MCAFEE CORP. Organization
McAfee Corp. (the "Corporation") was incorporated inDelaware onJuly 19, 2019 . The Corporation was formed for the purpose of completing an initial public offering (the "IPO") and related transactions in order to carry on the business of FTW and its subsidiaries. OnOctober 21, 2020 , the Corporation became the sole managing member and holder of 100% of the voting power of FTW due to the reorganization transactions described below. With respect to the Corporation and the Company, each entity owns nothing other than the respective entities below it in the corporate structure and each entity has no other material operations, assets, or liabilities. The Reorganization Transactions were accounted for as a reorganization of entities under common control. As a result, the financial statements for periods prior to the IPO and the Reorganization Transactions are the financial statements of FTW as the predecessor to the Corporation for accounting and reporting purposes. See Note 1 to the Consolidated Financial Statements in Item 8 for a detailed discussion of the Reorganization Transactions, as defined in that note, and the IPO.
The Reorganization Transactions
Reorganization
In connection with the closing of the IPO, the following Reorganization Transactions were consummated:
•
a new limited liability company operating agreement ("New LLC Agreement") was adopted for FTW making the Corporation the sole managing member of FTW;
•
the Corporation's certificate of incorporation was amended and restated to,
among other things, (i) provide for Class A common stock and Class B common
stock and (ii) issue shares of Class B common stock to the Continuing Owners and
Management Owners, on a one-to-one basis with the number of LLC Units they own
(except that Management Owners will not receive shares of Class B common stock
in connection with their exchange of Management Incentive Units ("MIUs")), the
exchange of which will be settled in cash or shares of Class A common stock, at
the option of the Company, for nominal consideration;
•
the Corporation (i) issued 126.3 million shares of its Class A common stock to
certain of the Continuing Owners in exchange for their contribution of LLC units
or the equity of certain other entities, which pursuant to the Reorganization
Transactions, became its direct or indirect subsidiaries and (ii) settled 5.7
million restricted stock units ("RSUs") with shares of its Class A common stock,
net of tax withholding, held by certain employees, which were satisfied in
connection with the Reorganization Transactions; and
•
the Corporation entered into (i) a tax receivable agreement ("TRA") with certain
of our Continuing Owners and certain Management Owners (collectively "TRA
Beneficiaries") and (ii) a stockholders agreement and a registration rights
agreement with investment funds affiliated with or advised by TPG Global, LLC
("TPG") and Thoma Bravo, L.P. ("Thoma Bravo"), respectively, and Intel Americas,
Inc. ("Intel").
Organization of Information
In Item 7, we discuss the year ended December 25, 2021 results and compare the
year ended December 25, 2021 results to the year ended December 26, 2020
results. Discussions of the year ended December 26, 2020 results and comparisons
of the year ended December 26, 2020 results to the year ended December 28, 2019
results can be found in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the Corporation's Prospectus dated
September 9, 2021 and filed with the SEC on September 10, 2021 pursuant to Rule
424(b)(4) of the Securities Act.
Overview
As a global leader and trusted brand in cybersecurity for over 30 years, McAfee protects millions of consumers with one of the industry's most comprehensive cybersecurity portfolios. Our award-winning products offer individuals and families protection for their digital lives. We meet the cyber security needs of consumers wherever they are, with solutions for device security, privacy and safe Wi-Fi, online protection, and identity protection, among others. Our mission is to protect all things that matter through leading-edge cybersecurity products.
Our consumer-focused products protect consumers across the digital spectrum providing holistic digital protection of the individual and family wherever they go under our Total Protection and LiveSafe brands. We achieve this by integrating the following solutions and capabilities within our bundled products:
•
Device Security, which includes our
•
Online Privacy and Comprehensive Internet Security, which includes our Safe
Connect VPN, TunnelBear, and WebAdvisor products, help make Wi-Fi connections
safe with our bank-grade AES 256-bit encryption, keeping personal data protected
while keeping IP addresses and physical locations private.
52
--------------------------------------------------------------------------------•
Identity Protection, which includes our Identity Theft Protection and Password Manager products, searches over 600,000 online black markets for compromised personally identifiable information, helping consumers take action to prevent fraud. Our go-to-market digitally-led omnichannel approach reaches the consumer at crucial moments in their purchase lifecycle including direct to consumer online sales, acquisition through trial pre-loads on PC OEM devices, and other indirect modes via additional partners such as mobile providers, ISPs, electronics retailers, ecommerce sites, and search providers. We have longstanding exclusive partnerships with many of the leading PC OEMs and continue to expand our presence with mobile service providers and ISPs as the demand for mobile security protection increases. Through these relationships, our consumer security software is pre-installed on devices on either a trial basis until conversion to a paid subscription, which is enabled by a tailored renewal process that fits the customer's journey, or through a live version that can be purchased directly through the OEMs' website. Our consumer go-to-market channel also consists of partners including some of the largest electronics retailers and ISPs globally.
Agreement and Plan of Merger; Proposed Merger
OnNovember 5, 2021 , the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") withCondor BidCo, Inc. , aDelaware corporation ("Parent"), andCondor Merger Sub, Inc. , aDelaware corporation and wholly owned subsidiary of Parent ("Merger Subsidiary"), pursuant to which Merger Subsidiary will merge with and into the Company whereupon the separate corporate existence of Merger Subsidiary will cease and the Company will be the surviving corporation in the Merger and will continue as a wholly owned subsidiary of Parent (the "Merger"). Parent has obtained equity financing and debt financing commitments for the purpose of financing the transactions contemplated by the Merger Agreement. Affiliates of funds advised by each ofAdvent International Corporation ,Permira Advisers LLC ,Crosspoint Capital Partners L.P. ,Abu Dhabi Investment Authority , andCanada Pension Plan Investment Board andGIC Private Ltd. have committed to capitalize Parent at the Closing with an aggregate equity contribution equal to$5.2 billion on the terms and subject to the conditions set forth in signed equity commitment letters. OnFebruary 3, 2022 , Merger Subsidiary received commitments of$5,160 million under a proposedU.S. dollar term loan facility and Euro-equivalent$1,800 million under a proposed Euro term loan facility. OnFebruary 17, 2022 , Merger Subsidiary closed its offering of$2,020 million 7.375% senior notes due 2030. Under the terms of the Merger Agreement, the Company's stockholders will receive$26.00 in cash for each share of Class A common stock they hold on the transaction closing date. The transaction's closing is subject to customary closing conditions, including, among others, approval by the Company's stockholders, the expiration or early termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act"), the receipt of other regulatory approvals, and clearance by theCommittee on Foreign Investment inthe United States . OnDecember 20, 2021 at11:59 p.m. , the waiting period under the HSR Act expired. OnFebruary 9, 2022 , the Company's stockholders approved the Merger at a special meeting of stockholders. OnFebruary 22, 2022 , theCommittee on Foreign Investment inthe United States closed its review and cleared the transactions contemplated by the Merger Agreement. Pursuant to the terms of the Merger Agreement, the completion of the Merger remains subject to various customary conditions, including (1) the absence of an order, injunction or law prohibiting the Merger, (2) the receipt of antitrust approval in theEuropean Union andSwitzerland , (3) the accuracy of each party's representations and warranties, subject to certain materiality standards set forth in the Merger Agreement, (4) compliance in all material respects with each party's obligations under the Merger Agreement, and (5) no Company Material Adverse Effect (as defined in the Merger Agreement) having occurred since the date of the Merger Agreement.
Upon completion of the transaction, McAfee common stock will no longer be listed on any public securities exchange.
In connection with the closing of the Merger, the Company, FTW and certain other parties thereto have entered into a Tax Receivable Agreement and LLC Agreement Amendment (the "Amendment"). The Amendment provides for, among other things, (i) the payment of amounts due under the tax receivable agreement currently in effect (the "TRA") with respect toU.S. federal income tax year 2020 of the Company in accordance with the terms of the TRA up to an aggregate amount of$2 million , which payments shall be paid no later than 10 business days prior to the Closing Date, (ii) the suspension of all other payments under the TRA from and afterNovember 5, 2021 and (iii) the amendment of the TRA, effective as of immediately prior to and contingent upon the occurrence of the Effective Time of the Merger, which shall result in the TRA (and all of the Company's obligations thereunder, including the obligation to make any of the foregoing suspended payments) terminating immediately prior to the Effective Time of the Merger. For a summary of the transaction, please refer to our Form 8-K filed with theU.S. Securities and Exchange Commission (the "SEC") onNovember 8, 2021 . 53 --------------------------------------------------------------------------------
Divestiture of Enterprise Business
OnMarch 6, 2021 , we entered into a definitive agreement (the "Purchase Agreement") with a consortium led bySymphony Technology Group ("STG") under which STG agreed to purchase certain of our Enterprise assets together with certain of our Enterprise liabilities ("Enterprise Business"), representing substantially all of our Enterprise segment, for an all-cash purchase price of$4.0 billion . The divestiture transaction closed onJuly 27, 2021 . The divestiture of our Enterprise Business, represents a strategic shift in our operations that allows us to focus on our Consumer business. As a result of the divestiture, the results of our Enterprise Business were reclassified as discontinued operations in our consolidated statements of operations and excluded from both continuing operations and segment results for all periods presented. Starting in the first quarter of fiscal 2021, we began to operate as one reportable segment as the Enterprise Business comprised substantially all of our Enterprise segment. Results of discontinued operations includes all revenues and expenses directly derived from our Enterprise Business, with the exception of general corporate overhead costs that were previously allocated to our Enterprise segment but have not been allocated to discontinued operations. The Enterprise Business was reclassified as discontinued operations in our consolidated balance sheets. In connection with the divestiture, we recognized a gain of$2.2 billion , net of estimated taxes and transaction costs. See Note 4, Discontinued Operations and Held-for-Sale Assets in Part II, Item 8 of this Annual Report on Form 10-K for additional information about the divestiture of our Enterprise Business. OnAugust 3, 2021 , the Board of Directors ofMcAfee Corp. , using a portion of the proceeds received from the divestiture of Enterprise Business, declared a special one-time cash dividend of$4.50 per share of Class A common stock payable to shareholders of record onAugust 13, 2021 (the "Special Dividend"). In connection with the declaration of the Special Dividend, the Board of Directors ofMcAfee Corp. , as sole managing member of FTW, authorized FTW to declare a special one-time cash distribution to its members in the aggregate of$2.8 billion (the "Special Distribution"). The Special Distribution resulted in the payment of$1.7 billion to Continuing LLC Owners and$1.1 billion toMcAfee Corp. McAfee Corp. used$0.8 billion of its share of the Special Distribution to pay the Special Dividend to participating shareholders onAugust 27, 2021 . We used a portion of the proceeds from the divestiture to prepay$332 million of 1st Lien USD Term Loan and €563 million of 1st Lien Euro Term Loan inAugust 2021 . In connection with this prepayment, we incurred a loss on extinguishment of debt of$10 million related to recognition of unamortized discount and deferred financing costs. See Note 13 to the consolidated financial statements for further information. We also terminated$150 million of our$250 million notional interest rate swap that had an expiration date ofJanuary 29, 2022 . See Note 15 to the consolidated financial statements for further information.
