015.

 

 

The following potential common shares were excluded from the computation of diluted net income per share as their effect would have been anti-dilutive:

 

 

For the three-month periods ended June 30, 2007 and 2006, the effect of the warrants and Convertible note was excluded because, as discussed in Note 6, they have no impact on diluted net income per share until our average stock price for the applicable period reaches $27.3175 per share.

 

 

The effective tax rate was approximately 36.5% and 39% for the three-month periods ended June 30, 2007 and 2006. The effective tax rate for both periods is impacted by the benefits of lower-taxed foreign earnings and domestic manufacturing tax incentives, offset by state income taxes and non-deductible stock-based compensation

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

resulting from the adoption of SFAS No. 123R, Share-Based Payment . The higher effective tax rate for the June 2006 quarter includes an accrual of approximately $6 million for penalty risks associated with the late filing of Veritas’ final pre-acquisition income tax return.

 

We adopted the provisions of FIN 48 effective April 1, 2007. FIN 48 addresses the accounting for and disclosure of uncertainty in income tax positions by prescribing a minimum recognition threshold that a tax position is required to satisfy 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.

 

The cumulative effect of adopting FIN 48 was a decrease in tax reserves of $18 million, resulting in a decrease to Veritas goodwill of $11 million, an increase of $6 million to the April 1, 2007 Retained earnings balance, and a $1 million increase in Capital in excess of par value. Upon adoption, the gross liability for unrecognized tax benefits at April 1, 2007 was $455 million, exclusive of interest and penalties. This gross liability is reduced by offsetting tax benefits associated with the correlative effects of potential transfer pricing adjustments, and state income taxes as well as payments made to date. Of the total unrecognized tax benefits, $89 million, if recognized would favorably affect our effective tax rate while the remaining amount would reduce goodwill. In addition, consistent with the provisions of FIN 48, certain reclassifications were made to the balance sheet, including the reclassification of $350 million of income tax liabilities from current to non-current liabilities because payment of cash is not anticipated within one year of the balance sheet date.

 

Our policy to include interest and penalties related to gross unrecognized tax benefits within our provision for income taxes did not change upon the adoption of FIN 48. To the extent accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced in the period that such determination is made, and reflected as a reduction of the overall income tax provision, to the extent that the interest expense had been provided through the tax provision, or as a reduction to goodwill to the extent it had been recognized through purchase accounting. At April 1, 2007, before any tax benefits, we had $91 million of accrued interest and $13 million of accrued penalties on unrecognized tax benefits. Interest included in our provision for income taxes was approximately $5 million for the three months ended June 30, 2007.

 

We recorded an increase of unrecognized tax benefits of approximately $64 million during the quarter-ended June 30, 2007, of which $57 million is related to the acquisition of Altiris and is reflected in the purchase accounting for the acquisition. Of the remaining $7 million, which was recorded through our income tax provision for the quarter, approximately $5 million relates to interest accrued during the period.

 

We file income tax returns in the United States (“U.S.”) on a federal basis and in many U.S. state and foreign jurisdictions. Our two most significant tax jurisdictions are the U.S. and Ireland. Our tax filings remain subject to examination by applicable tax authorities for a certain length of time following the tax year to which those filings relate. Our 2000 through 2007 tax years remain subject to examination by the IRS for U.S. federal tax purposes, and our 1995 through 2007 tax years remain subject to examination by the appropriate governmental agencies for Irish tax purposes. Other significant jurisdictions include California and Japan. As of April 1, 2007, we are under examination by the Internal Revenue Service, or IRS, for the Veritas U.S. federal income taxes for the 2002 through 2005 tax years.

 

On June 26, 2006, we filed a petition with the U.S. Tax Court to protest a Notice of Deficiency from the IRS claiming that we owe $867 million, excluding penalties and interest, for the 2000 through 2001 tax years of Veritas. On August 30, 2006, the IRS answered our petition and the case has been docketed for trial in U.S. Tax Court and is scheduled to begin on June 30, 2008. In the March 2007 quarter, the IRS agreed to dismiss any penalty assessment, and we have otherwise agreed to settle several of the lesser issues (representing $35 million of the total assessment) for $7 million of tax. As a result, the outstanding issue represents $832 million of tax. No payments will be made on the assessment until the issue is definitively resolved. If, upon resolution, we are required to pay an amount in excess of our provision for this matter, the incremental amounts due would be accounted for principally as additions to the

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Veritas purchase price as an increase to goodwill. Any incremental interest accrued related to periods subsequent to the date of the Veritas acquisition would be recorded as an expense in the period the matter is resolved.

