##### Table of Contents



UNITED STATES SECURITIES AND
    EXCHANGE COMMISSIONWashington, D.C.
    20549
      Form 10-K
  þ

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the Fiscal Year Ended
    December 31, 2005oro

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
    SECURITIES EXCHANGE ACT OF 1934For the Transition Period
    from          
    to   Commission File Number:
    001-31216
  McAfee, Inc.
 (Exact name of registrant as
    specified in its charter)
  Delaware

77-0316593(State or other jurisdiction
    of incorporation or organization)

(I.R.S. Employer
    Identification Number)3965 Freedom Circle

95054Santa Clara,
    California

(Zip Code)(Address of principal executive
    offices)   Registrants telephone number, including area code:
 (408) 988-3832
  Securities registered pursuant to Section 12(b) of the
    Act:
 None
  Securities registered pursuant to Section 12(g) of the
    Act:
  Common Stock, $0.01 Par Value, together with associated
    Rights
  þ o
  o þ
  þ o
  Regulation S-K Form 10-K Form 10-K. þ
   Large
    accelerated filer o
    Accelerated
    filer þ
    Non-accelerated
    filer o  Rule 12b-2 o þ
    DOCUMENTS INCORPORATED BY REFERENCE




---



##### 



McAFEE
    INC.
  FORM 10-K
    For the fiscal year ended December 31, 2005
  TABLE OF
    CONTENTS
  PagePART IItem 1.

Business


3Item 1A.

Risk Factors


11Item 1B.

Unresolved Staff
    Comments


23Item 2.

Properties


23Item 3.

Legal
    Proceedings


23Item 4.

Submission of
    Matters to a Vote of Security Holders


23PART IIItem 5.

Market for the
    Registrants Common Equity, Related Stockholder Matters and
    Issuer Purchases of Equity Securities


24Item 6.

Selected Financial
    Data


26Item 7.

Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations


27Item 7A.

Quantitative and
    Qualitative Disclosures About Market Risk


60Item 8.

Financial
    Statements and Supplementary Data


60Item 9.

Changes In and
    Disagreements With Accountants on Accounting and Financial
    Disclosure


61Item 9A.

Controls and
    Procedures


61Item 9B.

Other
    Information


66PART IIIItem 10.

Directors and
    Executive Officers of the Registrant


66Item 11.

Executive
    Compensation


66Item 12.

Security Ownership
    of Certain Beneficial Owners and Management and Related
    Stockholder Matters


66Item 13.

Certain
    Relationships and Related Transactions


66Item 14.

Principal
    Accountant Fees and Services


66PART IVItem 15.

Exhibits and
    Financial Statement Schedules


67Signatures


121Letter Agreement Amendment to Employment AgreementEmployment AgreementSubsidiaries of the RegistrantConsent of Independent Registered Public Accounting FirmConsent of Independent Registered Public Accounting FirmCertification of CEO and CFO Pursuant to Section 302Certification of CEO and CFO Pursuant to Section 906   2




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##### Table of Contents



PART I  Item 1.
    Business  General
  Form 10-K Form 10-K
    and/or
  1-800-SEC-0330. www.sec.gov
  (408) 988-3832. www.mcafee.com Form 10-K, Form 10-Q Form 8-K, Form 10-K.
  OVERVIEW
   3




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up-to-date
        McAfee
    System Protection Solutions
        McAfee
    Network Protection Solutions
  e-mail
 4




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Policy
    Management
  up-to-date
  Expert
    Services and Technical Support
          
    McAfee Technical Support
    ServicePortal  Consists of a searchable
    knowledge base of technical solutions and links to a variety of
    technical documents such as product FAQs and technical notes and
    the ability to submit and track support cases online.
    McAfee Gold Technical Support  Provides
    unlimited, toll-free (where available) telephone access to
    technical support 24 hours a day, 7 days a week and
    access to the McAfee Technical Support ServicePortal.
    McAfee Platinum Technical Support  Offers
    proactive, personalized service and includes an assigned
    Technical Account Manager, or TAM. Customers receive
    proactive support contact (telephone or
    e-mail) with
    customer-defined frequency, election of five designated customer
    contacts, access to all the services in McAfee Gold Technical
    Support and the McAfee Technical Support ServicePortal.  www.mcafee.com
 5




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Research
    and Development
      Strategic
    Alliances
    Product
    Licensing Model
      On-Line
    Subscriptions and Managed Applications
  www.mcafee.com www.mcafee.com
  up-to-date
 6




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Sales and
    Marketing
    Resellers
    and Distributors
          Original
    Equipment Manufacturers
    United
    States Sales
   7




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International
    Sales
    Other
    Marketing Activities
    www.mcafee.com
    Customers
      Product
    Development, Investments, and Acquisitions
     8




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Manufacturing
    Competition
    
    performance,
    quality,
    breadth of product group,
    integration of products,
    introduction of new products,
    brand name recognition,
    price,
    market presence,
    functionality,
    innovation,
    customer support,
    frequency of upgrades and updates,
    reduction of production costs,
    manageability of products and
    reputation.  and/or
 9




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System Protection Market.
  Network Protection Market.
  Other Competitors.
  Proprietary
    Technology
    Employees
    Special
    Note Regarding Forward-Looking Statements in This
    Report
  Form 10-K Form 10-K
 10




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##### Table of Contents




    future investments in complementary businesses, products and
    technologies;
    our expectation that our financial results will continue to
    fluctuate;
    our expectation that international revenue will remain a
    significant percentage of our net revenue;
    our expectation that both product and pricing competition will
    increase;
    our expectation that product-related expenses will increase;
    expectations about future sales to our top ten distributors and
    our sales efforts through the channel and other partners;
    our future dividend policy;
    the expected geographic composition of our future revenues;
    our expected future revenue mix;
    the anticipated future trend of specific categories of expenses;
    the expected future impact of the adoption of Statement of
    Financial Accounting Standard No. 123R Share-Based
    Payment on our results or operations;
    our expected future level of DSOs; and
    our expected ability to meet our obligations through available
    cash and internally generated funds, our expectation of
    generating positive working capital through operations, and our
    belief as to working capital being sufficient to meet our cash
    requirements in future periods.    Item 1A.
    Risk
    Factors  Investing in our common stock involves a high degree of risk.
    The risks described below are not the only ones facing our
    company. Additional risks not presently known to us or that we
    deem immaterial may also impair our business operations. Any of
    the following risks could materially adversely affect our
    business, operating results and financial condition and could
    result in a complete loss of your investment.
  Our
    Financial Results Will Likely Fluctuate, Making It Difficult for
    Us to Accurately Estimate Operating Results.
  period-to-period
    
    introduction of new products, product upgrades or updates by us
    or our competitors;
    revenue recognition which may be influenced by volume, size,
    timing and contractual terms of new licenses and renewals of
    existing licenses; 11




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
    the mix of products we sell and services we offer and whether
    (i) our products are sold directly by us or indirectly
    through distributors, resellers, ISPs such as AOL, OEMs such as
    Dell, and others, (ii) the product is hardware or software
    based and (iii) in the case of software licenses, the
    licenses are perpetual licenses or time-based subscription
    licenses;
    changes in our supply chains and product delivery channels,
    which may result in product fulfillment delays;
    personnel limitations, which may adversely impact our ability to
    process the large number of orders that typically occur near the
    end of a fiscal quarter;
    costs or charges related to our acquisitions or dispositions,
    including our acquisition of Wireless Security Corporation in
    June 2005 and the dispositions of our McAfee Labs assets;
    the components of our revenue that are deferred, including our
    on-line subscriptions and that portion of our software licenses
    attributable to support and maintenance;
    stock-based compensation expense, which we will begin
    recognizing for our stock-based compensation plans in the first
    quarter of 2006;
    costs and charges related to certain events, including
    Sarbanes-Oxley compliance efforts, litigation, relocation of
    personnel and previous financial restatements;
    changes in generally accepted accounting principles;
    our ability to effectively manage our operating expense
    levels; and
    factors that lead to substantial declines in estimated values of
    long-lived assets below their carrying value.      We Face
    Risks in Connection With the Material Weakness Resulting From
    Our Sarbanes-Oxley Section 404 Management Report and Any
    Related Remedial Measures That We Undertake.
   12




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Form 10-K
    If We
    Fail to Effectively Upgrade Our Information Technology System,
    We May Not Be Able to Accurately Report Our Financial Results or
    Prevent Fraud.
    We Face
    Risks Related to Our International Operations.
      
    longer payment cycles and greater difficulty in collecting
    accounts receivable; 13




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
    increased costs and management difficulties related to the
    growth and operation of our international sales and support
    organization;
    our ability to successfully establish, manage and staff shared
    service centers for worldwide sales finance and accounting
    operations centralized from locations in the U.S. and Europe;
    our ability to adapt to sales and marketing practices and
    customer requirements in different cultures;
    our ability to successfully localize software products for a
    significant number of international markets;
    compliance with more stringent consumer protection and privacy
    laws;
    currency fluctuations, including weakness of the
    U.S. dollar relative to other currencies, or the
    strengthening of the U.S. dollar that may have an adverse
    impact on revenues, financial results and cash flows and risks
    related to hedging strategies;
    enactment of additional regulations or restrictions on the use,
    import or export of encryption technologies, which would delay
    or prevent the acceptance and use of encryption products and
    public networks for secure communication;
    political instability in both established and emerging markets;
    tariffs, trade barriers and export restrictions;
    a high incidence of software piracy in some countries; and
    international labor laws and our relationship with our employees
    and regional work councils.  We Are
    Subject to Intense Competition in the System and Network
    Protection Markets, and We Expect to Face Increased Competition
    in the Future.
  and/or
  
    in the system protection market, which includes our anti-virus
    and risk assessment and vulnerability management solutions,
    Symantec Corp., Computer Associates International Inc. and
    Microsoft Corp. Trend Micro Inc. remains the strongest
    competitor in the Asian anti-virus market and has recently
    entered the U.S. market. F-Secure Corporation,
    Dr. Ahns Anti-Virus Lab, Panda Software and Sophos
    are also showing growth in their respective markets; and
    in the network protection market, which includes our other
    intrusion detection and protection products, Cisco Systems Inc.,
    Computer Associates International Inc., Internet Security
    Systems Inc., Juniper Networks, Inc., Symantec Corp. and 3Com
    Corporation. Qualys and Internet Security Systems Inc. are the
    strongest competitors for our Foundstone products and solutions.     14




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We Rely
    Heavily on Our Intellectual Property Rights Which Offer Only
    Limited Protection Against Potential Infringers.
    We Face
    Risks Related to Our Strategic Alliances.
    
    Strategic alliances require significant coordination between the
    parties involved. To be successful, our alliances may require
    the integration of other companies products with our
    products, which may involve significant time and expenditure by
    our technical staff and the technical staff of our strategic
    allies.
    Our agreements with our strategic alliances are terminable
    without cause with no or minimal notice or penalties. We may
    expend significant time, money and resources to further
    relationships with our strategic alliances that are thereafter
    terminated.
    The integration of products from different companies may be more
    difficult than we anticipate, and the risk of integration
    difficulties, incompatible products and undetected programming
    errors or bugs may be higher than that normally associated with
    new products.
    Our sales force and our marketing and professional services
    personnel may require additional training to market products
    that result from our strategic alliances. The marketing of these
    products may require additional sales force efforts and may be
    more complex than the marketing of our own products.
    We may be required to share ownership in technology developed as
    part of our strategic alliances. 15




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We Face
    Product Development Risks Associated with Rapid Technological
    Changes in Our Market.
    
    offer a broad range of network and system protection products;
    enhance existing products and expand product offerings;
    extend security technologies to additional digital devices such
    as mobile phones and personal digital assistants;
    respond promptly to new customer requirements and industry
    standards;
    provide frequent, low cost upgrades and updates for our products;
    maintain quality; and
    remain compatible with popular operating systems such as Linux,
    Windows XP, and Windows NT, and develop products that are
    compatible with new or otherwise emerging operating systems.    We Face
    Risks Associated with Past and Future Acquisitions.
    Integration
    
    integrate and retain key management, sales, research and
    development and other personnel;
    integrate the acquired products into our product offerings both
    from an engineering and sales and marketing perspective;
    integrate and support preexisting supplier, distribution and
    customer relationships;
    coordinate research and development efforts; and
    consolidate duplicate facilities and functions and integrate
    back-office accounting, order processing and support functions.   16




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day-to-day
  Internal
    Controls, Policies and Procedures
    Open
    Source Software
    
    open source license terms may be ambiguous and may result in
    unanticipated obligations regarding our products;
    competitors will have improved access to information that may
    help them develop competitive products;
    open source software cannot be protected under trade secret law;
    it may be difficult for us to accurately determine the
    developers of the open source code and whether the acquired
    software infringes third-party intellectual property
    rights; and
    open source software potentially increases customer support
    costs because licensees can modify the software and potentially
    introduce errors.  Use of
    Cash and Securities
    We Face
    Manufacturing, Supply, Inventory, Licensing and Obsolescence
    Risks Relating to Our Products.
  Third-Party
    Manufacturing
   17




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Sourcing
    Third-Party
    Licenses
    Obsolescence
    Product
    Fulfillment
    False
    Detection of Viruses and Actual or Perceived Security Breaches
    Could Adversely Affect Our Business.
    We Face a
    Number of Risks Related to Our Product Sales Through
    Intermediaries.
    Sale
    of Competing Products
   18