Subsequent to the Enterprise Business divestiture, we concluded that a full
valuation allowance against the net deferred tax assets of our domestic entities
will no longer be required and released
We also expect to realize certain tax benefits subject to our TRA and thus we recognized and recorded an additional TRA liability. As the net deferred tax assets have been recognized as of the date of divestiture of the Enterprise Business, the full liability under the TRA also became probable as of that date. During the year endedDecember 25, 2021 , TRA liability increases of$121 million resulting from post divestiture exchanges ofFTW LLC Units for shares of Class A common stock were recorded to Additional paid-in capital on the consolidated balance sheet. TRA liability increases of$313 million resulting from pre-divestiture exchanges and TRA liability decreases of$6 million resulting from unutilized tax attributes were recorded within Other income (expense), net. TRA liability increases of$4 million resulting from divestiture related events were recorded within Income from discontinued operations on the consolidated statement of operations. As ofDecember 25, 2021 , we have TRA liabilities of$2 million and$432 million recorded in the consolidated balance sheet within Accounts payable and other accrued liabilities and Tax receivable agreement liability, less current portion, respectively. See Note 14 to the consolidated financial statements for further information and the income tax impact of the Enterprise Business divestiture. InJuly 2021 , two amendments to the definitive agreement with a consortium led by STG for the purchase of the Enterprise Business were executed. The amendments modified certain provisions for assets and liabilities to be transferred as well as the timing and procedures for transfer of certain assets and employees in foreign jurisdictions in connection with the sale, and clarifying requirements for maintenance of such assets prior to transfer. The amendments also include certain other modifications or clarifications of the purchase agreement. As a result of the amendments, our results of operations for the year endedDecember 26, 2020 andDecember 28, 2019 and ourDecember 26, 2020 consolidated balance sheet reflect changes in the assets and liabilities that were determined to be part of discontinued operations as reported in our previously filed Form 8-K, Item 8 for the year endedDecember 26, 2020 . These changes resulted in increases of$8 million to loss from discontinued operations, net of tax, for the year endedDecember 26, 2020 , as compared to the amounts reported in our previously filed Form 8-K, Item 8 for the year endedDecember 26, 2020 . These changes are reflected in the information presented below and all relevant disclosures. See Note 20 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for revised selected quarterly financial data.
Financial Highlights
For the year ended
•
Net revenue increased by 23% to
54
--------------------------------------------------------------------------------•
Net income increased to
•
Income from continuing operations increased by 218% to
•
Adjusted EBITDA increased by 37% to
•
Net cash provided by operating activities was
•
Free cash flow generated was
See "Non-GAAP Financial Measures" for a description of adjusted EBITDA, and free cash flow, and a reconciliation of these measures to the nearest financial measure calculated in accordance with GAAP.
COVID-19 Pandemic
The COVID-19 pandemic is having widespread, rapidly evolving, and unpredictable impacts on global society, economies, financial markets, and business practices. Federal, state and foreign governments have implemented measures to contain the virus, including social distancing, travel restrictions, border closures, limitations on public gatherings, work from home, and closure of non-essential businesses. To protect the health and well-being of our employees, partners, and third-party service providers, we have implemented work-from-home requirements, made substantial modifications to employee travel policies, and cancelled or shifted marketing and other corporate events to virtual-only formats for the foreseeable future. The ultimate duration and extent of the impact from the COVID-19 pandemic depends on future developments that cannot be accurately forecasted at this time. These developments include the severity and transmission rate of the disease, the actions of governments, businesses and individuals in response to the pandemic, the extent and effectiveness of containment actions and vaccines, the impact on economic activity and the impact of these and other factors. We have experienced growth and increased demand for our solutions in recent quarters, which may be due in part to greater demand for devices or our solutions in response to the COVID-19 pandemic. We cannot determine what, if any, portion of our growth in net revenue, the number of our Direct to Consumer Subscribers, or any other measures of our performance during the fiscal 2021 compared to the fiscal 2020 was the result of such responses to the COVID-19 pandemic. Fiscal Calendar
We maintain a 52- or 53-week fiscal year that ends on the last Saturday in
December. The year ending
Key Operating Metrics
We monitor the following key metrics to help us evaluate our business, identify
trends affecting our business, measure our performance, formulate business
plans, and make strategic decisions. We believe the following metrics are useful
in evaluating our business, but should not be considered in isolation or as a
substitute for GAAP. Certain judgments and estimates are inherent in our
processes to calculate these metrics.
We define Core Direct to Consumer Subscribers as active subscribers whose
transaction for a subscription is directly with McAfee. These subscribers
include those who (i) transact with us directly through McAfee web properties,
(ii) are converted during or after the trial period of the McAfee product
preinstalled on their new PC purchase, or (iii) are channel led subscribers who
are converted to Core Direct to Consumer Subscribers after expiration of their
subscription of our product initially purchased through our retail, ecommerce or
PC OEM partners.
We define Trailing Twelve Months ("TTM") Dollar Based Retention - Core Direct to
Consumer Subscribers as the annual contract value of Core Direct to Consumer
Subscriber subscriptions that were renewed in the trailing twelve months divided
by the annual contract value for Core Direct to Consumer Subscribers
subscriptions that were up for renewal in the same period. We monitor TTM Dollar
Based Retention as an important measure of the value we retain of our existing
Core Direct to Consumer Subscriber base and as a measure of the effectiveness of
the strategies we deploy to improve those rates over time.
We define Monthly Average Revenue Per Customer ("ARPC") as monthly subscription
net revenue from transactions directly between McAfee and Core Direct to
Consumer Subscribers, divided by average Core to Direct Consumer Subscribers
from the same period. ARPC can be impacted by price, mix of products, and change
between periods in Core Direct to Consumer Subscriber count. We believe that
ARPC allows us to understand the value of our solutions to the portion of our
subscriber base transacting directly with us.
55
--------------------------------------------------------------------------------
December 25, 2021 December 26, 2020
Core Direct to Consumer Subscribers (in millions) 20.7 18.0
TTM Dollar Based Retention - Core Direct to Consumer
Subscribers 99.9 % 100.0 %
Year Ended
December 25, 2021 December 26, 2020
Monthly ARPC $ 6.02 $ 6.01
Non-GAAP Financial Measures
We have included both financial measures compiled in accordance with GAAP and certain non-GAAP financial measures in this Annual Report on Form 10-K for our continuing operations, including adjusted operating income, adjusted operating income margin, adjusted EBITDA, adjusted EBITDA margin, adjusted net income, adjusted net income margin, and free cash flow and ratios based on these financial measures.
Adjusted Operating Income, Adjusted Operating Income Margin, Adjusted EBITDA and Adjusted EBITDA Margin
We regularly monitor adjusted operating income, adjusted operating income
margin, adjusted EBITDA, and adjusted EBITDA margin to assess our operating
performance. We define adjusted operating income as net income (loss), excluding
the impact of amortization of intangible assets, equity-based compensation
expense, restructuring and transition charges, interest expense, foreign
exchange (gain) loss, net, provision for income tax expense, Tax Receivable
Agreement ("TRA") adjustment, income from Transition Services Agreement ("TSA"),
income (loss) from discontinued operations, net of taxes, and other costs that
we do not believe are reflective of our ongoing operations. Adjusted operating
income margin is calculated as adjusted operating income divided by net revenue.
We define adjusted EBITDA as adjusted operating income, excluding the impact of
depreciation expense plus certain other non-operating costs. Adjusted EBITDA
margin is calculated as adjusted EBITDA divided by net revenue. We believe
presenting adjusted operating income, adjusted operating income margin, adjusted
EBITDA, and adjusted EBITDA margin provides management and investors consistency
and comparability with our past financial performance and facilitates period to
period comparisons of operations, as it eliminates the effects of certain
variations unrelated to our overall performance. Adjusted operating income,
adjusted operating income margin, adjusted EBITDA, and adjusted EBITDA margin
have limitations as analytical tools, and you should not consider it in
isolation or as a substitute for analysis of our results as reported under GAAP.
Some of these limitations are:
•
although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
•
adjusted operating income and adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs;
•
adjusted operating income and adjusted EBITDA do not reflect the significant interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;
•
adjusted operating income and adjusted EBITDA do not reflect income tax payments that may represent a reduction in cash available to us; and
•
other companies, including companies in our industry, may calculate adjusted
operating income and adjusted EBITDA differently, which reduce their usefulness
as comparative measures.
Because of these limitations, you should consider adjusted operating income and
adjusted EBITDA alongside other financial performance measures, including
operating income (loss), net income (loss) and our other GAAP results. In
evaluating adjusted operating income, adjusted operating income margin, adjusted
EBITDA, and adjusted EBITDA margin, you should be aware that in the future we
may incur expenses that are the same as or similar to some of the adjustments in
this presentation. Our presentation of adjusted operating income, adjusted
operating income margin, adjusted EBITDA, and adjusted EBITDA margin should not
be construed as an inference that our future results will be unaffected by the
types of items excluded from the calculation of adjusted operating income,
adjusted operating income margin, adjusted EBITDA, and adjusted EBITDA margin.
Adjusted operating income, adjusted operating income margin, adjusted EBITDA,
and adjusted EBITDA margin are not presentations made in accordance with GAAP
and the use of these terms vary from other companies in our industry.
56
--------------------------------------------------------------------------------The following table presents a reconciliation of our adjusted operating income and adjusted EBITDA to our net income for the periods presented:
Year Ended
(in millions) December 25, 2021 December 26, 2020
Net income (loss) $ 2,688 $ (289 )
Add: Amortization 170 251
Add: Equity-based compensation 71 113
Add: Cash in lieu of equity awards(1) 1 1
Add: Acquisition and integration costs(2) 1 8
Add: Restructuring and transition charges(3) 70 2
Add: Management fees(4) - 28
Add: Transformation(5) 12 20
Add: Executive severance(6) 1 3
Add: Interest expense 212 303
Add: Foreign exchange loss (gain), net(7) (41 ) 104
Add: Provision for income tax expense (benefit) (160 ) 5
Add: TRA adjustment(8) 307 2
Less: Income from TSA(9) (18 ) -
Add: Other (income) expense, net(10) 2 2
Less: Loss (income) from discontinued operations,
net of taxes (2,441 ) 79
Adjusted operating income 875 632
Add: Depreciation 23 23
Less: Other (income) expense 1 (1 )
Adjusted EBITDA $ 899 $ 654
Net revenue $ 1,920 $ 1,558
Net income (loss) margin 140.0 % (18.5 )%
Adjusted operating income margin 45.6 % 40.6 %
Adjusted EBITDA margin 46.8 % 42.0 %
See "Description of Non-GAAP Adjustments" section for an explanation of adjustments to non-GAAP measures and other items.
57
--------------------------------------------------------------------------------Adjusted Net Income and Adjusted Net Income Margin
We regularly monitor adjusted net income and adjusted net income margin to assess our operating performance. Adjusted net income assumes all net income (loss) is attributable toMcAfee Corp. , which assumes the full exchange of all outstanding LLC Units for shares of Class A common stock ofMcAfee Corp. , and is adjusted for the impact of amortization of intangible assets, amortization of debt issuance costs, equity-based compensation expense, restructuring and transition charges, foreign exchange loss (gain), net, TRA adjustment, income fromTSA , income (loss) from discontinued operations, net of taxes, and other costs that we do not believe are reflective of our ongoing operations. The adjusted provision for income taxes represents the tax effect on net income, adjusted for all of the listed adjustments, assuming that all consolidated net income was subject to corporate taxation for all periods presented. We have assumed an annual effective tax rate of 22%, which represents our long term expected corporate tax rate excluding discrete and non-recurring tax items. This amount has been recast for periods reported previously. Adjusted net income margin is calculated as adjusted net income divided by net revenue. Adjusted net income and adjusted net income margin have limitations as analytical tools, and you should not consider it in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
•
although amortization is a non-cash charge, the assets being amortized may have to be replaced in the future, and adjusted net income does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements;
•
adjusted net income does not reflect changes in, or cash requirements for, our working capital needs;
•
other companies, including companies in our industry, may calculate adjusted net income differently, which reduce its usefulness as comparative measures.