 

The Company continues to monitor the progress of ongoing income tax controversies and the impact, if any, of the expected tolling of the statute of limitations in various taxing jurisdictions. Considering these facts, the Company does not currently believe there is a reasonable possibility of any significant change to its total unrecognized tax benefits within the next twelve months.

 

 

On March 29, 2006, we received a Notice of Deficiency from the IRS claiming that we owe additional taxes, plus interest and penalties, for the 2000 and 2001 tax years based on an audit of Veritas. The incremental tax liability asserted by the IRS was $867 million, excluding penalties and interest. On June 26, 2006, we filed a petition with the U.S. Tax Court protesting the IRS claim for such additional taxes. On August 30, 2006, the IRS answered our petition and this matter has been docketed for trial in U.S. Tax Court and is scheduled to begin on June 30, 2008. We have subsequently agreed to pay $7 million out of $35 million originally assessed by the IRS in connection with one of the issues covered in the assessment. The IRS has also agreed to waive the assessment of penalties. We do not agree with the IRS on the $832 million remaining at issue. We strongly believe the IRS’ position with regard to this matter is inconsistent with applicable tax laws and existing Treasury regulations, and that our previously reported income tax provision for the years in question is appropriate. See Note 11 for additional information on this matter.

 

On July 7, 2004, a purported class action complaint entitled Paul Kuck, et al. v. Veritas Software Corporation, et al. was filed in the United States District Court for the District of Delaware. The lawsuit alleges violations of federal securities laws in connection with Veritas’ announcement on July 6, 2004 that it expected results of operations for the fiscal quarter ended June 30, 2004 to fall below earlier estimates. The complaint generally seeks an unspecified amount of damages. Subsequently, additional purported class action complaints have been filed in Delaware federal court, and, on March 3, 2005, the Court entered an order consolidating these actions and appointing lead plaintiffs and counsel. A consolidated amended complaint, or CAC, was filed on May 27, 2005, expanding the class period from April 23, 2004 through July 6, 2004. The CAC also named another officer as a defendant and added allegations that Veritas and the named officers made false or misleading statements in the our press releases and SEC filings regarding the company’s financial results, which allegedly contained revenue recognized from contracts that were unsigned or lacked essential terms. The defendants to this matter filed a motion to dismiss the CAC in July 2005; the motion was denied in May 2006. The defendants to this matter intend to defend this case vigorously. Because our liability, if any, cannot be reasonably estimated, no amounts have been accrued for this matter. An adverse outcome in this matter could have a material adverse effect on our financial position and results of operations.

 

After Veritas announced in January 2003 that it would restate its financial results as a result of transactions entered into with AOL Time Warner in September 2000, numerous separate complaints purporting to be class actions were filed in the United States District Court for the Northern District of California alleging that Veritas and some of its officers and directors violated provisions of the Securities Exchange Act of 1934. The complaints contain varying allegations, including that Veritas made materially false and misleading statements with respect to its 2000, 2001 and 2002 financial results included in its filings with the SEC, press releases and other public disclosures. A consolidated complaint entitled In Re VERITAS Software Corporation Securities Litigation was filed by the lead plaintiff on July 18, 2003. On February 18, 2005, the parties filed a Stipulation of Settlement in the class action. On March 18, 2005, the Court entered an order preliminarily approving the class action settlement. Pursuant to the terms of the settlement, a $35 million settlement fund was established on March 25, 2005. Veritas’ insurance carriers funded the entire amount of the settlement fund. In July 2007, the Court of Appeals vacated the settlement, finding that the notice of settlement was inadequate. The matter has been returned to the District Court for further proceedings, including reissuance of the notice. If the settlement is not approved, an adverse outcome in this matter could have a material adverse effect on our financial position and results of operations.

