Annual Report

 

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 20-F

 

(Mark One)

 

¨ Registration statement pursuant to Section 12(b) or 12(g) of the Securities Exchange Act of 1934

 

or

 

x Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal year ended December 31, 2004

 

or

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                          to                         

 

Commission file number 333-10486

 


 

TREND MICRO KABUSHIKI KAISHA

(Exact Name of Registrant as Specified in Its Charter)

 

TREND MICRO INCORPORATED

(Translation of Registrant’s Name Into English)

 

JAPAN

(Jurisdiction of Incorporation or Organization)

 

Shinjuku MAYNDS Tower, 1-1, Yoyogi 2-chome, Shibuya-ku, Tokyo

151-0053, Japan

(Address of Principal Executive Offices)

 


 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of Each Class


 

Name of Each Exchange on

Which Registered


None   None

 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

(1) Common Stock*

(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

(Title of Class)

 


 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

As of December 31, 2004, 133,167,433 shares of common stock were outstanding, including 934,800 American Depositary Shares represented by 934,800 shares of common stock.

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes  x    No  ¨

 

Indicate by check mark which financial statement item the registrant has elected to follow.

 

Item 17  ¨    Item 18  x

 

All information contained in this report is as of December 31, 2004 or for the year ended December 31, 2004 unless the context otherwise indicates. In tables appearing in this annual report, figures may not add up to totals due to rounding.

 

* Not for trading, but only in connection with the registration of American Depositary Shares, each of which represents one share of Common Stock.

 



Cautionary Statement Regarding Forward-Looking Statements

 

This annual report on Form 20-F contains “forward-looking statements” within the meaning of the Section 21E of the Securities Exchange Act of 1934. To the extent that statements in this annual report do not relate strictly to historical or current facts, they may constitute forward-looking statements. These forward-looking statements are based upon management’s current assumptions and beliefs in light of the information currently available to it, but involve known and unknown risks and uncertainties. Our actual actions or results may differ materially from those discussed in the forward-looking statements. We undertake no obligation to publicly update any forward-looking statement after the date of this annual report, but investors are advised to consult any further disclosures by us in our subsequent filings pursuant to the Securities Exchange Act of 1934.

 

Important risks and factors that could cause our actual results to differ materially from our expectations are generally set forth in Item 3.D of this annual report and include, without limitation:

 

difficulties in addressing new virus and other computer security problems;

 

timing of new product introductions and lack of market acceptance for our new products;

 

the level of continuing demand for, and timing of sales of, our existing products;

 

rapid technological change within the anti-virus software industry;

 

changes in customer needs for anti-virus software;

 

existing products and new product introductions by our competitors and the pricing of these products;

 

declining prices for our products and services;

 

the effect of future acquisitions on our financial condition and results of operations;

 

the effect of adverse economic trends on our principal markets;

 

the effect of foreign exchange fluctuations on our results of operations;

 

an increase in the incidence of product returns;

 

the potential lack of attractive investment targets;

 

difficulties in successfully executing our investment strategy; and

 

other risks discussed under “Risk Factors” and elsewhere in this annual report.

 

As used in this annual report, unless otherwise specified, references to “Trend Micro” are to Trend Micro Incorporated. Also, as used in this annual report, references to “we”, “our” and “us” are to Trend Micro Incorporated and, except as the context otherwise requires, its consolidated subsidiaries.

 

Also, as used in this annual report:

 

  “dollar” or “$” means the lawful currency of the United States of America, and “yen” or “(Yen)” means the lawful currency of Japan.

 

  “U.S. GAAP” means generally accepted accounting principles in the United States.

 

  “ADS” means an America Depositary Share, each representing 1 share of our common stock, and “ADR” means an American Depositary Receipt evidencing ADSs.

 

  “fiscal 2004” and “fiscal year 2004” refer to our fiscal year ended December 31, 2004, and other fiscal years are referred to in a corresponding manner.

 

  In tables appearing in this annual report, figures may not add up to totals due to rounding.


A. Selected Financial Data.

 

You should read the following selected consolidated financial information together with the financial statements and notes to the statements which begin on page F-2 and are in response to Item 8 and Item 18. You should also read the Operating and Financial Review and Prospects included as Item 5.

 

The consolidated income statement information for the fiscal years ended December 31, 2002, 2003 and 2004, and the consolidated balance sheet information as of December 31, 2003 and 2004, are derived from and should be read together with our consolidated financial statements prepared in accordance with U.S. GAAP included elsewhere in this annual report.

 

The consolidated income statement information for the fiscal years ended December 31, 2000 and 2001, and the consolidated balance sheet information as of December 31, 2000, 2001 and 2002 are derived from our consolidated financial statements prepared in accordance with U.S. GAAP but are not included in this annual report.

 

    Year Ended December 31,

    2000

  2001

  2002

  2003

  2004

  2004

    (in millions of yen and thousands of dollars, except per share data)

Sales

  (Yen)20,070   (Yen)31,326   (Yen)42,980   (Yen)48,088   (Yen)62,049   $ 602,420

Cost of sales

  1,474   1,899   2,354   3,168   3,236     31,422
   
 
 
 
 
 

Gross profit

  18,596   29,427   40,626   44,920   58,813     570,998
   
 
 
 
 
 

Operating expenses:(1)

                         

Selling

  5,445   10,001   15,052   15,360   16,009     155,431

Research and development and maintenance

  2,044   2,755   3,506   3,919   4,858     47,168

Customer Support

  —     2,449   3,858   4,831   5,724     55,567

General and administrative

  5,304   4,453   4,344   5,656   6,144     59,651

Goodwill amortization

  276   —     —     —     —       —  

Goodwill write-off

  —     2,253   —     —     —       —  
   
 
 
 
 
 

Total operating expenses

  13,069   21,911   26,760   29,766   32,735     317,817
   
 
 
 
 
 

Operating income

  5,527   7,516   13,866   15,154   26,078     253,181

Other income (expense), net

  1,365   241   (768)   175   247     2,401

Net income before tax

  6,892   7,757   13,098   15,329   26,325     255,582

Income taxes

  3,123   3,241   5,395   6,103   10,503     101,973

Income before minority interest and equity in earnings (losses) of affiliated companies

  3,769   4,516   7,703   9,226   15,822     153,609

Minority interest in income of a consolidated subsidiary

  7   —     —     —     —       —  

Income from consolidated companies

  3,762   4,516   7,703   9,226   15,822     153,609

Equity in earnings (losses) of affiliated companies

  (87)   (130)   11   24   53     516

Net income

  (Yen)3,675   (Yen)4,386   (Yen)7,714   (Yen)9,250   (Yen)15,875   $ 154,125
   
 
 
 
 
 

Net income per share (basic)(2)

  (Yen)28.18   (Yen)33.33   (Yen)58.39   (Yen)70.11   (Yen)120.64   $ 1.17
   
 
 
 
 
 

 

- 1 -


     Year Ended December 31,

     2000

   2001

   2002

   2003

   2004

   2004

     (in millions of yen and thousands of dollars, except per share data)

Net income per share (diluted)(2)

   (Yen) 27.53    (Yen) 33.02    (Yen) 58.22    (Yen) 69.95    (Yen)118.59    $ 1.15
    
  
  
  
  
  

Cash dividends per share(2)

   (Yen) —      (Yen) —      (Yen) —      (Yen) —      (Yen) 14    $ 0.14
    
  
  
  
  
  

Weighted average common shares outstanding (basic)(2)

   130,388,962    131,594,913    132,111,467    131,940,179    131,588,738       

Weighted average common shares outstanding (diluted)(2)

   133,454,940    132,832,159    132,494,201    132,235,128    133,863,237       

 

(1) Effective from the year ended December 31, 2003, we started to report customer support expenses, previously included in general and administrative expenses, as a separate line item under “Operating expenses” and reclassified certain operating expenses such as overhead costs from general and administrative expenses to selling expenses. We have retroactively made corresponding changes in our income statements for the years ended December 31, 2001 and 2002. We have not made corresponding change in our income statement for the year ended December 31, 2000, because we do not have data from those years that form the basis for reclassifying the operating expense line items in the manner described above.

 

(2) We effected a one-to-two stock split on May18, 2001. The share and per share amounts for each of the two years ended December 31, 2000 and 2001 have been restated to reflect that stock split.

 

- 2 -


    Year Ended December 31,

    2000

  2001

  2002

  2003

  2004

  2004

    (in millions of yen and thousands of dollars, except per share data)

Consolidated Balance Sheet Information

                                   

Cash and cash equivalents

  (Yen) 24,436   (Yen) 40,783   (Yen) 47,830   (Yen) 46,719   (Yen) 52,908   $ 513,673

Total assets

    44,574     64,729     73,838     81,271     106,734     1,036,252

Current portion of long-term debt

    57     3,000     5,000     6,500     —       —  

Long-term debt

    9,800     11,500     6,500     —       —       —  

Total liabilities

    20,230     33,963     36,694     37,319     43,559     422,904

Common stock

    6,183     6,834     7,257     7,396     11,427     110,942

Shareholders’ equity

  (Yen) 24,344   (Yen) 30,766   (Yen) 37,144   (Yen) 43,952   (Yen) 63,175   $ 613,348

 

- 3 -


Exchange Rates.

 

In this annual report, we have translated Japanese yen amounts into U.S. dollars solely for the convenience of readers. Unless otherwise indicated, the rate we used for the translation was (Yen) 103. 00 per $1, which was the approximate rate on December 31, 2004. The following table shows the noon buying rates for Japanese yen expressed in Japanese yen per $1. On June 24, 2005 the noon buying rate announced by the Federal Reserve Bank of New York was (Yen) 109.22 per $1.

 

Year ended/ending December 31,    


   High

   Low

  

Average

(1)


  

Period-

end


2000

   114.62    101.70    108.37    114.35

2001

   131.47    114.26    122.18    131.04

2002

   134.77    115.71    124.81    118.75

2003

   121.42    106.93    115.99    107.13

2004

   114.30    102.56    108.15    102.68

2005 (through June 24)

   109.58    102.26    106.14    109.22

Calendar Year 2004

                   

December

   114.30    102.56    108.15    102.67

Calendar Year 2005

                   

January

   104.93    102.26    103.34    103.55

February

   105.84    103.70    104.94    104.25

March

   107.49    103.87    105.25    107.22

April

   108.67    104.64    107.19    104.64

May

   108.17    104.41    106.59    107.97

June (until June 24)

   109.58    106.64    108.44    109.22

(1) For annual averages, calculated based on the average of the exchange rates on the last day of each month during the period. For monthly averages, calculated based on the average of daily closing exchange rates.

 

- 4 -


D. Risk Factors.

 

The occurrence of any of the following risks could hurt our business, financial condition or results of operations. In such case, the trading price of our shares and the ADSs could decline and you could lose all or part of your investment. Other risks and uncertainties not now known to us or that we think are immaterial may also impair our business.

 

MAJOR SOFTWARE AND HARDWARE VENDORS MAY INCORPORATE ANTI-VIRUS PROTECTION IN THEIR PRODUCT OFFERINGS, WHICH COULD RENDER OUR PRODUCTS OBSOLETE OR UNMARKETABLE.

 

Major vendors of operating system software and other software such as firewall or e-mail software or computer hardware may decide to enhance or bundle their products with their other products to include anti-virus functions. These companies may offer anti-virus protection as a standard feature in their products, at minimal or no additional cost to customers. This could render our products obsolete or unmarketable, particularly if anti-virus products offered by these vendors were comparable or superior to our products. In addition, even if these vendors’ anti-virus products offered fewer functions than our products, or were less effective in detecting and cleaning virus-infected files, customers could still choose them over our products due to lower cost or for any other reasons.

 

In June 2003, Microsoft Corp., a major operating system vendor, announced that it acquired certain valuable intellectual property and technology assets from GeCAD Software Srl., an anti-virus software vendor in Romania. In February 2005, Microsoft Corp. also announced that it has signed contracts to acquire Sybari Software Inc., a leading provider of anti-virus and messaging security products in the United States. At this time, we do not know the intentions of Microsoft with regard to these transactions, but if antivirus functions were to be included in its operating system products, and/or, if Microsoft decides to sell antivirus products under their own brand, this could have a material adverse effect on our business, financial condition and results of operations.

 

- 5 -


BECAUSE WE GENERATE SUBSTANTIALLY ALL OF OUR SALES FROM A SINGLE PRODUCT LINE, WE ARE VULNERABLE TO DECREASED DEMAND FOR SUCH PRODUCTS.

 

Unlike software companies with diversified product lines, we derive substantially all of our net sales from licensing and selling anti-virus software products. Although we have begun to offer more comprehensive network and internet security and management software and services, we expect anti-virus products to continue to account for the largest portion of our net sales for the foreseeable future. If the demand for, or the prices of, anti-virus products drop as a result of competition, technological change or other factors such as lower growth or a contraction in the worldwide anti-virus software market, this could have a material adverse effect on our business, financial condition and results of operations.

 

DETERIORATION IN OUR RELATIONSHIP WITH SOFTBANK BB CORP. COULD RESULT IN A DECREASE IN SALES OF OUR PRODUCTS.

 

We depend on our relationship with SOFTBANK BB (formerly SOFTBANK COMMERCE CORP.), which has played an instrumental role in the development of our business in Japan. SOFTBANK BB also has close relationships with many resellers and systems integrators through which we sell our anti-virus software to corporate end users in Japan. An adverse change in our relationship with SOFTBANK BB would result in decreased sales to SOFTBANK BB and could disrupt our relationship with many resellers of our products. This could make it difficult for us to market our products in Japan. Sales to SOFTBANK BB totaled approximately (Yen)10.1 billion, or 23.6%, of our net sales in fiscal 2002, approximately (Yen)9.2 billion, or 19.1%, of our net sales in fiscal 2003 and approximately (Yen)10.4 billion ($101.0 million), or 16.8%, of our net sales in fiscal 2004. Because of our dependence on SOFTBANK BB, the price of shares and ADSs could fall as a result of adverse events affecting SOFTBANK BB, even if the events do not relate directly to us.

 

OUR PRODUCTS MAY BECOME OBSOLETE BECAUSE RAPID TECHNOLOGICAL CHANGE REGULARLY OCCURS IN THE ANTI-VIRUS SOFTWARE MARKET.

 

The anti-virus software market is characterized by:

 

  rapid technological change;

 

  the proliferation of new and changing computer viruses;

 

  frequent product introductions and updates; and

 

  changing customer needs.

 

These characteristics of our market create significant risks and uncertainties for our business success. For example, our competitors might introduce anti-virus products that are technologically superior to our products. Additionally, new software operating system, network system or anti-virus software industry standards could emerge. Emerging trends in these systems and standards currently include applications distributed over the Internet and the use of a Web browser to access client-server systems. Our existing products might be incompatible with some or all of such standards. Our business, financial condition and results of operations could materially suffer unless we are able to respond quickly and effectively to these developments.

 

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OUR HARDWARE-BASED PRODUCTS FACE MANUFACTURING AND INVENTORY RISKS.

 

We rely on a small number of third parties to manufacture some of our hardware-based products, such as the Trend Micro Network VirusWall described in Item 4.B. We expect our reliance on third-party manufacturers to become more important as the number of our hardware-based products increases. Reliance on third-party manufacturers involves a number of risks, including a lack of control over the manufacturing process and the potential absence or unavailability of adequate capacity. If any of our third-party manufacturers cannot or will not manufacture our products in required volumes in compliance with environmental and other regulations in the markets we serve, on a cost-effective basis, in a timely manner, or at all, we will have to secure additional manufacturing capacity. The unexpected loss of any of our manufacturers could disrupt our business. Furthermore, our hardware-based products contain critical components supplied by a single or a limited number of third parties. Any significant shortage of components or the failure of the third-party supplier to maintain or enhance these products could lead to cancellation of customer orders or delays in the placement of orders and adversely affect our financial condition and results of operation.