Because of these limitations, you should consider adjusted net income alongside other financial performance measures, including net income (loss) and our other GAAP results. In evaluating adjusted net income and adjusted net income margin, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of adjusted net income and adjusted net income margin should not be construed as an inference that our future results will be unaffected by the types of items excluded from the calculation of adjusted net income and adjusted net income margin. Adjusted net income and adjusted net income margin are not presentations made in accordance with GAAP and the use of these terms vary from other companies in our industry.
The following table presents a reconciliation of our adjusted net income to our net income for the periods presented:
Year Ended
(in millions) December 25, 2021 December 26, 2020
Net income (loss) $ 2,688 $ (289 )
Add: Amortization of debt discount and issuance
costs 23 36
Add: Amortization 170 251
Add: Equity-based compensation 71 113
Add: Cash in lieu of equity awards(1) 1 1
Add: Acquisition and integration costs(2) 1 8
Add: Restructuring and transition charges(3) 70 2
Add: Management fees(4) - 28
Add: Transformation(5) 12 20
Add: Executive severance(6) 1 3
Add: Foreign exchange loss (gain), net(7) (41 ) 104
Add: Provision for income taxes expense (benefit) (160 ) 5
Add: TRA adjustment(8) 307 2
Less: Income from TSA(9) (18 ) -
Add: Other (income) expense, net(10) 2 2
Less: Loss (income) from discontinued operations,
net of taxes (2,441 ) 79
Adjusted income before taxes $ 686 $ 365
Adjusted provision for income taxes(11) 151 80
Adjusted net income $ 535 $ 285
Net revenue $ 1,920 $ 1,558
Net income (loss) margin 140.0 % (18.5 )%
Adjusted net income margin 27.9 % 18.3 %
58--------------------------------------------------------------------------------
See "Description of Non-GAAP Adjustments" section for an explanation of adjustments to non-GAAP measures and other items.
Description of Non-GAAP Adjustments
Below are additional information to the adjustments for adjusted operating income, adjusted EBITDA, and adjusted net income: (1) As a result of the purchase from Intel of a majority interest inFoundation Technology Worldwide LLC ("FTW") inApril 2017 , cash awards were provided to certain employees who held Intel equity awards in lieu of equity in FTW. As these rollover awards reflect one-time grants to former employees of Intel in connection with these transactions, we believe this expense is not reflective of our ongoing results. (2) Represents both direct and incremental costs in connection with business acquisitions, including acquisition consideration structured as cash retention, third party professional fees, and other integration costs. (3) Represents both direct and incremental costs associated with costs to execute strategic restructuring events, including third-party professional fees and services, severance, and facility restructuring costs. Also inclusive of transition charges including legal, advisory, consulting and other costs directly incurred due to the divestiture of the Enterprise Business that were incurred subsequent to the sale in support of the transition services agreement. (4) Represents management fees paid to certain affiliates of TPG, Thoma Bravo, and Intel pursuant to the Management Services Agreement. The Management Services Agreement has been terminated subsequent to the IPO and we paid a total one-time fee of$22 million to such parties inOctober 2020 . (5) Represents costs incurred in connection with transformation of the business including the cost of workforce restructuring involving both eliminations of positions and relocations to lower cost locations in connection with our transformational initiatives, strategic initiatives to improve customer retention, activation to pay and cost synergies, inclusive of duplicative run rate costs related to facilities and data center rationalization, and other one-time costs. The 2021 amount also includes legal and consulting costs incurred in conjunction the Merger Agreement and related pending transaction. (6) Represents severance for executive terminations not associated with a strategic restructuring event. (7) Represents Foreign exchange gain (loss), net as shown on the consolidated statements of operations. This amount is attributable to gains or losses on non-U.S. Dollar denominated balances and is primarily due to unrealized gains or losses associated with our 1st Lien Euro Term Loan. (8) Represents the impact on net income of adjustments to liabilities under our tax receivable agreement. (9) Represents income earned under the Transition Service Agreement. (10) Represents other income or expense not associated with our core operations and it is recorded within Other income (expense), net, on the consolidated statements of operations. (11) Prior to our IPO, our structure was that of a pass-through entity forU.S. federal income tax purposes with certainU.S. and foreign subsidiaries subject to income tax in their respective jurisdictions. Subsequent to the IPO,McAfee Corp. is taxed as a corporation and pays corporate federal, state, and local taxes on income allocated to it from FTW. The adjusted provision for income taxes represents the tax effect on net income, adjusted for all of the listed adjustments, assuming that all consolidated net income was subject to corporate taxation for all periods presented. We have assumed an annual effective tax rate of 22% which represents our long term expected corporate tax rate excluding discrete and non-recurring tax items.
Free Cash Flow
We define free cash flow as net cash provided by operating activities less capital expenditures. We consider free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that can be used for strategic opportunities, including investing in our business, making strategic acquisitions, and strengthening the balance sheet.
The following table presents a reconciliation of our free cash flow to our net cash provided by operating activities for the periods presented:
Year Ended
(in millions) December 25, 2021 December 26, 2020 Net cash provided by operating activities $ 513 $ 760 Less: Capital expenditures(1) (26 ) (46 ) Free cash flow(2) $ 487 $ 714 (1) Capital expenditures includes payments for property and equipment and capitalized labor costs incurred in connection with certain software development activities. (2) Free cash flow includes$188 million , and$268 million , in cash interest payments for the years endedDecember 25, 2021 , andDecember 26, 2020 , respectively. 59 --------------------------------------------------------------------------------
Factors Affecting the Comparability of Our Results of Operations
As a result of a number of factors, our historical results of operations are not comparable from period to period and may not be comparable to our financial results of operations in future periods. Set forth below is a brief discussion of the key factors impacting the comparability of our results of operations.
Payments to
We make various payments to our channel partners, which may include revenue share, product placement fees and marketing development funds. Costs that are incremental to revenue, such as revenue share, are capitalized and amortized over time as cost of sales. This classification is an accounting policy election, which may make comparisons to other companies difficult. Product placement fees and marketing development funds are expensed in sales and marketing expense as the related benefit is received. Many of our channel partner agreements contain a clause whereby we pay the greater of revenue share calculated for the period or product placement fees. This may impact the comparability of our financial results between periods. Under certain of our channel partner agreements, the partners pay us a royalty on our technology sold to their customers, which we recognize as revenue in accordance with our revenue recognition policy. In certain situations, the payments made to our channel partners are recognized as consideration paid to a customer, and thus are recorded as reductions to revenue up to the amount of cumulative revenue recognized from contracts with the channel partner during the period of measurement. Any payments to channel partners in excess of such cumulative revenue during the period of measurement are recognized as cost of sales or marketing expense as described above. As royalty revenue from individual partners varies, the amount of costs recognized as a reduction of revenue rather than as cost of sales or sales and marketing expense fluctuates and may impact the comparability of our financial statements between periods.
Impact of Purchase Accounting Related to Mergers and Acquisitions
ThroughApril 3, 2017 , the McAfee cybersecurity business was operated as a part of a business unit of Intel. Also prior toApril 3, 2017 ,McAfee, Inc. , which was then a wholly-owned subsidiary of Intel, was converted into a limited liability company,McAfee, LLC . Following such conversion, Intel contributedMcAfee, LLC to FTW, a wholly-owned subsidiary of Intel. OnApril 3, 2017 , Intel and its subsidiaries transferred assets and liabilities of the McAfee business not already held through FTW to FTW. Immediately thereafter onApril 3, 2017 , investment funds affiliated with or advised byTPG Global, LLC ("TPG") andThoma Bravo, L.P. ("Thoma Bravo") (collectively "Sponsors") and certain of their co-investors acquired a majority stake in FTW, pursuant to the Sponsor Acquisition. Following the Sponsor Acquisition, our Sponsors and certain of their co-investors owned 51.0% of the common equity interests in FTW, with certain affiliates of Intel retaining the remaining 49.0% of the common equity interests. We have operated as a standalone company at all times following the Sponsor Acquisition. As a result of the Sponsor Acquisition, we recorded all assets and liabilities at their fair value, including our deferred revenue and deferred costs balances, as of the effective date of the Sponsor Acquisition, which in some cases was different than the historical book values. Adjusting our deferred revenue and deferred costs balances to fair value on the date of the Sponsor Acquisition had the effect of reducing revenue and expenses from that which would have otherwise been recognized in subsequent periods. We also recorded identifiable intangible assets that are amortized over their useful lives, increasing expenses from that which would otherwise have been recognized. In addition, we have made acquisitions and recorded the acquired assets and liabilities at fair value on the date of acquisition, which similarly impacted deferred revenue and deferred costs balances and reduced revenue and expenses from that which would have otherwise been recognized in subsequent periods. We also recorded identifiable intangible assets that are amortized over their useful lives, increasing expenses from that which would otherwise have been recognized. The accounting impact resulting from these acquisitions limits the comparability of our financial statements between periods. The table below shows the impact of purchase accounting on our financial statements. Year Ended (in millions) December 25, 2021 December 26, 2020 Cost of sales $ 94 $ 109 Amortization of intangibles 76 143 Expense attributable to the impact of purchase accounting related to continuing operations 170 252 Expense attributable to the impact of purchase accounting related to discontinued operations 36 187 Total expense attributable to the impact of purchase accounting $ 206 $ 439 60
--------------------------------------------------------------------------------
Income Tax and Tax Receivable Agreement
McAfee Corp. is a corporation forU.S. federal and state income tax purposes. Following the Reorganization Transactions, FTW is the predecessor ofMcAfee Corp. for accounting purposes. FTW is and remains a partnership forU.S. federal income tax purposes and will therefore generally not be subject to anyU.S. federal income taxes at the entity level in respect of income it recognizes directly or through itsU.S. and foreign subsidiaries that are also pass- through or disregarded entities forU.S. federal income tax purposes. Instead, taxable income and loss of these entities will flow through to the members of FTW (includingMcAfee Corp. and certain of its subsidiaries) forU.S. federal income tax purposes. Certain of FTW's non-U.S. subsidiaries that are treated as pass-through or disregarded entities forU.S. federal income tax purposes are nonetheless treated as taxable entities in their respective jurisdictions and are thus subject to non-U.S. taxes at the entity level. FTW also has certainU.S. and foreign subsidiaries that are treated as corporations forU.S. federal income tax purposes and that therefore are or may be subject to income tax at the entity level.McAfee Corp. paysU.S. federal, state and local income taxes as a corporation on its share of the taxable income of FTW (taking into account the direct and indirect ownership of FTW byMcAfee Corp. ). In addition, in connection with the Reorganization Transactions and the IPO,McAfee Corp. entered into the tax receivable agreement as described in Note 14 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K. As a result of the divestiture, we expect to utilize certain deferred tax assets from the domestic portion of the gain on the sale. We have concluded that a full valuation allowance against the net deferred tax assets of our domestic entities will no longer be required and have released$211 million of the$212 million of valuation allowance that existed as ofDecember 26, 2020 . The valuation allowance of$19 million as ofDecember 25, 2021 relates to foreign capital and state net operating loss carryforwards primarily generated in the current year that we have determined are not more likely than not going to be utilized. In addition, we recognized a deferred tax asset of$223 million with a corresponding charge to equity whenFTW LLC Units are exchanged for shares of Class A common stock (the "Exchanges") in fiscal 2021. Offset To Provision for Income Tax Income from Deferred Tax Additional (Expense) Discontinued (in millions) Asset Paid-in Capital Benefits Operations Release of valuation allowance on deferred tax assets $ 211 $ -$ 211 $ - Exchanges and tax attributes in Fiscal 2021 223 223 - - As the net deferred tax assets have been recognized as of the date of divestiture of the Enterprise Business, the full liability under the TRA also became probable as of that date. During the year endedDecember 25, 2021 , TRA liability increases of$121 million resulting from post divestiture Exchanges were recorded to Additional paid-in capital on the consolidated balance sheet. TRA liability increases of$313 million resulting from pre-divestiture Exchanges and TRA liability decreases of$6 million resulting from unutilized tax attributes were recorded within Other income (expense), net. TRA liability increases of$4 million resulting from divestiture related events were recorded within Income from discontinued operations on the consolidated statement of operations. As ofDecember 25, 2021 , we have TRA liabilities of$2 million and$432 million recorded in the consolidated balance sheet within Accounts payable and other accrued liabilities and Tax receivable agreement liability, less current portion, respectively. TRA Liability Offset To Income from Additional Other Income Discontinued (in millions) Current Portion Noncurrent
Portion
$ 2 $ -
Exchanges and tax attributes that
existed prior to divestiture - 317 $ - $ (313 ) $ (4 )
Exchanges and tax attributes that
existed on or after divestiture - 115 (121 ) 6 -
As of December 25, 2021 $ 2 $ 432 $ (121 ) $ (307 ) $ (4 )
61--------------------------------------------------------------------------------
Equity-Based Compensation
Upon consummation of the IPO inOctober 2020 , we recognized a cumulative catch-up of equity-based compensation expense relating to our management equity participation units ("MEPU"s) and cash-settled restricted equity units ("CRSU"s). Concurrently, we modified the terms of our unvested FTW RSUs, outstanding CRSUs, and outstanding MEPUs to permit settlement in the Company's Class A common stock, par value$0.001 per share ("Class A common stock") (collectively, "Replacement RSUs") in lieu of cash settlement, at the Company's election. No service or performance vesting terms were changed at the time of modification. All of our outstanding equity awards were probable of vesting and the change was accounted for as a Type I modification. In addition, the Company granted stock options with a strike price equal to the IPO price to certain holders of MEPUs with distribution thresholds not fully satisfied at the time of modification and, at the time of the grant, recognized expense for these options immediately. See Note 12 to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report on Form 10-K for a detailed discussion of equity-based compensation. The accounting impact resulting from the recognition of this equity-based compensation limits the comparability of our financial statements between periods. The table below shows the impact of all equity-based compensation on our financial statements. Year Ended (in millions) December 25, 2021 December 26, 2020 Cost of sales $ 3 $ 5 Sales and marketing 19 23 Research and development 20 40 General and administrative 29 45 Total equity-based compensation expense from continuing operations 71 113 Discontinued operations 31 200 Total equity-based compensation expense $ 102 $ 313
Composition of Revenues, Expenses, and Cash Flows
Net Revenue
We derive our revenue primarily from the sale of software subscriptions or royalty agreements, primarily through our indirect relationships with our partners or direct relationships with end customers through our website. We have various marketing programs with certain business partners who we consider customers and reduce revenue by the cash consideration given to these partners. Revenue is recognized as control of the promised goods or services are transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for the promised goods or services.