 

SYMANTEC CORPORATION

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

We are also involved in a number of other judicial and administrative proceedings that are incidental to our business. Although adverse decisions (or settlements) may occur in one or more of the cases, it is not possible to estimate the possible loss or losses from each of these cases. The final resolution of these lawsuits, individually or in the aggregate, is not expected to have a material adverse effect on our financial condition or results of operations.

 

 

During the June 2007 quarter, we added an additional segment which consists of the Altiris products. We also moved our Ghost ^tm , pcAnywhere ^tm , and LiveState ^tm Delivery products from the Security and Data Management segment to the Altiris segment. We also moved our Managed Security Services and DeepSight products and services from the Security and Data Management segment to the Services segment. In addition, following implementation of our new enterprise resource planning system completed during the December 2006 quarter, we refined the methodology of allocating maintenance revenues among our enterprise segments. The maintenance analysis largely impacts our Data Center Management segment, offset by the impact to our Security and Data Management segment. As a result of these revisions, we have recast segment information for fiscal 2007 to reflect the segment reporting structure described below.

 

Our operating segments are significant strategic business units that offer different products and services, distinguished by customer needs. As of June 30, 2007, we operated in six operating segments:

 

 

The accounting policies of the segments are described in our Annual Report on Form 10-K for the fiscal year ended March 31, 2007. There are no intersegment sales. Our chief operating decision maker evaluates performance based on direct profit or loss from operations before income taxes not including nonrecurring gains and losses, foreign exchange gains and losses, and certain income and expenses. Except for goodwill, as disclosed in Note 5, the majority of our assets are not discretely identified by segment. The depreciation and amortization of our property,

 

 

 

 

Forward-Looking Statements and Factors That May Affect Future Results

 

The discussion below contains forward-looking statements, which are subject to safe harbors under the Securities Act of 1933, as amended, or the Securities Act, and the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements include references to the expected results of the cost savings initiative that was announced in January 2007 and our ability to utilize our deferred tax assets, as well as statements including words such as “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects,” and similar expressions. In addition, statements that refer to projections of our future financial performance, anticipated growth and trends in our businesses and in our industries, the anticipated impacts of acquisitions, and other characterizations of future events or circumstances are forward-looking statements. These statements are only predictions, based on our current expectations about future events and may not prove to be accurate. We do not undertake any obligation to update these forward-looking statements to reflect events occurring or circumstances arising after the date of this report. These forward-looking statements involve risks and uncertainties, and our actual results, performance, or achievements could differ materially from those expressed or implied by the forward-looking statements on the basis of several factors, including those that we discuss in Risk Factors , set forth in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended March 31, 2007. We encourage you to read this section carefully.

 

OVERVIEW

 

Our Business

 

We are a world leader in providing infrastructure software to protect individuals and enterprises from a variety of risks. We provide consumers, home offices, and small businesses with Internet security and personal computer, or PC, problem-solving products; we provide small and medium-sized businesses with software to provision, backup, secure, and remotely access their PCs and servers; we provide enterprise and large enterprise customers with security, storage and server management, data protection, and application performance management solutions; and we provide a full range of consulting and educational services to enterprises of all sizes. In addition, we continually work to enhance the features and functionality of our existing products, extend our product leadership, and create innovative solutions for our customers to address the rapidly changing threat environment. Founded in 1982, we have operations in 40 countries worldwide.

 

On April 6, 2007, we completed our acquisition of Altiris, Inc., a leading provider of IT management software that enables businesses to easily manage and service network-based endpoints. We used approximately $841 million of our cash and cash equivalents to fund the acquisition, which amount was net of Altiris’ cash and cash equivalents balance. We believe this acquisition will enable us to help customers better manage and enforce security policies at the endpoint, identify and protect against threats, and repair and service assets.

 

Our Operating Segments

 

Our operating segments are significant strategic business units that offer different products and services, distinguished by customer needs. During the June 2007 quarter, we added an additional segment which consists of the Altiris products. We also moved our Ghost ^tm , pcAnywhere ^tm , and LiveState ^tm Delivery products from the Security and Data Management segment to the Altiris segment. We also moved our Managed Security Services and DeepSight products and services from the Security and Data Management segment to the Services segment. In addition, following implementation of our new enterprise resource planning system completed during the December 2006 quarter, we refined the methodology of allocating maintenance revenues among our enterprise segments. This change largely positively impacts our Data Center Management segment to the offsetting detriment of the Security and Data Management segment. These initiatives have resulted in us recasting our segment data for all periods presented.