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Loss
    of a Distributor
    Payment
    Difficulties
    We Face
    Risks Related to Customer Outsourcing to System
    Integrators.
    Critical
    Personnel May Be Difficult to Attract, Assimilate and
    Retain.
    and/or
    Competition
    for Personnel; Need for Competitive Pay Packages
   19




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Reduced
    Productivity of New Hires; Senior Management
    Additions
        Product
    Liability and Related Claims May Be Asserted Against
    Us.
    Intellectual
    Property Litigation in the Network and System Security Market Is
    Common and Can Be Expensive.
      
    result in the loss of our proprietary rights;
    subject us to significant liabilities, including monetary
    liabilities;
    require us to seek licenses from third parties; or
    prevent us from manufacturing or selling our products.     20




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Computer
    Hackers May Damage Our Products, Services and
    Systems.
    Pending
    or Future Litigation Could Have a Material Adverse Impact on Our
    Results of Operation and Financial Condition.
    We Face
    Risks Related to the Settlement Agreement with the Securities
    and Exchange Commission.
  day-to-day
  We Face
    Risks Related to Our Anti-Spam and Anti-Spyware Software
    Products.
   21




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Cryptography
    Contained in Our Technology is Subject to Export
    Restrictions.
    Our
    Business Strategy Exposes Us to Significant Risks.
    
    increasing direct competition from larger, more established
    competitors, such as Microsoft Corp. and Cisco Systems Inc.;
    dependence on our channel and other partners to sell our
    products;
    business decisions by our competitors may change the dynamics of
    the market in which we compete; and
    there may be customer confusion around our strategy.  Business
    Interruptions May Impede Our Operations and the Operations of
    Our Customers.
      Our Stock
    Price Has Been Volatile and Is Likely to Remain
    Volatile.
    We Face
    the Risk of a Decrease in Our Cash Balances and Losses in Our
    Investment Portfolio.
   22




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Our
    Charter Documents and Delaware Law and Our Rights Plan May
    Impede or Discourage a Takeover, Which Could Lower Our Stock
    Price.
  Our
    Charter Documents and Delaware Law
      Our
    Rights Plan
    Item 1B.
    Unresolved
    Staff Comments    Item 2.
    Properties      Item 3.
    Legal
    Proceedings  Form 10-K.
  Item 4.
    Submission
    of Matters to a Vote of Security Holders   23




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PART II  Item 5.
    Market
    for the Registrants Common Equity and Related Stockholder
    Matters  Price
    Range of Common Stock
      High


LowYear Ended December 31,
    2005First Quarter

$
29.15


$
21.94Second Quarter


28.71



20.35Third Quarter


33.24



26.00Fourth Quarter


32.59



25.35Year Ended December 31,
    2004First Quarter

$
18.90


$
14.90Second Quarter


19.75



15.60Third Quarter


20.42



15.79Fourth Quarter


33.55



20.09   Dividend
    Policy
    Holders
    of Common Stock
    Common
    Stock Repurchases
    Total Number of


Approximate DollarShares Purchased as


Value of SharesTotal





Part of Publicly


That May yet beNumber of


Average


Announced Plan or


Purchased UnderShares


Price Paid


Repurchase


Our Stock RepurchasePeriod

Purchased


per Share


Program


Program(in thousands, except price per
    share)October 1, 2005 through
    October 31, 2005













$
251,245November 1, 2005 through
    November 30, 2005


345


$
27.47



345


$
241,767December 1, 2005 through
    December 31, 2005


420


$
27.50



420


$
230,217Total


765


$
27.49



765  24




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Retirements
    of Common Stock
     25




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Item 6.
    Selected
    Financial Data    Years Ended
    December 31,2005(1)


2004(2)


2003


2002(3)


2001(In thousands, except for per
    share amounts)Statement of Operations
    DataTotal net revenue

$
987,299


$
910,542


$
936,336


$
1,043,044


$
1,071,660Income from operations


158,129



322,671



64,402



124,028



153,483Income before provision for income
    taxes, minority interest and cumulative effect of change in
    accounting principle


181,534



316,471



73,125



129,933



148,136Income before cumulative effect of
    change in accounting principle


138,828



225,065



59,905



128,312



83,253Cumulative effect of change in
    accounting principle, net of taxes










10,337







Net income


138,828



225,065



70,242



128,312



83,253Income per share, before
    cumulative effect of change in accounting principle, basic

$
0.84


$
1.40


$
0.37


$
0.86


$
0.60Income per share, before
    cumulative effect of change in accounting principle, diluted

$
0.82


$
1.31


$
0.36


$
0.80


$
0.53Cumulative effect of change in
    accounting principle, basic

$



$



$
0.07


$



$
Cumulative effect of change in
    accounting principle, diluted

$



$



$
0.07


$



$
Net income per share, basic

$
0.84


$
1.40


$
0.44


$
0.86


$
0.60Net income per share, diluted

$
0.82


$
1.31


$
0.43


$
0.80


$
0.53Shares used in per share
    calculation  basic


165,087



160,714



160,338



149,441



137,847Shares used in per share
    calculation  diluted


169,234



177,099



164,489



176,249



164,363   Years Ended
    December 31,2005(1)


2004(2)


2003


2002(3)


2001(In thousands)Balance Sheet DataCash and cash equivalents

$
728,592


$
291,155


$
333,651


$
674,226


$
612,832Working capital


698,670



255,696



415,768



475,418



443,035Total assets


2,642,624



2,246,532



2,120,498



2,045,487



1,658,093Deferred revenue


746,420



601,373



459,557



329,195



404,826Long-term debt and other long-term
    liabilities


142,638



204,796



570,162



519,150



579,243Total equity


1,455,033



1,201,248



888,089



770,168



341,493     (1)
    
    In 2005, we reserved $50.0 million in connection with the
    settlement with the SEC and we deposited $50.0 million in
    an escrow account with the SEC as the designated beneficiary. 26




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(2)
    
    In 2004, we sold our Sniffer and Magic product lines for
    aggregate net cash proceeds of $260.9 million and
    recognized pre-tax gains on the sale of assets and technology
    aggregating $243.5 million. We also received
    $25.0 million from our insurance carriers for insurance
    reimbursements related to the class action lawsuit settled in
    2003.(3)
    
    We agreed to settle a pending class action lawsuit in September
    2003 for $70.0 million, which was recorded as expense in
    2002 as the settlement agreement was entered into prior to the
    filing of the 2002 financial statements.  Item 7.
    Managements
    Discussion and Analysis of Financial Condition and Results of
    Operations  Forward-Looking
    Statements and Factors That May Affect Future Results
    Overview
    and Executive Summary
    up-to-date
     27




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Net
    Revenues by Geography
    Net
    Revenues by Product and Customer Category
  
    McAfee.  Our McAfee products include our
    corporate products and consumer products. Our corporate products
    include our small and medium-sized business, or SMB, products
    and our enterprise products, which include our IntruShield
    intrusion protection products that were acquired in connection
    with the Intruvert acquisition in 2003, our Entercept host-based
    intrusion protection products that were acquired in connection
    with the Entercept acquisition in 2003, and Foundstone Risk
    Management products that were acquired in connection with the
    Foundstone acquisition in October 2004. Revenues from our
    corporate products increased $25.6 million, or 5%, to
    $536.8 million during 2005 from $511.2 million in
    2004. The
    year-over-year
    increase reflects an increase in corporate IT spending related
    to security in 2005, partially offset by the impact of our
    perpetual-plus license model, which recognizes less revenue
    up-front and defers more revenue to future periods.    
    Sniffer Technologies.  Net revenue from the
    sale of Sniffer products were $90.9 million in 2004. In
    July 2004, we sold our Sniffer product line for net cash
    proceeds of $213.8 million. We agreed to provide certain
    post-closing transition services to Network General Corporation,
    the acquirer of the Sniffer product line. We were reimbursed for
    our cost plus a profit margin and present these reimbursements
    as a reduction of operating expenses on a separate line in our
    income statement. In 2005, we recorded approximately
    $0.4 million for these transition services. In 2004, we
    recorded $6.0 million. We completed our obligations under
    the transition services agreement in July 2005.
    Magic.  In 2004, net revenue from the sale of
    Magic Solutions products totaled approximately
    $2.9 million. We sold the assets of our Magic Solutions
    service desk business to BMC Software, Inc. The sale closed on
    January 30, 2004 and we received cash proceeds of
    approximately $47.1 million, net of direct expenses.
    McAfee Labs.  We sold our McAfee Labs assets to
    SPARTA, Inc. for $1.5 million in April 2005. Net revenue
    related to McAfee Labs was $1.9 million in 2005 and
    $6.4 million in 2004.    Deferred
    Revenue
   28




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Cash,
    Cash Equivalents and Marketable Securities
      Critical
    Accounting Policies and Estimates
        
    revenue recognition;
    estimating valuation allowances and accrued liabilities,
    specifically sales returns and other incentives, the allowance
    for doubtful accounts, our facility restructuring accrual; and
    the assessment of the probability of the outcome of litigation
    against us;
    accounting for income taxes; and
    valuation of goodwill, finite-lived intangibles and long-lived
    assets.  Revenue
    Recognition
   29




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Software Revenue Recognition, SOP 97-2, Revenue Recognition,
    
    persuasive evidence of an arrangement exists,
    the product or service has been delivered,
    the fee is fixed or determinable, and
    collection of the resulting receivable is reasonably assured.      and/or
    Sales Incentives and Sales Returns.
 30




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Deferred Costs of Revenue.
  Allowance
    for Doubtful Accounts
      Estimation
    of Restructuring Accrual and Litigation
  Restructuring Accrual. Accounting for Exit Costs
    Associated With Exit or Disposal Activities
   31




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Litigation.
  Accounting
    for Income Taxes
        Valuation
    of Goodwill, Intangibles, and Long-lived Assets
  Goodwill and Other Intangible Assets
   32




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##### Table of Contents



Accounting for
    the Impairment or Disposal of Long-Lived Assets.
      
    significant under performance relative to expected historical or
    projected future operating results;
    significant changes in the manner of our use of the acquired
    assets or the strategy for our overall business;
    significant negative industry or economic trends;
    significant declines in our stock price for a sustained
    period; and
    our market capitalization relative to net book value.    Results
    of Operations
  Years
    Ended December 31, 2005, 2004 and 2003
  Net
    Revenue
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)Net revenue:Product

$
167,538


$
294,163


$
(126,625
)


(43
)%

$
513,610


$
(219,447
)


(43
)%Services and support


819,761



616,379



203,382



33



422,726



193,653



46Total net revenue

$
987,299


$
910,542


$
76,757



8


$
936,336


$
(25,794
)


(3
)Percentage of total net revenue:Product


17
%


32
%










55
%Services and support


83



68











45Total net revenue


100
%


100
%










100
%  33




---



##### Table of Contents



Net
    Revenue by Geography
    2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)Net revenue:North America

$
578,636


$
554,400


$
24,236



4
%

$
606,685


$
(52,285
)


(9
)%EMEA


273,108



241,724



31,384



13



240,616



1,108



Japan


76,994



54,850



22,144



40



40,519



14,331



35Asia-Pacific, excluding Japan


37,147



38,494



(1,347
)


(4
)


29,014



9,480



33Latin America


21,414



21,074



340



2



19,502



1,572



8Total net revenue

$
987,299


$
910,542


$
76,757



8


$
936,336


$
(25,794
)


(3
)Percentage of total net revenue:North America


58
%


61
%










65
%EMEA


28



27











26Japan


8



6











4Asia-Pacific, excluding Japan


4



4











3Latin America


2



2











2Total net revenue


100
%


100
%










100
%   year-over-year
 34




---



##### Table of Contents



35




---



##### Table of Contents



Product
    Revenue
    2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(dollars in thousands)Net product revenue:Term subscription licenses

$
24,574


$
39,682


$
(15,108
)


(38
)%

$
113,696


$
(74,014
)


(65
)%Perpetual licenses


86,568



118,301



(31,733
)


(27
)


227,492



(109,191
)


(48
)Hardware


36,679



79,828



(43,149
)


(54
)


99,502



(19,674
)


(20
)Retail


18,276



27,787



(9,511
)


(34
)


45,993



(18,206
)


(40
)Other


1,441



28,565



(27,124
)


(95
)


26,927



1,638



6Total product revenue

$
167,538


$
294,163


$
(126,625
)


(43
)

$
513,610


$
(219,447
)


(43
)Percentage of product revenue:Term subscription licenses


15
%


14
%










23
%Perpetual licenses


51



40











44Hardware


22



27











19Retail


11



9











9Other


1



10











5Total product revenue


100
%


100
%










100
%      36




---



##### Table of Contents



Services
    and Support Revenue
    2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(dollars in thousands)Net services and support revenue:Support and maintenance

$
546,617


$
436,299


$
110,318



25
%

$
313,731


$
122,568



39
%Consulting


20,213



19,157



1,056



6



27,421



(8,264
)


(30
)Training


5,080



8,394



(3,314
)


(39
)


9,486



(1,092
)