 

WE MAY NOT GENERATE EXPECTED RESULTS IN STRATEGIC ALLIANCES

 

Because we are mainly focusing our business on the field of anti-virus software and do not offer other security products such as firewalls, we actively pursue strategic alliances with other companies that allow us to provide customers with integrated or other new products and services derived from the alliances. In fiscal year 2004, we began to provide a third party URL filtering solution and have signed contracts with Cisco Systems to integrate network worm and virus outbreak-prevention services with Cisco’s products and services. To launch and provide such products and services, we may invest substantial cash and other resources in product developments, marketing promotions and support and maintenance activities. But we may not earn revenue successfully from alliances despite our efforts, and such alliance may be terminated or dissolved by various causes before generating revenue.

 

WE MAY NOT BE ABLE TO INCREASE OUR MARKET SHARE IN THE U.S. AND EUROPEAN MARKETS BECAUSE OUR COMPETITORS ARE MORE ESTABLISHED THAN WE ARE IN THESE MARKETS.

 

We believe that our share of the anti-virus software market in the U.S. and Europe is significantly small relative to the market shares of our principal competitors, despite the growth of our sales in these markets in fiscal 2003 and 2004. Because our competitors are already well-established in these key markets and have greater financial and other resources and market recognition, we may not be able to compete effectively for market share. If this happens, we may not be able to increase sales or our market share in these markets, which could materially hurt the prospects for growth in our business.

 

Some of our major competitors have the following important advantages over us in the U.S. and European markets:

 

  greater name recognition;

 

  more diversified product lines;

 

  larger customer bases; and

 

  significantly greater financial, technical, marketing and other resources.

 

As a result, as compared to us, our competitors may be able to:

 

  better withstand downturns in the anti-virus software market and in the computer software market in general;

 

  adapt more quickly to new or emerging technologies or changes in customer requirements; or

 

  more effectively and profitably market, sell and support their products.

 

- 7 -


WE MAY SUFFER A LOSS OF SALES AND MARKET SHARE IN OUR CORE JAPANESE MARKET IF OUR COMPETITORS ACHIEVE SUCCESS IN JAPAN.

 

Our major competitors, McAfee, Inc. and Symantec Corporation, are active in the Japanese anti-virus software market and have allocated significant resources to achieve success in the Japanese anti-virus software market. Although these competitors currently have smaller shares of the Japanese market than us, each has significantly greater financial, marketing and other resources than we do. Additionally, competition in our core Japanese market could intensify in the future if other competitors emerge. As a result of our competitors’ efforts, we may not be able to maintain our current leading market position in Japan in the future. Also, in order to respond effectively to increased competition, we may be required to devote more of our product development, marketing and other resources to the Japanese market, which could limit our ability to grow in other markets. A material loss of sales and market share in Japan as a result of our competitors’ success could have a material adverse effect on our business, financial condition and results of operations.

 

BECAUSE WE MAY ACQUIRE COMPANIES TO GROW OUR BUSINESS, FUTURE ACQUISITIONS MAY REDUCE OUR EARNINGS AND RESULT IN INCREASED COSTS IN OUR BUSINESS OPERATIONS.

 

In a rapidly changing industry, we occasionally review acquisition opportunities. Accordingly, we may seek to expand our business through acquisitions. Unlike some of our major competitors, we have limited experience in acquiring existing businesses. Future acquisitions could result in numerous risks and uncertainties, including:

 

  our inability to retain customers, suppliers and other important business relationships of an acquired business;

 

  difficulties in integrating an acquired company into Trend Micro, including the acquired company’s operations, personnel, products and information systems;

 

  diversion of our management’s attention from other business concerns; and

 

  adverse effects on our results of operations from acquisition-related charges, impairment of goodwill and purchased technology and possible recognition of impairment charge.

 

If we make such an acquisition using stock, our current shareholders’ ownership interests will be diluted. Any of these factors could materially hurt our business, financial condition and results of operations.

 

For example, in 2000, we acquired ipTrend to start a new business selling a Linux based remotely managed server appliance solution to small and medium sized companies. However, ipTrend performed poorly and was liquidated in December 2001. Due to the liquidation of ipTrend, (Yen)2.3 billion was booked as goodwill write-off in 2001.

 

- 8 -


IF HACKERS GAIN UNAUTHORIZED ACCESS TO OUR SYSTEMS, WE COULD SUFFER DISRUPTIONS IN OUR BUSINESS AND LONG-TERM DAMAGE TO OUR REPUTATION.

 

We may be more susceptible to problems caused by hackers than other software companies. As an anti-virus software company that delivers virus protection products over the Internet, hackers specifically target us in order to cause us to transmit computer viruses or interrupt the delivery of our anti-virus software monitoring and security services over the Internet which could result in further interruptions. We could suffer substantial disruptions in our business and material damage to our reputation which could in turn result in a significant loss of our customers and other important business relationships. We could also incur costs for public relations efforts following attacks by hackers. Hacker activities could also force us to incur substantial costs to fix technical problems or result in hackers gaining access to our proprietary information.

 

WE MUST EFFECTIVELY MANAGE OUR GROWTH.

 

Our business has grown rapidly. This growth has placed, and any future growth would continue to place, a significant strain on our limited personnel, management and other resources. Our ability to manage any future growth in our business will require us to:

 

  attract, train, retain, motivate and manage new employees successfully;

 

  effectively integrate new employees into our operations; and

 

  continue to improve our operational, financial, management and information systems and controls.

 

If we continue to grow, our management systems currently in place may be inadequate or we may not be able to effectively manage our growth. In particular, we may be unable to:

 

  provide effective customer service;

 

  develop and deliver products in a timely manner;

 

  implement effective financial reporting and control systems; and

 

  exploit new market opportunities and effectively respond to competitive pressures.

 

- 9 -


WE SELL OUR PRODUCTS THROUGH INTERMEDIARIES WHO MAY NOT VIGOROUSLY MARKET OUR PRODUCTS, OR MAY RETURN OUR PRODUCTS.

 

We market substantially all of our products to end users through intermediaries, including distributors, resellers and value-added resellers. Our distributors sell other products that are complementary to, or compete with, our products. While we encourage our distributors to focus on our products, these distributors may give greater priority to products of other suppliers, including competitors’. They may also return the products to us under certain circumstances.

 

OUR CUSTOMERS MAY CANCEL OR DELAY THEIR PURCHASES OF OUR PRODUCTS, WHICH COULD ADVERSELY AFFECT OUR BUSINESS.

 

Our products may be considered to be capital purchases by certain enterprise customers. Capital purchases are often uncertain and, therefore, are canceled or delayed if the customer experiences a downturn in its business prospects or as a result of unfavorable economic conditions. Any cancellation or delay could adversely affect our results of operations.

 

WEAK FINANCIAL CONDITIONS OF SOME OF OUR DISTRIBUTORS MAY ADVERSELY AFFECT OUR OPERATING RESULTS.

 

Some of our distributors are experiencing financial difficulties worldwide, which may adversely impact our collection of accounts receivable. We regularly review the collectibility and creditworthiness of our distributors to determine an appropriate allowance for doubtful receivables. Our uncollectible accounts could exceed our current or future allowance for doubtful receivables, which would adversely impact our operating results.

 

- 10 -


OUR RESULTS OF OPERATIONS MAY SUFFER IF WE ARE REQUIRED TO PAY SIGNIFICANT AMOUNTS OF PENALTY PAYMENTS PURSUANT TO THE TERMS OF OUR SERVICE LEVEL AGREEMENTS.

 

We guarantee a certain quality of product support to our customers through our service level agreements. Pursuant to the terms of these agreements, under some circumstances, we are required to make penalty payments to our customers. For example, if we fail to provide our customers a virus pattern file within two hours of our receipt of a virus from the customer, the terms of the agreement require us to make a penalty payment to the dissatisfied customer which may amount up to 100% of the initial sale price. We have established reserves based on our assumptions and estimates. However, our assumptions and estimates may be wrong and our actual total penalty payments could materially exceed our reserves and adversely affect our results of operations and financial condition.

 

WE RELY HEAVILY ON OUR MANAGEMENT AND TECHNICAL PERSONNEL, WHO MAY NOT REMAIN WITH US IN THE FUTURE.

 

We rely, and will continue to rely, on a number of key technical and management employees, including our Chief Executive Officer, Eva Yi-Fen Chen. While we require our employees to sign employment agreements, our employees are generally not otherwise subject to noncompetition covenants. If any of our key employees leave, our business, results of operations and financial condition could suffer.

 

FLUCTUATIONS IN OUR QUARTERLY FINANCIAL RESULTS COULD CAUSE THE MARKET PRICE FOR OUR SHARES AND OUR ADSs TO BE VOLATILE.

 

We believe that our quarterly financial results may fluctuate in ways that do not reflect the long-term trend of our future financial performance. It is likely that in some future quarterly periods, our operating results may be below the expectations of public market analysts and investors. In this event, the price of our shares and our ADSs could fall.

 

Factors which could cause our quarterly financial results to fluctuate include:

 

  timing of sales of our products and services due to customers’ budgetary constraints, seasonal buying patterns and our promotional activities;

 

  new product introductions by our competitors;

 

  significant marketing campaigns, research and development efforts, employee hirings, and other capital expenditures by us to drive the growth of our business;

 

  changes in customer needs for anti-virus software; and

 

  changes in economic conditions in our major markets.

 

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WEAKNESS IN THE JAPANESE ECONOMY MAY HURT OUR BUSINESS PERFORMANCE BECAUSE JAPAN IS OUR LARGEST MARKET.

 

While our sales in the U.S. and Europe have increased in recent years, we remain significantly dependent on the Japanese market. Net sales in Japan accounted for approximately 43% of our net sales in fiscal 2002, approximately 42% in fiscal 2003 and approximately 41% in fiscal 2004. In the past three years, the Japanese economy has performed poorly due to a number of factors, including weak consumer spending and lower capital investment by Japanese companies. We believe the sluggish Japanese economy has hindered growth in our net sales during the last three years. Because of our dependence on the Japanese market, any further deterioration in the condition of the Japanese economy could negatively impact our net sales.

 

FOREIGN EXCHANGE FLUCTUATIONS COULD LOWER OUR RESULTS OF OPERATIONS BECAUSE WE EARN REVENUES DENOMINATED IN SEVERAL DIFFERENT CURRENCIES.

 

Our reporting currency is the Japanese yen and the functional currency of each of our subsidiaries is the currency of the country in which the subsidiary is domiciled. However, a significant portion of our revenues and operating expenses is denominated in currencies other than the Japanese yen, primarily the U.S. dollar, euro and the New Taiwan dollar. As a result, appreciation or depreciation in the value of other currencies as compared to the Japanese yen could result in material transaction or translation gains or losses which could reduce our operating results. These negative effects from currency fluctuations could become more significant if we are successful in increasing our sales in markets outside of Japan. We do not currently engage in currency hedging activities.

 

BECAUSE OUR BUSINESS DEPENDS SIGNIFICANTLY ON INTELLECTUAL PROPERTY, INFRINGEMENT OF OUR INTELLECTUAL PROPERTY COULD HURT OUR BUSINESS.

 

Our success depends upon the development of proprietary software technology. We rely on a combination of contractual rights and patent, copyright, trademark and trade secret laws to establish and protect proprietary rights in our software. If we are unable to establish and protect these rights, our competitors may be able to use our intellectual property to compete against us. This could limit our growth and hurt our business. At present, our U.S. consolidated subsidiary holds seven issued U.S. patents and our Taiwan consolidated subsidiary holds four issued U.S. patents. It is possible that no additional patents will be issued to us or any of our subsidiaries. In addition, our issued patents may not prevent other companies from competing with us. We also enter into confidentiality agreements with our employees and license agreements with our customers, and limit access to our proprietary information and its distribution. However, we cannot guarantee that any of these measures will discourage others from misappropriating our technology or independently developing similar technology.

 

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PRODUCT LIABILITY CLAIMS ASSERTED AGAINST US IN THE FUTURE COULD HURT OUR BUSINESS.

 

Our products are designed to protect customers’ network systems and personal computers from damage caused by computer viruses. As a result, if a customer suffers damage from viruses, the customer could sue us on product liability or related grounds, claim damages for data loss or make other claims. Additionally, as viruses are constantly evolving, purchasers of our software products must regularly update the software they have purchased from us with virus protection files that we make available for download from our website. Should we fail to properly test these virus protection files and distribute a defective file, these files could cause damage to the personal computers of our customers who have downloaded a defective file. For example, a file that we distributed on April 23, 2005 for an approximately 90 minute period caused the computers of those updating with the file to slow and, in some cases, shut down. Cases of our files damaging the computers or our customers could lead to significant damage to our reputation and customers could sue on product liability or related grounds. Furthermore, starting in 2001, we began selling hardware devices which could give rise to a higher incidence of product liability claims than we have up until now experienced. Our license agreements typically contain provisions, such as disclaimers of warranty and limitations of liability, which seek to limit our exposure to certain types of product liability claims. However, in some jurisdictions these provisions may not be enforceable on statutory, public policy or other grounds. We currently do not carry product liability insurance covering claims arising in the U.S. Damage to our reputation or successful product liability or related claims brought against us could materially harm our business.

 

OUR BUSINESS FACES THE RISK OF INTERRUPTION FROM POWER SHORTAGES, EARTHQUAKES, OUTBREAK OF BIOLOGICAL VIRUSES AND OTHER HAZARDS.

 

We face a number of potential business interruption risks that are beyond our control. The State of California experienced intermittent power shortages in 2000, sharp increases in the cost of energy and even interruptions of service to some business customers. If power shortages continue to be a problem, our business may be materially adversely affected. Additionally, we may experience natural disasters that could interrupt our business.

 

Tokyo, where our corporate headquarter is located, is near a major earthquake fault. The impact of a major earthquake on our facilities, infrastructure and overall operations is not known. There is no guarantee that an earthquake would not seriously disturb our entire business operations. We are largely uninsured for losses and business disruptions caused by an earthquake and other natural disasters.

 

In addition, many of the key countries and regions in which we operate have sustained negative economic impact from events such as the continued fear of future terrorist attacks and the outbreak of severe acute respiratory syndrome, or SARS. Prolonged continuation of these adverse factors may hurt our results of operations and financial condition.

 

WE MAY HAVE TO CONSTRAIN OUR BUSINESS ACTIVITIES TO AVOID BEING DEEMED AN INVESTMENT COMPANY UNDER THE U.S. INVESTMENT COMPANY ACT OF 1940.

 

In general, a company which is or holds itself out as being engaged primarily in the business of investing, reinvesting or trading in securities, may be deemed to be an investment company under the U.S. Investment Company Act of 1940. We do not believe that we are an investment company as defined under the U.S. Investment Company Act of 1940. However, if we were to be deemed an investment company, we would be prohibited from issuing our securities in the United States and may have to terminate our U.S. listing or other sponsorship promoting a U.S. trading market for our issued securities. In order to avoid these prohibitions, we may be forced to forego otherwise attractive business opportunities, potentially limiting our growth and our profitability.

 

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BECAUSE OF THE INFLUENCE OF OUR PRINCIPAL SHAREHOLDERS, OUR OTHER SHAREHOLDERS MAY BE UNABLE TO INFLUENCE OUR BUSINESS.

 

Our principal shareholders, including major shareholders who beneficially own more than 5% of the issued shares of our common stock and directors, beneficially owned approximately 43.1% of our outstanding shares as of December 31, 2004. These shareholders, if they act together, would be able to significantly influence all matters requiring approval by our shareholders, including the election of directors and the approval of mergers or other business combination transactions. Our principal shareholders may have strategic or other interests that conflict with the interests of our other shareholders. As a result, the concentration in our shareholdings may have the effect of delaying or preventing a change in control of Trend Micro, which could result in the loss of a significant financial gain to our shareholders.

 

OUR STOCK PRICE IS VOLATILE, AND INVESTORS BUYING THE SHARES OR ADSs MAY NOT BE ABLE TO RESELL THEM AT OR ABOVE THEIR PURCHASE PRICE.