Cost of Sales
Our total cost of sales include fees paid under revenue share arrangements, amortization of certain intangibles, transaction processing fees, the costs of providing delivery (i.e., hosting), support including salaries and benefits for employees and fees related to third parties, and technology licensing fees. We anticipate our total cost of sales to increase in absolute dollars as we grow our net revenue. Cost of sales as a percentage of net revenue may vary from period to period based on our investments in the business, the efficiencies we are able to realize going forward as well as due to the accounting for payments to channel partners discussed in Factors Affecting the Comparability of Our Results of Operations. We expect the divestiture of the Enterprise Business to lead to costs that were previously allocated to both segments to now be part of continuing operations, which will have a dilutive impact on gross margins.
Operating Expenses
Our operating expenses consist of sales and marketing, research and development, general and administrative, amortization of intangibles, and restructuring and transition charges. We expect the divestiture of the Enterprise Business to lead to costs that were previously allocated to both segments will be part of continuing operations, which will have a dilutive impact on operating margins.
•
Sales and Marketing. Sales and marketing expenses consist primarily of product
placement fees and marketing development funds, advertising and marketing
promotions, salaries, commissions, benefits for sales and marketing personnel as
well as allocated facilities and IT costs. Sales and marketing as a percentage
of net revenue may vary from period to period based due to the accounting for
payments to channel partners discussed in Factors Affecting the Comparability of
Our Results of Operations.
62
--------------------------------------------------------------------------------•
Research and Development. Research and development expenses consist primarily of salaries and benefits for our development staff and a portion of our technical support staff, contractors' fees, and other costs associated with the enhancement of existing products and services and development of new products and services, as well as allocated facilities and IT costs.
•
General and Administrative. General and administrative expenses consist primarily of salaries and benefits and other expenses for our executive, finance, human resources, and legal organizations. In addition, general and administrative expenses include outside legal, accounting, and other professional fees, and an allocated portion of facilities and IT costs.
•
Amortization of Intangibles. Amortization of intangibles includes the
amortization of customer relationships and other assets associated with our
acquisitions, including the Sponsor Acquisition in
•
Restructuring and Transition Charges. Restructuring charges consist primarily of costs associated with employee severance and facility restructuring charges related to realignment of our workforce. Transition charges are costs incurred subsequent to the divestiture of the Enterprise Business in support of the Transition Service Agreement. These costs include legal, advisory, consulting and other costs and are generally paid when incurred. We also expect to pay approximately$300 million in cumulative one-time separation costs and stranded cost optimization. Interest Expense
Interest expense primarily relates to interest expense on our outstanding indebtedness.
Foreign Exchange Gain (Loss), Net
Foreign exchange gain (loss), net is comprised of realized and unrealized gains
or losses on non-
Other Income (expense), Net
Other income (expense), net is primarily attributable to adjustments related to the TRA, as well as the revenue from the transition service agreement we entered into in connection with the divestiture of the Enterprise Business under which we provide assistance to Enterprise Business including, but not limited to, business support services and information technology services.
Provision for Income Tax
McAfee Corp. is taxed as a corporation and pays corporate federal, state and local taxes on income allocated to it from FTW based uponMcAfee Corp.'s economic interest in FTW. FTW is a pass through entity forU.S. federal income tax purposes and will not incur any federal income taxes either for itself or itsU.S. subsidiaries that are also pass through or disregarded subsidiaries. Taxable income or loss for these entities will flow through to its respective members forU.S. tax purposes. FTW does have certainU.S. and foreign subsidiaries that are corporations and are subject to income tax in their respective jurisdiction.
Income from Discontinued Operations, Net of Taxes
Following the agreement with STG, the results of our Enterprise Business through
the date of transaction close were classified as discontinued operations in our
consolidated statements of operations and excluded from continuing operations.
63--------------------------------------------------------------------------------
Results of Operations
The following tables set forth the consolidated statements of operations in dollar amounts and as a percentage of our total revenue for the periods indicated. The period-to-period comparison of results is not necessarily indicative of results for future periods.
Year Ended
(in millions) December 25, 2021 December 26, 2020
Net revenue $ 1,920 $ 1,558
Cost of sales 470 444
Gross profit 1,450 1,114
Operating expenses:
Sales and marketing 375 345
Research and development 184 187
General and administrative 196 231
Amortization of intangibles 76 143
Restructuring and transition charges 70 2
Total operating expenses 901 908
Operating income 549 206
Interest expense (212 ) (303 )
Foreign exchange gain (loss), net 41 (104 )
Other income (expense), net (291 ) (4 )
Income (loss) from continuing operations before
income taxes 87 (205 )
Provision for income tax expense (benefit) (160 ) 5
Income (loss) from continuing operations 247 (210 )
Income (loss) from discontinued operations, net of taxes
2,441 (79 )
Net income (loss) 2,688 (289 )
Less: Net income (loss) attributable to redeemable noncontrolling interests
1,839 (171 )
Net income (loss) attributable to McAfee Corp. $ 849 $ (118 )
Year Ended
December 25, 2021 December 26, 2020
Net revenue 100.0 % 100.0 %
Cost of sales 24.5 % 28.5 %
Gross profit 75.5 % 71.5 %
Operating expenses:
Sales and marketing 19.5 % 22.1 %
Research and development 9.6 % 12.0 %
General and administrative 10.2 % 14.8 %
Amortization of intangibles 4.0 % 9.2 %
Restructuring and transition charges 3.6 % 0.1 %
Total operating expenses 46.9 % 58.3 %
Operating income 28.6 % 13.2 %
Interest expense (11.0 )% (19.4 )%
Foreign exchange gain (loss), net 2.1 % (6.7 )%
Other income (expense), net (15.2 )% (0.3 )%
Income (loss) from continuing operations before
income taxes 4.5 % (13.2 )%
Provision for income tax expense (benefit) (8.3 )% 0.3 %
Income (loss) from continuing operations 12.9 % (13.5 )%
Income (loss) from discontinued operations, net
of taxes 127.1 % (5.1 )%
Net income (loss) 140.0 % (18.5 )%
Less: Net income (loss) attributable to
redeemable noncontrolling interests 95.8 % (11.0 )%
Net income (loss) attributable to McAfee Corp. 44.2 % (7.6 )%
64--------------------------------------------------------------------------------
Net Revenue
Year Ended Variance in
(in millions, except
percentages) December 25, 2021 December 26, 2020 Dollars Percent Net revenue $ 1,920 $ 1,558$ 362 23.2 % The net revenue increase was primarily driven by (i) growth in Core Direct to Consumer Subscribers, (ii) increases in secure search revenue, (iii) growth in Mobile and Internet Service Provider business, and (iv) an increase in ARPC.
Net Revenue by
Net revenue by geographic region based on the sell-to address of the end-users
is as follows:
Year Ended
(in millions except
percentages) December 25, 2021 % of Total December 26, 2020 % of Total
Americas $ 1,281 66.7 % $ 1,027 65.9 %
EMEA 441 23.0 % 365 23.4 %
APJ 198 10.3 % 166 10.7 %
Total net revenue $ 1,920 100.0 % $ 1,558 100.0 %
The
Net revenue by geographic region in fiscal 2021 showed growth in all geographies when compared to the corresponding periods in the prior year and we expect such percentages to remain relatively consistent in the near term.
Net Revenue by Channel
Direct to Consumer revenue is from subscribers who transact with us directly through McAfee web properties, including those converted after the trial period of the McAfee product preinstalled on their new PC purchase or converted subsequent to their subscription period purchased from another channel. Indirect revenue is driven by users who purchase directly through a partner inclusive of mobile providers, ISPs, electronics retailers, ecommerce sites, and search providers.
Net revenue by channel of the end-users is as follows:
Year Ended
(in millions except
percentages) December 25, 2021 % of Total December 26, 2020 % of Total
Direct to Consumer $ 1,397 72.8 % $ 1,195 76.7 %
Indirect 523 27.2 % 363 23.3 %
Total net revenue $ 1,920 100.0 % $ 1,558 100.0 %
Cost of Sales
Year Ended Variance in
(in millions, except
percentages) December 25, 2021 December 26, 2020 Dollars Percent
Cost of sales $ 470 $ 444 $ 26 5.9 %
Gross profit margin 75.5 % 71.5 %
The increase in cost of sales was primarily attributable to a $44 million
increase in revenue share expense and online transaction processing fees driven
by increases in Core Direct to Consumer Subscribers, partially offset by a $14
million decrease in amortization due to assets becoming fully amortized as of
March 2021 .