(12
)On-line subscription arrangements


247,851



152,529



95,322



62



72,088



80,441



112Total services and support revenue

$
819,761


$
616,379


$
203,382



33


$
422,726


$
193,653



46Percentage of services and support
    revenue:Support and maintenance


67
%


71
%










74
%Consulting


2



3











7Training


1



1











2On-line subscription arrangements


30



25











17Total services and support revenue


100
%


100
%










100
%      37




---



##### Table of Contents



Cost
    of Net Revenue; Gross Margin
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)Cost of net revenue:Product

$
63,272


$
73,058


$
(9,786
)


(13
)%

$
80,895


$
(7,837
)


(10
)%Services and support


85,828



62,520



23,308



37



57,362



5,158



9Amortization of purchased
    technology


15,515



13,331



2,184



16



11,369



1,962



17Total cost of net revenue

$
164,615


$
148,909


$
15,706



11


$
149,626


$
(717
)


Percentage of total cost of net
    revenue:Product


39
%


49
%










54
%Services and support


52



42











38Amortization of purchased
    technology


9



9











8Total cost of net revenue


100
%


100
%










100
%Gross margin

$
822,684


$
761,633










$
786,710Gross margin percentage


83
%


84
%










84
%   Cost of
    Product Revenue
    Cost of
    Services and Support
   38




---



##### Table of Contents



Amortization
    of Purchased Technology
      Gross
    Margins
    Operating
    Costs
  Research
    and Development
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)Research and development
    expenses(1)

$
176,350


$
172,717


$
3,633



2
%

$
184,606


$
(11,889
)


(6
)%Percentage of net revenues


18
%


19
%










20
%     (1)
    
    Includes stock-based compensation (benefits) charges of ($234),
    $6,518 and $5,157 in 2005, 2004 and 2003, respectively.   39




---



##### Table of Contents



Marketing
    and Sales
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)Marketing and sales expenses(1)

$
294,234


$
354,380


$
(60,146
)


(17
)%

$
363,306


$
(8,926
)


(2
)%Percentage of net revenues


30
%


39
%










39
%     (1)
    
    Includes stock-based compensation (benefits) charges of ($25),
    $2,642 and $5,065 in 2005, 2004 and 2003, respectively.       40




---



##### Table of Contents



General
    and Administrative
  year-over-year
  2005 vs. 2004


2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)General and administrative
    expenses(1)

$
122,182


$
139,845


$
(17,663
)


(13
)%

$
129,920


$
9,925



8
%Percentage of net revenues


12
%


15
%










14
%     (1)
    
    Includes stock-based compensation charges of $1,315, $4,085 and
    $2,285 in 2005, 2004 and 2003, respectively.          SEC
    Settlement Charge
   41




---



##### Table of Contents



Amortization
    of Intangibles
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)Amortization of intangibles

$
12,902


$
14,065


$
(1,163
)


(8
)%

$
15,637


$
(1,572
)


(10
)%Percentage of net revenues


1
%


2
%










2
%     In-Process
    Research and Development Expense
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)In-process research and development

$
4,000


$



$
4,000



100
%

$
6,600


$
(6,600
)


(100
)%Percentage of net revenues


0
%


0
%










1
%      42




---



##### Table of Contents



Restructuring
    Charges
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(Dollars in thousands)Restructuring charges

$
3,731


$
17,493


$
(13,762
)


(79
)%

$
22,667


$
(5,174
)


(23
)%Percentage of net revenues


0
%


2
%










2
%   2005
    Restructuring
      LeaseTermination


Severance and other


OtherCosts


benefits


Costs


TotalBalance, January 1, 2005

$



$



$



$
Restructuring accrual


1,852



216



4



2,072Cash payments


(1,127
)


(216
)


(4
)


(1,347
)Effects of foreign currency
    exchange


(14
)










(14
)Accretion


23











23Balance, December 31, 2005

$
734


$



$



$
734   2004
    Restructuring
   43




---



##### Table of Contents



44




---



##### Table of Contents



LeaseTermination


Severance and


OtherCosts


Other Benefits


Costs


TotalBalance, January 1, 2004

$



$



$



$
Restructuring accrual


8,685



7,932



480



17,097Cash payments


(579
)


(4,175
)


(63
)


(4,817
)Adjustment to liability


(222
)


(275
)






(497
)Accretion


74











74Balance, December 31, 2004


7,958



3,482



417



11,857Restructuring accrual


1,402



1,382



20



2,804Cash payments


(2,747
)


(4,864
)


(297
)


(7,908
)Adjustment to liability


(819
)






(140
)


(959
)Effects of foreign currency
    exchange


(46
)










(46
)Accretion


341











341Balance, December 31, 2005

$
6,089


$



$



$
6,089   2003
    Restructuring
           45




---



##### Table of Contents



LeaseTermination


Severance and


OtherCosts


Other Benefits


Costs


TotalBalance, January 1, 2003

$



$



$



$
Restructuring accrual


15,734



6,692



739



23,165Cash payments


(1,707
)


(6,259
)


(167
)


(8,133
)Adjustment to liability


(273
)


(116
)


(572
)


(961
)Accretion


463











463Balance, December 31, 2003


14,217



317







14,534Cash payments


(1,841
)


(194
)






(2,035
)Adjustment to liability


(623
)


(123
)






(746
)Accretion


548











548Balance, December 31, 2004


12,301











12,301Cash payments


(1,279
)










(1,279
)Adjustment to liability


(1,048
)










(1,048
)Accretion


498











498Balance, December 31, 2005

$
10,472


$



$



$
10,472     Provision
    for (Recovery from) Doubtful Accounts, Net
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(dollars in thousands)Provision for (recovery from
    doubtful accounts, net

$
1,574


$
1,716


$
(142
)


(8
)%

$
(1,216
)

$
2,932



(241
)%Percentage of net revenues


0
%


0
%










0
%    46




---



##### Table of Contents



Reimbursement
    from Transition Services Agreement
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(dollars in thousands)Reimbursement from transition
    services agreement

$
(362
)

$
(5,997
)

$
5,635



94
%

$



$
(5,997
)


(100
)%Percentage of net revenues


0
%


(1
)%










0
%     (Gain)
    loss on Sale of Assets and Technology
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(dollars in thousands)(Gain) loss on sale of assets and
    technology(1)

$
(56
)

$
(240,336
)

$
240,280



100
%

$
788


$
(241,124
)


*Percentage of net revenues


0
%


(26
)%










0
%     (1)
    
    Net of stock-based compensation charge of $84 in 2004*
    
    Calculation is not meaningful.      Reimbursement
    Related to Litigation Settlement
   47




---



##### Table of Contents



Severance/Bonus
    Costs Related to Sniffer and Magic Dispositions
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(dollars in thousands)Severance/bonus related to Sniffer
    and Magic dispositions(1)

$



$
10,070


$
(10,070
)


(100
)%

$



$
10,070



100
%Percentage of net revenues


0
%


1
%










0
%     (1)
    
    Includes stock-based compensation charge of $991 in 2004      Interest
    and Other Income
    Interest
    and Other Expenses
    Loss
    on Repurchase of Convertible Debt
  In 2005, we had no convertible debt.
  Loss
    (Gain) on Investments, Net
  available-for-sale
 48




---



##### Table of Contents



Provision
    for Income Taxes
  year-over-year
  2005 vs. 2004





2004 vs. 20032005


2004


$


%


2003


$


%(dollars in thousands)Provision for income taxes

$
42,706


$
91,406


$
(48,700
)


(53
)%

$
16,810


$
74,596



444
%Effective tax rate


24
%


29
%










19
%       and/or
    Cumulative
    Effect of Change in Accounting Principle
    Stock-Based
    Compensation
    Years Ended
    December 31,2005


2004


2003New and existing executives and
    employees

$
1,616


$
1,928


$
424Exchange of McAfee.com options


(115
)


6,669



3,369Repriced options


(445
)


3,343



Former employees






1,216



1,125Extended life of vested options of
    terminated employees






1,164



3,720Extended period of Employee Stock
    Purchase Plan










3,869Total stock-based compensation

$
1,056


$
14,320


$
12,507  49




---



##### Table of Contents



New and existing executives and employees.
        Exchange of McAfee.com options.
  Accounting for Stock Appreciation Rights and Other
    Variable Stock Option or Award Plans.
    Repriced Options.
 50




---



##### Table of Contents



Former Employees.
      Extended Life of Vested Options Held by Terminated
    Employees. 90-day
    Extended Period of Employee Stock Purchase
    Plan.
  Impact of Recent Accounting Pronouncement on Stock-Based
    Compensation. Share-Based Payment
 51




---



##### Table of Contents



Acquisitions
  Wireless
    Security Corporation
    Foundstone,
    Inc.
    IntruVert
    Networks, Inc.
   52




---



##### Table of Contents



Entercept
    Security Technologies, Inc.
    Liquidity
    and Capital Resources
  2005


2004


2003(In thousands)Net cash provided by operating
    activities

$
419,457


$
358,913


$
156,304Net cash used in investing
    activities

$
4,595


$
(39,373
)

$
(374,480
)Net cash (used in) provided by
    financing activities

$
39,841


$
(369,867
)

$
(146,579
)   Overview
    Operating
    Activities
       53




---



##### Table of Contents



Investing
    Activities
    2005


2004


2003Purchase of marketable securities

$
(793,581
)

$
(1,243,990
)

$
(1,120,561
)Proceeds from sale and maturity of
    marketable securities


896,139



1,033,402



1,022,700(Increase) decrease in restricted
    cash


(50,322
)


19,930



664Purchase of property and equipment
    and leasehold improvements, net


(28,941
)


(25,374
)


(60,027
)Acquisitions, net of cash acquired


(20,200
)


(84,650
)


(217,078
)Proceeds from sale of assets and
    technology


1,500



261,309



Purchases of acquired technology










(178
)Net cash provided by (used in)
    investing activities

$
4,595


$
(39,373
)

$
(374,480
)  54




---



##### Table of Contents



Investments
  available-for-sale,
  Restricted
    Cash
        Property
    and Equipment
      Acquisitions
     55




---



##### Table of Contents



Proceeds
    from Sale of Assets and Technology
      Financing
    Activities
    2005


2004


2003Proceeds from issuance of common
    stock under stock option plan and stock purchase plans

$
108,236


$
113,793


$
35,417Repurchase of common stock


(68,395
)


(221,816
)


(4,707
)Repurchase of convertible debt






(265,623
)


(177,289
)Contribution of proceeds from sale
    of common stock held in trust






3,779



Net cash provided by (used in)
    financing activities

$
39,841


$
(369,867
)

$
(146,579
)   Stock
    Option and Stock Purchase Plans
      Repurchase
    of Common Stock
    Redemption
    of Convertible Debt
   56




---



##### Table of Contents



Contribution
    of Proceeds from Sale of Common Stock Held in Trust
    Credit
    Facility
    Contractual
    Obligations
    Payments Due by PeriodLess Than


1-3


3-5


More ThanContractual
    Obligations

Total


1 Year


Years


Years


5 YearsOperating leases(1)

$
87,239


$
17,265


$
23,602


$
19,097


$
27,275Other commitments(2)


39,204



26,507



12,697







Purchase obligations(3)


5,694



5,694











Total

$
132,137


$
49,466


$
36,299


$
19,097


$
27,275     (1)
    
    Operating leases are for office space and office equipment. The
    operating lease commitments above reflect contractual and
    reasonably assured rent escalations under the lease
    arrangements. The majority of our lease contractual obligations
    relate to the following three leases: $45.8 million for the
    Santa Clara, California facility lease, $17.0 million
    for the Slough, United Kingdom facility lease and
    $4.3 million for the Cork, Ireland facility lease.(2)
    
    Other commitments are minimum commitments on telecom contracts,
    contractual commitments for naming rights and advertising
    services and software licensing agreements and royalty
    commitments associated with the shipment and licensing of
    certain products.(3)
    
    We generally issue purchase orders to our contract manufacturers
    with delivery dates from four to six weeks from the purchase
    order date. In addition, we regularly provide such contract
    manufacturers with rolling six-month forecasts of product
    requirements for planning and long-lead time parts procurement
    purposes only. We are committed to accept delivery of materials
    pursuant to our purchase orders subject to various contract
    provisions which allow us to delay receipt of such order or
    allow us to cancel orders beyond certain agreed lead times. Such
    cancellations may or may not include cancellation costs payable
    by us. If we are unable to adequately manage our contract
    manufacturers and adjust such commitments for changes in demand,
    we may incur additional inventory expenses related to excess and
    obsolete inventory.   57




---



##### Table of Contents



Off-Balance
    Sheet Arrangements
    Financial
    Risk Management
    Foreign
    Currency Risk
        Euro

$
116British Pound Sterling


288Brazilian Real


420Japanese Yen


1Australian Dollar


4Canadian Dollar


39$
868  58




---



##### Table of Contents



Interest
    Rate Risk
  Investments
  available-for-sale,
      Valuation ofSecurities Givenan Interest Rate