 

Shares of our common stock are traded on the Tokyo Stock Exchange, which is the principal market for our shares. Recently, the U.S. and Japanese securities markets have experienced significant price and volume fluctuations. The market prices of securities of high-tech companies, and internet companies in particular, have been especially volatile. Since trading in our shares commenced on the Tokyo Stock Exchange on August 17, 2000, our stock price has fluctuated between a low of (Yen)1,440 and a high of (Yen)9,005. Since trading in our ADSs commenced on the Nasdaq National Market on July 8, 1999, the price of our ADSs has fluctuated between a low of $12.16 and a high of $159.38. The closing price on the Tokyo Stock Exchange for our stock on May 27, 2005 was (Yen)3,520, and the closing price on the Nasdaq National Market for our ADSs on May 27, 2005 was $32.45 per ADS. The market price of our shares and ADSs is likely to fluctuate in the future.

 

BECAUSE OF DAILY PRICE RANGE LIMITATIONS UNDER JAPANESE STOCK EXCHANGE RULES, YOU MAY NOT BE ABLE TO SELL YOUR SHARES OF OUR COMMON STOCK AT A PARTICULAR PRICE ON ANY PARTICULAR TRADING DAY, OR AT ALL.

 

Stock prices on Japanese stock exchanges are determined on a real-time basis by the equilibrium between bids and offers. These exchanges are order-driven markets without specialists or market makers to guide price formation. To prevent excessive volatility, these exchange set daily upward and downward price fluctuation limits for each stock, based on the previous day’s closing price. Although transactions may continue at the upward or downward limit price if the limit price is reached on a particular trading day, no transactions may take place outside these limits. Consequently, an investor wishing to sell at a price above or below the relevant daily limit may not be able to sell his or her shares at such price on a particular trading day, or at all.

 

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THE RIGHTS OF SMALL SHAREHOLDERS ARE LIMITED UNDER THE JAPANESE UNIT SHARE SYSTEM.

 

Our Articles of Incorporation provide that 500 shares of our common stock constitute one “unit.” The Japanese Commercial Code restricts the rights of shares that do not constitute whole units. Holders of shares constituting less than one unit do not have the right to vote. Each ADS offered in the offering represents the right to receive one share. A holder who owns less than 500 ADSs will indirectly own less than a whole unit. Under the deposit agreement governing the rights of ADS holders, in order to withdraw any shares, an ADS holder must surrender ADRs evidencing 500 ADSs or a multiple of 500 ADSs. Each ADR will bear a legend to that effect. Under the unit share system, holders of less than a unit have the right to require us to purchase their shares. Holders of ADSs that represent other than multiples of whole units cannot withdraw the underlying shares representing less than one unit. They will, therefore, be unable, as a practical matter, to:

 

  exercise the right to require us to purchase the underlying shares, or

 

  receive cash settlement in lieu of withdrawal.

 

As result, as a holder of ADSs, you will not be able to access the Japanese markets through the withdrawal mechanism to sell shares in lots of less than one unit.

 

AS A HOLDER OF ADSs, YOU WILL HAVE FEWER RIGHTS THAN A SHAREHOLDER HAS AND YOU WILL HAVE TO ACT THROUGH THE DEPOSITARY TO EXERCISE THOSE RIGHTS.

 

The rights of shareholders under Japanese law to take actions, including voting their shares, receiving dividends and distributions, bringing derivative actions, examining our accounting books and records and exercising appraisal rights are available only to holders of record. Because the depositary, through its custodian agents, is the record holder of the shares underlying the ADSs, only the depositary can exercise those rights in connection with the deposited shares. The depositary will make efforts to vote the shares underlying your ADSs as instructed by you and will pay you the dividends and distributions collected from us. However, in your capacity as an ADS holder, you will not be able to bring a derivative action, examine the accounting books and our records or exercise appraisal rights through the depositary.

 

RIGHTS OF SHAREHOLDERS UNDER JAPANESE LAW MAY BE MORE LIMITED THAN UNDER THE LAW OF OTHER JURISDICTIONS.

 

Our Articles of Incorporation, our Board of Directors’ regulations and the Japanese Commercial Code govern our corporate affairs. Legal principles relating to such matters as the validity of corporate procedures, directors’ and officers’ fiduciary duties and shareholders’ rights may be different from those that would apply if we were a non-Japanese company. For example, under the Japanese Commercial Code, only holders of 3% or more of the issued and outstanding shares are entitled to examine our accounting books and records. Shareholders’ rights under Japanese law may not be as extensive as shareholders’ rights under the laws of other countries. You may have more difficulty in asserting your rights as a shareholder than you would as a shareholder of a corporation organized in another jurisdiction. In addition, Japanese courts may not be willing to enforce liabilities against us in actions brought in Japan which are based upon the securities laws of the United States or any U.S. state.

 

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Item 4. Information on the Company.

 

A. History and Development of the Company.

 

We develop, market and support antivirus and Internet content security software and services. Our legal name in Japan is Trend Micro Kabushiki Kaisha and Trend Micro Incorporated in the U.S. Our commercial name in both Japan and the U.S. is Trend Micro. Founded in 1988 by Steve Chang, we led the migration of virus protection from the desktop to the network server and the Internet gateway. Today, through Trend Micro Enterprise Protection Strategy, we focus on providing customers with an approach to managing the impact of mixed threats such as the NIMDA and Code Red viruses.

 

We were established in 1989 as a Taiwanese company. Through a series of transactions in August 1996, Trend Micro Kabushiki Kaisha (a joint stock corporation) which was established in October 1988, became the parent company of the Trend Micro group.

 

Our head office is located at Shinjuku MAYNDS Tower, 1-1, Yoyogi 2-Chome, Shibuya-ku, Tokyo 151-0053, Japan. Our telephone number is 81-3-5334-3600. Our North American headquarter is in Cupertino, California, U.S.A. and we have business units worldwide. Our agent for service of process in the United States is Eva Chen, Director, c/o Trend Micro Inc., 10101 N. De Anza Blvd., Cupertino, California 95014.

 

We began commercial operations in May 1989, shortly after computer viruses were first detected, and we completed our initial public offering on the Japanese over-the-counter market in August 1998. We listed American Depositary Shares on the Nasdaq National Market in July 1999 in connection with a global offering of 12,750,000 shares in the form of shares and ADRs. In August 2000 we listed on the first section of Tokyo Stock Exchange.

 

We currently have more than 2,600 employees and are represented more than 30 countries.

 

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B. Business Overview.

 

INDUSTRY BACKGROUND

 

A computer virus is a program—a piece of executable code—that has the unique ability to replicate. Like biological viruses, computer viruses can spread quickly and are often difficult to eradicate. With e mail now used as an essential business communication tool, viruses are spreading faster than ever. Viruses attached to email messages can infect an entire enterprise in a matter of minutes, which may cost companies millions of dollars annually in lost productivity and clean-up expenses. Mixed-threat attacks like NIMDA, threaten computer systems at multiple levels.

 

In response to the virus threat, the antivirus software market has grown significantly in the past few years and is expected to continue to grow in the future. According to International Data Corporation, an independent research organization, in 2003, worldwide revenue for antivirus software reached $2.6 billion, representing a 21% growth over 2002 revenue and estimates that this market will increase at a 12.5% compound annual growth rate and reach $4.8 billion by 2008.

 

Our vision is to create “A world safe for exchanging digital information”. We offer solutions to prevent the invasion of viruses and other malicious content into corporate networks, small and medium business networks and individual PCs.

 

Network systems including the Internet are an integral part of corporate activities and life at home. However, the methods viruses use to access computers have become more elaborate and malicious, causing serious problems for users. Furthermore, problems are arising where spyware, spam and inappropriate Web use diminish the functionality and efficiency of network and Internet use.

 

Against this backdrop, the needs of corporate networks and individual users for security vendors have expanded and intensified. Our role extends beyond merely developing and selling security products. We also provide services to offer a more effective security solution. Through this business model, we are contributing to the development of a digital society around the world.

 

Our products and services have evolved with the development of the antivirus software market. Initially, our sales of antivirus software products consisted primarily of sales of our desktop programs, such as PC-cillin/Virus Buster, which were introduced in Japan in 1991. To meet increased demand for network-based products as companies shifted from stand-alone desktop personal computers to client-server enterprise networks in the early 1990s, we introduced LANprotect, our first server application, in 1993. To address the increased risk of virus infection for enterprise networks resulting from widespread use of the Internet, we introduced InterScan VirusWall in 1996 to provide real-time scanning at the Internet gateway, the point where data enters the network from the Internet. In 1998 we introduced Trend Virus Control System, the forerunner of Trend Micro Control Manager (described below) to enable network-wide antivirus software to monitor, update and manage from a central management console. Since 1998 we have continued to develop our Internet security solutions, and in 2002 we unveiled Trend Micro Enterprise Protection Strategy, which is described below.

 

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Trend Micro Enterprise Protection Strategy

 

Trend Micro Enterprise Protection Strategy, our threat and outbreak management strategy to prevent computer viruses, is implemented using centralized management of an integrated security suite and outbreak prevention appliance. This solution is supported by real-time, threat-specific knowledge from TrendLabs, Trend Micro’s global network of security experts.

 

We help enable IT managers to proactively manage the outbreak lifecycle. This lifecycle consists of four phases—vulnerability prevention, outbreak prevention, virus response and assessment and restoration.

 

Vulnerability Prevention

 

In this phase, vulnerability assessment tools help enforce security policies, block noncompliant devices from network access and isolate specific threat-related vulnerabilities to pre-empt attacks. Trend Micro Vulnerability Assessment is a key product component of this phase. Centrally managed by Trend Micro Control Manager, a centralized outbreak management console, Vulnerability Assessment integrates with other Trend Micro products and services to identify vulnerabilities in the network. Vulnerability Assessment determines risk ratings to alert IT managers of specific viruses correlated with system vulnerabilities and identifies patches needed to prevent exploits. Leveraging data from Vulnerability Assessment, Trend Micro Network VirusWall (described below) assists IT managers to selectively perform the following actions:

 

  Isolate unpatched machines for Microsoft operating system vulnerabilities before or at the onset of an outbreak.

 

  Quarantine infected LAN segments to stop virus propagation.

 

  Check devices for the latest pattern files, scan engine, and antivirus software from major antivirus vendors, to control network access of noncompliant machines.

 

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Outbreak Prevention

 

The outbreak prevention phase is the critical period when a threat has been identified, but a pattern file or patch has not yet been deployed. Without sufficient information, IT managers struggle to not only identify protective actions but also to deploy them effectively across the organization. Trend Micro Outbreak Prevention Services include outbreak prevention policies, which are strategic recommendations to manage the various methods in attacking the virus and to assist IT managers in deflecting, isolating, and stopping virus outbreaks. Through Trend Micro Control Manager, outbreak prevention policies can be deployed manually or automatically to block any combination of file extensions, executables, IP addresses, ports, instant message channels, and file transfer protocols. IT managers can use outbreak prevention policies to perform the following actions:

 

  Keep viruses from propagating and impeding network traffic;

 

  Automatically activate Trend Micro Damage Cleanup Services (described below) to ease administrative burden; and

 

  Generate detailed reports for threat analyses.

 

Virus Response

 

The virus response phase of the outbreak lifecycle occurs during the deployment of a pattern file, network signature, or patch. This reactive phase is the single focus of most antivirus products. In contrast, Trend Micro Control Manager coordinates virus response with outbreak prevention policies to enable proactive outbreak lifecycle management from a central console. Our scanning engines provide IT managers with the following benefits:

 

  Comprehensive protection with virus scanning and detection at both the network layer and the application layer;

 

  Increased accuracy, scanning performance and virus detection with scanning engines that search for viruses based on the identified threat; and

 

  A guarantee (Trend Micro Service Level Agreement) that new virus pattern files will be delivered within two hours of virus case submission or Trend Micro will pay a certain penalty fee depending on the terms of the agreement entered into with the customer.

 

Assessment and Restoration

 

The assessment and restoration phase of the outbreak management lifecycle is the period after a pattern file, network signature, or patch is deployed and the virus has been contained. Cleaning the network of virus remnants and restoring systems is tedious and costly because most organizations perform these tasks manually. In contrast, Trend Micro Damage Cleanup Services automate clean-up and restoration to mitigate administrative cost and burden. Centrally managed through Trend Micro Control Manager, Damage Cleanup Services feature agent-less remote deployment, allowing IT managers to assess, clean, and restore infected PCs and servers located in remote locations without end-user intervention. Damage Cleanup Services are designed to result in cost-effective clean-up by helping IT managers do the following:

 

  Prevent re-infection by removing memory resident worms and Trojans (a type of virus that can conceal itself) and their effects, such as unwanted registry entries and viral files;

 

  Reduce administrative burden via coordination with outbreak prevention policies; and

 

  Perform consistent clean up aided by detailed reports from Trend Micro Control Manager.

 

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Distribution of a Defective Virus Pattern File in April 2005

 

On April 23, Trend Micro published pattern file 2.594.00 with the intent to protect customers from a new type of BOT virus that could cause an infected PC to become a launching point for spam. Given the number of variants of this threat and what they are designed to do, we believe they have the potential to cause great damage to users and puts at risk the safety and integrity of the networks through which they might spread. Unfortunately, pattern file 2.594.00, which employed a new, generic unpacking and heuristic script technology designed to detect and eliminate these new types of BOT viruses and their variants, generated some performance conflict with computers running on Microsoft Windows XP and certain other operating systems. As a result, this caused the impacted machines to experience high CPU consumption and subsequent system instability.

 

For any customers experiencing instability, Trend Micro has provided a set of solutions which can be found under the Support section of Trend Micro’s website. Additionally, Trend Micro has extended support hours especially to help those customers who had this special intersection of circumstances and were affected by this issue. Trend Micro continued testing in order to fully understand initial assessments and fix the issue. We found that the pattern file caused performance issues on systems with Scan Engine 7.5 and above while scanning a particular type of executable file found in certain versions of operating system service packs. Owing to a large number of variants discovered by our researchers of a particular BOT threat (each of which used a different compression algorithm), Trend Micro enhanced the decompression ability of its pattern file with a view to prevent further variants of this BOT from infecting customers. However, within pattern file 2.594.00, TrendLabs included support for 3 additional heuristic patterns, including UltraProtect decompression support, which is used by several WORM_RBOT variants. Due to an isolated anomaly in the engineering, development and pattern release process, the UltraProtect decompression may in certain circumstances cause some systems to experience high CPU power consumption, which can lead to system instability when this specific file type is scanned using pattern file 2.594.00.

 

Through its analysis, Trend Micro has determined that while pattern file 2.594.00 was designed to prevent several new variants of a fairly new type of BOT threat from infecting its customers, the issues with pattern file 2.594.00 were caused by how the testing was conducted for this type of solution. Therefore, we are taking the following steps to ensure that future instances of this issue do not occur.

 

  We have invested in additional resources to immediately improve our development, review, testing and monitoring processes to ensure efficient execution of Trend Micro virus pattern signatures.

 

  We are developing an automated method within the tool used to create virus pattern signatures. This automation would help to determine the potential for possible future instances of high CPU utilization caused by our pattern files.

 

  We are enhancing the Scan Engine to include a self-monitoring mechanism.

 

We are increasing the scope and support of our testing coverage and of our processes to prevent reoccurrence of such issues.

 

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Trend Micro Products and Services

 

Our products and services are designed to deliver coordinated protection at the file, application, data, and network layers to proactively manage the outbreak lifecycle. Our solutions, described in more detail below, operate across a range of computer operating system platforms, including Windows Server 2003, Windows NT, Windows 98/XP/2000, Linux, Sun Solaris and several versions of UNIX. Our products protect all entry points in the network.

 

Management Product

 

Trend Micro Control Manager is a centralized outbreak management console designed to simplify enterprise-wide coordination of outbreak security actions and management of Trend Micro products and services. Trend Micro Control Manager acts as a central command center for deployment of Trend Micro’s threat-specific expertise across the network and to select third-party products to proactively manage outbreaks. Designed to deliver the flexibility and scalability organizations need, Trend Micro Control Manager offers a multi-tier management structure with customization options for expanded control. Robust graphical reporting provides vital security insights, such as sources of infections or vulnerabilities and consolidated, detailed information regarding virus events or unusual activities.