Operating Expenses
Year Ended Variance in
(in millions, except
percentages) December 25, 2021 December 26, 2020 Dollars Percent
Sales and marketing $ 375 $ 345 $ 30 8.7 %
Research and development 184 187 (3 ) (1.6 )%
General and
administrative 196 231 (35 ) (15.2 )%
Amortization of
intangibles 76 143 (67 ) (46.9 )%
Restructuring and
transition charges 70 2 68 3400.0 %
Total $ 901 $ 908 $ (7 ) (0.8 )%
65--------------------------------------------------------------------------------
Sales and Marketing
The increase in sales and marketing expense was primarily attributable to (i) a$25 million increase in marketing spend and (ii) a$9 million increase in expenses for consulting services. These increases were partially offset by the decrease in equity-based compensation expense.
Research and Development
The decrease in research and development expense was primarily attributable to the decrease in equity-based compensation expense, partially offset by an increase in employee expenses.
General and Administrative
The decrease in general and administrative expense was primarily attributable to (i) a$28 million decrease in management fee expense including a one-time fee for the termination of the management agreement at the time of the IPO, and (ii) a decrease in equity-based compensation and acquisition and integration costs. These increases were partially offset by a$9 million increase in professional services expenses primarily related to costs of being a public company.
Amortization of Intangibles
The decrease in amortization of intangibles was attributable to assets that
became fully amortized in
Restructuring and Transition Charges
The increase in restructuring and transition charges is primarily the result of$60 million of transition charges including legal, advisory, consulting and other costs directly incurred due to the divestiture of the Enterprise Business, including incremental costs associated with data disentanglement and acceleration of data migration to the cloud, that were incurred subsequent to the sale in support of the transition services agreement. There was an additional$8 million increase driven by restructuring and one-time termination benefits to impacted employees, including severance payments and healthcare and other accrued benefits related to the workforce reduction that was initiated inDecember 2020 . Operating Income Year Ended Variance in (in millions, except percentages) December 25, 2021 December 26, 2020 Dollars Percent Operating income $ 549 $ 206$ 343 166.5 % Operating income margin 28.6 % 13.2 % The operating income increase was primarily driven by (i) the$362 million increase in net revenue, (ii)$81 million decrease in amortization expense, (iii) a$42 million decrease in equity-based compensation, and (iv) a$28 million decrease in management fee expense including the one-time termination fee at the time of the IPO. These were partially offset by (i) a$68 million increase in restructuring and transition charges, (ii) a$44 million increase in revenue share expense resulting from increases in Core Direct to Consumer Subscribers, (iii) a$25 million increase in marketing spend, and (iv) an$18 million dollar increase in professional service and external consulting expenses. Interest Expense Year Ended Variance in (in millions, except percentages) December 25, 2021 December 26, 2020 Dollars Percent Interest expense $ (212 ) $ (303 ) $ 91 (30.0 )% The decrease in interest expense was primarily attributable to (i) lower debt balances due to the payoff of our 2nd Lien Term Loan and prepayment on our 1st Lien USD Term Loan in the fourth quarter of 2020 in addition to our third quarter 2021 prepayment of 1st Lien Term Loans with a portion of the proceeds of the divestiture of the Enterprise business as discussed above and (ii) a$14 million loss on extinguishment in 2020 for the remaining unamortized discount and unamortized deferred financing costs at the time of the payoff of our 2nd Lien Term Loan. These decreases were partially offset by a (i)$10 million loss on extinguishment of debt for recognition of unamortized discount and deferred financing in the third quarter of 2021 for the 1st Lien Term Loans prepayment and (ii) a$9 million increase in interest rate swap expense due to a decrease in LIBOR.
Other Income (Expense), Net
Year Ended Variance in
(in millions, except
percentages) December 25, 2021 December 26, 2020 Dollars Percent
Other income (expense),
net $ (291 ) $ (4 ) $ (287 ) 7175.0 %
66-------------------------------------------------------------------------------- The decrease in other income (expense), net was primarily attributable to$307 million in tax receivable agreement liability recorded to expense subsequent to the release of the valuation allowance against the deferred tax assets discussed within the Provision for Income Tax Expense section below. This was partially offset by$18 million increase inTSA income.
Provision for Income Tax Expense
Year Ended Variance in
(in millions, except
percentages) December 25, 2021 December 26, 2020 Dollars Percent
Provision for income tax
expense (benefit) $ (160 ) $ 5 The change in the provision for income tax benefit was primarily attributable to the release of the valuation allowance on the deferred tax assets in theU.S. due to no longer being in a cumulative pre-tax loss as a result of the gain on the divestiture of the Enterprise Business, partially offset by increased in income in higher taxed jurisdictions. Discontinued Operations Year Ended Variance in (in millions, except percentages) December 25, 2021 December 26, 2020 Dollars Percent Net revenue $ 781 $ 1,348$ (567 ) (42.1 )% Operating income (loss) 99 (54 ) 153 (283.3 )% Pre-tax gain on divestiture of Enterprise Business 2,628 - 2,628 NM Income (loss) from discontinued operations before income taxes 2,722 (54 ) 2,776 (5140.7 )% Income tax expense 281 25 256 1024.0 % Income (loss) from discontinued operations, net of tax 2,441 (79
) 2,520 (3189.9 )%
The changes in net revenue and operating income related to discontinued
operations was primarily the result of the sale closing
The increase in the income from discontinued operations before income taxes was primarily the result of the$2,628 million pre-tax gain on the divestiture of the Enterprise Business recognized in 2021.
The increase in income tax expense is primarily due to the
Seasonality While portions of our business are impacted by seasonality, the net impact of seasonality on our business is limited. Orders are generally higher in the first and fourth quarters and lower in the second and third quarters. A significant number of orders in the fourth quarter is reflective of historically higher holiday sales of PC computers leading to higher subscriptions in the fourth quarter as well as in the first quarter due to lag from computer purchase to paid subscription of our products. This seasonal effect is present both in new subscriptions as well as in the renewal of prior year subscriptions due in those quarters.
Liquidity and Capital Resources
McAfee Corp. is a holding company with no operations and, as such, will depend on its subsidiaries for cash to fund all of its operations and expenses through the payment of distributions by its current and future subsidiaries, including FTW. The terms of the agreements governing our senior secured credit facilities contain certain negative covenants prohibiting certain of our subsidiaries from making cash dividends or distributions toMcAfee Corp. or to FTW unless certain financial tests are met. For a discussion of those restrictions, see "-Senior Secured Credit Facilities" below and "Risk Factors-Risks Related to Our Indebtedness-Restrictions imposed by our outstanding indebtedness and any future indebtedness may limit our ability to operate our business and to take certain actions". We currently anticipate that such restrictions will not impact our ability to meet our cash obligations.
Sources of Liquidity
As ofDecember 25, 2021 , we had cash and cash equivalents of$816 million . Our primary source of cash for funding operations and growth has been through cash flows generated from operating activities. In addition, we have funded certain acquisitions, distributions to members, and to a lesser extent, capital expenditures and our operations, through borrowings under the Senior Secured Credit Facilities, primarily in the form of long-term debt obligations. As ofDecember 25, 2021 , we had$660 million of additional unused borrowing capacity under our Revolving Credit Facility. 67 -------------------------------------------------------------------------------- We believe that our existing cash on hand, expected future cash flows from operating activities, and additional borrowings available under our credit facilities will provide sufficient resources to fund our operating requirements as well as future capital expenditures, debt service requirements, and investments in future growth for at least the next twelve months. Our future capital requirements will depend on many factors, including our growth rate, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced product and service offerings, and the continuing market acceptance of our products. In the event that additional financing is required from outside sources, we may not be able to raise such financing on terms acceptable to us or at all. If we are unable to raise additional capital when desired, our business, operating results, and financial condition may be adversely affected.
On
Senior Secured Credit Facilities
As ofDecember 25, 2021 , our Senior Secured Credit Facilities consisted of aU.S. dollar-denominated term loan tranche of$2,369 million (the "First Lien USD Term Loan"), a Euro-denominated term loan tranche of €499 million (the "First Lien EUR Term Loan", and together with the First Lien USD Term Loan, the "First Lien Term Loans"), and a$664 million Revolving Credit Facility, of which we had$4 million outstanding as letters of credit. The Revolving Credit Facility includes a$50 million sublimit for the issuance of letters of credit. The commitments under the First Lien Term Loans will mature onSeptember 29, 2024 . As ofDecember 25, 2021 , our total outstanding indebtedness under the Senior Secured Credit Facilities was$2,935 million . The First Lien Term Loans require equal quarterly repayments equal to 0.25% of the total amount borrowed. Our 1st Lien Net Leverage Ratio as defined in the credit facility agreement was 1.7 as ofDecember 25, 2021 . For the year endedDecember 25, 2021 , the weighted average interest rate was 3.9% under the First Lien USD Term Loan and 3.5% under the First Lien EUR Term Loan. The commitment fee of the unused portion of the Revolving Credit Facility was 0.25% as ofDecember 25, 2021 . InAugust 2021 , we prepaid$332 million of 1st Lien USD Term Loan and €563 million of 1st Lien Euro Term Loan. In connection with this prepayment, we incurred a loss on extinguishment of debt in the third quarter of our 2021 fiscal year of$10 million related to recognition of unamortized discount and deferred financing costs. See Note 13 to the consolidated financial statements for more information. We also terminated$150 million of our$250 million notional interest rate swap that had an expiration date ofJanuary 29, 2022 . See Note 15 to the consolidated financial statements for more information and refer to "-Divestiture of Enterprise Business" above.
Tax Receivable Agreement
The contribution by the Continuing Owners (as defined in Note 1 to the
consolidated financial statements in Part II, Item 8 of this Annual Report on
Form 10-K) to the Corporation of certain corporate entities in connection with
the IPO (including the Reorganization Transactions) and future exchanges of LLC
Units for shares of the Corporation's Class A common stock are expected to
produce or otherwise deliver to the Corporation favorable tax attributes that
can reduce its taxable income. Prior to the completion of the IPO, the
Corporation entered into a Tax Receivable Agreement ("TRA"), which generally
will require it to pay the TRA Beneficiaries, as defined in Note 1 to the
consolidated financial statements, 85% of the applicable cash savings, if any,
in U.S. federal, state, and local income tax that the Corporation actually
realizes or, in certain circumstances, is deemed to realize as a result of (i)
all or a portion of the Corporation's allocable share of existing tax basis in
the assets of FTW (and its subsidiaries) acquired in connection with the
Reorganization Transactions, (ii) increases in the Corporation's allocable share
of existing tax basis in the assets of FTW (and its subsidiaries) and tax basis
adjustments in the assets of FTW (and its subsidiaries) as a result of sales or
exchanges of LLC Units after the IPO, (iii) certain tax attributes of the
corporations acquired by McAfee Corp. in connection with the Reorganization
Transactions (including their allocable share of existing tax basis in the
assets of FTW (and its subsidiaries)), and (iv) certain other tax benefits
related to entering into the tax receivable agreement, including tax benefits
attributable to payments under the tax receivable agreement. The Corporation
generally will retain the benefit of the remaining 15% of the applicable tax
savings. The payment obligations under the tax receivable agreement are
obligations of McAfee Corp. , and we expect that the payments that will be
required to make under the tax receivable agreement will be substantial.