 

As of June 30, 2007, we had six operating segments, descriptions of which are provided in Note 13 of Notes to Condensed Consolidated Financial Statements.

Financial Results and Trends

 

Our net income was $95 million for the three-months ended June 30, 2007 as compared to our net income of $101 million for the three-months ended June 30, 2006. The lower net income for the June 2007 quarter as compared to the June 2006 quarter was primarily due to higher sales and marketing expenses and a restructuring charge of $19 million incurred in the June 2007 quarter related to the 2007 cost savings initiative discussed below. During the June 2007 quarter, employee headcount increased by approximately 3% from March 31, 2007 and by approximately 10% from June 30, 2006, partially as a result of our acquisition of Altiris.

 

Revenue for the three months ended June 2007 was 11% higher than revenue for the three months ended June 2006. For the three months ended June 30, 2007, we delivered revenue growth across all of our geographic regions as compared to the three months ended June 2006 and experienced revenue growth in all of our segments. This growth was largely due to our having a higher deferred revenue balance at the beginning of the June 2007 quarter than at the beginning of the June 2006 quarter, which resulted in a larger amount of deferred revenue being converted into revenue in the fiscal 2008 period versus the fiscal 2007 period. The factors contributing to the growth in deferred revenue are discussed more fully in “Results of Operations” below. We believe our revenue growth is also attributable to increased awareness of Internet-related threats around the world and demand for storage solutions.

 

Weakness in the U.S. dollar compared to foreign currencies positively impacted our international revenue growth by approximately $38 million during the three months ended June 30, 2007 as compared to the June 2006 quarter. We are unable to predict the extent to which revenues in future periods will be impacted by changes in foreign currency exchange rates. If international sales become a greater portion of our total sales in the future, changes in foreign exchange rates may have a potentially greater impact on our revenues and operating results.

 

In the fourth quarter of fiscal 2007, we implemented a cost savings initiative, which included a workforce reduction of approximately five percent worldwide. Once these cost reductions are fully implemented, we expect to save approximately $200 million in costs on an annualized basis. The cost savings initiative resulted in a restructuring charge of $19 million in the first quarter of fiscal 2008. We expect that the cost savings initiative will result in an additional restructuring charge in other future periods.

 

Our gross margins and operating expenses were affected in the June 2007 quarter, and we expect them to be affected in future periods, as a result of recent changes in the terms of some of our relationships with key Original Equipment Manufacturers, or OEMs. We have negotiated new contract terms with some of our OEM partners, which have resulted in payments to OEM partners being included as Operating expenses rather than Cost of revenues. In general, payments to OEMs made on a placement fee per unit basis will be treated as Operating expenses, while payments based on a revenue-sharing model will be amortized as Cost of revenues. As a result of these recent changes, we expect Cost of revenues to decrease and we expect Operating expenses to increase. The increase in Operating expenses will more than offset the decrease in Cost of revenues because placement fee arrangements are expensed on an estimated average cost basis, while revenue-sharing arrangements are amortized ratably over a one-year period, and because payments to OEMs have increased.

 

Critical Accounting Estimates

 

On April 1, 2007, we adopted a new pronouncement related to income taxes, as discussed under the Significant Accounting Policies portion of Note 1. Other than this, there have been no significant changes in our critical accounting estimates during the three-months ended June 30, 2007 as compared to the critical accounting estimates disclosed in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2007.

 

The increase in revenue for the three months ended June 30, 2007 over the same prior year period is primarily due to higher amortization of deferred revenue, as a result of the higher amount of deferred revenue at the beginning of the June 2007 quarter than at the beginning of the June 2006 quarter. Our total deferred revenue was $2.163 billion and $2.754 billion at the beginning of the first quarter of fiscal 2007 and 2008, and was $2.209 billion and $2.664 billion at the end of each such quarter, respectively. The higher deferred revenue balance at the beginning of the June 30, 2007 quarter is due to a greater portion of the revenue from deals being subject to deferral in the Company’s fiscal year ended March 31, 2007 compared to the prior year. This increase in deferred revenue is the result of our doing more multi-year deals, selling more services along with our license and maintenance arrangements, and the combination of our buying programs for all of our enterprise offerings, which resulted in a change in the vendor-specific objective evidence, VSOE, of pricing for our storage and availability offerings. The increase in June 2007 quarter revenues was augmented by $42 million as a result of growth in demand for our Consumer products.