 

Network Product

 

Trend Micro Network VirusWall is an outbreak prevention appliance that assists organizations in stopping network viruses such as MSBLAST and NETSKY. It also blocks high threat vulnerabilities during outbreaks and quarantines and cleans infection sources including unprotected devices as they enter the network. Trend Micro Network VirusWall does not only monitor threats or provide threat information but also helps organizations take precise outbreak security actions and proactively detects, prevents, contain and eliminates outbreaks. By deploying Trend Micro Network VirusWall in network LAN segments, organizations can significantly reduce their security risk, network downtime and outbreak management burden. Trend Micro Network VirusWall supports the Trend Micro Enterprise Protection Strategy and is managed by Trend Micro Control Manager.

 

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Internet Gateway Products

 

Trend Micro Spam Prevention Solution is a high-performance anti-spam application that blocks non-productive and malicious spam at the Internet gateway. It employs patent-pending, heuristic technology that can evaluate, identify and monitor existing and new messages using multiple spam email characteristics, providing highly accurate spam capture rates with very low false positives. Flexible configuration options allow administrators to set different spam-catching sensitivities for various spam categories and can delete suspected spam immediately to help alleviate congestion on downstream servers. An easy-to-use configuration menu, designed to hide the complexity of the underlying Anti-Spam Engine technology, helps enable administrators to implement updates without changing the existing rules structure. The Anti-Spam Engine technology is integrated within Trend Micro InterScan Messaging Security Suite, which provides antivirus and content security offerings. Spam Prevention Solution runs seamlessly with third-party Message Transfer Agents and mail servers. Trend Micro Spam Prevention Solution sits at the gateway, analyzing messages while in-transit, to address the performance and scalability requirements of the global enterprise.

 

Trend Micro InterScan Messaging Security Suite is an extensible messaging security platform for the gateway that addresses mixed-threat attacks by delivering coordinated policies for antivirus, anti-spam, and content security. Trend Micro InterScan Messaging Security Suite helps IT managers minimize time-consuming installation and configuration for multiple messaging security solutions. Its extensible, platform approach to messaging security provides enhanced protection from multi-vector attacks which simultaneously deploy aggressive tactics to infiltrate network defenses. Deployed with Trend Micro Control Manager, it provides enterprise-wide visibility of the messaging security platform, allowing centralized reporting and configuration, pattern file and scan engine updates, and management of Trend Micro Outbreak Prevention Services—all accessible via remote administration.

 

InterScan Web Security Suite is designed to deliver high-performance, scalable Web security at the gateway for both HTTP (Hyper-text Transfer Protocol) and FTP (File Transfer Protocol) traffic. Specifically designed to improve the Web user experience, InterScan Web Security Suite addresses the performance decline associated with the natural latency introduced by virus scanning. InterScan Web Security Suite can support both standalone and Internet Content Adaptation Protocol scanning, offering flexible Web security for the enterprise. Designed for alternative configurations and future applications, this new architecture coupled with the Trend Micro Enterprise Protection Strategy, extends the benefits of outbreak lifecycle management to Web-based traffic, resulting in a lower cost and longer-term investment.

 

InterScan VirusWall provides high-performance, comprehensive Internet gateway protection against viruses and malicious codes. The optional eManager plug-in offers administrators additional tools for spam blocking, content filtering, and email scheduling.

 

InterScan eManager provides real-time content filtering, spam blocking, and reporting to help companies monitor and control the type of information that enters or leaves the network. The optional eManager plug-in integrates seamlessly with InterScan VirusWall to safeguard intellectual property and confidential information, block inappropriate email and attachments, and protect against viruses. InterScan eManager also enables Trend Micro Outbreak Prevention Services to provide proactive protection against virus outbreaks by deploying attack-specific policies to contain the outbreak.

 

InterScan AppletTrap protects against known and unknown malicious programs written in ActiveX, JavaScript, and VBScript codes at the Internet gateway. AppletTrap features patented technologies including Java instrumentation to monitor applet behavior in real time. Its patented, multi-tiered process safeguards enterprise computing environments through analysis and verification of digital certificates, filtering for known malicious code, and monitoring the behavior of unsigned code at the client browser to help protect against unknown malicious applets. A centrally managed policy-based management tool, AppletTrap requires no client deployment and is transparent to end users.

 

Trend Micro InterScan VirusWall for Small and Medium Business, a comprehensive gateway antivirus, anti-spam and content filtering solution, protects against malicious threats at the gateway before they reach the interior of your network. Designed for growing companies, it filters Internet email and Web traffic to ensure that email and Web contents are free of viruses and spam. InterScan VirusWall for Small and Medium Business features a single point of management with an intuitive interface that facilitates administration and lowers the total lifetime cost of your security strategy. InterScan VirusWall for Small and Medium Business provides a high degree of protection at the gateway, featuring in-depth scans of SMTP (Simple Mail Transfer Protocol), HTTP, and FTP streams. Furthermore, it also checks POP3 (Post Office Protocol 3) traffic helping to ensure that networks are protected even when employees access their Internet email accounts. Integrated anti-spam and email content filtering also help maintain productivity and ensure the appropriate use of Internet resources.

 

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Email and Groupware Products

 

ScanMail for Microsoft Exchange provides real-time detection and removal of viruses from email and attachments before they reach the desktop. It is easy to deploy and configure via either a Web or Windows-based management console. Coupled with the ScanMail eManager plug-in, it provides comprehensive content filtering to help block non-business email and filter inappropriate content in emails and attachments. ScanMail is fully integrated with the latest Microsoft APIs and supports Microsoft Exchange 5.5, Microsoft Exchange 2000, and Exchange 2003 servers.

 

ScanMail eManager provides real-time content filtering, spam blocking, and reporting to help companies monitor and control the type of information that enters or leaves the network. The optional eManager plug-in integrates seamlessly with ScanMail for Microsoft Exchange and ScanMail for Lotus Notes to safeguard intellectual property and confidential information, block inappropriate email and attachments, and protect against viruses. eManager also enables Trend Micro Outbreak Prevention Services to provide proactive protection against virus outbreaks by deploying attack-specific policies to contain the outbreak.

 

ScanMail for Lotus Domino offers comprehensive virus protection and content security for the Lotus Domino environment. It scans viruses hidden in databases and email attachments, and it also protects collaboration tools such as Lotus Sametime and Quickplace. ScanMail is designed to operate as a native Domino server application and provides administrators with a familiar, intuitive interface. It supports Microsoft Windows 2000, Sun Solaris, IBM AIX, S/390, AS/400, Red Hat Linux, and SuSE.

 

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File Server and Storage Products

 

Trend Micro ServerProtect provides antivirus scanning for servers or storage appliances. It detects and removes viruses from files and compressed files in real time before they reach the end user. Administrators can use a Windows-based console for centralized management of virus outbreaks, virus scanning, virus pattern file updates, notifications, and remote installation. ServerProtect supports Microsoft Windows Server 2003, Microsoft Windows 2000, Microsoft Windows NT 4, Linux, Novell NetWare servers, Network Appliance filers, and EMC celerra.

 

Trend Micro PortalProtect provides comprehensive virus protection and content security for enterprise information portal (EIP) systems and their users. Designed for specific use with EIP systems built using Microsoft SharePoint Portal Server, PortalProtect offers integration with the Microsoft Virus Scanning API and other Microsoft technologies.

 

Desktop Products

 

OfficeScan Corporate Edition provides comprehensive virus protection for desktop and mobile clients. OfficeScan offers centralized management features, which allow administrators to fully manage and enforce antivirus policies across the entire organization. Designed to provide reliable and transparent virus scanning and virus removal, OfficeScan incorporates robust damage cleanup services that help remove malicious codes and repair system damages.

 

Trend Micro PC-cillin Internet Security provides comprehensive and easy-to-use protection from viruses, hackers, and other Internet-based threats. Its new advanced features go far beyond standard antivirus and firewall protection, helping to safeguard your PC from new emerging threats like network viruses, spam email, inappropriate web content, and spyware programs that can compromise your privacy. The Network Virus Emergency Center provides the most advanced protection from today’s fast spreading network viruses such as MSBLAST, SOBIG, and Code Red. It proactively warns users about new network virus outbreaks and scans for these viruses at the network firewall level where they attempt to penetrate your PC. If network virus activity is detected, it can automatically invoke the Internet Lock feature stopping the virus from infecting the PC and spreading to other computers. PC-cillin Internet Security also includes a powerful new anti-spam scanner that detects and flags annoying and potentially dangerous unwanted email. For business travelers, the Firewall Profiles feature allows users to quickly adjust security control levels for different network environments such as home, work, Wi-Fi (Wireless Fidelity), and on the road. Trend Micro PC-cillin Internet Security is backed by our technical support.

 

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Services and Support

 

We provide several industry-unique services that complement our products, including information deployment and attack-specific policies and cleaning templates that help minimize the impact of network viruses, network vulnerabilities, and mixed-threat attacks. We offer a range of services, backed by timely knowledge and expertise from TrendLabs, including Trend Micro Vulnerability Assessment, Trend Micro Outbreak Prevention Services, Virus Response Services, and Trend Micro Damage Cleanup Services, to help customers manage all phases of the virus outbreak lifecycle.

 

Virus Response Service Level Agreement guarantees customers that fully tested virus pattern files will be delivered within two hours from the time a virus case is submitted. If we fail, however, based on the terms of the agreement entered into with the customer, we may make a penalty payment which may amount up to 100% of the initial sale price.

 

Premium Support Program provides customers with timely assistance that combines rapid response times with technical and computer security expertise to quickly address customer issues. A wide range of service plan options are offered that provide varying levels of personalized customer service from enhanced online support to dedicated on-site support.

 

Our products are backed by TrendLabs, a global network of antivirus research and support centers with an ISO9001:2000 and Customer Operations Performance Center (COPC)-2000 standards-certified headquarters. COPC-2000 is a comprehensive operations performance standard that specifies minimum operational requirements in critical functional areas that are important to end users and clients. A team of more than 250 engineers and antivirus specialists operate around the clock to monitor virus activity, develop information on new threats, and deliver prompt, effective services designed to deal with specific threats.

 

Seasonality

 

Our quarterly net sales are subject to seasonal fluctuations. For example, net sales of corporate products in Japan may be lower in the quarters ending June and December, and higher in the quarters ending March and September, while net sales of consumer products in Japan may be higher in the quarter ending December. Net sales of corporate products in the U.S. and Europe may be lower in the quarter ending March and higher in the quarter ending December.

 

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SALES AND MARKETING

 

Our products are generally sold to corporate customers on a per-user license basis through our channel partners which include systems integrators, distributors, and value-added resellers, with the remaining portion consisting largely of package software sales through channel partners and our online Web stores. We view our channel partnerships as key to our success. Our support programs, such as training and certification programs for our products, help cultivate relationships with our channel partners. Channel partners are integral to increasing the brand recognition and visibility of Trend Micro products and services in the network antivirus and Internet content security market.

 

In our marketing strategy, Trend Micro Enterprise Protection Strategy plays a central role. By emphasizing this industry-unique approach through media and industry analyst community, interest for Trend Micro products and services is generated at the customer level primarily through our channel partners as well as through our global Web sites, corporate alliances, advertising in trade and business publications, customer references, direct marketing campaigns, and trade shows and events worldwide. Furthermore, an extensive and expertise-driven service and support organization contribute to customer loyalty. Current marketing efforts are targeted at a combination of enterprise, small and medium businesses, as well as consumer and broadband customers.

 

Regional Overview

 

Japan

 

Overview. We sell our products in Japan to both corporate and individual end users primarily through systems integrators and distributors, and conduct a limited amount of direct sales to end users, including online sales through a reseller’s website. Our Japan net sales accounted for approximately 41% of our net sales or (Yen)25.4 billion in 2004, approximately 42% or (Yen)20.1 billion in 2003 and approximately 43% or (Yen)18.4 billion in 2002.

 

Distribution Through Systems Integrators and Distributors. Virtually all sales to Japanese corporate users are made through systems integrators. In Japan, systems integrators play a large role in delivering management information services, providing primary computer support services such as installation, systems integration, upgrades, and maintenance.

 

Relationship with SOFTBANK. Since 1996, we have entered into numerous agreements with SOFTBANK in connection with the distribution of our products in Japan by SOFTBANK. Currently, all distribution by SOFTBANK of our products in Japan is covered by an October 1999 distribution agreement with SOFTBANK BB, an indirect wholly-owned subsidiary of SOFTBANK. This distribution agreement gives SOFTBANK BB the non-exclusive right in Japan to distribute all of our products. It is automatically renewable for successive one-year terms, unless either party exercises its right of non-renewal by giving prior written notice. The October 1999 distribution agreement supersedes all prior agreements between SOFTBANK and us relating to distribution of our products. We make rebate payments to SOFTBANK based on SOFTBANK’s achievement of sales targets agreed upon between SOFTBANK and us.

 

Historically, a significant percentage of our Japan net sales have been sales to SOFTBANK. For example, sales to SOFTBANK BB totaled approximately (Yen)10.1 billion or 23.6% of net sales in 2002, (Yen)9.2 billion or 19.1% of net sales in 2003 and (Yen)10.4 billion ($101.0 million) or 16.8% of net sales in 2004. The majority of sales to SOFTBANK BB in 2001, 2002, and 2003 consisted of SOFTBANK BB’s sales of our products to systems integrators.

 

Service Provider and Other Relationships. We contracted with Nifty, NTT-Communications, Internet Initiative Japan, Cable & Wireless IDC and NTT-ME, to license InterScan VirusWall technology to them which enables them to provide virus scanning service to their subscribers. We entered into agreements with SECOM Trust net, Hitachi Software Engineering, Fujitsu Business Systems and Otsuka Shokai which allow them to provide antivirus outsourcing service to their customers.

 

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North America

 

Overview. Our North American region includes the United States and Canada, with headquarters in Cupertino, California. Products are sold through distributors, value-added resellers and managed service providers. Our North America net sales accounted for approximately 19% of our net sales or (Yen)11.9 billion in 2004, approximately 20% or (Yen)9.6 billion in 2003 and approximately 21% or (Yen)9.2 billion in 2002.

 

Distributors. The majority of our North American revenue is from sales of site licenses to corporate users. Principal distributors in the U.S. include Ingram Micro (CA), Ingram Micro (NY), Tech Data, and Synnex. In Canada, principal distributors include Interwork Technologies, Ingram Micro Canada and Tech Data Canada.

 

Our customers in the U.S. include the U.S. federal and state government agencies, educational institutions, large corporations from all industries, and small and medium sized businesses. A majority of the contracts were comprised of Internet gateway and e-mail and groupware products as described above.

 

Europe, the Middle East and Africa

 

Overview. We are represented throughout Europe, the Middle East and Africa (EMEA), with offices in Germany, France, Italy, Spain, U.K., Norway, Sweden, the Netherlands, Belgium, and United Arab Emirates. Our European Support Center, which is located in Munich, Germany, offers real-time technical support and antivirus expertise to our channel partners throughout Europe. Our EMEA net sales accounted for approximately 26% of our net sales or (Yen)16.4 billion in 2004, approximately 25% or (Yen)12.1 billion in 2003 and approximately 23% or (Yen)9.8 billion in 2002.

 

Distributors. The majority of European revenues are from sales of site licenses to corporate users. Principal distributors for the EMEA region include: Belgium/Luxembourg: Logix, Risc Technology, NOXS and Solution Wiz (consumer/SoHo products). Netherlands: Risc, NOXS, Solution Wiz (consumer and SoHo products). Middle East/Africa: SecureData, Online Distribution and Hilan Tech. France: Cris Reseaux, IP Vista, Risc, Risc Technology, ComputerLinks, InfoManage (Switzerland) and Config (North Africa). Germany: ComputerLinks AG, Entrada Kommunikations GmbH, ICON Systems GmbH, Infinigate Deutschland GmbH and Tech Data Midrange GmbH. Italy: IT Way SPA, Computer GROSS, ComputerLinks, Esprinet SPA and J.Soft SRL. Nordic Region: Network Technologies A/S (Denmark), Itegra AB (Sweden), Securesoft AB (Sweden), Scribona AS (Norway), Itegra AS (Norway) and Securesoft OY (Finland). Spain: ADD, AFINA, GTI and Diode (effective June 2003) UK: e92plus Ltd, Sphinx and Unipalm.