Valuation of Securities GivenDecrease of


No


an Interest Rate Increase ofX Basis Points


Change in


X Basis PointsIssuer

100 BPS


50 BPS


Interest Rate


50 BPS


100 BPS


150 BPSU.S. Government notes and
    bonds

$
206.4


$
205.9


$
205.4


$
204.9


$
204.4


$
203.9Corporate notes and bonds


190.5



190.2



190.1



189.8



189.6



189.4Asset-backed securities


159.4



159.5



159.4



159.4



159.4



159.3Mortgaged-backed securities


2.0



2.0



2.0



2.0



2.0



2.0Non-corporate credit


2.1



2.1



2.1



2.1



2.1



2.1Total

$
560.4


$
559.7


$
559.0


$
558.2


$
557.5


$
556.7     Valuation ofSecurities Givenan Interest Rate





Valuation of Securities GivenDecrease of


No


an Interest Rate Increase ofX Basis Points


Change in


X Basis PointsIssuer

100 BPS


50 BPS


Interest Rate


50 BPS


100 BPS


150 BPSU.S. Government notes and
    bonds

$
209.6


$
209.2


$
208.8


$
208.4


$
208.0


$
207.6Corporate notes and bonds


193.9



193.8



193.8



193.7



193.6



193.6Asset-backed securities


162.1



162.3



162.5



162.6



162.8



162.9Mortgaged-backed securities


2.7



2.7



2.7



2.7



2.7



2.7Non-corporate credit


2.5



2.5



2.4



2.4



2.4



2.4Total

$
570.8


$
570.5


$
570.2


$
569.8


$
569.5


$
569.2   Interest
    Rate Swap Transactions
   59




---



##### Table of Contents



Recent
    Accounting Pronouncements Update
    Item 7A.
    Quantitative
    and Qualitative Disclosure About Market Risk    Item 8.
    Financial
    Statements and Supplementary Data  Quarterly
    Operating Results (Unaudited)
  Three Months EndedDecember 31,


September 30,


June 30,


March 31,


December 31,


September 30,


June 30,


March 31,2005


2005


2005


2005


2004


2004


2004


2004(In thousands, except per share
    data)Statement of Operation and Other
    Data:Net revenues

$
253,279


$
252,911


$
245,382


$
235,727


$
244,153


$
221,633


$
225,678


$
219,078Gross margin


201,270



215,818



208,526



197,070



204,273



187,360



188,114



181,886Income from operations


48,974



15,488



45,989



48,121



23,427



210,585



13,059



75,180Income before provision for income
    taxes


55,887



22,641



50,573



52,433



23,621



199,457



13,969



79,424Net income

$
38,613


$
22,547


$
41,698


$
35,970


$
38,747


$
118,148


$
10,200


$
57,970Basic net income per share

$
.23


$
.14


$
.25


$
.22


$
.24


$
.75


$
.06


$
.35Diluted income per share

$
.23


$
.13


$
.25


$
.21


$
.23


$
.70


$
.06


$
.33   period-to-period
     60




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##### Table of Contents



Form 10-Q
  Three Months EndedMarch 31,


June 30,


September 30,2005


2005


2005Net revenue:Total product revenue

$
44,092


$
53,423


$
39,253Total services and support revenue


191,635



191,959


$
213,658Total net revenue

$
235,727


$
245,382


$
252,911     As restated


Three Months


Twelve MonthsThree Months Ended


Ended


EndedMarch 31,


June 30,


September 30,


December 31,


December 31,2005


2005


2005


2005


2005Net revenue:Total product revenue

$
45,145


$
43,805


$
32,578


$
46,010


$
167,538Total services and support revenue


190,582



201,577


$
220,333


$
207,269


$
819,761Total net revenue

$
235,727


$
245,382


$
252,911


$
253,279


$
987,299     Item 9.
    Changes
    In and Disagreements With Accountants on Accounting and
    Financial Disclosure    Item 9A.
    Controls
    and Procedures  Evaluation
    of Disclosure Controls and Procedures
  Rules 13a-15(e) 15d-15(e) Form 10-K.
  Managements
    Report on Internal Control over Financial Reporting
  Rules 13a-15(f)
  Internal
    Control   Integrated Framework
 61




---



##### Table of Contents



Financial
    Close Process
    Internal
    Control  Integrated Framework.
    Changes
    in Internal Control over Financial Reporting
    (a)
    gain the expertise necessary to interpret and implement the
    accounting treatment for complex transactions;  (b)
    gain sufficient worldwide resources to improve upon the quality
    of the interim and annual review and reconciliation processes
    for certain key account balances;  (c)
    coordinate the accounting functions of our domestic and
    international locations by consolidating the oversight
    responsibilities under one worldwide controller, thereby
    allowing for the consistent application of accounting principles
    in all geographies;  (d)
    implement additional monitoring controls that are designed to
    improve upon the accuracy and timely preparation of our
    financial statements and related SEC filings;  (e)
    establish a stable executive finance team to monitor the
    operation of our newly implemented controls during each interim
    and annual close process going forward.    
    Automating many of our controls and financial reporting processes
    Improving business processes, including the redesign and
    automation of certain activities, related to the financial close
    process
    Standardizing our worldwide policies and procedures
    Increasing the number of accounting and finance staff where
    appropriate 62




---



##### Table of Contents



Inherent
    Limitation on the Effectiveness of Internal Controls
   63




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
               64




---



##### Table of Contents



65




---



##### Table of Contents



Item 9B.
    Other
    Information   PART III  Item 10.
    Directors
    and Executive Officers of the Registrant  www.mcafee.com. Form 8-K.
  Section 16(a)
    Beneficial Ownership Reporting Compliance
    Item 11.
    Executive
    Compensation    Item 12.
    Security
    Ownership of Certain Beneficial Owners and Management and
    Related Stockholder Matters    Item 13.
    Certain
    Relationships and Related Transactions    Item 14.
    Principal
    Accountant Fees and Services   66




---



##### Table of Contents



PART IV  Item 15.
    Exhibits
    and Financial Statement Schedules  Consolidated Financial Statements
  PageNumberReports of
    Independent Registered Public Accounting Firms


68Consolidated
    Balance Sheets:December 31, 2005 and 2004


70Consolidated
    Statements of Income and Comprehensive Income:Years ended December 31,
    2005, 2004 and 2003


71Consolidated
    Statements of Stockholders Equity:Years ended December 31,
    2005, 2004 and 2003


73Consolidated
    Statements of Cash Flows:Years ended December 31,
    2005, 2004, and 2003


75Notes to
    Consolidated Financial Statements


77   Consolidated Financial Statement Schedule
  Form 10-K
      Exhibits
 67




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##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM          Internal
    Control  Integrated Framework
      68




---



##### Table of Contents



REPORT OF
    INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  
          69




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
 CONSOLIDATED
    BALANCE SHEETS  December 31,2005


2004(In thousands, exceptshare data)ASSETSCurrent assets:Cash and cash equivalents

$
728,592


$
291,155Restricted cash


50,489



Short-term marketable securities


316,298



232,929Accounts receivable, net of
    allowance for doubtful accounts of $2,389 and $2,536,
    respectively


158,680



146,376Prepaid expenses, income taxes and
    other current assets


106,791



99,513Deferred income taxes


206,811



200,459Total current assets


1,567,661



970,432Long-term marketable securities


212,131



400,597Restricted cash


939



617Property and equipment, net


85,641



91,715Deferred income taxes


241,315



220,604Intangible assets, net


80,782



107,133Goodwill


438,396



439,180Other assets


15,759



16,254Total assets

$
2,642,624


$
2,246,532LIABILITIESCurrent liabilities:Accounts payable

$
34,678


$
32,891Accrued SEC settlement


50,000



Accrued income taxes


81,227



70,778Accrued compensation


50,617



53,146Accrued liabilities


82,011



82,300Deferred revenue


570,458



475,621Total current liabilities


868,991



714,736Deferred revenue, less current
    portion


175,962



125,752Accrued taxes and other long-term
    liabilities


142,638



204,796Total liabilities


1,187,591



1,045,284Commitments and contingencies
    (Notes 11, 12 and 20)STOCKHOLDERS
    EQUITYPreferred stock, $0.01 par
    value:Authorized: 5,000,000 shares;
    Issued and outstanding: none in 2005 and 2004






Common stock, $0.01 par value:Authorized:
    300,000,000 shares; Issued: 170,453,210 shares at
    December 31, 2005 and 162,266,174 shares at
    December 31, 2004 Outstanding: 167,688,210 shares at
    December 31, 2005 and 162,266,174 shares at
    December 31, 2004


1,705



1,623Treasury stock, at cost:
    2,765,000 shares at December 31, 2005 and no shares at
    December 31, 2004


(68,395
)


Additional paid-in capital


1,356,881



1,178,855Deferred stock-based compensation


(474
)


(1,777
)Accumulated other comprehensive
    income


31,302



27,361Retained earnings (accumulated
    deficit)


134,014



(4,814
)Total stockholders equity


1,455,033



1,201,248Total liabilities and
    stockholders equity

$
2,642,624


$
2,246,532    70




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
 CONSOLIDATED
    STATEMENTS OF INCOME
    AND COMPREHENSIVE INCOME  Years Ended
    December 31,2005


2004


2003(In thousands, except per share
    data)Net revenue:Product

$
167,538


$
294,163


$
513,610Services and support


819,761



616,379



422,726Total net revenue


987,299



910,542



936,336Cost of net revenue:Product


63,272



73,058



80,895Services and support


85,828



62,520



57,362Amortization of purchased
    technology


15,515



13,331



11,369Total cost of net revenue


164,615



148,909



149,626Operating costs:Research and development(1)


176,350



172,717



184,606Marketing and sales(2)


294,234



354,380



363,306General and administrative(3)


122,182



139,845



129,920SEC settlement charge


50,000







Amortization of intangibles


12,902



14,065



15,637In-process research and development


4,000







6,600Restructuring charges


3,731



17,493



22,667Provision for (recovery of)
    doubtful accounts, net


1,574



1,716



(1,216
)Reimbursement from transition
    services agreement


(362
)


(5,997
)


(Gain) loss on sale of assets and
    technology(4)


(56
)


(240,336
)


788Reimbursement related to
    litigation settlement






(24,991
)


Severance/bonus costs related to
    Sniffer and Magic disposition(5)






10,070



Total operating costs


664,555



438,962



722,308Income from operations


158,129



322,671



64,402Interest and other income


24,837



15,889



15,917Interest and other expenses






(5,315
)


(7,543
)Loss on repurchase of convertible
    debt






(15,070
)


(2,727
)(Loss) gain on investments, net


(1,432
)


(1,704
)


3,076Income before provision for income
    taxes and cumulative effect of change in accounting principle


181,534



316,471



73,125Provision for income taxes


42,706



91,406



13,220Income before cumulative effect of
    change in accounting principle


138,828



225,065



59,905Cumulative effect of change in
    accounting principle, net of taxes of $3,590










10,337Net income

$
138,828


$
225,065


$
70,242 71




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##### Table of Contents



Years Ended
    December 31,2005


2004


2003(In thousands, except per share
    data)Other comprehensive income:Unrealized losses on marketable
    securities, net of reclassification adjustment for losses
    recognized on marketable securities during the period and income
    tax

$
(638
)

$
(2,129
)

$
(709
)Foreign currency translation
    (loss) gain


4,579



(4,537
)


10,578Comprehensive income

$
142,769


$
218,399


$
80,111Basic net income per share:Income before cumulative effect of
    change in accounting principle

$
0.84


$
1.40


$
0.37Cumulative effect of change in
    accounting principle, net of taxes










0.07Net income per
    share  basic

$
0.84


$
1.40


$
0.44Shares used in per share
    calculation  basic


165,087



160,714



160,338Diluted net income per share:Income before cumulative effect of
    change in accounting principle

$
0.82


$
1.31


$
0.36Cumulative effect of change in
    accounting principle, net of taxes










0.07Net income per
    share  diluted

$
0.82


$
1.31


$
0.43Shares used in per share
    calculation  diluted


169,234



177,099



164,489     (1)
    
    Includes stock-based compensation (benefits) charges of ($234),
    $6,518 and $5,157 in 2005, 2004 and 2003, respectively.(2)
    
    Includes stock-based compensation (benefits) charges of ($25),
    $2,642 and $5,065 in 2005, 2004 and 2003, respectively.(3)
    
    Includes stock-based compensation charges of $1,315, $4,085 and
    $2,285 in 2005, 2004 and 2003, respectively.(4)
    
    Net of stock-based compensation charge of $84 in 2004.(5)
    
    Includes stock-based compensation charge of $991 in 2004.   72




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  CONSOLIDATED
    STATEMENTS OF STOCKHOLDERS EQUITY
  AccumulatedOther


RetainedAdditional


Deferred


Comprehensive


Earnings


TotalCommon Stock


Treasury Stock


Paid-In


Stock-Based


Income


(Accumulated


StockholdersShares


Amount


Shares


Amount


Capital


Compensation


(Loss)


Deficit)


Equity(In thousands)Balances, December 31, 2002


157,928


$
1,579






$



$
1,050,288


$
(5,736
)

$
24,158


$
(300,121
)

$
770,168Issuance of common stock upon
    exercise of stock options


2,548



26











19,610















19,636Issuance of common stock from
    Employee Stock Purchase Plans


1,596



16











15,765















15,781Repurchase of common stock


(350
)






350



(4,707
)


















(4,707
)Deferred stock-based compensation


















(643
)


643











Amortization of deferred
    stock-based compensation and other stock-based compensation
    charge


















8,012



4,495











12,507Reclassification of cash payable in
    excess of exercise price related to exchange of McAfee.com
    options


















(5,407
)














(5,407
)Foreign currency translation


























10,578







10,578Net decrease in unrealized gains on
    investments


























(709
)