 

Furthermore, June 2007 quarter revenues increased $37 million due to the sales of products acquired through our April 6, 2007 acquisition of Altiris for which there is no comparable revenue in the June 2006 quarter. The segment discussions that follow further describe the revenue increases. Included in the total net revenues increase is a favorable foreign currencies impact of $38 million in the June 2007 quarter compared to the June 2006 quarter.

 

As a result of our initiative to offer customers a more comprehensive solution to protect and manage a global IT infrastructure, we expect to sell more services with our license and maintenance contracts. VSOE may not exist for some of these services, which will result in our recognizing an increased amount of deferred revenue, and increased classification of revenues as Content, subscriptions, and maintenance revenue, from these contracts. We also increased the amount of maintenance renewals sold with a license component, resulting in a larger portion of revenues associated with contracts being classified as Content, subscriptions, and maintenance revenue, which is subject to deferral, instead of Licenses revenue, which is generally recognized immediately.

 

Content, subscriptions, and maintenance revenues

 

 

Content, subscriptions, and maintenance revenue includes arrangements for software maintenance and technical support for our products, content and subscription services primarily related to our security products, revenue from arrangements where VSOE of the fair value of undelivered elements does not exist, and managed security services. These arrangements are generally offered to our customers over a specified period of time and we recognize the related revenue ratably over the maintenance, subscription, or service period. Beginning with the release of our 2006 consumer products that include content updates in the December 2005 quarter, we recognize revenue related to these products ratably. As a result, this revenue has been classified as Content, subscriptions, and maintenance beginning in the December 2005 quarter. In addition, as noted above, increased flexibility in contract

terms and the combination of our buying programs in the December 2006 quarter have impacted revenue recognition. These changes cause a larger portion of revenue associated with contracts to be classified as Content, subscriptions, and maintenance revenue instead of Licenses revenue.

 

Content, subscriptions, and maintenance revenue also includes professional services revenue, which consists primarily of the fees we earn related to consulting and educational services. We generally recognize revenue from our professional services as the services are performed or upon written acceptance from customers, if applicable, assuming all other conditions for revenue recognition have been met.

 

Content, subscriptions, and maintenance revenues increased in the three months ended June 30, 2007 as compared to the three months ended June 30, 2006 primarily due to a $109 million increase related to enterprise products and services, excluding acquired Altiris products, as a result of higher amortization of deferred revenue.

 

Revenue related to our Consumer Products increased $48 million in the June 2007 quarter as compared to the June 2006 quarter primarily due to growth in sales of Norton Internet Security products and in online revenues due to growth in the use of the Internet, and increased awareness and sophistication of security threats. Further, June 2007 quarter revenues increased $12 million due to the sales of products acquired through our acquisition of Altiris for which there is no comparable revenue in the June 2006 quarter.

 

Licenses revenues

 

 

Licenses revenues decreased in the three months ended June 30, 2007 as compared to the three months ended June 30, 2006 primarily due to an aggregate decrease in revenues from the Security and Data Management and Data Center Management segments of $50 million as a result of a decreased volume of large transactions. The June 2007 quarter decrease is partially offset by an increase of $25 million due to the sales of products acquired through our acquisition of Altiris for which there is no comparable revenue in the June 2006 quarter.

 

Net revenues by segment

 

Consumer Products segment

 

 

Consumer Products revenues increased in the three-month period ended June 30, 2007 as compared to the three months ended June 30, 2006 primarily due to an aggregate increase of $76 million in revenue from our Norton Internet Security and Norton 360 products. This increase was partially offset by aggregate decreases in revenue from our Norton AntiVirus and Norton System Works ^tm products of $30 million. These decreases resulted from our customers’ continued migration to the Norton Internet Security products and to our new Norton 360 products, which offer broader protection to address the rapidly changing threat environment. Our electronic orders include Original Equipment Manufacturers, or OEM, subscriptions, upgrades, online sales, and renewals. Revenue from electronic orders (which includes sales of our Norton Internet Security products, Norton 360 products, and our Norton

AntiVirus products) grew by $51 million in the June 2007 quarter as compared to the June 2006 quarter. Included in the total Consumer Products increase is a favorable foreign currencies impact of $14 million in the June 2007 quarter compared to the June 2006 quarter.