 

Our customers in EMEA include various government departments, educational institutions, large corporations and small and medium sized businesses. A majority of the contracts include Internet gateway, email server, and client server products as described above.

 

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Asia Pacific

 

Overview. We are represented throughout the Asia Pacific region (excluding Japan), with offices in Taiwan, Hong Kong, China, Singapore, Malaysia, Thailand, Indonesia, India, Korea, Australia, and New Zealand. Trend Micro’s ISO9001:2000 and COPC-2000 standards-certified headquarters for TrendLabs, our global product support and antivirus research center, is located in Manila, the Philippines; this facility and others like it provide continuous 24 hours-a-day, seven-days-a week coverage to our customers around the world. Our Asia Pacific net sales accounted for approximately 10% of our net sales or (Yen)6.3 billion in 2004, approximately 10% or (Yen)4.8 billion in 2003 and approximately 10% or (Yen)4.2 billion in 2002.

 

Distributors. The majority of Asia Pacific revenue is from sales of site licenses to corporate users and consumer products to home users. Principal distributors in Asia Pacific include: Taiwan: TWP, UCOM and Jetwell Computer. Hong Kong: Datalink, SIS, and Digital China. China: Dawncom Business Technology and Service and Secure China Global Communication. South Asia: Ingram Micro, ACA Pacific, ECS Computer, Select Technologies. Korea: Daou System, Intercom Software and Sun Tek. Australia: Alstom IT, Ingram Micro, and Channelworx. New Zealand: Lan One and Soft Solutions.

 

Our customers in Asia Pacific include local government departments and agencies and large corporations from various industry sectors like commercial banking, telecommunications, Internet service providers, and other service providers over the Internet and securities firms. A majority of the contracts include the purchase of Internet gateway, client PC, and server products as described above.

 

Latin America

 

Overview. Our Latin America Region (LAR) includes the countries located in South America, Central America, the Caribbean, as well as Mexico. Our LAR has offices established in Mexico and Brazil. Products are sold through a network of distributors and resellers, with the majority of LAR revenues derived from sales of software licenses to corporate users. Our Latin America net sales accounted for approximately 3% of our net sales or (Yen)2.0 billion in 2004, approximately 3% or (Yen)1.5 billion in 2003 and approximately 3% or (Yen)1.4 billion in 2002.

 

Distributors. The bulk of Latin American revenue is from sales of software licenses through distributors and resellers to enterprise users. Principal distributors in Latin America include Afina (Latin America), CNT (Brazil) and Mude (Brazil).

 

Our customers in the Latin America Region include various government agencies, and large corporations from the commercial banking, energy, securities and telecommunication sectors.

 

OPERATIONS

 

In Japan, we outsource assembly, packaging and shipping of all of our anti-virus software products to value-added resellers. Our Taiwanese subsidiary and, in some cases, third-party service providers assemble, package, and ship products to be sold in the United States, Europe, and Asia other than Japan. Software products are generally shipped within seven days of receipt of an order and hardware products are generally shipped within ten days. Accordingly, there is some minimal order backlog at all times.

 

LEGAL PROCEEDINGS

 

We are involved in normal claims and other legal proceedings in the ordinary course of business, and are not involved in any litigation or other legal proceedings which, if determined adversely to us, would individually or in the aggregate have a material adverse effect on us or our operations.

 

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C. Organizational Structure.

 

We are not, directly or indirectly, owned or controlled by other corporations or by the Japanese government or any foreign government. The following table lists our consolidated subsidiaries as of April 30, 2005.

 

NAME


  

COUNTRY OF

INCORPORATION


  

EQUITY HELD BY

TREND MICRO

DIRECTLY OR

INDIRECTLY


 

Trend Micro Incorporated

   Taiwan    99 %

Trend Micro Inc.

   USA    100 %

Trend Micro Korea Inc.

   Korea    99 %

Trend Micro Italy S.r.l.

   Italy    100 %

Trend Micro Deutschland GmbH

   Germany    100 %

Trend Micro Australia Pty. Ltd.

   Australia    100 %

Trend Micro do Brasil Ltda.

   Brazil    99 %

Trend Micro France

   France    99 %

Trend Micro Hong Kong Limited

   China    100 %

Trend Micro Latinoamerica S.A. de C.V.

   Mexico    100 %

Trend Micro (UK) Limited

   UK    100 %

Trend Micro (China) Incorporated

   China    100 %

Servicentro TMLA, S.A. de C.V.

   Mexico    100 %

Trend Micro (EMEA) Limited

   Ireland    100 %

Trend Micro (Singapore) Private Limited

   Singapore    99 %

Trend Micro (NZ) Limited

   NZ    100 %

Trend Micro Malaysia Sdn. Bhd.

   Malaysia    99 %

Trend Micro (Thailand) Limited

   Thailand    91 %

 

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D. Property, Plants and Equipment.

 

Our headquarters is located in Tokyo, Japan, where we lease an aggregate of 3,897 square meters of office space under a lease contract which expires in April 2007. We also lease an aggregate of approximately 579 square meters of office space in Osaka, Fukuoka, and Nagoya.

 

We lease approximately 37,490 square feet of office space in Cupertino, California, U.S.A., under a lease which expires in January 2009. We also lease an aggregate of approximately 17,290 square feet of office space in Marlow, United Kingdom., under a lease which expires in June 2013. We lease office space for our regional sales, research and development and sales office in Taiwan and for our customer service center in the Philippines. We also lease small sales offices in Argentina, Australia, Benelux, Brazil, China, France, Germany, Hong Kong, India, Italy, Malaysia, Thailand, Mexico, Middle East-Africa, Norway, Belgium, Singapore, South Korea, Spain and Sweden.

 

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Item 5. Operating and Financial Review and Prospects.

 

A. Operating Results.

 

You should read the following discussion together with the financial statements and notes included in this annual report. Additionally, the following discussion includes forward-looking statements about our business and future performance. These forward-looking statements are based on our current assumptions and beliefs in light of the information currently available to us, and involve known and unknown risks and uncertainties. You should read these forward-looking statements together with the description of the risks and uncertainties associated with these statements contained under the headings “Cautionary Statement Regarding Forward-Looking Statements” immediately following the cover page and under Item 4.D. of this annual report.

 

OVERVIEW

 

Strategy

 

We develop, market and support anti-virus software and management solutions for corporate computer systems and desktop personal computers. In the anti-virus industry there are two U.S. competitors having a higher global market share than we. These companies have strong brand-name recognition and sales forces especially outside Japan because they have longer histories in the industry. They are also developing businesses supported by management resources larger than ours, including work forces and financial strength under such circumstances, we aim for further growth by developing original solutions which respond to the evolution of computer viruses faster than our competitors by concentrating our management resources, by improving our superiority in products and services with additional improvements in the specifications and performance of our products from the view point of customers, and by strengthening customers’ loyalty with our marketing development which is conscious of customer attributes characterized by the differences in purchasing behavior.

 

While we specialize in the antivirus area, we have formed several alliances with dominant vendors in areas other than antivirus solutions. During this year, we announced affiliation with U.S. Cisco Systems, the world’s largest network equipment vendor. As a result of the affiliation, we have now a plan to put our antivirus solutions on the market as internal functions of Cisco’s routers, switches and security appliance products. We consider that this sort of affiliation plays an important role in our sales strategy since we can expect effects of combination of products to be competitive in their respective areas and complement each other’s sales channels.

 

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Critical Accounting Estimates

 

The methods, estimates and judgments we use in applying our accounting policies have a significant impact on the results we report in our financial statements, which we discuss under “Results of Operations” below. Some of our accounting policies require us to make difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain. Our most critical accounting estimates include: judgment for revenue recognition which impacts our net sales; estimate of allowance for sales returns and allowance for doubtful accounts, which impacts our sales return provision and doubtful accounts provision; recognition and measurement of income tax, current and deferred income tax assets and liabilities, which impacts our tax provision. We discuss these policies further, as well as the estimates and judgments involved, below.

 

Revenue Recognition

 

We account for the licensing of software in accordance with Statement Of Position (SOP) 97-2, “Software Revenue Recognition”, released by the American Institute of Certified Public Accountants. The application of SOP 97-2 requires judgment, including whether a software arrangement includes multiple elements, and if so, whether vendor-specific objective evidence (VSOE) of fair value exists for those elements. End users receive certain elements of our products over a period of time. These elements include post-contract customer support services which includes virus pattern updates, unspecified product version updates, telephone and online technical support, the fair value of which is recognized ratably over the service period. We allocate revenue to post-contract customer support services based on the fair value of the post-contract customer support services, which is determined based on separate sales of renewals to customers. Changes to the elements in a software arrangement, the ability to identify VSOE for those elements and the fair value of the respective elements could materially impact the amount of earned and unearned revenue.

 

- 32 -


Allowance for Sales Returns and Allowance for Doubtful Accounts

 

We primarily sell retail packages through intermediaries. After sale of a retail package, we may approve certain returns from intermediaries or end-users. Therefore, we must make estimates of potential future product returns related to current period product revenue. We analyze historical returns, current economic trends, and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns. Significant management judgments and estimates must be made and used in connection with establishing the sales returns in any accounting period. Material differences may result in the amount and timing of our revenue for any period if management made different judgments or utilized different estimates. The balance of allowance for doubtful accounts and sales returns were (Yen) 293 million ($2,843 thousand) and (Yen) 572 million ($5,554 thousand) as of December 31, 2004, respectively. Similarly, we must make estimates of the uncollectability of our accounts receivables. We specifically analyze 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. Our accounts receivable balance was (Yen) 15,245 million ($148,012 thousand), net of allowance for doubtful accounts and sales returns of (Yen) 865 million ($8,397 thousand), as of December 31, 2004.

 

Income Taxes

 

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves our estimating our actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income. To the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

 

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded this valuation allowance of (Yen) 181 million ($1,762 thousand) as of December 31, 2004, due to uncertainties related to our ability to utilize some of our deferred tax assets, primarily consisting of certain net operating losses carried forward before they expire. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods we may need to establish an additional valuation allowance which could materially impact our financial position and results of operations.

 

The net deferred tax asset as of December 31, 2004 was (Yen) 7,921 million ($76,901 thousand), net of a valuation allowance of (Yen) 181 million ($1,762 thousand).

 

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POTENTIAL EFFECT ON OUR RESULTS OF OPERATIONS FROM DISTRIBUTION OF A DEFECTIVE VIRUS PATTERN FILE IN APRIL 2005

 

As described under in Item 4.B. - Distribution of a Defective Virus Pattern File in April 2005, we distributed a defective virus file pattern that resulted in damage to the computers of our customers who downloaded the file. As described in Item 4.B., we took steps to resolve our customers’ problems and ensure that a similar problem would not recur. While the ultimate effect on our results of operations for the year ending December 31, 2005 is still not known, as of June 10, 2005 we have incurred approximately (Yen) 584 million in costs and expenses related to this issue. However, the possibility of incurring further cost is undeniable. In addition, despite the fact that it is impossible to calculate the ultimate effect. Management expects this issue to result in decreased.

 

RESULTS OF OPERATIONS

 

Our consolidated financial statements are denominated in Japanese yen. All asset and liability accounts of our foreign subsidiaries are translated into Japanese yen at the year-end rates of exchange. We translate all income and expense accounts at rates of exchange that approximate those prevailing at the time of the transactions and accumulate the resulting adjustments as a separate component of shareholders’ equity. We translate foreign currency-denominated receivables and payables into Japanese yen at year-end rates of exchange and recognize or expense the resulting translation gains or losses on a current basis. Fluctuations in the exchange rate between the Japanese yen and other currencies, principally the U.S. dollar, Euro and the New Taiwan dollar, will affect the translation of the financial results of our foreign subsidiaries into Japanese yen for purposes of our consolidated financial results, and will also affect the Japanese yen value of any amounts we receive from our subsidiaries.

 

The following table sets forth certain consolidated statements of income data as a percentage of net sales for the periods indicated:

 

     Years ended December 31,

 
     2002

    2003

    2004

 

Net sales

   100.0 %   100.0 %   100.0 %

Cost of sales

   5.5 %   6.6 %   5.2 %
    

 

 

Gross profit

   94.5 %   93.4 %   94.8 %
    

 

 

Operating expenses:

                  

Selling

   35.0 %   31.9 %   25.8 %

Research and development and maintenance

   8.1 %   8.2 %   7.9 %

Customer Support

   9.0 %   10.0 %   9.2 %

General and administrative

   10.1 %   11.8 %   9.9 %
    

 

 

Total operating expenses

   62.2 %   61.9 %   52.8 %
    

 

 

Operating income

   32.3 %   31.5 %   42.0 %
    

 

 

 

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Our Revenue Structure

 

Our revenue is derived primarily from product revenue, which includes software product license and post-contract customer support (PCS) services. Product revenue includes limited sales of our products to other companies for inclusion in their products. Revenue from our post-contract customer support services, which includes virus pattern updates, product version updates, telephone and online technical support, is deferred and recognized ratably over the service period. We allocate revenue to post-contract customer support services based on the fair value of the post-contract customer support services, which are determined based on separate sales of renewals to customers. Upon expiration of the initial term, corporate end users can renew the post-contract customer support services annually by paying a fee generally equal to one-half of the initial license fee in Japan and between 20% and 50% of the initial license fee in the United States and elsewhere, depending on the country. For retail purchasers of PC-cillin/Virus Buster, the license fee includes post-contract customer support services for the initial one-year term only. In order to receive post-contract customer support services after the initial term, these retail purchasers must pay a percentage, generally less than one-half, of the original license fee.

 

We generally recognize revenues from software product licenses when:

 

    persuasive evidence of an arrangement exists;

 

    the product has been delivered;

 

    the fee is fixed and determinable; and

 

    collection of the resulting receivable is reasonably assured.

 

In general, we record sales revenues attributable to post-contract customer support services as deferred revenue and recognize such revenues ratably over the license term. The percentage of the license fee which is deferred varies depending on the location of the Trend Micro entity making the sale, as well as the product sold.

 

In our operations, operating expenses tend to be substantially larger than cost of sales. This is primarily because cost of sales consists of outbound shipping and handling costs, costs of producing manuals and packaging, and amortization of software development costs. Thus, our operating income is affected more by changes in operating expenses than by those in cost of sales.

 

We operate our business in five geographic regions: Japan, Europe, North America, Asia Pacific and Latin America. Japan accounted for around 40% and, together with Europe and North America, over 80% of our net sales for each of our last three fiscal years.

 

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Sales by Product and Service

 

The following table sets forth net sales by Product and Service for the periods indicated:

 

     2002

   2003

   2004

   Year over Year Growth

     (in millions of yen and thousands of U.S. dollars, except percentages)

   2003

   2004

Server based

   (Yen) 5,218    12%    (Yen) 6,805    14%    (Yen) 9,953    $ 96,635    16%    30%    46%

Personal Computer

     15,070    35%      16,679    35%      23,533      228,474    38%    11%    41%

Retail sales

     6,945    16%      8,141    17%      12,384      120,230    20%    17%    52%

Site license sales

     8,125    19%      8,538    18%      11,149      108,244    18%    5%    31%

Internet based

     14,857    35%      14,323    30%      21,958      213,183    35%    -4%    53%

PCS*1 and Royalties

     6,659    15%      9,214    19%      4,714      45,772    8 %    38%    -49%

Other

     1,176    3%      1,067    2%      1,891      18,356    3 %    -9%    77 %
    

  
  

  
  

  

  
  
  
     (Yen) 42,980    100%    (Yen) 48,088    100%    (Yen) 62,049    $ 602,420    100%    12%    29%
    

  
  

  
  

  

  
  
  

* Post –contract customer support fees

 

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We have some products that have several function across these categories. Based on our estimate of such products’ usage, we have divided revenue from them into several categories for analysis purpose.