(709
)Net income






























70,242



70,242Balances, December 31, 2003


161,722



1,621



350



(4,707
)


1,087,625



(598
)


34,027



(229,879
)


888,089Issuance of common stock upon
    exercise of stock options


9,152



92











105,638















105,730Issuance of common stock from
    Employee Stock Purchase Plans


775



8











8,055















8,063Issuance of common stock upon
    exercise of warrants


184



2











(2
)














Issuance of common stock upon
    conversion of debt


4,616



46











83,364















83,410Repurchase of common stock


(12,623
)






12,623



(221,816
)


















(221,816
)Retirement of treasury stock






(130
)


(12,973
)


226,523



(226,393
)














Deferred stock-based compensation


















6,443



(6,443
)










Shares returned from trust


(1,560
)


(16
)










16















Amortization of deferred
    stock-based compensation and other stock-based compensation
    charge


















6,804



7,516











14,320Reclassification of cash payable in
    excess of exercise price related to exchange of McAfee.com
    options


















(3,154
)














(3,154
)Contribution of proceeds from sale
    of common stock held in trust


















3,779















3,779Tax benefits from exercise of
    non-qualified stock options


















72,622















72,622Stock options issued in connection
    with acquisition


















7,039



(2,252
)










4,787Release of tax contingency related
    to acquisition accounted for as a pooling of interests


















27,019















27,019Foreign currency translation


























(4,537
)






(4,537
)Net decrease in unrealized gains on
    investment


























(2,129
)






(2,129
)Net income






























225,065



225,065 73




---



##### Table of Contents



AccumulatedOther


RetainedAdditional


Deferred


Comprehensive


Earnings


TotalCommon Stock


Treasury Stock


Paid-In


Stock-Based


Income


(Accumulated


StockholdersShares


Amount


Shares


Amount


Capital


Compensation


(Loss)


Deficit)


Equity(In thousands)Balances, December 31, 2004


162,266



1,623











1,178,855



(1,777
)


27,361



(4,814
)


1,201,248Issuance of common stock upon
    exercise of stock options


7,212



72











96,647















96,719Issuance of common stock from
    Employee Stock Purchase Plans


790



8











11,465















11,473Issuance of restricted stock


185



2



























2Repurchase of common stock


(2,765
)






2,765



(68,395
)


















(68,395
)Deferred stock-based compensation


















(1,054
)


1,054











Amortization of deferred
    stock-based compensation and other stock-based compensation
    charge


















807



249











1,056Reclassification of cash payable in
    excess of exercise price related to exchange of McAfee.com
    options


















(1,704
)














(1,704
)Contribution of proceeds from sale
    of common stock held in trust


















42















42Tax benefits from exercise of
    non-qualified stock options


















32,985















32,985Release of tax contingency related
    to acquisition accounted for as a pooling of interests


















38,838















38,838Foreign currency translation


























4,579







4,579Net increase in unrealized losses
    on investment


























(638
)






(638
)Net income






























138,828



138,828Balances, December 31, 2005


167,688


$
1,705



2,765


$
(68,395
)

$
1,356,881


$
(474
)

$
31,302


$
134,014


$
1,455,033    74




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  CONSOLIDATED
    STATEMENTS OF CASH FLOWS
  Years Ended
    December 31,2005


2004


2003(In thousands)Cash flows from operating
    activities:Net income

$
138,828


$
225,065


$
70,242Adjustments to reconcile net
    income to net cash provided by operating activities:Cumulative effect of change in
    accounting principle, net










(10,337
)Depreciation and amortization


64,884



66,699



62,830Tax benefit from exercise of
    nonqualified stock options


34,442



72,622



Deferred income taxes


(13,762
)


(21,503
)


(25,368
)Non-cash restructuring charge


686



9,624



14,534Acquired in-process research and
    development


4,000







6,600Interest earned on restricted cash


(489
)






Provision for (recovery of)
    doubtful accounts


1,574



1,716



(1,216
)Stock-based compensation charges


1,056



14,320



12,507Premium amortization of marketable
    securities


42



4,614



7,114Loss (gain) on sale of investments


1,432



1,704



(3,076
)(Gain) loss on sale of assets and
    technology


(56
)


(238,923
)


788Loss on repurchase of zero coupon
    convertible debenture






15,070



2,727Change in fair value of interest
    rate swap, net of change in the fair value of the debt






382



(5,646
)Non-cash interest and other
    expense on convertible debt






1,224



3,162Changes in assets and liabilities,
    net of acquisitions:Accounts receivable


(23,309
)


35,668



(6,676
)Prepaid expenses, income taxes and
    other assets


(13,249
)


(6,267
)


(17,624
)Accounts payable


2,060



(423
)


106Accrued taxes and other liabilities


39,128



15,388



(78,558
)Deferred revenue


182,190



161,933



124,195Net cash provided by operating
    activities


419,457



358,913



156,304Cash flows from investing
    activities:Purchase of marketable securities


(793,581
)


(1,243,990
)


(1,120,561
)Proceeds from sale and maturity of
    marketable securities


896,139



1,033,402



1,022,700(Increase) decrease in restricted
    cash (1)


(50,322
)


19,930



664Purchase of property and equipment
    and leasehold improvements, net


(28,941
)


(25,374
)


(60,027
)Acquisitions, net of cash acquired


(20,200
)


(84,650
)


(217,078
)Proceeds from sale of assets and
    technology


1,500



261,309



Purchases of acquired technology










(178
)Net cash provided by (used in)
    investing activities


4,595



(39,373
)


(374,480
)Cash flows from financing
    activities:Proceeds from issuance of common
    stock under stock option and stock purchase plans


108,236



113,793



35,417 75




---



##### Table of Contents



Years Ended
    December 31,2005


2004


2003(In thousands)Repurchase of common stock


(68,395
)


(221,816
)


(4,707
)Repurchase of convertible debt






(265,623
)


(177,289
)Contribution of proceeds from sale
    of common stock held in trust






3,779



Net cash provided by (used in)
    financing activities


39,841



(369,867
)


(146,579
)Effect of exchange rate
    fluctuations


(26,456
)


7,831



24,180Net (decrease) increase in cash
    and cash equivalents


437,437



(42,496
)


(340,575
)Cash and cash equivalents at
    beginning of period


291,155



333,651



674,226Cash and cash equivalents at end
    of period

$
728,592


$
291,155


$
333,651Non cash investing and financing
    activities:Unrealized losses on marketable
    investments, net

$
(638
)

$
(2,129
)

$
(709
)Fair value of assets acquired in
    business combinations

$
17,080


$
110,394


$
247,958Liabilities assumed in business
    combinations

$
749


$
20,037


$
25,465Purchase of property and equipment
    and leasehold improvements, net

$
1,283


$



$
Realization of deferred tax assets
    of acquired company

$
38,838


$
27,019


$
Issuance of common stock upon
    conversion of debt

$



$
83,410


$
Stock options issued in connection
    with acquisition

$



$
7,039


$
Supplemental disclosure of cash
    flow information:Cash paid during the year for
    interest

$



$
6,349


$
10,434Cash paid during the year for
    income taxes

$
38,024


$
31,393


$
20,864     (1)
    
    The $50.0 million placed in escrow for the settlement with
    the SEC (see Note 20) is reflected as cash used in
    investing activities. The SEC approved the settlement in January
    2006. In the first quarter of 2006, it will be reflected as cash
    provided by investing activities of $50.0 million and cash
    used in operating activities of $50.0 million.   76




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL STATEMENTS
  1.
    Organization
    and Business    2.
    Summary
    of Significant Accounting Policies  Basis
    of Presentation
      Use of
    Estimates
    Certain
    Risks and Concentrations
     77




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
            Foreign
    Currency Translation
    Derivatives
  Accounting for
    Derivative Instruments and Hedging Activities,
  Cash
    and Cash Equivalents
   78




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Restricted
    Cash
      Marketable
    Securities
  available-for-sale Available-for-sale
  available-for-sale other-than-temporary
  Inventory
    Deferred
    Costs of Revenue
    Property
    and Equipment
    
    building  interior  seven years;
    exterior  twenty years; 79




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   
    office furniture and equipment  three to five
    years; and
    computer hardware and software  three to five
    years;
    leasehold improvements  the shorter of the lease
    term, including assumed lease renewal periods that are
    reasonably assured or the estimated useful life of the asset.        Internal
    Use Software
  Accounting for the Costs of Computer Software Developed
    or Obtained for Internal Use.
    Goodwill
    and Other Intangible Assets
  Goodwill and Other
    Intangible Assets.
  Finite-Lived
    Intangibles, Long-Lived Assets and Assets Held for
    Sale
   80




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Accounting for
    the Impairment or Disposal of Long-Lived Assets.
      Fair
    Value of Financial Instruments
    Revenue
    Recognition
      Software Revenue Recognition, SOP 97-2, Revenue
    Recognition,
    
    persuasive evidence of an arrangement exists,
    the product or service has been delivered,
    the fee is fixed or determinable, and
    collection of the resulting receivable is reasonably assured.   81




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      and/or
    Research
    and Development
    Advertising
    Costs
    Stock-based
    Compensation
  Accounting for
    Stock-Based Compensation Accounting for
    Stock-Based Compensation  Transition and
    Disclosure Accounting for
    Stock Issued to Employees,
 82




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      Year Ended
    December 31,2005


2004


2003Net income, as reported

$
138,828


$
225,065


$
70,242Deduct: Total stock-based employee
    compensation expense determined under fair value based method
    for all awards, net of tax


(32,524
)


(24,117
)


(55,848
)Add back: stock-based compensation
    expense, net of tax, included in reported net income


685



9,182



7,504Pro forma net income

$
106,989


$
210,130


$
21,898Net income per share:Basic  as reported

$
0.84


$
1.40


$
0.44Basic  pro forma

$
0.65


$
1.31


$
0.14Diluted  as
    reported

$
0.82


$
1.31


$
0.43Diluted  pro forma

$
0.63


$
1.25


$
0.13       2005


2004


2003Risk free interest rate


3.9
%


3.1
%


2.4
%Expected life (years)


4.0



4.0



4.0Volatility


54.4
%


62.8
%


96.0
%Dividend yield










Weighted-average grant date fair
    value of options granted

$
11.24


$
9.08


$
10.38     2005


2004


2003Risk free interest rate


3.1
%


2.0
%


1.4
%Expected life (years)


1.0



1.3



1.3Volatility


40.0
%


47.5
%


71.6
%Dividend yield










Weighted-average fair value of
    employee stock purchase rights

$
8.41


$
6.58


$
13.75  83




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Income
    Taxes
    Net
    Income Per Share
    Warranty
    Comprehensive
    Income (Loss)
  available-for-sale
    Before





Net ofIncome Tax


Income Tax


Income Tax2005Unrealized loss on marketable
    securities, net

$
(2,496
)

$
998


$
(1,498
)Reclassification adjustment for
    net loss on marketable securities recognized during the period


1,432



(572
)


860Foreign currency translation gain


4,579







4,579Total other comprehensive income

$
3,515


$
426


$
3,9412004Unrealized loss on marketable
    securities, net

$
(5,253
)

$
2,102


$
(3,151
)Reclassification adjustment for
    net loss on marketable securities recognized during the period


1,704



(682
)


1,022Foreign currency translation loss


(4,537
)






(4,537
)Total other comprehensive loss

$
(8,086
)

$
1,420


$
(6,666
) 84




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Before





Net ofIncome Tax


Income Tax


Income Tax2003Unrealized gain on marketable
    securities, net

$
1,894


$
(757
)

$
1,137Reclassification adjustment for
    net gain on marketable securities recognized during the period


(3,076
)


1,230



(1,846
)Foreign currency translation gain


10,578







10,578Total other comprehensive income

$
9,396


$
473


$
9,869     2005


2004Unrealized loss on
    available-for-sale
    securities

$
(2,022
)

$
(1,384
)Cumulative translation adjustment


33,324



28,745Total

$
31,302


$
27,361   Recent
    Accounting Pronouncements and Guidance
  Stock-based
    Compensation
  Share-Based Payment
       85




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Transition Election Related to Accounting for
    the Tax Effects of Share-Based Payment Awards
  Income
    Taxes
  Accounting
    and Disclosure Guidance for the Foreign Earnings Repatriation
    Provision within the American Jobs Creations Act of 2004 FAS 109-2.
  Earnings
    per Share
    Electronic
    Equipment Waste Obligations
  SFAS 143-1, Accounting for Electronic Equipment Waste
    Obligations SFAS 143-1 FAS 143-1
  Accounting
    Changes and Error Corrections
  Accounting Changes and Error Corrections, Accounting Changes, Reporting Accounting
    Changes in Interim Financial Statements.
 86




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    The
    Meaning of
    Other-Than-Temporary
    Impairment
  The Meaning of
    Other-Than-Temporary
    Impairment and Its Application to Certain Investments, other-than-temporary other-than-temporary Accounting for Certain Investments in Debt and Equity
    Securities The
    Equity Method of Accounting for Investments in Common
    Stock. No. 03-1, The Meaning of
    Other-Than-Temporary
    Impairment and Its Application to Certain Investments, No. D-44, Recognition of
    Other-Than-Temporary
    Impairment upon the Planned Sale of a Security Whose Cost
    Exceeds Fair Value.
  3.
    Cumulative
    Effect of Change in Accounting Principle    4.
    Business
    Combinations and Other Acquisitions  Wireless
    Security Corporation
     87




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    (In thousands)Technology

$
1,500Other intangibles


300Goodwill


13,247Cash


129Other assets


34Deferred tax assets


1,870Total assets acquired


17,080Liabilities


38Deferred tax liabilities


711Total liabilities assumed


749Net assets acquired


16,331In-process research and
    development expensed


4,000Total acquisition cost

$
20,331     Foundstone,
    Inc.
     88




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
          (In thousands)Technology

$
27,000Other intangible assets


1,600Goodwill


57,421Cash


920Other assets


12,682Deferred tax assets


10,758Total assets acquired


110,381Liabilities


8,727Deferred tax liabilities


11,297Total liabilities assumed


20,024Net assets acquired

$
90,357  89




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Year Ended
    December 31,2004


2003(Unaudited)Net revenue

$
927,595


$
954,136Income before cumulative effect of
    change in accounting principle

$
212,227


$
46,838Net income

$
212,227


$
57,175Basic net income per share

$
1.32


$
0.36Shares used in per share
    calculation  basic


160,714



160,338Diluted net income per share

$
1.24


$
0.35Shares used in per share
    calculation  diluted


177,099



164,489     IntruVert
    Networks, Inc.
         90




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Entercept
    Security Technologies, Inc.
        Original accrual, April 30,
    2003

$
2,837Cash payments


(1,106
)Adjustments


(1,137
)Balance, December 31, 2004


594Cash payments


(384
)Balance, December 31, 2005

$
210    91




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Total AssetsIntruVert


Entercept Security


Acquired andNetworks, Inc.