On July 27, 2021 , we completed the sale of our Enterprise Business to STG for an
all-cash purchase price of $4.0 billion . As the net deferred tax assets have
been recognized as of the date of divestiture of the Enterprise Business, the
full liability under the TRA also became probable as of that date. During the
year ended December 25, 2021 , TRA liability increases of $121 million resulting
from post divestiture Exchanges were recorded to Additional paid-in capital on
the consolidated balance sheet. TRA liability increases of $313 million
resulting from pre-divestiture Exchanges and TRA liability decreases of $6
million resulting from unutilized tax attributes were recorded within Other
income (expense), net. TRA liability increases of $4 million resulting from
divestiture related events were recorded within Income from discontinued
operations on the consolidated statement of operations.
68
--------------------------------------------------------------------------------
As of December 25, 2021 , we have TRA liabilities of $2 million and $432 million
recorded in the consolidated balance sheet within Accounts payable and other
accrued liabilities and Tax receivable agreement liability, less current
portion, respectively. See Note 1 and 14 to the consolidated financial
statements in Part II, Item 8 of this Annual Report on Form 10-K for further
information.
Dividend Policy
FTW paid a cash distribution to its members for each of the first three quarters
of fiscal 2021 at an aggregate annual rate of approximately $200 million . McAfee
Corp. received a portion of such distributions through the LLC Units it holds
directly or indirectly through its wholly-owned subsidiaries on the record date
such distributions were declared by FTW. McAfee Corp. used a portion of its
share of the cash distributions declared by FTW to declare or pay the dividends
noted in the table below during the year ended December 25, 2021 . Remaining
distributions received by McAfee Corp. were used for corporate taxes and general
corporate purposes. Pursuant to the terms of the Merger Agreement, the Company
has agreed to suspend its dividend during the term of the Merger Agreement.
Amount
Declaration Date Record Date Payment Date Dividend per Share (in millions)
December 9, 2020 December 24, 2020 January 7, 2021 $ 0.087 $ 14 March 11, 2021 March 26, 2021 April 9, 2021 $ 0.115 $ 19 June 10, 2021 June 25, 2021 July 9, 2021 $ 0.115 $ 19 August 3, 2021 August 13, 2021 August 27, 2021 $ 4.500 $ 760 September 13, 2021 September 24, 2021 October 8, 2021 $ 0.115 $ 21 OnAugust 3, 2021 , we declared a one-time Special Dividend of$4.50 per share of Class A common stock outstanding in connection with the consummation of the sale of our Enterprise Business. See Note 7 to the consolidated financial statements for additional dividend information on the Special Dividend. 69 --------------------------------------------------------------------------------
Consolidated Statements of Cash Flows
Our cash flows for the years endedDecember 25, 2021 andDecember 26, 2020 were: Year Ended December 25, 2021 December 26, 2020 Net cash provided by operating activities $ 513 $ 760 Net cash provided by (used in) investing activities 3,935 (51 ) Net cash used in financing activities (3,851 ) (651 ) Effect of exchange rate fluctuations on cash and cash equivalents (12 ) 6 Change in cash and cash equivalents $ 585 $ 64
See Note 4 to the consolidated financial statements for additional cash flow information associated with our discontinued operations.
Operating Activities
For the year endedDecember 25, 2021 , net cash provided by operating activities was$513 million , as a result of net income of$2,688 million , adjusted for non-cash charges of$2,161 million and net cash outflow of$14 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$2,628 million of pre-tax gain on divestiture of Enterprise Business,$173 million in deferred taxes primarily from the release of valuation allowance due to divestiture of Enterprise Business, and$41 million in foreign exchange gains, partially offset by$311 million in TRA remeasurement,$236 million in depreciation and amortization,$102 million in equity-based compensation, and$35 million in other operating activities primarily consisting of lease asset amortization, and amortization of debt discount and issuance costs. The net cash outflow from changes in operating assets and liabilities was primarily due to (i) a$55 million decrease in other liabilities primarily due to payment of annual bonuses and year-end commissions in fiscal 2021 to employees of Enterprise Business, (ii) a$51 million increase in deferred costs primarily due to increased deferred revenue share resulting from an increased subscriber base, (iii) a$51 million increase in other assets primarily due to increases in long-term deferred revenue share and in right of use assets recorded primarily due to renewed leases, and (iv) a$30 million increase in receivable from and payable to the Enterprise Business primarily due to receivable related toTSA receivable and misdirected payments. These changes were partially offset by (i) an$86 million decrease in accounts receivable, net primarily due to collection of accounts receivable outstanding atDecember 26, 2020 , including those related to the Enterprise Business, (ii) a$32 million increase in other current liabilities primarily due to accrual of transition costs incurred in 2021, (iii) a$24 million increase of deferred revenue primarily due to an increased subscriber base, and (iv) a$28 million increase of income taxes payable primarily due to tax obligations from the gain on the divestiture of Enterprise Business. The increase in income taxes paid, net of refunds from the year endedDecember 26, 2020 to the year endedDecember 25, 2021 is primarily driven by taxes paid related to the gain on the sale of the Enterprise Business. For the year endedDecember 26, 2020 , net cash provided by operating activities was$760 million , as a result of a net loss of$289 million , adjusted for non-cash charges of$968 million and net cash inflow of$81 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of$491 million in depreciation and amortization,$313 million in equity-based compensation,$104 million for foreign exchange loss, and$70 million in other operating activities primarily consisting of lease asset amortization, and amortization of debt discount and issuance costs, partially offset by$10 million in deferred income taxes. The net cash inflow from changes in operating assets and liabilities was primarily due to (i) a$106 million increase in deferred revenue balances resulting from increases in Consumer deferred revenue consistent with the increases in subscriber base and dollar retention rates, partially offset by decrease in deferred revenue primarily due to recognition of Enterprise deferred revenue outpacing billings, (ii) a$41 million increase other current liabilities due largely to increased amounts for revenue share and shipments fees related to our increased Consumer subscriber base and increased PC shipments for our OEM partners as well as timing of vendor payments, and (iii) a$15 million decrease in accounts receivable, net which is primarily caused by the decrease in Enterprise billings. These changes were partially offset by (i) a$46 million increase in deferred costs primarily due to increased deferred revenue share resulting from an increased consumer subscriber base and new Consumer affiliate programs, (ii) a$26 million decrease in other liabilities primarily due to lower bonus attainment in 2020 due to slightly lower performance against target, and a slightly lower ending headcount in 2020, and (iii) a$9 million increase in other assets primarily due to new leases signed during the period.
Investing Activities
For the year endedDecember 25, 2021 , net cash provided by investing activities was$3,935 million , which was primarily$3,930 million of net proceeds from divestiture of Enterprise Business and$31 million from disposal of the Plano facility. These in flows were partially offset by additions to property and equipment and other investing activities totaling$26 million . For the year endedDecember 26, 2020 , net cash used in investing activities was$51 million , which was primarily the result of additions to property and equipment and other investing activities totaling$46 million and a$5 million business acquisition, net of cash. 70 --------------------------------------------------------------------------------
Financing Activities
For the year endedDecember 25, 2021 , net cash used in financing activities was$3,852 million , which was primarily the result of (i) distribution to members of FTW of$1,894 million , (ii) payment of long-term debt of$1,038 million including prepayments made using a portion of the proceeds from divestiture of the Enterprise Business, (iii)$833 million of dividends paid to holders of Class A common stock, and (iv)$101 million of payment of tax withholding for shares withheld. For the year endedDecember 26, 2020 , net cash used in financing activities was$651 million , which was primarily the result of (i) payment of long-term debt of$869 million , (ii) distributions to members of FTW of$277 million before our IPO, (iii)$24 million in payment of tax withholding on equity awards, (iv)$8 million in payment of IPO related costs, and (v)$23 million in other financing activities primarily relating to equity repurchases. The uses were partially offset by proceeds from IPO of$586 million , net of underwriters' discount, commissions offset by$33 million to purchaseFTW LLC Units.
Contractual Obligations and Commitments
The following is a summary of our contractual obligations as ofDecember 25, 2021 : Payments Due by Period(1) Less than 1 (in millions) Total Year 1-3 Years 3-5 Years Over 5 Years
Long-term debt(2)$ 2,935 $ 43$ 2,892 $ - $ - Cash interest(3) 391 156 235 - - Purchase obligations 399 108 209 82 - Operating lease obligations, including imputed interests 51 8 12 10 21 Total$ 3,776 $ 315$ 3,348 $ 92 $ 21 (1) Excludes any obligations under the TRA. In connection with the closing of the Merger, the Company, FTW and certain other parties thereto have entered into a Tax Receivable Agreement and LLC Agreement Amendment (the "Amendment"). The Amendment provides for, among other things, (i) the payment of amounts due under the TRA currently in effect with respect toU.S. federal income tax year 2020 of the Company in accordance with the terms of the TRA up to an aggregate amount of$2 million , which payments shall be paid no later than 10 business days prior to the Closing Date, (ii) the suspension of all other payments under the TRA from and afterNovember 5, 2021 and (iii) the amendment of the TRA, effective as of immediately prior to and contingent upon the occurrence of the Effective Time of the Merger, which shall result in the TRA (and all of the Company's obligations thereunder, including the obligation to make any of the foregoing suspended payments) terminating immediately prior to the Effective Time of the Merger. See Note 14 to our consolidated financial statements included (Part II, Item 8 of this Form 10-K) for further information on our tax receivable agreement.
(2)
See Note 13 to our consolidated financial statements included (Part II, Item 8 of this Form 10-K) for further information on our long-term debt.
(3)
Interest payments were calculated based on the interest rate in effect onDecember 25, 2021 and based upon expected debt balances after mandatory repayments related to the First Lien USD Term Loan, and First Lien Euro Term Loan, and include the impact of our interest rate swaps. See Note 13 to our consolidated financial statements for further information on the First Lien USD Term Loan and First Lien Euro Term Loan and Note 15 to our consolidated financial statements for further information on our interest rate swaps (included in Part II, Item 8 of this Form 10-K).
Off-Balance Sheet Arrangements
As ofDecember 25, 2021 , andDecember 26, 2020 , we did not have any relationships with unconsolidated entities or financial partnerships, such as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements or other purposes. 71 --------------------------------------------------------------------------------
Critical Accounting Policies and Use of Estimates
Our discussion and analysis of operating results and financial condition are
based upon our consolidated financial statements included elsewhere in this
document. The preparation of our financial statements in accordance with GAAP
requires us to make estimates and assumptions that affect the reported amounts
of assets, liabilities, revenue, expenses and related disclosures of contingent
assets and liabilities. We base our estimates on past experience and other
assumptions that we believe are reasonable under the circumstances, and we
evaluate these estimates on an ongoing basis. Actual results may differ from
those estimates.
Our critical accounting policies are those that materially affect our
consolidated financial statements including those that involve difficult,
subjective or complex judgments by management. A thorough understanding of these
critical accounting policies is essential when reviewing our consolidated
financial statements. We believe that the critical accounting policies listed
below are those that are most important to the portrayal of our results of
operations or involve the most difficult management decisions related to the use
of significant estimates and assumptions as described above. For further
information, see Note 2 of our consolidated financial statements (Part II, Item
8 of this Form 10-K).
Revenue Recognition
We derive revenue from the sale of security products, subscriptions, software as
a service ("SaaS") offerings, support and maintenance, professional services, or
a combination of these items, primarily through our indirect relationships with
our partners or direct relationships with end customers through our internal
sales force.
We recognize revenue pursuant to the five-step framework within ASC Topic 606:
1.
Identify the contract(s) with a customer: Contracts are generally evidenced by a binding and non-cancelable purchase order or agreement that creates enforceable rights and obligations.
2.
Identify the performance obligations in the contract: Performance obligations are the promises contained in the contract to provide distinct goods or services.
3.