 

Net sales of post-contract customer support fees and royalties in 2004 decreased 49% from 2003. Until 2003, the renewal sales were categorized as post-contract customer support fees and royalties in the United Sates, because their system could not separate the renewal sales amount by product. Because of the improvement of the system, the renewal sales amount can now be categorized by product. For descriptive purpose to compare 2004 to 2003, if such renewal sales amount had been categorized as post-contract customer support fees and royalties in 2004 in the United States, this line item would have increased 6.2% in 2004 compared with 2003.

 

Net sales of Server based products in 2004 increased 46% compared with 2003 by increased sales of Trend Micro ServerProtect and related Suite products, reflecting higher demand from small and medium sized companies for server-based products. If renewal sales amount had been categorized as post-contract customer support fees and royalties in 2004 in the United States as mentioned above, this line item would have increased 34% in 2004 compared with 2003.

 

Within the personal computer product category, net sales of anti-virus software, including retail package sales of Trend Micro PC-cillin/Virus Buster series, increased from approximately (Yen) 16,679 million in 2003 to approximately (Yen) 23,533 million ($228,474 thousand) in 2004. Retail package sales of personal computer software increased due primarily to increased sales of our products, including the Virus Buster 2005 which we released in October 2004, in the Japanese market. If renewal sales amount had been categorized as post-contract customer support fees and royalties in 2004 in the United States as mentioned above, this line item would have increased 35% in 2004 compared with 2003.

 

Net sales of internet-based products in 2004 increased 53% from 2003, reflecting mainly increased sales of InterScan products in 2004 compared with 2003. If renewal sales amount had been categorized as post-contract customer support fees and royalties in 2004 in the United States as mentioned above, this line item would have increased 32% in 2004 compared with 2003.

 

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Net sales in 2003 increased 12% compared with 2002. The increase was due primarily to increased sales of server-based products such as Trend Micro ServerProtect and related Suite products, reflecting higher small and medium sized companies’ demand for server-based products.

 

Net sales of internet-based products in 2003 decreased from 2002, reflecting mainly decreased sales of InterScan eManager in 2003 compared with 2002.

 

Our net sales also included revenues from post-contract customer support fees and royalties. Net sales of post-contract customer support fees and royalties increased from 2002 to 2003 due primarily to increased renewals of post-contract customer support by corporate customers.

 

Within the personal computer product category, net sales of anti-virus software, including retail package sales of Trend Micro PC-cillin/Virus Buster series, increased from approximately (Yen) 15,070 million in 2002 to approximately (Yen) 16,679 million in 2003. Retail package sales of personal computer software increased due primarily to increased sales of our products, including the Virus Buster 2004 which we released in October 2003, in our Japanese market.

 

Our gross profit percentage in 2002, 2003 and 2004, was 94.5%, 93.4% and 94.8%, respectively. During those years, cost of sales did not change substantially relative to net sales, and thus our gross profit remained relatively constant.

 

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Operating Expenses

 

Operating expenses for the three years ended December 31, 2004 were as follows:

 

     Years ended December 31,

     2002

   2003

   2004

   2004

     Millions of yen    Thousands of
U.S. dollars

Operating expenses:

                     

Selling

   (Yen)15,052    (Yen)15,360    (Yen)16,009    $ 155,431

Research and development and maintenance

   3,506    3,919    4,858      47,168

Customer Support

   3,858    4,831    5,724      55,567

General and administrative

   4,344    5,656    6,144      59,651
    
  
  
  

Total operating expenses

   (Yen)26,760    (Yen)29,766    (Yen)32,735    $ 317,817
    
  
  
  

 

Selling Expenses

 

Selling expenses consist primarily of advertising, selling commissions, payroll and related expenses of sales and marketing department. Selling expenses increased (Yen) 649 million, or 4%, in 2004 compared with 2003, and increased (Yen) 308 million, or 2%, in 2003 compared with 2002.

 

The increase in 2004 compared with 2003 was due primarily to the increase in the number of employees in the sales and marketing department. Additionally, in 2004, there was an increase in sales promotions over 2003. “Channel development activity” was stepped up in 2004 particularly in the United States and Europe. This activity is mainly focused on seminars to boost the channel sales. And in 2004, we conducted major marketing activities in Japan to boost the sales of “Virus Buster 2005”, which we released in the fourth quarter of the year.

 

However, since our selling expenses consist mostly of fixed costs, the percentage of selling expenses compared with net sales has decreased in the past two years.

 

The increase in 2003 compared with 2002 was due primarily to our investment in the development of sales channels, particularly in the United States and Europe, to expand our customer base to small and medium-sized businesses, and the development of a global sales training program to handle the deployment of new types of products based on the Trend Micro Enterprise Protection Strategy described in Item 4.B of this annual report.

 

- 39 -


Research and Development and Maintenance Expenses

 

Research and development and maintenance expenses consist primarily of payroll and related expenses for software engineers who develop and update our anti-virus software products. Research and development and maintenance expenses increased (Yen) 939 million, or 24%, in 2004 compared with 2003, and increased (Yen) 413 million, or 12%, in 2003 compared with 2002. All costs relating to research and development to establish the technological feasibility of our software products are expensed as incurred. In our software development process, technological feasibility is established upon completion of all significant testing for the original English language version of the product. We produce local language versions of our anti-virus software, such as Japanese and Chinese, from the English language version by adding local language functions. Localization costs, which include direct labor and overhead costs, are capitalized and amortized over the estimated life of the product in accordance with Statement of Financial Accounting Standards No. 86. Maintenance costs are the costs related to product version updates to enable our customers to cope with newly prevailing computer viruses and bug fixing and are expensed as incurred.

 

During 2004, we engaged in new research and development projects in network appliances. We engaged in research and development of new products in conjunction with our relationship with Cisco. We invested in the China Development Center. These new activities resulted in an increase to both the expense and the number of employees in research and development and maintenance expenses.

 

During 2003, we engaged in collaborative research and development activities with some alliance partners, such as Postini Corporation, an anti-spam technology vender. As a result of these activities, we paid software license fees to these alliance partners, which increased our research and development expenses for 2003 compared with 2002.

 

The number of employees at our research and development and maintenance department was 481 on December 31, 2002, 476 on December 31, 2003, and 641 on December 31, 2004.

 

Customer Support Expenses

 

Customer support expenses consist primarily of payroll, related expenses and outsourced customer service fees. Customer support expenses increased (Yen) 893 million, or 18%, in 2004 compared with 2003, and increased (Yen) 973 million, or 25%, in 2003 compared with 2002.

 

Compared to 2003, the number of employees in our customer support department increased by 250 in Asia Pacific. It is due to an expansion of the customer support centers in the Philippines to meet the satisfaction of our global customers. The expansion was for enterprise products such as outbreak prevention services and damage cleanup services based on the Trend Micro Enterprise Strategy described Item 4.B of this annual report, and the recent expansion of the services provided to customers by our customer support department.

 

- 40 -


General and Administrative Expenses

 

General and administrative expenses consist primarily of payroll and related expenses, accounting and administration and other general corporate expenses. General and administrative expenses increased (Yen) 488 million, or 9%, in 2004 compared with 2003, and increased (Yen) 1,312 million, or 30%, in 2003 compared with 2002.

 

General and administrative expenses for 2004 increased (Yen) 488 million, compared with 2003. The number of employees at general and administrative department increased 77 in Asia Pacific, compared to 2003. The increase was mainly due to the expansion of the information service function in the Philippines. This accounts for most of the increased number in employees in the general and administrative department from 351 at December 31, 2003 to 421 at December 31, 2004.

 

Other income (expenses) and Income taxes

 

Other income (expenses) and income taxes for the three years ended December 31, 2004 were as follows:

 

    Years ended December 31,

    2002

  2003

  2004

  2004

    Millions of yen  

Thousands
of

U.S. dollars

Other income (expenses):

                       

Interest income

  (Yen) 410   (Yen) 412   (Yen) 451   $ 4,381

Interest expense

    (277)     (174)     (88)     (849)

Gain (Loss) on sales of marketable securities

    (259)     (65)     101     983

Impairment loss of securities investments

    (805)     (7)     —       —  

Foreign exchange gain (loss), net

    52     120     (183)     (1,780)

Other income (expense), net

    111     (111)     (34)     (334)
   

 

 

 

Total other income (expenses)

    (768)     175     247     2,401
   

 

 

 

Income taxes:

                       

Current

    6,938     7,438     11,894     115,472

Deferred

    (1,543)     (1,335)     (1,391)     (13,499)
   

 

 

 

    (Yen) 5,395   (Yen) 6,103   (Yen) 10,503     $101,973
   

 

 

 

 

- 41 -


Other Income (Expenses)

 

Interest income in 2002, 2003 and 2004 arose mainly from our investments in bonds and cash in bank deposits.

 

Interest expense in 2002, 2003 and 2004 resulted mainly from our bonds with warrants issued to provide stock options to our directors and employees. Interest expense decreased during the period, generally corresponding to the progress of the redemption of the bonds.

 

We recognized a gain on sales of marketable securities in 2004. The gain primarily resulted from the redemption of the bonds, and investment trusts denominated in foreign currencies.

 

We recognized a loss on sales of marketable securities in 2002 and 2003. The loss primarily resulted from our sale in shares of common stock of Sina COM, a Nasdaq-listed U.S. Internet media and services company, in 2002, and the disposition of certain of our investments in bonds in 2003.

 

In 2002, we recognized a loss from impairment of securities investments. The loss primarily resulted from the impairment of our investments in SOFTBANK INTERNET FUND and in common stock of Information Security One Limited, Cayman Islands, a British West Indies provider of enterprise solutions and professional services company.

 

- 42 -


Income Taxes

 

Our statutory tax rate was 42.1% in 2002, 2003 and 2004. Our effective tax rate was 41.2% in 2002, 39.8% in 2003 and 39.9% in 2004. A decrease in 2003 compared with 2002 was mainly due to tax credit relating to tax law applied to parent company in 2003, which in turn lowered our effective tax rate.

 

Net deferred tax assets gradually increased from(Yen) 5,593 million in 2002 to (Yen) 6,701 million in 2003 and to (Yen) 7,921 million ($76,901 thousand) in 2004. The main reason this was for an increase of the portion derived from deferred revenue from (Yen) 3,299 million in 2002 to (Yen) 4,344 million in 2003 and to (Yen) 5,638 million ($ 54,737 thousand) in 2004.

 

Segment Information

 

Net sales and operating income (loss) by segment for each of the three years ended December 31 were as follows:

 

     Years ended December 31

   Year over Year
Growth


     2002

   2003

   2004

   2003

   2004

     (in millions of yen and thousands of US dollars, except percentages)          

Net sales

                                                  

Japan

   (Yen) 18,347    43%    (Yen) 20,052    42%    (Yen) 25,443    $247    41%    9%    27%

North America

     9,216    21%      9,633    20%      11,891    115    19%    5%    23%

Europe

     9,807    23%      12,138    25%      16,418    159    27%    24%    35%

Asia Pacific

     4,208    10%      4,809    10%      6,305    61    10%    14%    31%

Latin America

     1,402    3%      1,456    3%      1,992    19    3%    4 %    37%
    

  
  

  
  

  
  
  
  
     (Yen) 42,980    100%    (Yen) 48,088    100%    (Yen) 62,049    $601    100%    12%    29%
    

  
  

  
  

  
  
  
  

 

- 43 -


     Years ended December 31

  

Year ended

December 31,


  

Year over Year

Growth


     2002

   2003

   2004

   2004

   2003

   2004

     Millions of yen    Thousands of
U.S. dollars
         

Operating income (loss)

                                     

Japan

   (Yen) 12,246    (Yen) 12,741    (Yen) 16,600    $ 161    4%    30%

North America

     5,789      6,067      7,543      73    5%    24%

Europe

     4,761      5,606      9,733      94    18%    74%

Asia Pacific

     627      858      1,679      16    37%    96%

Latin America

     664      729      1,282      12    10%    76%

Corporate

     (10,221)      (10,847)      (10,759)      (104)    6%    (1)%
    

  

  

  

  
  

Consolidated Total

   (Yen) 13,866    (Yen) 15,154    (Yen) 26,078    $ 252    9%    72%
    

  

  

  

  
  

 

As stated above, in our operations, the operating expenses tend to be substantially larger than cost of sales, and the operating income is affected more by changes in operating expenses than by those in cost of sales. This is also the case for each of our segments.

 

- 44 -


Japan

 

Net sales in 2004 increased 27% compared with 2003, and net sales in 2003 increased 9% compared with 2002. Strong demand for “Virus Buster” series products including “Virus Buster 2005” released in the fourth quarter contributed to a significant increase in sales growth in year 2004. This result came from an increasing number of broadband users, a high level of experienced virus damages and continuous improving and expanded support from the Company. Additionally, in response to the enactment of the Personal Information Protection Act in Japan, which is to be fully enforced starting April 2005, the sales from corporate anti-virus products were also strong. The smaller growth rate in net sales in year 2003 from 2002 was mainly due to stronger sales in 2002 and declining demand in 2003 reflecting the slowdown of IT-related spending in the enterprise market in the second half of 2003.

 

The growth rate of operating income was higher than that of net sales in 2004. Cost of sales decreased by approximately (Yen) 89 million from (Yen) 927 million in 2003 to (Yen) 838 million ($8,140 thousand) in 2004. The operating expenses for year 2004 and 2003, which were 34.8% and 36.5%, respectively, of net sales for those years.

 

North America

 

Net sales in 2004 increased 23% compared with 2003 and net sales in 2003 increased 5% compared with 2002. The increase in sales growth for year 2004 is as a result of the positive attitude of our customers towards investment of security products as well as the reinforcement measures we took to expand sales channels for small and medium companies. The major increase contributed primarily from Neat Suite, PC-cillin, Client Server Messaging, Scan Mail product groups and the premium support services, which provide proactive, personalized service, combining round-the-clock urgent priority handling of service requests with leading edge anti-virus, content security, and technical expertise to quickly address issues and deliver product knowledge at each service level.

 

In 2003, revenues in this segment recovered due to the increase in sales of our anti-spam solution service and related products and the expansion of our customer base.

 

The growth rate of operating income in 2004 was almost the same as that of net sales in 2004. Cost of sales increased by approximately (Yen) 181 million from (Yen) 173 million in 2003 to (Yen) 354 million ($3,437 thousand) in 2004. One of the reasons for this increase was an increase in outsourcing costs which is due to increasing transaction volume. The cost of sales for year 2004 and 2003 were 3.0% and 1.8%, respectively. Operating expenses for year 2004 and 2003, which were 36.6% and 37.0%, respectively, of net sales for those years, mainly increased by approximately (Yen) 782 million from extended sales force and activities in line with sales growth.

 

- 45 -


Europe

 

Net sales in 2004 increased 35% compared with 2003, and net sales in 2003 increased 24% compared with 2002. With new product launches, stronger demand and targeting sales in the small and medium business market has had great impact on our sales increase in year 2004. Sales in the Northern European areas such as Norway and Sweden and the Southern European areas such as Italy significantly increased due to the positive impact of reorganization of the sales teams and management within the business units. The increase in 2003 was due to the expansion of our customer base to small and medium-sized businesses and the growth in some emerging countries included in this segment, such as Norway and Spain, as well as the strength of the Euro relative to the Japanese Yen.

 

The growth rate of operating income was higher than that of net sales in 2004. Cost of sales increased by approximately (Yen) 190 million from (Yen) 40 million in 2003 to (Yen) 230 million ($2,229 thousand) in 2004; mainly due to an increase in transaction volume related to small and medium size business products. But cost of sales for year 2004 and 2003 were 1.4% and 0.3%, respectively, of net sales for those years. Operating expenses were increased by approximately (Yen) 153 million from 2003 mainly from sales and support efforts to grow the business. However, operating expenses for 2004 and 2003, were 40.7% and 53.8%, respectively, of net sales for those years. The decreased ratio was due to improved sales productivity by changed compensation incentive structure and improved operation productivity and efficiency by centralized operation process in Ireland Shared Service Center that was implemented in 2003 and began operating efficiently in 2004.