Technologies, Inc.


Liabilities Assumed(In thousands)Deferred tax assets

$
436


$
10,560


$
10,996Technology


18,200



21,700



39,900Other intangible assets


1,900



2,800



4,700Cash


10,986



1,028



12,014Goodwill


71,598



99,565



171,163Other assets


4,984



3,517



8,501Total assets acquired


108,104



139,170



247,274Current liabilities


2,649



4,739



7,388Deferred tax liabilities


7,839



9,555



17,394Total liabilities assumed


10,488



14,294



24,782Net assets acquired

$
97,616


$
124,876


$
222,492In-process research and
    development expensed

$
5,700


$
900


$
6,600Total acquisition cost

$
103,316


$
125,776


$
229,092     December 31,2003(Unaudited)Net revenue

$
939,953Income before cumulative effect of
    change in accounting principle

$
49,721Net income

$
60,058Basic net income per share

$
0.38Shares used in per share
    calculation  basic


160,338Diluted net income per share

$
0.37Shares used in per share
    calculation  diluted


164,489    92




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   5.
    Sale of
    Businesses  McAfee
    Labs
      Sniffer
    Technologies
      (In thousands)Assets:Prepaid expenses

$
2,227Inventory


6,759Equipment, net


2,396Goodwill


50,547Total assets

$
61,929Liabilities:Accrued liabilities

$
2,069Deferred revenue


43,477Total liabilities

$
45,546        93




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Magic
    Solutions
      Assets:Accounts receivable

$
12,991Prepaid expenses


888Inventory


20Equipment, net


1,023Goodwill


9,797Assets held for sale

$
24,719Liabilities:Accounts payable

$
215Accrued liabilities


1,050Deferred revenue


22,045Liabilities related to assets held
    for sale

$
23,310       6.
    Marketable
    Securities and Cash and Cash Equivalents  available-for-sale,
  2005Purchase/


Gross


GrossAmortized


Unrealized


Unrealized


AggregateCost


Gains


Losses


Fair ValueU.S. Government debt
    securities

$
199,233


$



$
(1,770
)

$
197,463Corporate debt securities


293,917



17



(1,618
)


292,316Time deposits


38,650











38,650$
531,800


$
17


$
(3,388
)

$
528,429   94




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  2004Purchase/


Gross


GrossAmortized


Unrealized


Unrealized


AggregateCost


Gains


Losses


Fair ValueU.S. Government debt
    securities

$
274,594


$
40


$
(1,021
)

$
273,613Corporate debt securities


340,037



138



(1,458
)


338,717Municipal debt securities


4,850











4,850Time deposits


16,350







(4
)


16,346$
635,831


$
178


$
(2,483
)

$
633,526       2005


2004Cash and money market funds, at
    cost which approximates fair value

$
718,109


$
262,216Corporate debt securities,
    primarily commercial paper


10,483



28,939Total cash and cash equivalents

$
728,592


$
291,155     2005


2004


2003Realized gains

$
697


$
922


$
3,753Realized losses


(2,129
)


(2,626
)


(677
)Net realized (loss) gain

$
(1,432
)

$
(1,704
)

$
3,076   available-for-sale
  Less Than 12 Months


12 Months or greater


TotalGross





Gross





GrossUnrealized





Unrealized





UnrealizedFair Value


Losses


Fair Value


Losses


Fair Value


LossesU.S. Government debt
    securities

$
48,589


$
(556
)

$
137,127


$
(1,214
)

$
185,716


$
(1,770
)Corporate debt securities


21,932



(115
)


76,395



(767
)


98,327



(882
)Asset-backed securities


110,482



(401
)


30,556



(335
)


141,038



(736
)$
181,003


$
(1,072
)

$
244,078


$
(2,316
)

$
425,081


$
(3,388
)    95




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   7.
    Derivatives  Forward
    Exchange Contracts
      Euro

$
116British Pound Sterling


288Brazilian Real


420Japanese Yen


1Australian Dollar


4Canadian Dollar


39$
868   Interest
    Rate Swaps
           96




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
      8.
    Consolidated
    Balance Sheet Detail (in thousands):  December 31,2005


2004Property and equipment:Building

$
19,828


$
19,828Furniture and fixtures


16,564



18,728Computers, equipment and software


159,894



154,005Leasehold improvements


22,826



21,421Construction in progress


8,533



2,034227,645



216,016Accumulated depreciation


(147,066
)


(129,363
)80,579



86,653Land


5,062



5,062Total property and equipment, net

$
85,641


$
91,715     December 31,2005


2004Accrued liabilities:Accrued marketing costs

$
15,172


$
11,662Accrued legal and accounting fees


9,077



9,231Other accrued expenses


57,762



61,407$
82,011


$
82,300Accrued income taxes and other
    long-term liabilities:Accrued income taxes, long-term

$
123,061


$
188,734Other


19,577



16,062$
142,638


$
204,796    97




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   9.
    Restructuring
    Charges  2005
    Restructuring
      LeaseTermination


Severance and


OtherCosts


other benefits


Costs


TotalBalance, January 1, 2005

$



$



$



$
Restructuring accrual


1,852



216



4



2,072Cash payments


(1,127
)


(216
)


(4
)


(1,347
)Effects of foreign currency
    exchange


(14
)










(14
)Accretion


23











23Balance, December 31, 2005

$
734


$



$



$
734     2004
    Restructuring
       98




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
            LeaseTermination


Severance and


OtherCosts


Other Benefits


Costs


TotalBalance, January 1, 2004

$



$



$



$
Restructuring accrual


8,685



7,932



480



17,097Cash payments


(579
)


(4,175
)


(63
)


(4,817
)Adjustment to liability


(222
)


(275
)






(497
)Accretion


74











74Balance, December 31, 2004


7,958



3,482



417



11,857Restructuring accrual


1,402



1,382



20



2,804Cash payments


(2,747
)


(4,864
)


(297
)


(7,908
)Adjustment to liability


(819
)






(140
)


(959
)Effects of foreign currency
    exchange


(46
)










(46
)Accretion


341











341Balance, December 31, 2005

$
6,089


$



$



$
6,089     2003
    Restructuring
   99




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
           100




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     LeaseTermination


Severance and


OtherCosts


Other Benefits


Costs


TotalBalance, January 1, 2003

$



$



$



$
Restructuring accrual


15,734



6,692



739



23,165Cash payments


(1,707
)


(6,259
)


(167
)


(8,133
)Adjustment to liability


(273
)


(116
)


(572
)


(961
)Accretion


463











463Balance, December 31, 2003


14,217



317







14,534Cash payments


(1,841
)


(194
)






(2,035
)Adjustment to liability


(623
)


(123
)






(746
)Accretion


548











548Balance, December 31, 2004


12,301











12,301Cash payments


(1,279
)










(1,279
)Adjustment to liability


(1,048
)










(1,048
)Accretion


498











498Balance, December 31, 2005

$
10,472


$



$



$
10,472       10.
    Goodwill
    and Other Intangible Assets   101




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Effects of











Effects ofForeign


December 31,





ForeignJanuary 1,


Goodwill





Currency





Goodwill





Currency


December 31,2004


Acquired


Adjustments


Exchange


2004


Acquired


Adjustments


Exchange


2005North America

$
364,325


$
49,027


$
(59,007
)

$
571


$
354,916


$
9,422


$
(11,070
)

$
266


$
353,534EMEA


44,360



7,322



(2,930
)


221



48,973



3,406



(2,033
)


(322
)


50,024Japan


16,748



1,286



(351
)






17,683



163



(327
)






17,519Asia-Pacific (excluding Japan)


6,087



826



(520
)






6,393



(32
)


(404
)






5,957Latin America


12,073



774



(1,724
)


92



11,215



128



(317
)


336



11,362Total

$
443,593


$
59,235


$
(64,532
)

$
884


$
439,180


$
13,087


$
(14,151
)

$
280


$
438,396         December 31, 2005


December 31, 2004Accumulated








AccumulatedAmortization








AmortizationWeighted





(Including Effects








(Including EffectsAverage


Gross


of Foreign


Net


Gross


of Foreign


NetUseful


Carrying


Currency


Carrying


Carrying


Currency


CarryingLife


Amount


Exchange)


Amount


Amount


Exchange)


AmountOther Intangible assets:Purchased technologies


6.0 years


$
138,052


$
(86,965
)

$
51,087


$
139,509


$
(74,400
)

$
65,109Trademarks and patents


0.3 years



28,838



(26,986
)


1,852



28,838



(23,100
)


5,738Customer base and other intangibles


6.3 years



62,089



(34,246
)


27,843



61,497



(25,211
)


36,286$
228,979


$
(148,197
)

$
80,782


$
229,844


$
(122,711
)

$
107,133  102




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     2005


2004(In thousands)Intangible assets, beginning of
    year

$
229,844


$
219,468Add: Purchased technologies
    (amortized over one to seven years)


1,500



27,000Add: Trademarks, patents and other
    intangibles (amortized over one to seven years)


489



1,600Add: Change in value due to
    foreign exchange


(2,854
)


2,122228,979



250,190Dispositions






(20,346
)Intangible assets, end of year

$
228,979


$
229,844       Fiscal Years:2006

$
25,2392007


22,4362008


16,9852009


10,7262010


4,319Thereafter


1,077$
80,782   11.
    Commitments  Leases
    Lease Expiration

Renewal OptionCorporate Headquarters,
    Santa Clara, California


March 2013



NoneEuropean Headquarters, Cork,
    Ireland


December 2014



Two 5 year renewalsSunnyvale, California


May 2010



NoneSlough, England


September 2017



NoneBangalore, India


February 2009



5 year renewalTokyo, Japan


February 2009



2 year renewal    103




---



##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     SubleasePayments


Income2006

$
17,265


$
1,6672007


12,474



4572008


11,128



4352009


9,809



4592010


9,288



483Thereafter


27,275



483Total

$
87,239


$
3,984       Purchase


OtherObligations


Commitments2006

$
5,694


$
26,5072007






10,1782008






2,519Total

$
5,694


$
39,204   12.
    Warranty
    Provision and Guarantees    2005


2004


2003Warranty provision, beginning of
    year

$
1,818


$
1,103


$
1,153Additional accruals


3,514



8,037



3,881Disposition of Sniffer






(807
)


Costs incurred during the period


(4,249
)


(6,515
)


(3,931
)Warranty provision, end of year

$
1,083


$
1,818


$
1,103   Guarantors Accounting and Disclosure
    Requirements for Guarantees, Including Indirect Guarantees of
    Indebtedness of Others.
 104