 

Security and Data Management segment

 

 

The increase in revenues from our Security and Data Management segment in the three-month period ended June 30, 2007 as compared to the three-months ended June 30, 2006 was primarily due to an aggregate increase in revenue from our Enterprise Messaging, Compliance, and Backup products of $14 million as a result of higher amortization of deferred revenue, driven by a higher amount of deferred revenue at the beginning of the quarter than at the beginning of the comparable period last year, for the reasons discussed above. Included in the total Security and Data Management increase is a favorable foreign currencies impact of $11 million in the June 2007 quarter compared to the June 2006 quarter.

 

Data Center Management segment

 

 

The increase in Data Center Management revenue in the three months ended June 30, 2007 as compared to the three months ended June 30, 2006 was primarily due to an aggregate increase in revenue from our NetBackup and Storage Foundation products of $26 million driven by increased demand for products related to the standardization and simplification of data center infrastructure and higher amortization of deferred revenue, as a result of the higher amount of deferred revenue at the beginning of the quarter than at the beginning of the comparable period last year, for the reasons discussed above. Included in the total in Data Center Management increase is a favorable foreign currencies impact of $10 million in the June 2007 quarter compared to the June 2006 quarter

 

Services segment

 

 

Revenue from our Services segment increased in three-month period ended June 30, 2007 as compared to the three months ended June 30, 2006 due to increased demand in our service offerings and the contribution to Service revenues of service offerings acquired in our acquisition of Company-i.

Altiris segment

 

 

 

 

The increase in Altiris revenue in the three-month period ended June 30, 2007 as compared to the three months ended June 30, 2006 was primarily due to $37 million in sales of products acquired through our acquisition of Altiris for which there is no comparable revenue in the June 2006 quarter. This amount was offset slightly by the continued decline in sales of our pcAnywhere product.

 

Other segment

 

Our Other segment is comprised primarily of sunset products and products nearing the end of their life cycle. Revenues from the Other segment during the three-month period ended June 30, 2007 and 2006 were immaterial.

 

Net revenues by geographic region

 

 

International revenues increased in the three months ended June 30, 2007 as compared to the three months ended June 30, 2006 primarily due to the growth in revenues from our Consumer Products of $31 million, driven by sales of Norton Internet Security Products, growth in revenues from our Data Center Management products of $22 million, increased demand for products related to the standardization and simplification of data center infrastructure, and sales of products acquired through our acquisition of Altiris of $13 million for which there is no comparable revenue in the June 2006 quarter. In North America, the increase from the June 2007 quarter compared to the June 2006 quarter was primarily due to sales of products acquired through our acquisition of Altiris of $24 million for which there is no comparable revenue in the June 2006 quarter, growth in revenues from our Security and Data Management products of $14 million, driven by increased sales in our channel-based business, and growth in revenues from our Consumer Products of $11 million, driven by Norton Internet Security. Both domestic and international revenue from enterprise offerings were positively impacted by higher amortization of deferred revenue, as a result of the higher amount of deferred revenue at the beginning of the quarter than at the

beginning of the comparable period last year, for the reasons discussed above. Foreign currencies had a favorable impact on net revenues of $38 million in the June 2007 quarter compared to the June 2006 quarter.

 

We are unable to predict the extent to which revenues in future periods will be impacted by changes in foreign currency exchange rates. If international sales become a greater portion of our total sales in the future, changes in foreign currency exchange rates may have a potentially greater impact on our revenues and operating results.

 

 

Cost of revenues consists primarily of amortization of acquired product rights, fee-based technical support costs, costs of billable services, payments to OEMs under revenue-sharing arrangements, manufacturing and direct material costs, and royalties paid to third parties under technology licensing agreements.