 

Asia Pacific

 

Net sales in 2004 increased 31% compared with 2003, and net sales in 2003 increased 14% compared with 2002. The continuous growth of our net sales in the territories of South Asia and Southeast Asia countries, Australia and China contributed to the growth in this segment’s net sales from 2003 to 2004 as well as from 2002 to 2003. The major increase contributed primarily from Neat Suite, Gateway products, PC-cillin, and the premium support services.

 

The growth rate of operating income was higher than that of net sales in 2004. Cost of sales increased by approximately (Yen) 233 million from (Yen) 796 million in 2003 to (Yen) 1,029 million ($9,992 thousand) in 2004, mainly due to an increase in hardware-related product sales. Cost of sales for 2004 and 2003 were 16.3% and 16.5%, respectively, of net sales for those years. Operating expenses for 2004 and 2003, which were 73.4% and 82.2%, respectively, of net sales for those years, increased by approximately (Yen) 675 million from 2003 to 2004 mainly due to our sales and support activities designed to increase demand for our products in the market.

 

- 46 -


Latin America

 

Net sales in 2004 increased 37% compared with 2003, and net sales in 2003 increased 4% compared with 2002. The increase in the growth rate primarily came from the introduction of new products or new versions such as Spam Prevention Service, Network VirusWall, and products focusing on small and medium sized business in 2004. Net sales in 2003 did not increase as much as it did in 2002 mainly due to the relative strength of the Japanese yen relative to the local currencies related to this segment.

 

The growth rate of operating income was higher than that of net sales in 2004. Cost of sales increased by approximately (Yen) 60 million, from (Yen) 13 million in 2003 to (Yen) 73 million ($708 thousand) in 2004, mainly due to an increase in costs related to selling of network related hardware products. Cost of sales for year 2004 and 2003 were 3.7% and 0.9%, respectively, of net sales for those years. Operating expenses for year 2004 and 2003, which were 35.6% and 49.9%, respectively, of net sales for those years, decreased by approximately (Yen) 17 million. The decreased ratio is due to the reduction of statutory profit sharing cost from legal restructuring of the company and the reduction in the number of remote offices.

 

Corporate

 

Operating loss of the Corporate segment in 2004 decreased 1% compared with 2003. Such decreased expenses included those related to our corporate marketing department which decreased by approximately (Yen) 603 million, those related to our corporate general and administrative department, which decreased by approximately (Yen) 106 million, and our amortization of software development cost which decreased by approximately (Yen) 507 million. However, there was increase in expenses related to our research and development department of approximately (Yen) 939 million derived mainly from our research and development projects in network appliances, our research and development of new products in conjunction with our relationship with Cisco and investment in the China Development Center.

 

Operating loss of the Corporate segment in 2003 increased 6% compared with 2002. The primary reason for this increase was the increase in expenses except for those related to our corporate marketing department. Such increased expenses included those related to our research and development department, which increased by approximately (Yen) 413 million, those related to our corporate general and administrative department, which increased by approximately (Yen) 163 million, and amortization of software development costs, which increased by approximately (Yen) 310 million. The decrease in expenses related to our corporate marketing department, by approximately (Yen) 748 million, was mainly due to the reduction in marketing personnel in our corporate marketing department and our policy change to attribute more marketing related resources under each regional segment than under the corporate segment, to increase efficiency. The increase in expenses related to our research and development department was mainly due to the increase in maintenance costs of approximately (Yen) 388 million, which were derived mainly from our research and development projects for our personal computer products in Japan and those for our internet-based products in Germany.

 

- 47 -


Stock Options

 

In March, June and November 2001 and April 2002, we granted warrants to attract and retain key employees. Also, in March 2001, options were granted under an incentive stock option plan with subscription rights which qualified under Article 280-19 of the unrevised Japanese Commercial Code. In addition, in February, May and November 2003, and in April, October 2004, the stock options with stock acquisition rights were granted. The warrants granted in 2001 and the stock option with subscription rights granted in 2001 generally commenced vesting one year after the grant date. The warrants granted in 2002 generally commenced vesting one year after the grant date. The stock options with stock acquisition rights granted in 2003 and 2004 generally commenced or will generally commence vesting 9 months or one year after the grant date. Using methodology under Accounting Principles Board Opinion No. 25, we have not recorded any non-cash compensation expense for the years ended December 31, 2002, 2003 and 2004. Had such non-cash compensation expense for our warrants and stock options in 2001, 2002, 2003 and 2004 been determined based on the fair value of such warrants or options at the grant dates, as prescribed by Statement of Financial Accounting Standards No. 123, our pro forma net income and net income per share would have been as follows:

 

     Years ended December 31,

     2002

   2003

   2004

   2004

     (In millions of yen and in thousands of U.S. dollars, except per share data)

Pro forma net income

   (Yen) 6,853    (Yen) 7,899    (Yen) 13,235    $ 128,494

Pro forma net income per share:

                           

Basic

   (Yen) 51.87    (Yen) 59.87    (Yen) 100.58    $ 0.98

Diluted

     51.72      59.73      98.87      0.96

 

These figures are significantly different than those determined under Accounting Principles Board Opinion No.25. Those differences result mainly from the current price of the shares and their expected volatility. The impact of the pro forma value of the warrants or options computed under Statement of Financial Accounting Standards No. 123 has not affected our reported earnings or cash flows. The impact has been measured for disclosure purposes only and is entirely non-cash in nature. See “Significant accounting policies” and note 14 to the financial statements in included in this annual report.

 

- 48 -


Employee Benefit plans

 

The parent company has an unfunded retirement allowance plan covering substantially all of its employees who meet eligibility requirements under such plan, and some subsidiaries have defined benefit / defined contribution pension plans. All of the details are described more fully in “Note 14: Employee benefit plans”. The Company’s total cost for defined benefit pension plan is (Yen) 237 million in 2004, and the aggregated balance at December 31, 2004 of the Company’s projected benefit obligation and plan assets are, (Yen) 910 million and (Yen) 125 million, respectively. We believe our risk exposure to variation from estimates made for these plans is immaterial.

 

In December 2004, the Financial Accounting Standards Board revised Statement of Financial Accounting Standards (SFAS) No.123 “Share-Based Payment” This new SFAS No.123 focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement is effective as of the beginning of the first fiscal year that starts after June 15, 2005. We intend to adopt the provisions on Financial Accounting Standards 123(R) effective January 1, 2006. The Company is currently evaluating which transition method and valuation technique to be used upon adoption. The Company’s pro forma net income and net income per share for the year ended December 31, 2004 based on the fair values of the stock options with Stock acquisition rights, which were estimated on the date of grant using the Black-Scholes option pricing model in accordance with the original SFAS No.123, are disclosed in Note 2 (1) “Significant accounting policies - Stock-based compensation.”

 

- 49 -


B. Liquidity and Capital Resources.

 

Our short-term capital requirements depend on numerous factors, including

 

  market acceptance of our products,

 

  the resources we devote to developing, marketing, selling and supporting our products, and

 

  the extent to which we are able to establish relationships with strategic partners in the U.S., Europe and elsewhere.

 

Our short-term capital resources are mainly derived from net cash provided by operating activities. We believe that our current cash balance, net cash provided by operating activities and existing credit facilities will be sufficient to meet our working capital and capital expenditure requirements for the next 12 months.

 

In the medium and long terms, we may make acquisitions and strategic investments in order to grow our business. Insofar as we are not able to satisfy our working capital and capital expenditure requirements, we may seek to raise additional capital through equity or debt financing. However, we cannot be certain that such funding will be available on commercially reasonable terms, if at all.

 

At December 31, 2004, we had cash and cash equivalents, time deposits and marketable securities of approximately (Yen) 68,580 million ($665,827 thousand), up from approximately (Yen) 51,929 million at December 31, 2003. The increase was primarily due to cash inflow from operating activities. Our marketable securities consist only of debt securities with high credit ratings and mutual funds which consist of debt securities with high credit ratings in accordance with our investment policy. At December 31, 2004, we had cash and cash equivalents of approximately (Yen) 52,908 million ($513,673 thousand), which mainly consisted of (Yen) 33,476 million ($325,011 thousand) in Japanese yen, (Yen) 4,022 million ($39,052 thousand) in U.S. dollar and (Yen) 10,905 million ($105,872 thousand) in Euro. At December 31, 2003, we had cash and cash equivalents of approximately (Yen) 46,719 million, which mainly consisted of (Yen) 27,899 million in Japanese yen, (Yen) 8,824 million in U.S. dollars and (Yen) 7,085 million in Euro.

 

Previously, the Company has disclosed all of “available for sale” debt securities as Marketable securities in current assets. However, since the balance of cash and cash equivalents has increased, in fiscal 2004, the possibility of sales before maturity of “available for sale” debt securities classified into working capital has decreased. Therefore, from fiscal 2004, the Company discloses “available for sale” debt securities with maturities later than one year as Securities investments in investments and other assets. The balance sheet as of December 31, 2003 has been reclassified on a consistent basis. As a result, “available for sale” debt securities of (Yen) 5,483,094 thousand is reclassified from current assets to investments and other assets. In addition, related deferred taxes of (Yen) 2,522 thousand have been reclassified from current liabilities to long-term liabilities.

 

- 50 -


At December 31, 2004, we had deferred revenue under both current liabilities and long-term liabilities of approximately (Yen) 27,904 million ($270,908 thousand), compared with approximately (Yen) 20,503 million at December 31, 2003. Deferred revenue as of each fiscal year end is expected to become net sales in accordance with contractual period in the future. Deferred revenue was derived from each region as shown in the following table:

 

     December 31,

   December 31,

     2003

   2004

   2004

     Millions of yen    Thousands of U.S. dollars

Deferred Revenue

                    

Japan

   (Yen) 9,321    (Yen) 12,369    $ 120,085

North America

     4,073      5,597      54,341

Europe

     5,416      7,469      72,511

Asia Pacific

     1,368      1,968      19,111

Latin America

     325      501      4,861
    

  

  

Consolidated Total

   (Yen) 20,503    (Yen) 27,904    $ 270,909
    

  

  

 

Most of deferred revenue at December 31, 2003 and 2004 was attributable to Japan, North America and Europe. Deferred revenue in Japan at December 31, 2004 increased 33% compared with December 31, 2003 due mainly to increased net sales as a result of an increase in the number of broadband users, a high level of experience with virus damages and continuously improving and expanded support from the Company. Deferred revenue in North America at December 31, 2004 increased 37% compared with December 31, 2003 due mainly to increased net sales as a result of the positive attitude of our customers towards investment in security products as well as the measures we took to reinforce sales channels to expand sales to small and medium companies. Deferred revenue in Europe at December 31, 2004 increased 38% compared with December 31, 2003 due mainly to increased net sales as a result of new product launches, stronger demand and targeting sales in the small and medium business market.

 

- 51 -


Net cash provided by operating activities was approximately (Yen) 15,666 million in 2003 and (Yen) 24,900 million ($,241,747 thousand) in 2004. The increase from 2003 to 2004 was primarily due to an increase of net income and the stronger increase in deferred revenue.

 

Net cash used in investing activities was approximately (Yen) 9,453 million in 2003 and approximately (Yen) 16,030 million ($155,626 thousand) in 2004. The increase from 2003 to 2004 was primarily due to a (Yen) 6,991 million ($67,876 thousand) increase in payments for purchases of marketable securities and security investments and the payment of (Yen) 2,156 million ($20,934 thousand) for purchases of marketable securities with maturities of three months or less. These increases in payments ware partially offset by a (Yen) 2,041 million ($19,812 thousand) increase in proceeds from sales of marketable securities.

 

Net cash used by financing activities was approximately (Yen) 6,811 million in 2003 approximately (Yen) 3,250 million ($31,554 thousand) in 2004. The decrease from 2003 to 2004 was primarily due to a (Yen) 7,771 million ($75,447 thousand) increase in the issuance of common stock pursuant to the exercise of stock warrants and stock acquisition rights. This increase in proceeds was partially offset by the payment of (Yen) 1,820 million ($17,666 thousand) dividends and a (Yen) 1,500 million ($14,563 thousand) increase in redemption of bonds.

 

Net cash provided by operating activities was approximately (Yen) 14,743 million in 2002 and (Yen) 15,666 million in 2003. The increase from 2002 to 2003 was primarily due to an increase of net income. The increase in net income was primarily offset by the negative effect of the slow-down of the increase in deferred revenue. The increase of deferred revenue mainly related to increased net sales, especially as the result of renewals by end users of post-contract customer support services after the expiration of initial periods.

 

Net cash used in investing activities was approximately (Yen) 3,173 million in 2002 and approximately (Yen) 9,453 million in 2003. The increase from 2002 to 2003 was primarily due to a (Yen) 8,922 million increase in payments for purchases of marketable securities and investments in securities. This increase was partially offset by a (Yen) 2,653 million increase in proceeds from sales of marketable securities.

 

Net cash used by financing activities was approximately (Yen) 4,007 million in 2002 and approximately (Yen) 6,811 million in 2003. The increase from 2002 to 2003 was primarily due to a (Yen) 2,000 million increase in redemption of bonds and a (Yen) 564 million decrease in the issuance of common stock pursuant to the exercise of stock warrants and stock acquisition rights.

 

- 52 -


At the fifteenth ordinary general meeting of our shareholders held on March 25, 2004, a dividend of (Yen) 14.00 ($0.13) per share was approved. Based on the number of shares outstanding as of December 31, 2003, the record date for the dividend, the maximum cash dividend amount we will pay is (Yen) 1,829 million.

 

At the sixteenth ordinary general meeting of our shareholders held on March 25, 2005, a dividend of (Yen) 36.00 ($0.35) per share was approved. Based on the number of shares outstanding as of December 31, 2004, the record date for the dividend, the maximum cash dividend amount we will pay is (Yen) 4,794 million.

 

We issued (Yen) 5,000 million worth of unsecured bonds due June 2003 with detachable warrants in connection with our 2000 incentive plan in June 2000. The bonds bear interest at the annual rate of 2.1%. Of the (Yen) 5,000 million worth of unsecured bonds, (Yen) 5,000 million ($46,729 thousand) were redeemed in 2003.

 

We issued (Yen) 5,000 million worth of unsecured bonds due March 2004 with detachable warrants in connection with our 2001 incentive plan in March 2001. The bonds bear interest at the annual rate of 1.75%. These bonds were redeemed in March 2004.

 

We issued (Yen) 1,500 million worth of unsecured bonds due June 2004 with detachable warrants in connection with our 2001 incentive plan in June 2001. The bonds bear interest at the annual rate of 1.5%. These bonds were redeemed in June 2004.

 

We issued (Yen) 6,000 million worth of unsecured bonds due November 2004 with detachable warrants in connection with our 2001 incentive plan in November 2001. The bonds bear interest at the annual rate of 1.75%. (Yen) 6,000 million worth of unsecured bonds issued in November 2001 was repurchased in December 2001. These bonds were redeemed in November 2004.

 

We issued (Yen) 4,000 million worth of unsecured bonds due April 2006 with detachable warrants in connection with our 2002 incentive plan in April 2002. The bonds bear interest at the annual rate of 1.90%. (Yen) 4,000 million worth of unsecured bonds issued in April 2002 were repurchased in May 2002.

 

We have invested the proceeds of the bonds in cash and other short-term investments. Since these investments are likely to yield less interest income than the interest expense on the bonds, we will incur a net interest expense with respect to the bonds.

 

In order to reduce interest cost, we repurchased some of the bonds in the market with the intention to hold the treasury bonds until they can be extinguished legally. As the repurchase transaction is deemed as redemption of the bonds in substance, the treasury bonds are offset with the bonds on the face of our consolidated balance sheet. We used the proceeds of the bond issuance for working capital and general corporate purposes.