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    
    Under the terms of our software license agreements with our
    customers, we agree that in the event the software sold
    infringes upon any patent, copyright, trademark, or any other
    proprietary right of a third-party, it will indemnify our
    customer licensees against any loss, expense, or liability from
    any damages that may be awarded against our customer. We include
    this infringement indemnification in all of our software license
    agreements and selected managed service arrangements. In the
    event the customer cannot use the software or service due to
    infringement and we can not obtain the right to use, replace or
    modify the license or service in a commercially feasible manner
    so that it no longer infringes then we may terminate the license
    and provide the customer a pro-rata refund of the fees paid by
    the customer for the infringing license or service. We have
    recorded no liability associated with this indemnification, as
    we are not aware of any pending or threatened infringement
    actions that are probable losses. We believe the estimated fair
    value of these intellectual property indemnification clauses is
    minimal.
    Under the terms of certain vendor agreements, in particular,
    vendors used as part of our managed services, we have agreed
    that in the event the service provided to the customer by the
    vendor on behalf of us infringes upon any patent, copyright,
    trademark, or any other proprietary right of a third-party, we
    will indemnify our vendor, against any loss, expense, or
    liability from any damages that may be awarded against our
    customer. No maximum liability is stipulated in these vendor
    agreements. We have recorded no liability associated with this
    indemnification, as we are not aware of any pending or
    threatened infringement actions or claims that are probable
    losses. We believe the estimated fair value of these
    indemnification clauses is minimal.
    We have agreed to indemnify members of the board of directors,
    as well as our officers, if they are made a party or are
    threatened to be made a party to any proceeding (other than an
    action by or in the right of us) by reason of the fact that they
    are an agent of us, or by reason of anything done or not done by
    them in any such capacity. The indemnity is for any and all
    expenses and liabilities of any type whatsoever (including
    judgments, fines and amounts paid in settlement) actually and
    reasonably incurred by the directors or officers in connection
    with the investigation, defense, settlement or appeal of such
    proceeding, provided they acted in good faith. We maintain
    insurance coverage for directors and officers liability, or
    D&O insurance. No maximum liability is stipulated in these
    agreements that include indemnifications of members of our board
    of directors and officers. We have recorded no liability
    associated with these indemnifications as we are not aware of
    any pending or threatened actions or claims against our members
    of the board of directors or officers that are probable losses
    in excess of amounts covered by our D&O insurance. As a
    result of the insurance policy coverage, we believe the
    estimated fair value of these indemnification agreements is
    minimal.
    Under the terms of our agreement to sell Magic in January 2004,
    we agreed to indemnify the purchaser for any breach of
    representations or warranties in the agreement as well as for
    any liabilities related to the assets prior to sale that are not
    included in the purchaser assumed liabilities (undiscovered
    liabilities). Subject to limited exceptions, the maximum
    potential loss related to the indemnification is
    $10.0 million. To date, we have paid no amounts under the
    representations and warranties indemnification. We have not
    recorded any accruals related to these agreements.
    Under the terms of our agreement to sell Sniffer in July 2004,
    we agreed to indemnify the purchaser for any breach of
    representations or warranties in the agreement as well as for
    any liabilities related to the assets prior to sale that are not
    included in the purchaser assumed liabilities (undiscovered
    liabilities). Subject to limited exceptions, the maximum
    potential loss related to the indemnification is
    $200.0 million. To date, we have paid no amounts under the
    representations and warranties indemnification. We have not
    recorded any accruals related to these agreements. 105




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   
    Under the terms of our agreement to sell McAfee Labs assets in
    December 2004, we agreed to indemnify the purchaser for any
    breach of representations or warranties in the agreement as well
    as for any liabilities related to the assets prior to sale that
    are not included in the purchaser assumed liabilities
    (undiscovered liabilities). Subject to limited exceptions, the
    maximum potential loss related to the indemnification is
    $1.5 million. We have not recorded any accruals related to
    these agreements.    13.
    Convertible
    Debt and Line of Credit    Zero
    Coupon Convertible Debentures Due 2018
      5.25% Convertible
    Subordinated Note Due 2006
       106




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Line
    of Credit
    14.
    Employee
    Benefit Plan    15.
    Stockholders
    Equity  Common
    Stock
       107




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Preferred
    Stock
    Company
    Stock Incentive Plans
          Years ended
    December 31,2005


2004


2003Weighted-





Weighted-





Weighted-Average





Average





AverageNumber of


Exercise


Number of


Exercise


Number of


ExerciseOptions


Price


Options


Price


Options


PriceOutstanding at beginning of period


19,382


$
16.12



29,693


$
15.32



28,255


$
15.12Options granted


5,549



24.59



5,674



18.00



7,807



15.16Options assumed in conjunction
    with acquisition










429



2.69







Options exercised


(7,165
)


13.52



(9,152
)


11.61



(2,548
)


8.06Options canceled


(1,655
)


19.79



(7,262
)


19.24



(3,821
)


18.32Outstanding at end of period


16,111


$
19.79



19,382


$
16.12



29,693


$
15.32    108




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
         Options Outstanding


Options ExercisableWeightedAverage


Weighted





WeightedRemaining


Average





AverageNumber


Contractual


Exercise


Number


ExerciseRange of Exercise
    Prices

Outstanding


Life (Yrs)


Price


Exercisable


Price$1.29 - $5.19


661



5.3


$
4.09



625


$
4.14$6.03 - $13.98


1,981



6.6


$
11.89



1,167


$
11.50$14.01 - $19.96


4,967



7.7


$
16.85



2,092


$
16.97$20.00 - $30.76


8,031



8.2


$
24.04



2,313


$
24.48$30.85 - $71.26


471



8.2


$
33.66



125


$
37.3216,111



7.7


$
19.79



6,322


$
17.85     Employee
    Stock Purchase Plan
    Preferred
    Shares Rights Agreement
   109




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    16.
    Stock-Based
    Compensation    Years Ended
    December 31,2005


2004


2003New and existing executives and
    employees

$
1,616


$
1,928


$
424Exchange of McAfee.com options


(115
)


6,669



3,369Repriced options


(445
)


3,343



Former employees






1,216



1,125Extended life of vested options of
    terminated employees






1,164



3,720Extended period of Employee Stock
    Purchase Plan










3,869Total stock-based compensation

$
1,056


$
14,320


$
12,507   New and existing executives and employees.
       110




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
   Exchange of McAfee.com options.
  Accounting for Stock Appreciation Rights and Other
    Variable Stock Option or Award Plans.
    Repriced Options.
      Former Employees.
 111




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       Extended Life of Vested Options Held by Terminated
    Employees. 90-day
    Extended Period of Employee Stock Purchase
    Plan.
  17.
    Provision
    for Income Taxes    2005


2004


2003Domestic

$
111,502


$
180,462


$
17,303Foreign


70,032



136,009



69,752$
181,534


$
316,471


$
87,055  112




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Years Ended
    December 31,2005


2004


2003Federal:Current

$
46,902


$
2,630


$
18,148Deferred


(8,103
)


68,370



(23,332
)Total Federal


38,799



71,000



(5,184
)State:Current


13,684



(1,834
)


5,863Deferred


(454
)


8,439



(4,802
)Total State


13,230



6,605



1,061Foreign:Current


10,844



21,648



18,167Deferred


(20,167
)


(7,847
)


2,766Total Foreign


(9,323
)


13,801



20,933Provision for income taxes

$
42,706


$
91,406


$
16,810    113




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     Years Ended
    December 31,2005


2004ASSETSDeferred revenue

$
195,894


$
154,910Accrued liabilities and allowances


63,122



74,627Depreciation and amortization


139,527



166,647Tax credits


97,430



107,871Deferred stock compensation


4,019



7,870Net operating loss carryover


35,308



27,948535,300



539,873Valuation allowance


(48,222
)


(65,820
)Total deferred tax assets


487,078



474,053LIABILITIESIntangibles not amortizable for
    tax purposes


30,418



41,043Accrued liabilities and allowances


8,534



11,947Total deferred tax liability


38,952



52,990Net deferred tax asset

$
448,126


$
421,063Current portion

$
206,811


$
200,459Noncurrent portion


241,315



220,604$
448,126


$
421,063        114




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  and/or non-U.S. subsidiaries.
      Years Ended
    December 31,2005


2004


2003Federal income tax provision at
    statutory rate

$
63,537


$
110,765


$
30,470State tax expense (net of Federal
    benefit)


5,139



8,979



1,258Non deductible acquisition and
    other costs


1,407







2,310Foreign earnings taxed at rates
    different than the Federal rate


(31,840
)


(10,266
)


(3,480
)Federal and state tax expense
    related to SEC settlement


19,638







Permanent and other differences


(1,973
)


(2,335
)


867Tax credits


(2,434
)


(12,183
)


(2,532
)Net tax expense on repatriation of
    foreign earnings  American Jobs Creation Act of
    2004


1,531







Benefit from accruals for tax
    exposures and valuation allowance no longer required


(12,299
)


(25,036
)


(12,083
)Difference between book and tax
    basis of businesses sold






22,840



Other






(1,358
)


$
42,706


$
91,406


$
16,810   18.
    Net
    Income Per Share    Years Ended
    December 31,2005


2004


2003Numerator  BasicIncome before cumulative effect of
    change in accounting principle

$
138,828


$
225,065


$
59,905Cumulative effect of change in
    accounting principle, net of tax










10,337Net income

$
138,828


$
225,065


$
70,242 115




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
  Years Ended
    December 31,2005


2004


2003Numerator  DilutedIncome before cumulative effect of
    change in accounting principle

$
138,828


$
225,065


$
59,905Cumulative effect of change in
    accounting principle, net of tax










10,337Interest on convertible
    debentures(1)






7,556



Net income, adjusted

$
138,828


$
232,621


$
70,242Denominator  BasicBasic weighted-average common
    shares outstanding


165,087



160,714



160,338Denominator  DilutedBasic weighted-average common
    shares outstanding


165,087



160,714



160,338Effect of dilutive securities:Convertible debentures(1)






12,154



Common stock options and shares
    subject to repurchase(2)


4,147



4,207



3,992Warrants






24



159Diluted weighted-average shares


169,234



177,099



164,489Basic net income per share:Income before cumulative effect of
    change in accounting principle

$
0.84


$
1.40


$
0.37Cumulative effect of change in
    accounting principle, net of tax










0.07Net income per
    share  Basic

$
0.84


$
1.40


$
0.44Diluted net income per share:Income before cumulative effect of
    change in accounting principle

$
0.82


$
1.31


$
0.36Cumulative effect of change in
    accounting principle, net of tax










0.07Net income per
    share  Diluted

$
0.82


$
1.31


$
0.43     (1)
    
    Convertible debt interest and related 19.1 million as-if
    converted shares were excluded from the calculation since the
    effect was anti-dilutive in 2003. The convertible debt was
    repaid in 2004 so there were no amounts outstanding in 2005.(2)
    
    At December 31, 2005, 2004 and 2003, 2.1 million,
    5.1 million, and 15.6 million options to purchase
    common stock, respectively, were excluded from the calculation
    since the effect was anti-dilutive.  19.
    Business
    Segment and Major Customer Information   116




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
        Years Ended
    December 31,2005


2004


2003Net revenue by
    region:North America

$
578,636


$
554,400


$
606,685EMEA


273,108



241,724



240,616Japan


76,994



54,850



40,519Asia-Pacific, excluding Japan


37,147



38,494



29,014Latin America


21,414



21,074



19,502Net revenue

$
987,299


$
910,542


$
936,336Operating income by
    region:North America

$
232,911


$
194,179


$
216,016EMEA


111,290



89,666



89,159Japan


39,115



18,891



11,013Asia-Pacific, excluding Japan


8,211



11,903



5,962Latin America


8,485



4,193



1,338Corporate


(241,883
)


3,839



(259,086
)Operating income

$
158,129


$
322,671


$
64,402Depreciation expense by
    region:North America

$
12,209


$
12,457


$
9,254EMEA


1,419



2,180



2,631Japan


370



818



1,846Asia-Pacific, excluding Japan


1,478



1,763



1,629Latin America


109



112



66Corporate


20,882



21,973



20,399Depreciation expense

$
36,467


$
39,303


$
35,825  117




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
       December 31,2005


2004North America

$
2,158,266


$
1,509,761EMEA


306,077



536,037Japan


70,766



61,824Asia-Pacific, excluding Japan


36,124



25,794Latin America


15,401



19,729Corporate


55,990



93,387Total assets

$
2,642,624


$
2,246,532     2005


2004India

$
6,149


$
3,667Japan


4,029



4,038United Kingdom


2,530



2,094Ireland


2,112



The Netherlands


384



2,354Other foreign countries


3,962



6,793Total foreign countries


19,166



18,946United States


66,475



72,769Total

$
85,641


$
91,715     2005


2004


2003United Kingdom

$
73,006


$
67,443


$
67,229Germany


46,934



41,910



43,717Japan


76,994



54,609



40,519Canada


31,783



34,403



33,423Other foreign countries


211,729



192,180



178,185Total foreign countries


440,446



390,545



363,073United States


546,853



519,997



573,263Total

$
987,299


$
910,542


$
936,336  118




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
     2005


2004


2003McAfee

$
985,427


$
810,403


$
650,322Sniffer






90,878



210,176Magic






2,850



63,164McAfee Labs


1,872



6,411



11,023PGP










1,651Total net revenue

$
987,299


$
910,542


$
936,336     2005


2004


2003Software licenses

$
111,142


$
157,983


$
341,188Support and maintenance


546,617



436,299



313,731Hardware


36,679



79,828



99,502Retail


18,276



27,787



45,993Consulting


20,213



19,157



27,421Training


5,080



8,394



9,486On-line subscription arrangements


247,851



152,529



72,088Other


1,441



28,565



26,927Total

$
987,299


$
910,542


$
936,336     20.
    Litigation  General
     119




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##### Table of Contents



MCAFEE,
    INC. AND SUBSIDIARIES
  NOTES TO
    CONSOLIDATED FINANCIAL
    STATEMENTS  (Continued)
    Securities
    Cases
  In re Network Associates, Inc. II
    Securities Litigation
  In re McAfee.com Corp. Initial Public
    Offering Securities Litigation, In re Initial Public Offering
    Securities Litigation,
  Other
    Matters
      21.
    Subsequent
    Events   120




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##### Table of Contents



SIGNATURES      By:
    /s/  George Samenuk   Chairman of the Board and
    Chief Executive Officer
    Signature

Title

Date/s/  George Samenuk(George
    Samenuk)