 

Gross margin increased in the three months ended June 30, 2007 as compared to the three months ended June 30, 2006 due primarily to higher revenues more than offsetting year over year increases in services and technical support costs. We anticipate that our net revenues from our Services segment may grow to comprise a higher percentage of our total net revenues, which would have a negative impact on our gross margin, as our services typically have a higher Cost of revenues than our software products. Gross margin was also impacted as the terms of several of our OEM arrangements changed from revenue-sharing arrangements to placement fee arrangements during fiscal 2007. Placement fee arrangements are expensed on an estimated average cost basis as sales and marketing expenses, while revenue-sharing arrangements are amortized as Cost of revenues ratably over a one-year period.

 

Cost of content, subscriptions, and maintenance

 

 

Cost of content, subscriptions, and maintenance consists primarily of fee-based technical support costs, costs of billable services, and payments to OEMs under revenue-sharing agreements. Cost of content, subscriptions, and maintenance decreased as a percentage of the related revenue in the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. The quarter over quarter decrease in margin is primarily driven by higher revenues more than offsetting increases in Technical Support and Services expenses.

 

We expect our cost of content, subscriptions and maintenance to be affected in future periods as a result of recent changes in the terms of some of our key OEM relationships, as discussed above under “Financial Results and Trends”.

Cost of licenses

 

 

Cost of licenses consists primarily of royalties paid to third parties under technology licensing agreements and manufacturing and direct material costs. Cost of licenses decreased as a percentage of the related revenue in the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. The quarter over quarter decrease in absolute dollars is primarily due to high obsolete reserves in the June 30, 2006 quarter due to the Company’s decision to exit certain aspects of the appliance business.

 

Amortization of acquired product rights

 

 

Acquired product rights are comprised of developed technologies, revenue-related order backlog and contracts, and patents from acquired companies. The amortization in June 2007 and June 2006 quarter is primarily associated with the Veritas acquisition, for which amortization began in July 2005. In connection with the Veritas acquisition, we recorded $1.3 billion in acquired product rights which are being amortized over their expected useful lives of three months to five years. We amortize the fair value of all other acquired product rights over their expected useful lives, generally one to eight years. Amortization in the June 2007 quarter was higher than the June 2006 quarter primarily resulting from amortization associated with the Altiris acquisition, which was offset in part by certain acquired product rights becoming fully amortized. For further discussion of acquired product rights and related amortization, see Notes 4 and 5 of the Notes to Consolidated Financial Statements.

 

 

The increase in sales and marketing expense in the three month period ended June 30, 2007 as compared to the comparable period last year was primarily due to an increase in headcount and the change in our OEM expense model. The increase in headcount contributed approximately $65 million in employee compensation expense. The remaining increase is a result of changes in our OEM arrangements discussed above under “Financial Results and Trends”, which accounted for $42 million of the increase from the June 2006 quarter. We expect sales and marketing

expenses to continue to increase for the remainder of fiscal 2008 compared to the comparable fiscal 2007 periods due to recent changes in the terms of some of our key OEM relationships, as discussed above.

 

Research and development expenses

 

 

The increase in research and development expenses in the three-month period ended June 2007 as compared to the comparable period last year was due primarily to an increase in employee headcount, resulting in additional employee compensation expense.

 

General and administrative expenses

 

 

General and administrative expense remained relatively consistent as a percentage of revenues for the three-month period ended June 30, 2007 as compared to the comparable period last year.

 

Amortization of other intangible assets

 

 

Other intangible assets are comprised of customer base, trade names, partnership agreements, and marketing-related assets. The increased amortization in the three months ended June 30, 2007 compared to the three months ended June 30, 2006 is primarily associated with the acquisitions of Company-i Limited, and 4FrontSecurity, Inc. that occurred during fiscal 2007, and the acquisition of Altiris, which occurred during the three months ended June 30, 2007. We recorded $223 million of intangible assets related to the Altiris acquisition, which will be amortized over their useful lives of one to eight years. For further discussion of other intangible assets and related amortization, see Note 5 of Notes to Condensed Consolidated Financial Statements.

 

In the three months ended June 30, 2007, we recorded approximately $19 million of restructuring expenses related to the 2007 cost savings initiative announced in January 2007. The costs recorded during the three months ended June 30, 2007 were related primarily to employee severance payments. For further discussion on restructuring, see Note 9 of Notes to the Condensed Consolidated Financial Statements.