Determine the transaction price: The amount of consideration we expect to be entitled for transferring the promised goods and services to the customer.
4.
Allocate the transaction price to the performance obligations in the contract:
Standalone selling price ("SSP") is determined for each performance obligation
in the contract and a proportion of the overall transaction price is allocated
to each performance obligation based on the relative value of its SSP in
comparison to the transaction price except when a discount or variable
consideration can be allocated to a specific performance obligation in the
contract.
5.
Recognize revenue when (or as) we satisfy a performance obligation: Recognition for a performance obligation may happen over time or at a point in time depending on the facts and circumstances.
We generally consider our customer to be the entity with which we have a
contractual agreement. This could be the end user, or when we sell products and
services through the channel, our customer could be either the distributor or
the reseller. As part of determining whether a contract exists, probability of
collection is assessed on a customer-by-customer basis at the outset of the
contract. Customers are subjected to a credit review process that evaluates the
customers' financial position and the ability and intention to pay.
At contract inception, we assess the goods and services promised in our
contracts with customers and identify a performance obligation for each promise
to transfer to the customer a good or service (or bundle of goods or services)
that is distinct - i.e., if a good or service is separately identifiable from
other items in the bundled package and if a customer can benefit from it on its
own or together with other resources that are readily available to the customer.
To identify our performance obligations, we consider all of the goods or
services promised in the contract regardless of whether they are explicitly
stated or are implied by customary business practices. Determining whether
products and services are considered distinct performance obligations or should
be combined to create a single performance obligation may require significant
judgment. We recognize revenue when (or as) we satisfy a performance obligation
by transferring control of a good or service to a customer.
The transaction price is determined based on the consideration to which we will
be entitled in exchange for transferring goods or services to the customer,
adjusted for estimated variable consideration, if any. We typically estimate the
transaction price impact of sales returns and discounts offered to the
customers, including discounts for early payments on receivables, rebates or
certain distribution partner incentives, including marketing programs.
Constraints are applied when estimating variable considerations based on
historical experience where applicable.
Once we have determined the transaction price, we allocate it to each
performance obligation in a manner depicting the amount of consideration to
which we expect to be entitled in exchange for transferring the goods or
services to the customer (the "allocation objective"). If the allocation
objective is met at contractual prices, no allocations are made. Otherwise, we
allocate the transaction price to each performance obligation identified in the
contract on a relative SSP basis, except when the criteria are met for
allocating variable consideration or a discount to one or more, but not all,
performance obligations in the contract.
72
--------------------------------------------------------------------------------
To determine the SSP of our goods or services, we conduct a regular analysis to
determine whether various goods or services have an observable SSP. If we do not
have an observable SSP for a particular good or service, then SSP for that
particular good or service is estimated using an approach that maximizes the use
of observable inputs. We generally determine SSPs using various methodologies
such as historical prices, expected cost plus margin, adjusted market assessment
or non-standalone selling prices.
We recognize revenue as control of the promised goods or services is transferred
to our customers, in an amount that reflects the consideration we expect to be
entitled to in exchange for the promised goods or services. Revenue is
recognized net of any taxes collected from customers and subsequently remitted
to governmental authorities. Control of the promised goods or services is
transferred to our customers at either a point in time or over time, depending
on the performance obligation.
The nature of our promise to the customer to provide our time-based software
licenses and related support and maintenance is to stand ready to provide
protection for a specified or indefinite period of time. Maintenance and support
in these cases are typically not distinct performance obligations as the
licenses are dependent upon regular threat updates to the customer. Instead the
maintenance and support is combined with a software license to create a single
performance obligation. We typically satisfy these performance obligations over
time, as control is transferred to the customer as the services are provided.
Additional Revenue Recognition Considerations
Partner Royalty Revenues
Our original equipment manufacturer ("OEM"), mobile and internet service
provider ("MISP") and retail sales channels have revenues derived from sales- or
usage-based royalties. Such revenue is excluded from any variable consideration
and transaction price calculations and is recognized at the later of when the
sale or usage occurs, or the performance obligation is satisfied or partially
satisfied.
Consideration Payable to a Customer
We make various payments to our channel partners, which may include revenue share, product placement fees and marketing development funds. Costs that are incremental to revenue, such as revenue share, are capitalized and amortized over time as cost of sales. Product placement fees and marketing development funds are expensed in sales and marketing expense as the related benefit is received and were$185 million ,$187 million and$142 million for the years endedDecember 25, 2021 ,December 26, 2020 , andDecember 28, 2019 , respectively. Under certain of our channel partner agreements, the partners pay us royalties on our technology sold to their customers, which we recognize as revenue in accordance with our revenue recognition policy. In these situations, the payments made to our channel partners are recognized as consideration paid to a customer, and thus are recorded as reductions to revenue up to the amount of cumulative revenue recognized from the contract with the channel partner during the period of measurement. Contract Costs Contract acquisition costs consist mainly of sales commissions and associated fringe benefits, as well as revenue share under programs with certain of our distribution partners. For revenue share, the partner receives a percentage of the revenue we receive from an end user upon conversion to a paid customer or renewal. These costs would not have been incurred if the contract was not obtained and are considered incremental and recoverable costs of obtaining a contract with a customer. These costs are capitalized and amortized over time in accordance with Accounting Standards Codification ("ASC") 340-40. Contract fulfillment costs consist of software and related costs. These costs are incremental and recoverable and are capitalized and amortized on a systematic basis that is consistent with the pattern of transfer of the goods and services to which the asset relates.
Discontinued Operations
Certain of our perpetual software licenses or hardware with integrated software
are not distinct from their accompanying maintenance and support, as they are
dependent upon regular threat updates. These contracts typically contain a
renewal option that we have concluded creates a material right for our customer.
The license, hardware and maintenance and support revenue is recognized over
time, as control is transferred to the customer over the term of the initial
contract period while the corresponding material right is recognized over time
beginning at the end of the initial contractual period over the remainder of the
technology constrained customer life.
Alternatively, certain of our perpetual software licenses, hardware appliances,
or hardware with integrated software provide a benefit to the customer that is
separable from the related support as they are not dependent upon regular threat
updates. Revenue for these products is recognized at a point in time when
control is transferred to our customers, generally at shipment. The related
maintenance and support represent a separate performance obligation and the
associated transaction price allocated to it is recognized over time as control
is transferred to the customer.
73
--------------------------------------------------------------------------------
The nature of our promise to the customer to provide our SaaS offerings and
related support and maintenance is to stand ready to provide protection for a
specified or indefinite period of time. Maintenance and support in these cases
are typically not distinct performance obligations as the licenses are dependent
upon regular threat updates to the customer. Instead the maintenance and support
is combined with a software license to create a single performance obligation.
We typically satisfy these performance obligations over time, as control is
transferred to the customer as the services are provided.
Revenue for professional services that are a separate and distinct performance obligation is recognized as services are provided to the customer.
Payment Terms and Warranties
Our payment terms vary by the type and location of our customer and the products or services offered. The term between invoicing and when payment is due is not significant. For certain products or services and customer types, we require payment before the products or services are delivered to the customer. We provide assurance warranties on our products and services. The warranty timeframe varies depending on the product or service sold, and the resolution of any issues is at our discretion to either repair, replace, reperform or refund the fee. Contract Costs
Contract acquisition costs consist mainly of sales commissions and associated fringe benefits.
We typically recognize the initial commissions that are not commensurate with renewal commissions over the longer of the customer relationship (generally estimated to be four to five years) or over the same period as the initial revenue arrangement to which these costs relate. Renewal commissions paid are generally amortized over the renewal period. Contract fulfillment costs consist primarily of hardware and related costs. These costs are incremental and recoverable and are capitalized and amortized on a systematic basis that is consistent with the pattern of transfer of the goods and services to which the asset relates.
Goodwill is recorded as the excess of consideration transferred over the acquisition-date fair values of assets acquired and liabilities assumed in a business combination. Historically, we have assigned goodwill to our reporting units based on the relative fair value expected at the time of the acquisition.Goodwill and intangible assets to be disposed of as a result of our agreement with STG to sell certain assets of Enterprise Business were included in assets of discontinued operations in our consolidated balance sheet as ofDecember 26, 2020 . We now have one reporting unit for goodwill. We perform an annual impairment assessment on the first day of the third month in the fourth quarter or more frequently if indicators of potential impairment exist, which includes evaluating qualitative and quantitative factors to assess the likelihood of an impairment of our reporting unit's goodwill. If the conclusion of an impairment assessment is that it is more likely than not that the fair value is more than its carrying value, goodwill is not considered impaired and we are not required to perform the quantitative goodwill impairment test. If the conclusion of an impairment assessment is that it is more likely than not that the fair value is less than its carrying value, we perform the quantitative goodwill impairment test, which compares the fair value of the reporting unit to its carrying value. Impairments, if any, are based on the excess of the carrying amount over the fair value. Our goodwill impairment test considers the income method and/or market method to estimate a reporting unit's fair value.
Identified Intangible Assets
We amortize all finite-lived intangible assets that are subject to amortization over their estimated useful life of economic benefit on a straight-line basis.
For significant intangible assets subject to amortization, we perform a
quarterly assessment to determine whether facts and circumstances indicate that
the useful life is shorter than we had originally estimated or that the carrying
amount of assets may not be recoverable. If such facts and circumstances exist,
we assess recoverability by comparing the projected undiscounted net cash flows
associated with the related asset or group of assets over their remaining useful
lives against their respective carrying amounts. Impairments, if any, are based
on the excess of the carrying amount over the fair value of those assets. If an
asset's useful life is shorter than originally estimated, we accelerate the rate
of amortization and amortize the remaining carrying value over the updated,
shorter useful life.
74
--------------------------------------------------------------------------------
For our intangible assets not subject to amortization, we perform an annual
impairment assessment on the first day of the third month in the fourth quarter,
or more frequently if indicators of potential impairment exist, to determine
whether it is more likely than not that the carrying value of the asset may not
be recoverable. If necessary, a quantitative impairment test is performed to
compare the fair value of the indefinite-lived intangible asset with its
carrying value. Impairments, if any, are based on the excess of the carrying
amount over the fair value of the asset.