Chairman of the Board and Chief
    Executive Officer

February 28, 2006/s/  Eric F. Brown(Eric
    F. Brown)

Chief Financial Officer

February 28, 2006/s/  Robert B.
    Bucknam(Robert
    B. Bucknam)

Director

February 28, 2006/s/  Leslie G. Denend(Leslie
    G. Denend)

Director

February 28, 2006/s/  Robert Dutkowsky(Robert
    Dutkowsky)

Director

February 28, 2006/s/  Dale Fuller(Dale
    Fuller)

Director

February 28, 2006/s/  Denis J.
    OLeary(Denis
    J. OLeary)

Director

February 28, 2006/s/  Robert Pangia(Robert
    Pangia)

Director

February 28, 2006/s/  Liane Wilson(Liane
    Wilson)

Director

February 28, 2006  121




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##### Table of Contents



EXHIBIT INDEX
  ExhibitNumber

Description2
.1

Asset Purchase Agreement made and
    entered into as of April 22, 2004, by and among, Network
    General Corporation (formerly named Starburst Technology
    Holdings, Inc.), on the one hand; and (ii) McAfee, Inc.
    (formerly named Networks Associates, Inc.), Network Associates
    Technology, Inc., Network Associates International BV, Network
    Associates (India) Private Limited, McAfee Japan Co., Ltd.
    (formerly named Network Associates Japan Co., Ltd.), on the
    other hand, as amended by Amendment No. 1 thereto dated as
    of July 15, 2004.(1)3
.1

Second Restated Certificate of
    Incorporation of the Registrant, as amended on December 1,
    1997.(3)3
.2

Certificate of Ownership and
    Merger between Registrant and McAfee, Inc.(2)3
.3

Amended and Restated Bylaws of the
    Registrant.(2)3
.4

Certificate of Designation of
    Series A Preferred Stock of the Registrant.(5)3
.5

Certificate of Designation of
    Series B Participating Preferred Stock of the Registrant.(6)4
.3

Indenture dated as of
    August 17, 2001 between the Registrant and State Street
    Bank and Trust Company of California.(7)10
.1

Lease Assignment dated
    November 17, 1997 for facility at 3965 Freedom Circle,
    Santa Clara, California by and between Informix Corporation and
    McAfee Associates, Inc.(8)10
.2

Consent to Assignment Agreement
    dated December 19, 1997 by and among Birk S. McCandless,
    LLC, Guaranty Federal Bank, F.S.B., Informix Corporation and the
    Registrant.(8)10
.3

Subordination, Nondisturbance and
    Attornment Agreement dated December 18, 1997, between
    Guaranty Federal Bank, F.S.B., the Registrant and Birk S.
    McCandless, LLC.(8)10
.4

Lease dated November 22, 1996
    by and between Birk S. McCandless, LLC and Informix Corporation
    for facility at 3965 Freedom Circle, Santa Clara,
    California.(8)10
.5*

2002 Employee Stock Purchase Plan,
    as amended.(9)10
.6*

1997 Stock Incentive Plan, as
    amended.(9)10
.7*

Amended and Restated 1993 Stock
    Option Plan for Outside Directors.(4)10
.8*

2000 Nonstatutory Stock Option
    Plan.(10)10
.9*

Amended and Restated Employment
    Agreement between George Samenuk and the Registrant, dated
    October 9, 2001.(11)10
.11

1st Amendment to Lease dated
    March 20, 1998 between Birk S. McCandless, LLC and the
    Registrant.(13)10
.12

Confirmation, Amendment and Notice
    of Security Agreement dated March 20, 1998 among Informix
    Corporation, Birk S. McCandless, LLC and the Registrant.(13)10
.13

Second Amendment to Lease dated
    September 1, 1998 among Informix Corporation, Birk S.
    McCandless, LLC and the Registrant.(13)10
.14

Subordination, Nondisturbance and
    Attornment Agreement dated June 21, 2000, among Column
    Financial, Inc., Informix Corporation, Birk S. McCandless, LLC,
    and the Registrant.(13)10
.16*

Employment Agreement between Kent
    H. Roberts and the Registrant, dated October 9, 2001.(14)10
.18*

Employment Agreement between Kevin
    M. Weiss and the Registrant Dated October 15, 2002.(17)10
.19

Form of Indemnification Agreement
    between the Registrant and its Executive Officers(17)10
.20*

Summary of Pay for Performance
    Plan.(4)10
.21*

Network Associates, Inc. Tax
    Deferred Savings Plan.(16)10
.22

Umbrella Credit Facility of
    Registrant dated April 15, 2004.(18)10
.23

Fifth Amendment to Network
    Associates, Inc. Tax Deferred Savings Plan.(18)10
.24*

Amendment to Employment Agreement
    of George Samenuk effective as of January 20, 2004.(18)10
.26

Sixth Amendment to Network
    Associates, Inc. Tax Deferred Savings Plan.(20)10
.27*

Transition Agreement by and
    between Registrant and Stephen C. Richards.(19)10
.28*

Employment Agreement between
    Registrant and Eric F. Brown dated December 10, 2004 (22) 122




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##### Table of Contents



ExhibitNumber

Description10
.29*

2005 Independent Director Cash
    Compensation Plan (23)10
.30*

Executive Officer Annual
    Compensation for Fiscal Year Ending December 31, 2005(24)10
.31*

Second Amendment to Amended and
    Restated Employment Agreement between Registrant and George
    Samenuk dated May 21, 2005. (25)10
.32*

First Amendment to Employment
    Agreement between Registrant and Vernon Gene Hodges dated
    May 21, 2005. (25)10
.33*

First Amendment to Employment
    Agreement between Registrant and Eric F. Brown dated
    May 26, 2005. (25)10
.34*

First Amendment to Employment
    Agreement between Registrant and Kevin M. Weiss dated
    May 21, 2005. (25)10
.35*

First Amendment to Employment
    Agreement between Registrant and Kent H. Roberts dated
    May 21, 2005. (25)10
.36*

Letter Agreement Amendment to
    Employment Agreement between the Registrant and Eric F. Brown
    dated January 31, 200610
.37

Employment Agreement between
    William Kerrigan and the Registrant, dated October 1, 2004,
    as amended by First Amendment to Employment Agreement dated
    May 24, 2005.21
.1

Subsidiaries of the Registrant23
.1

Consent of Independent Registered
    Public Accounting Firm23
.2

Consent of Independent Registered
    Public Accounting Firm31
.1

Certification of Chief Executive
    Officer and Chief Financial Officer pursuant to Section 302
    of the Sarbanes-Oxley Act of 200232
.1

Certification of Chief Executive
    Officer and Chief Financial Officer pursuant to Section 906
    of the Sarbanes-Oxley Act of 2002     (1)
    
    Incorporated by reference from the Registrants Report on
    Form 8-K
    filed with the Commission on July 16, 2004.(2)
    
    Incorporated by reference from the Registrants Report on
    Form 10-Q
    for the quarter ended September 30, 2004, filed with the
    Commission on November 8, 2004.(3)
    
    Incorporated by reference from the Registrants
    Registration Statement on
    Form S-4
    filed with the Commission on March 25, 1998.(4)
    
    Incorporated by reference from the Registrants Annual
    Report on Form
    10-K for the
    year ended December 31, 2002, filed with the Commission on
    October 31, 2003.(5)
    
    Incorporated by reference from the Registrants Report on
    Form 10-Q
    for the quarter ended September 30, 1996, filed with the
    Commission on November 14, 1996.(6)
    
    Incorporated by reference from the Registrants Report on
    Form 8-A
    filed with the Commission on October 22, 1998.(7)
    
    Incorporated by reference from the Registrants
    Registration Statement on
    Form S-3
    filed with the Commission on November 9, 2001.(8)
    
    Incorporated by reference from the Registrants
    Registration Statement on
    Form S-3,
    filed with the Commission on February 11, 1998.(9)
    
    Incorporated by reference from the Registrants
    Registration Statement on
    Form S-8
    filed with the Commission on July 27, 2005.(10)
    
    Incorporated by reference from the Registrants report on
    Form 10-K
    for the year ended December 31, 2000, filed with the
    Commission on April 2, 2001.(11)
    
    Incorporated by reference from the Registrants report on
    Form 10-K
    for the year ended December 31, 2001, filed with the
    Commission on February 8, 2002. 123




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##### Table of Contents



(12)
    
    Incorporated by reference from the Registrants report on
    Form 10-Q
    for the quarter ended March 31, 2001, filed with the
    Commission on May 15, 2001.(13)
    
    Incorporated by reference from the Registrants report on
    Form 10-Q
    for the quarter ended September 30, 2001, filed with the
    Commission on November 13, 2001.(14)
    
    Incorporated by reference from the Registrants report on
    Form 10-K
    for the year ended December 31, 2001, filed with the
    Commission on February 8, 2002.(15)
    
    Incorporated by reference from the Registrants report on
    Form 10-Q
    for the quarter ended September 30, 2002, filed with the
    Commission on November 12, 2002.(16)
    
    Incorporated by reference from the Registrants
    Registration Statement on
    Form S-8
    filed with the Commission on November 5, 2003.(17)
    
    Incorporated by reference from the Registrants report on
    Form 10-K
    for the year ended December 31, 2003, filed with the
    Commission on March 9, 2004.(18)
    
    Incorporated by reference from the Registrants report on
    Form 10-Q
    for the quarter ended March 31, 2004, filed with the
    Commission on May 10, 2004.(19)
    
    Incorporated by reference from the Registrants report on
    Form 8-K
    filed with the Commission on September 7, 2004.(20)
    
    Incorporated by reference from the Registrants report on
    Form 10-Q
    for the quarter ended June 30, 2004, filed with the
    Commission on August 9, 2004.(21)
    
    Incorporated by reference from the Registrants report on
    Form 10-Q
    for the quarter ended September 30, 2004, filed with the
    Commission on November 8, 2004.(22)
    
    Incorporated by reference from the Registrants report on
    Form 8-K
    filed with the Commission on December 14, 2004.(23)
    
    Incorporated by reference from the Registrants report on
    Form 10-K/A
    for the year ended December 31, 2004, filed with the
    Commission on May 24, 2005.(24)
    
    Incorporated by reference from the Registrants report on
    Form 8-K
    filed with the Commission on April 22, 2005.(25)
    
    Incorporated by reference from the Registrants report on
    Form 8-K
    filed with the Commission on April 26, 2005.*
    
    Management contracts or compensatory plans or arrangements
    covering executive officers or directors of McAfee, Inc. 124




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SCHEDULE II
  MCAFEE,
    INC.
  VALUATION
    AND QUALIFYING ACCOUNTS
  Provision ForDoubtfulAccounts,Additions Charged


Write-Offs ofBalance at


to Expense,


Previously


Balance atBeginning of


Deferred Revenue or


Provided


End ofPeriod


Revenue Net(1)


Accounts


Period(In thousands)Year Ended December 31, 2005Allowance for Doubtful Accounts

$
2,536


$
1,574


$
(1,721
)

$
2,389Year Ended December 31, 2004Allowance for Doubtful Accounts

$
3,070


$
1,716


$
(2,250
)

$
2,536Year Ended December 31, 2003Allowance for Doubtful Accounts(2)

$
6,638


$
(1,216
)

$
(2,352
)

$
3,070     (1)
    
    Allowance for Doubtful Accounts, Net.  The
    provision for doubtful accounts, net consists of our estimates
    with respect to the uncollectibility of our receivables, net of
    recoveries of amounts previously written off. Our management
    must make estimates of the uncollectibility of our accounts
    receivables. Management specifically analyzes accounts
    receivable and analyzes historical bad debts, customer
    concentrations, customer credit-worthiness, current economic
    trends and changes in our customer payment terms when evaluating
    the adequacy of the allowance for doubtful accounts.(2)
    
    The allowance for doubtful accounts in the consolidated balance
    sheet as of December 31, 2003 is net of the
    $0.2 million allowance for Magic, which is included in
    assets held for sale.  Provision ForSales Returnsand OtherBalance at


Incentives


Actual


Balance atBeginning of


Charged to Net


Returns and


End ofPeriod


Revenue (3)


Incentives


Period(In thousands)Year Ended December 31, 2005Sales Returns and Other Incentives

$
29,224


$
146,256


$
(142,907
)

$
32,573Year Ended December 31, 2004Sales Returns and Other Incentives

$
39,599


$
65,350


$
(75,725
)

$
29,224Year Ended December 31, 2003Sales Returns and Other Incentives

$
32,337


$
85,612


$
(78,350
)

$
39,599     (3)
    
    Allowance for Sales Returns and Other
    Incentives.  The allowance for sales returns and
    incentives consists of our estimates of potential future product
    returns related to current period product revenue, and specific
    provisions for distributor, reseller, and retailer sales
    incentives that are reductions in the revenue to be realized. We
    analyze and monitor current and historical return rates, current
    economic trends and changes in customer demand and acceptance of
    our products when evaluating the adequacy of the sales returns
    and other allowances. We also budget for our sales incentives,
    such as end-user rebates, volume incentive rebate programs and
    marketing development funds each quarter and determine amounts
    to be spent and we monitor amounts spent against our budgets.
    These estimates affect our net revenue line item on our
    statement of income and affect our net accounts receivable line
    item on our consolidated balance sheet. These estimates affect
    all of our operating geographies. 125