 

In the June 2006 quarter, we recorded $13 million of restructuring costs. These restructuring costs related to executive severance and to severance, associated benefits, and outplacement services for the termination of 184 redundant employees located in the United States, Europe, and Asia Pacific.

 

 

The decrease in interest income in the three months ended June 30, 2007 as compared to the comparable period last year was due primarily to a lower average balance of our invested cash and available-for-sale securities due to our use of cash for the repurchase of our stock on the open market and the purchase of Altiris.

 

Interest expense in the three months ended June 30, 2007 as compared to the comparable period last year remained relatively consistent.

 

 

The effective tax rate was approximately 36.5% and 39% for the three-month periods ended June 30, 2007 and 2006. The effective tax rate for both periods is impacted by the benefits of lower-taxed foreign earnings and domestic manufacturing tax incentives, offset by state income taxes and non-deductible stock-based compensation resulting from the adoption of SFAS No. 123R, Share-Based Payment . The higher effective tax rate for the

June 2006 quarter includes an accrual of approximately $6 million for penalty risks associated with the late filing of Veritas’ final pre-acquisition income tax return.

 

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”) effective April 1, 2007. FIN 48 addresses the accounting for and disclosure of uncertainty in income tax positions, by prescribing a minimum recognition threshold that a tax position is required to satisfy 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.

 

The cumulative effect of adopting FIN 48 was a decrease in tax reserves of $18 million, resulting in a decrease to Veritas goodwill of $11 million, an increase of $6 million to the April 1, 2007 Retained earnings balance, and a $1 million increase in Paid in Capital. Upon adoption, the gross liability for unrecognized tax benefits at April 1, 2007 was $455 million, exclusive of interest and penalties. This gross liability is reduced by offsetting tax benefits associated with the correlative effects of potential transfer pricing adjustments and state income taxes as well as payments made to date. Of the total unrecognized tax benefits, $89 million, if recognized, would favorably affect the company’s effective tax rate while the remaining amount would affect goodwill. In addition, consistent with the provisions of FIN 48, certain reclassifications were made to the balance sheet, including the reclassification of $350 million of income tax liabilities from current to non-current liabilities because payment of cash is not anticipated within one year of the balance sheet date.

 

We believe realization of substantially all of our net deferred tax assets as of June 30, 2007 is more likely than not based on the future reversal of temporary tax differences and upon future taxable earnings exclusive of reversing temporary differences in certain foreign jurisdictions. Levels of future taxable income are subject to the various risks and uncertainties discussed in Risk Factors, set forth in Part I, Item 1A, of our Annual Report on Form 10-K for the fiscal year ended March 31, 2007. An additional valuation allowance against net deferred tax assets may be necessary if it is more likely than not that all or a portion of the net deferred tax assets will not be realized. We assess the need for an additional valuation allowance on a quarterly basis.

 

We must make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of tax credits, benefits, and deductions, and in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes, as well as the interest and penalties relating to these uncertain tax positions. Significant changes to these estimates may result in an increase or decrease to our tax provision in a subsequent period.

 

We report our results of operations based on our determinations of the amount of taxes owed in the various tax jurisdictions in which we operate. As a United States company with significant international activities and operations, we make transfer pricing determinations with respect to transfers of intellectual property, goods and services between and among us and our foreign subsidiaries. These pricing determinations can be complex and are subject to challenge by taxing authorities in the various tax jurisdictions in which we and our subsidiaries operate. From time to time, we receive notices that a tax authority to which we are subject has determined that we owe a greater amount of tax than we have reported to such authority, and we are regularly engaged in discussions, and sometimes disputes, with these tax authorities. Our current disputes with the U.S. Internal Revenue Service, which relate in large part to transfer pricing matters, are an example of this type of matter. If our transfer pricing methodologies are successfully challenged in the matters currently in dispute, it is likely that subsequent inter-company transfers that have been valued using similar methodologies will also be challenged.

 

If the ultimate determination of our taxes owed in any of these jurisdictions is for an amount in excess of the tax provision we have recorded or reserved for, our operating results, cash flows, and financial condition could be adversely affected.