Research and Development
Costs incurred in the research and development of new software products are expensed as incurred until technological feasibility is established. Research and development costs include salaries and benefits of researchers, supplies, and other expenses incurred during research and development efforts. Development costs are capitalized beginning when a product's technological feasibility has been established and ending when the product is available for general release to customers. Technological feasibility is reached when the product reaches the working-model stage. To date, new products and enhancements generally have reached technological feasibility and have been released for sale at substantially the same time. All research and development costs to date have been expensed as incurred except for software subject to a hosting arrangement. Software development costs of both internal-use applications and software sold subject to hosting arrangements are capitalized when we have determined certain factors are present, including factors that indicate technology exists to achieve the performance requirements, the decision has been made to develop internally versus buy and our management has authorized the funding for the project. Capitalization of software costs ceases when the software is substantially complete and is ready for its intended use and capitalized costs are amortized over their estimated useful life of three to five years using the straight-line method. When events or circumstances indicate the carrying value of internal use software might not be recoverable, we assess the recoverability of these assets by determining whether the amortization of the asset balance over its remaining life can be recovered through undiscounted future operating cash flows. Equity-Based Awards We currently provide various equity-based compensation to those whom, in the opinion of the Board or its designee, are in a position to make a significant contribution to our success. Equity-based compensation cost is measured at the grant date based on the fair value of the award and recognized as expense over the appropriate service period. Determining the fair value of equity-based awards requires considerable judgment, including assumptions and estimates of the following: • fair value of the unit; • life of the award; •
volatility of the unit price; and
•
dividend yield
Before our IPO, the fair value of the unit was determined by the Board reasonably and in good faith. Generally, this involved a review by an independent valuation of our business, which requires judgmental inputs and assumptions such as our cash flow projections, peer company comparisons, market data, growth rates and discount rate. The Board reviewed its prior determination of fair value of a unit on a quarterly basis to decide whether any change was appropriate (including whether to obtain a new independent valuation), considering such factors as any significant financial, operational, or market changes affecting the business since the last valuation date. Due to us not having sufficient historical volatility, we used the historical volatilities of publicly traded companies which were similar to us in size, stage of life cycle and financial leverage. We continued to use this peer group of companies unless a situation arose within the group that would require evaluation of which publicly traded companies were included or once sufficient data was available to use our own historical volatility. In addition, for awards where vesting was dependent upon achieving certain operating performance goals, we estimated the likelihood of achieving the performance goals. For goals dependent upon a qualifying liquidity event, (i.e., a change of control or public offering registered on a Form S-1 (or successor form), in either case, occurring on or beforeApril 3, 2024 ) (a "Qualifying Liquidity Event"), we would not recognize any expense until the event occurs. Upon consummation of our IPO, we recognized a cumulative catch-up of expense based on the vesting dates for our time-based awards and expected vesting dates for our performance-based awards. We recognize forfeitures as they occur. For awards with only time-vesting requirement, we recognize the expense over a straight-line basis during the vesting period. After the close of our IPO, our outstanding Management Equity Participation Units ("MEPUs") and Cash RSU ("CRSUs") were converted into RSUs ("Replacement RSUs"), which are to be settled in Class A common stock. The fair value of these Replacement RSUs was our IPO price less the present value of the expected dividends not received during the vesting period. For all other RSU grants after our IPO, we utilize the closing price of our common stock on the day of the grant date, less the present value of expected dividends not received during the vesting period to determine grant date fair value. 75 -------------------------------------------------------------------------------- In addition, certain MEPU holders were also granted stock options with a strike price equal to our IPO price. For all other stock option grants after our IPO, we utilize the closing price of our common stock on the day of grant date to determine the strike price. All of our granted stock options are non-qualified and expire 10 years after grant. We utilize a Black-Scholes model to determine grant date fair value of our stock options. Our time-based awards generally vest evenly over the 16 quarters following grant date. For time-based awards granted to our new hires, the vesting period is generally 25% vest one year after grant date and quarterly thereafter for 12 quarters. Time-based awards granted to our non-employee directors vest one year from grant date. Generally, unvested awards are forfeited upon termination of employment with us, however, our executive officers may have provisions permitting acceleration or pro rata acceleration upon termination without cause (as defined in the respective award agreements). Our performance-based RSU awards ("PSUs") are granted to executive officers and certain employees annually. These awards vest after approximately three years, with the number vesting based upon internal profitability targets that are communicated to employees in the year to which the targets relate. The number of shares of common stock issued will range from zero to stretch, with stretch typically defined as 130% of target. At the time our Board approves such grants, the targets for performance years other than the current year are not known or knowable by us nor our employees. Upon determination and communication of such targets in future years, grant date fair value is determined based upon the closing price, less the present value of expected dividends not received during the vesting period. A portion of our RSU awards and all of our performance-based stock option and performance-based MIU awards vest upon achievement of certain return of cash metrics. InJanuary 2021 , these awards were modified to vest annually in equal tranches over the three year anniversaries of our IPO. If the original return of cash performance is achieved prior to such anniversaries, the awards vest in full. In both cases, the unvested portion of the awards are forfeited upon termination. Upon the settlement of RSUs, we withhold a portion of the earned units to cover no more than the maximum statutory income and employment taxes and remit the net shares to an individual brokerage account. Authorized shares of our common stock are used to settle RSUs and stock options. Awards granted prior to our IPO and/or converted at the time of our IPO are covered under our 2017 Management Incentive Plan ("2017 Plan"). Stock options granted at our IPO and/or awards granted at our IPO or after are covered under our 2020 Equity Omnibus Plan ("2020 Plan"). No new awards may be authorized under our 2017 Plan.
Derivative and Hedging Instruments
The fair values of each of our derivative instruments are recorded as an asset
or liability on a net basis at the balance sheet date within other current or
long-term assets or liabilities. The change in fair value of our derivative
instruments is recorded through earnings in the line item on the consolidated
statements of operations to which the derivatives most closely relate, primarily
in Interest expense. Changes in the fair value of the underlying assets and
liabilities associated with the hedged risk are generally offset by the changes
in the fair value of the related derivatives. We do not use derivative financial
instruments for speculative trading purposes.
To reduce the interest rate risk inherent in variable rate debt, we entered into
certain interest rate swap agreements to convert a portion of our variable rate
borrowing into a fixed rate obligation (Note 15). These interest rate swap
agreements fix the London Interbank Offered Rate ("LIBOR") portion of the U.S.
dollar denominated variable rate borrowings. Accordingly, to the extent the cash
flow hedge is effective, changes in the fair value of interest rate swaps will
be included within Accumulated other comprehensive income (loss) in the
consolidated balance sheets. Hedge accounting will be discontinued when the
interest rate swap is no longer effective in offsetting cash flows attributable
to the hedged risk, the interest rate swap expires or the cash flow hedge is
dedesignated because it is no longer probable that the forecasted transaction
will occur according to the original strategy. When hedge accounting is
discontinued, any related amounts previously included in Accumulated other
comprehensive income (loss) would be reclassified to Interest expense, within
the consolidated statements of operations.
Leases
We adopted ASC No. 2016-02, Leases, and all related updates (collectively, "Topic 842"), which primarily requires leases to be recognized on the balance sheet. We adopted the standard using the modified retrospective approach with an effective date as of the beginning of our 2019 fiscal year,December 30, 2018 .
We determine if an arrangement contains a lease and classification of that lease, if applicable, at inception based on:
•
Whether the contract involves the use of a distinct identified asset;
•
Whether we obtain the right to obtain substantially all the economic benefits from the use of the asset throughout the period; and
•
Whether we have a right to direct the use of the asset.
76
--------------------------------------------------------------------------------
Right-of-use ("ROU") assets represent the right to use an underlying asset for
the lease term and lease liabilities represent the obligation to make minimum
lease payments arising from the lease. A ROU asset is initially measured at an
amount which represents the lease liability, plus any initial direct costs
incurred and less any lease incentives received. The lease liability is
initially measured at lease commencement date based on the present value of
minimum lease payments over the lease term. The lease term may include options
to extend or terminate when it is reasonably certain that we will exercise the
option. We have lease agreements with lease and non-lease components, and the
non-lease components are generally accounted for separately and not included in
our leased assets and corresponding liabilities.
The depreciable life of assets and leasehold improvements are limited by the
expected lease term unless there is a transfer of title or purchase option
reasonably certain of exercise. Payments related to short-term leases are
expensed on a straight-line basis over the lease term and reflected as a
component of lease cost within our consolidated statements of operations. Lease
payments generally consist of fixed amounts, as well as variable amounts based
on a market rate or an index which are not material to our consolidated lease
cost. Our leases do not contain significant terms and conditions for variable
lease payments.
When available, we use the rate implicit in the lease to discount lease payments
to present value; however, most of our leases do not provide a readily
determinable implicit rate. Therefore, we estimate our incremental borrowing
rate to discount the lease payments based on information available at lease
commencement. For leases which commenced prior to our adoption of ASC Topic 842,
we estimated our incremental borrowing rate as of adoption date based on our
credit rating, current economic conditions, and collateralized borrowing.
Discontinued Operations
We review the presentation of planned business dispositions in the consolidated financial statements based on the available information and events that have occurred. The review consists of evaluating whether the business meets the definition of a component for which the operations and cash flows are clearly distinguishable from the other components of the business, and if so, whether it is anticipated that after the disposal the cash flows of the component would be eliminated from continuing operations and whether the disposition represents a strategic shift that has a major effect on operations and financial results. In addition, we evaluate whether the business has met the criteria as a business held for sale. In order for a planned disposition to be classified as a business held for sale, the established criteria must be met as of the reporting date, including an active program to market the business and the expected disposition of the business within one year. Planned business dispositions are presented as discontinued operations when all the criteria described above are met. For those divestitures that qualify as discontinued operations, all comparative periods presented are reclassified in the consolidated balance sheets. Additionally, the results of operations of a discontinued operation are reclassified to income from discontinued operations, net of tax, for all periods presented in the consolidated statements of operations. Results of discontinued operations include all revenues and expenses directly derived from such businesses; general corporate overhead is not allocated to discontinued operations.
Income Tax
McAfee Corp. is taxed as a corporation and pays corporate federal, state and local taxes on income allocated to it from FTW based uponMcAfee Corp.'s economic interest in FTW. FTW is a pass through entity forU.S. federal income tax purposes and will not incur any federal income taxes either for itself or itsU.S. subsidiaries that are also pass through or disregarded subsidiaries. Taxable income or loss for these entities will flow through to its respective members forU.S. tax purposes. FTW does have certainU.S. and foreign subsidiaries that are corporations and are subject to income tax in their respective jurisdiction. We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities ("DTAs" and "DTLs") for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine DTAs and DTLs on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on DTAs and DTLs is recognized in income in the period that includes the enactment date. We recognize DTAs to the extent that we believe that these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, carryback potential if permitted under the tax law, and results of recent operations. If we determine that we would be able to realize our DTAs in the future in excess of their net recorded amount, we would make an adjustment to the DTA valuation allowance, which would reduce the provision for income taxes. We record uncertain tax positions in accordance with ASC 740 on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. 77 --------------------------------------------------------------------------------
Tax Receivable Agreement
Pursuant to our election under Section 754 of the Internal Revenue Code (the "Code"), we expect to obtain an increase in our share of the tax basis in the net assets of FTW whenFTW LLC Units are redeemed or exchanged by the Continuing LLC Owners and MIUs are redeemed or exchanged by Management Owners. We intend to treat any redemptions and exchanges of LLC Units as direct purchases of LLC Units forUnited States federal income tax purposes. These increases in tax basis may reduce the amounts that we would otherwise pay in the future to various tax authorities. They may also decrease gains (or increase losses) on future dispositions of certain capital assets to the extent tax basis is allocated to those capital assets. InOctober 2020 , we entered into a TRA that provides for the payment by us of 85% of the amount of any tax benefits that we actually realize, or in some cases are deemed to realize, as a result of: (i) all or a portion of the Corporation's allocable share of existing tax basis in the assets of FTW (and its subsidiaries) acquired in connection with the Reorganization Transactions, (ii) increases in the Corporation's allocable share of existing tax basis in the assets of FTW (and its subsidiaries) and tax basis adjustments in the assets of FTW (and its subsidiaries) as a result of sales or exchanges of LLC Units after the IPO, (iii) certain tax attributes of the corporations acquired byMcAfee Corp. in connection with the Reorganization Transactions (including their allocable share of existing tax basis in the assets of FTW (and its subsidiaries)), and (iv) certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement. The Corporation generally will retain the benefit of the remaining 15% of the applicable tax savings. The payment obligations under the tax receivable agreement are obligations of the Corporation. The timing and amount of aggregate payments due under the TRA may vary based on a number of factors, including the timing and amount of taxable income generated by the Corporation each year, as well as the tax rate then applicable.
Recent Accounting Pronouncements
See Note 3 to the consolidated financial statements (Part II, Item 8 of this Form 10-K) for further discussion.
78--------------------------------------------------------------------------------
© Edgar Online, source