 

In 1998, we entered into three overdraft agreements with Japanese commercial banks, under which we are able to obtain short-term financing at prevailing interest rates for periods not in excess of one year. One of the three overdraft agreements was terminated in 2002. The aggregate amount available under the remaining two overdraft agreements is (Yen) 700 million ($6,796 thousand) as of December 31, 2004. However, at December 31, 2004, no amounts were outstanding under these overdraft agreements. All of these overdraft agreements have been cancelled as of February 28, 2005.

 

- 53 -


C. Research and Development, Patents and Licenses, etc.

 

RESEARCH AND PRODUCT DEVELOPMENT

 

Our research and product development activities focus on the development of new anti-virus and security software, enhancements to existing products and integration of products to enable monitoring, updating and management via the Internet. We conduct research and development at our Tokyo headquarters and our U.S., Taiwan, Germany, U.K., and China subsidiaries and have a research staff of 641 engineers as of December 31, 2004.

 

Research and development and maintenance expenditures, consisting primarily of software development costs and research and development staff salaries and benefits, increased from (Yen) 3,505.6 million in 2002 to (Yen) 3,919.0 million in 2003 and to (Yen) 4, 858.3 million ($47.2 million) in 2004.

 

INTELLECTUAL PROPERTY

 

Our ability to compete successfully depends in part on our ability to protect the proprietary technology contained in our software products. We rely upon a combination of patent, trademark, copyright and trade secret laws and contractual provisions to establish and protect proprietary rights in our software.

 

- 54 -


Our U.S. and Taiwanese subsidiaries hold the following principal patents relating to core technologies:

 

NAME


   STATUS

   REGISTRATION
DATE


  

REGISTRATION

NUMBER


   EXPIRATION
DATE


  

APPLICANT/PATANTEE


Method and apparatus for controlling network and workstation access prior to workstation boot

   Patented    8/22/1995    5,444,850    8/3/2013    Trend Micro Inc. (USA)

Virus detection and removal apparatus for computer networks

   Patented    4/22/1997    5,623,600    9/25/2015    Trend Micro Inc. (USA)

Method and apparatus for controlling network and workstation access prior to workstation boot

   Patented    10/21/1997    5,680,547    8/7/2015   

Trend Micro Incorporated

(Taiwan)

Apparatus and method for electronic mail virus detection and elimination

   Patented    3/30/1999    5,889,943    3/28/2016   

Trend Micro Incorporated

(Taiwan)

System, apparatus and method for the detection and removal of viruses in macros

   Patented    9/14/1999    5,951,698    10/1/2016   

Trend Micro Incorporated

(Taiwan)

Event triggered iterative virus detection

   Patented    9/28/1999    5,960,170    3/17/2017   

Trend Micro Incorporated

(Taiwan)

Computer network malicious code scanner

   Patented    11/9/1999    5,983,348    9/9/2017    Trend Micro Inc. (USA)

Controlled distribution of application programs in a computer network

   Patented    9/12/2000    6,119,165    11/16/2017    Trend Micro Inc. (USA)

Computer network malicious code scanner method and apparatus

   Patented    8/7/2001    6,272,641    11/8/2019    Trend Micro Inc. (USA)

Distributed virus scanning arrangements and methods therefore

   Patented    4/27/2004    6,728,886    11/30/2019    Trend Micro Inc. (USA)

Techniques for providing add-on services for an email system

   Patented    12/28/04    6,836,792    12/2/2019    Trend Micro Inc. (USA)

 

- 55 -


We plan to transfer the ownership of these patents to Trend Micro (Japan).

 

We do not typically enter into signed license agreements with our corporate, government and institutional customers who license products directly from us. We include an electronic version of a “shrinkwrap” license in all of our electronically distributed software and a printed license in the box for our packaged products in order to protect our copyrights in those products. The enforceability of these licenses generally is uncertain in the United States as well as in foreign jurisdictions. In addition, the laws of some foreign countries either do not protect proprietary rights or offer only limited protection for those rights.

 

In addition, as is common in the software industry, third parties may sue us for alleged infringement of their intellectual property rights. We may also have to take legal action to defend our intellectual property from infringement.

 

We also generally enter into confidentiality agreements with our employees, and limit access to and distribution of proprietary information.

 

D. Trend Information.

 

The information required by this Item is set forth in Item 5.A of this annual report.

 

E. Off-Balance Sheet Arrangements.

 

We are not a party to any material off-balance sheet arrangements. In addition, we have no unconsolidated special purpose financing or partnership entities that are likely to create material contingent obligations.

 

- 56 -


F. Tabular Disclosure of Contractual Obligations.

 

Future payments due under our debt and lease obligations as of December 31, 2004 were as follows:

 

     Long-term debt

  

Non-cancelable

operating leases


   Total

   Total in U.S. $

     (in millions of yen and thousands of dollars)

Less than 1 year

   (Yen) —      (Yen) 575    (Yen) 575    $ 5,584

1-3 years

     —        539      539      5,232

3-5 years

     —        244      244      2,366

More than 5 years

     —        —        —        —  
    

  

  

  

Total

   (Yen) —      (Yen) 1,358    (Yen) 1,358    $ 13,182
    

  

  

  

 

As of December 31, 2004, we had no capital lease obligations, purchase obligations, or long-term liabilities reflected in our financial statements included in this annual report other than those set forth in the table above.

 

- 57 -


Item 6. Directors, Senior Management and Employees

 

A. Directors and Senior Management.

 

The following table shows information regarding our directors and executive officers as of April 30, 2005.

 

Name


   Age

  

Position(s)


  

Month and

year in

which

Current

Term Expires


  

Number of

Shares owned

as of

April 30,

2005


   Percent of
number of
Shares issued


 

Steve Chang

   50    Representative Director and Chairman of the Board    March 2007    5,368,000    4.0 %

Eva Chen

   46    Representative Director; President and Chief Executive Officer    March 2007    2,504,500    1.8 %

Mahendra Negi

   45    Representative Director, Chief Financial Officer and Executive Vice President    March 2007    32,000    0.0 %

Hirotaka Takeuchi

   58    Director    March 2007    0    —    

Fumio Hasegawa

   65    Corporate Auditor    March 2009    500    0.0 %

Sadatoshi Nakayama

   53    Corporate Auditor    March 2009    0    —    

Yasuo Kameoka

   49    Corporate Auditor    March 2009    0    —    

Kouji Fujita

   42    Corporate Auditor    March 2009    0    —    

 

Steve Chang is the founder and Chairman of Trend Micro. He has been serving as our Representative Director since December 1995. Chang formed Trend Micro in California in 1988, with the goal of developing anti-virus software for personal computers. Prior to launching Trend Micro, Chang worked as an engineer at Hewlett Packard and later founded AsiaTek, Inc., a Taiwan-based UNIX software design company. Steve Chang received his B.S. in Applied Mathematics from Fu-Jen Catholic University in Taiwan and his M.S. in Computer Science from Lehigh University, Pennsylvania in 1978. He is also currently serving as a director of SOFT TREND CAPITAL Corporation.

 

Eva Chen is one of the co-founders of Trend Micro and has been the Chief Executive Officer since January 1, 2005. She is currently Executive Vice President and a Director and has been our Chief Technology Officer since May 1988 and Director since August 1997. She graduated from Texas University in 1988. She is also Steve Chang’s sister-in-law.

 

- 58 -


Mahendra Negi is the Chief Financial Officer and a Representative Director of Trend Micro. He has been serving as a Representative Director since March 2002. He joined Trend Micro in May 2000 from Merrill Lynch. Negi started his career in the petroleum industry, and then moved to commercial banking before joining Merrill Lynch. He graduated from Nagpur University in India in addition to his MSc (Master of Science) in Management from the London Business School in 1993.

 

Dr. Hirotaka Takeuchi is Dean of the Graduate School of International Corporate Strategy, Hitotsubashi University. He has been serving as our Outside Director since March 2005. He became an assistant professor at the Graduate School of Business Administration at Harvard University before returning to Japan in 1983 as an assistant professor at Hitotsubashi University’s School of Commerce, where he later became professor in 1987. He has held his present position at the Graduate School of International Corporate Strategy since 1998. He went on to receive an MBA in 1971 and a Ph.D. in 1977 from the Graduate School of Business Administration at the University of California, Berkeley. He is also currently serving as an outside director of ORIX Corporation.

 

Fumio Hasegawa graduated from Chuo University with a degree from the commercial science department in 1967. He has worked for Shell Oil and Tokyo Shell Pack. He became one of our Corporate Auditors in March 2000.

 

Sadatoshi Nakayama graduated from Kyoto University’s Department of Science in 1977. He has worked for the Chuo Audit Corporation (now ChuoAoyama PricewaterhouseCoopers) and established Sadatoshi Nakayama CPA Office in 1992. He is currently the head of Sadatoshi Nakayama CPA Office and became one of our Corporate Auditors in March 2001.

 

Yasuo Kameoka graduated from Sohka University’s Department of Economics in 1978. He joined PriceWaterhouse in 1978 and Tokuichi Hayashi CPA Office in 1988. Currently he is a Chief Director and Senior Partner of Taiko Audit Corporation. He became one of our Corporate Auditors in March 2001.

 

Kouji Fujita graduated from Hitotsubashi University’s Department of Juristic Law in 1987. He was admitted to the Japanese Bar, joined Okuno & Partners legal office in April 1989. He became one of our Corporate Auditors in March 2002. He is also currently serving as a corporate auditor of TOEI Housing Corporation.

 

- 59 -


B. Compensation.

 

For the fiscal year ended December 31, 2004, the aggregate compensation of all directors and executive officers paid or accrued by Trend Micro was 106 million yen ($1,038 thousand), 89 million yen ($872 thousand) for directors and 17 million yen ($165 thousand) for corporate auditors. Under the Japanese Commercial Code and local practice, we may make severance payments to a retired director or corporate auditor with shareholder approval when our management proposes such payments based on a resolution of our Board of Directors. We have an internal formula to determine the amounts of severance payments to corporate auditors when we make such a proposal for corporate auditors. We have not recorded any liabilities relating to severance payments to directors and corporate auditors as of December 31, 2000, 2001, 2002, 2003 and 2004 because we have no liabilities to directors, and related liabilities to corporate auditors were insignificant.

 

Information regarding stock options granted to our directors and executive officers is provided in Item 6.E.

 

C. Board Practices.

 

Directors are elected at a general meeting of shareholders, and the normal term of office of a director is two years, although they may serve any number of consecutive terms. We do not have audit or remuneration committees, a standard practice in Japan. We do not have any service contracts with any of our directors providing for benefits upon termination of employment.

 

In accordance with the requirements of the Commercial Code and Law for Special Exceptions to the Commercial Code concerning Audit, etc. of Japan, our Articles of Incorporation provide for not less than three corporate auditors. Corporate auditors, of whom at least one must be from outside of the company, are elected at a general meeting of shareholders, and the normal term of office of a corporate auditor is four years, although they may serve any number of consecutive terms. Corporate auditors are under a statutory duty to oversee the administration of our affairs by the directors, to examine our financial statements and business reports to be submitted by the Board of Directors to the general meetings of shareholders and to report their opinions thereon to the shareholders, and to oversee accounting firms which audit our financial statements. They are required to attend meetings of the Board of Directors and to express their opinions if necessary, but they are not entitled to vote. Corporate auditors also have a statutory duty to provide their report on the audit report prepared by our independent certified public accountants to the board of corporate auditors, which must submit its audit report to the Board of Directors. The board of corporate auditors will also determine matters relating to the duties of the corporate auditors, such as audit policy and methods of investigation of our affairs.

 

Nasdaq Marketplace Rule 4350(a)(1) provides that a foreign private issuer may follow its home country practice in lieu of the requirements of Rule 4350, provided that such foreign private issuer discloses in its annual reports filed with the Securities and Exchange Commission each requirement of Rule 4350 that it does not follow and describes the home country practice followed by the issuer in lieu of such requirements.

 

- 60 -


Nasdaq Marketplace Rule 4350-1(c), currently applicable to foreign private issuers, provides that there be independent directors as defined in Rule 4200-1(a)(14) on the board of directors. Currently, for a foreign private issuer, Nasdaq requires that there be two independent directors. Effective July 31, 2005, Nasdaq Marketplace Rule 4350(c) will require that (i) a majority of the board of directors be independent directors as defined in Rule 4200(a)(15), (ii) independent directors have regularly scheduled meetings at which only they are present, (iii) compensation of the chief executive officer and other executive officers be determined, or recommended to the board of directors for determination, either by a majority of the independent directors or by a compensation committee comprised solely of independent directors, and (iv) director nominees be selected, or recommended for selection by the board of directors, either by a majority of the independent directors or by a nominations committee comprised solely of independent directors, in accordance with the nominations process set forth in a formal written charter or board resolution. For large Japanese companies under the Commercial Code and Law for Special Exceptions to the Commercial Code concerning Audit, etc. of Japan ( “Large Japanese Companies”), including us, which employ a corporate governance system based on a board of corporate auditors, Japan’s company law (including the Commercial Code and the Law for Special Exceptions to the Commercial Code concerning Audit, etc.) has no independence requirement with respect to directors. As discussed above, the task of overseeing management and accounting firms is assigned to the corporate auditors, who are separate and independent from the company’s management. Large Japanese Companies, including us, are required to have at least one “outside” corporate auditor who must meet additional independence requirements under the Law for Special Exceptions to the Commercial Code concerning Audit, etc. An outside corporate auditor is defined in the Law for Special Exceptions to the Commercial Code concerning Audit, etc. as a corporate auditor who had not served as a director, manager or any other employee of the company or any of its subsidiaries for the last five years prior to the appointment. Currently, we have four outside corporate auditors. Starting on the date of our ordinary meeting of shareholders relating to the fiscal year ending December 31, 2005, by amendment of the Law for Special Exceptions to the Commercial Code concerning Audit etc., at least 50% of our corporate auditors will be required to be outside corporate auditors. Also, starting on the same date, the independence requirements for outside corporate auditors will be strengthened by extending the five-year period referred to above to any time prior to the appointment.

 

Nasdaq Marketplace Rule 4350-1(d), currently applicable to foreign private issuers, provides that there be an audit committee of the board of directors. Currently, for a foreign private issuer, Nasdaq requires that a majority of the audit committee’s members be independent directors as defined in Rule 4200-1(a)(14). Effective July 31, 2005, Nasdaq Marketplace Rule 4350(d) will require that (i) each issuer have adopted a formal written audit committee charter meeting the requirements of Rule 4350(d)(1) and (ii) the issuer have an audit committee of at least three members who are independent as defined under Rule 4200(a)(15), meet the independence criteria set forth in Rule 10A-3(b)(1) under the U.S. Securities Exchange Act of 1934 and satisfy certain other criteria. Like a majority of Japanese companies, we employ the corporate auditor system as described above. Under this system, the board of corporate auditors is a legally separate and independent body from the board of directors. The function of the board of corporate auditors is similar to that of independent directors, including those who are members of the audit committee, of a U.S. company: to monitor the performance of the directors, and review and express an opinion on the method of auditing by the company’s accounting firm and on such accounting firm’s audit reports, for the protection of the company’s shareholders. Large Japanese Companies, including us, are required to have at least three corporate auditors. Currently, we have four corporate auditors. In addition, as discussed above, our corporate auditors serve a longer term than our directors. Starting on July 31, 2005, when the requirements of Rule 10A-3 relating to listed company audit committees become applicable to foreign private issuers, we expect to rely on an exemption under that rule which is available to foreign private issuers with boards of corporate auditors meeting certain criteria. We will make the disclosure required by Item 16D of Form 20-F regarding such reliance in our annual reports on Form 20-F for the fiscal year ending December 31, 2005 and thereafter.

 

- 61 -


Nasdaq Marketplace Rule 4350(f) provide that each issuer provide for a quorum as specified in its by-laws for any meeting of holders of common stock, which shall be at least 33 1/3% of the outstanding shares of the issuer’s voting common stock. We provide for a quorum as specified in the Articles of Incorporation for any meeting of holders of common stock, which shall be at least one-third of our outstanding shares of the voting common stock.

 

Nasdaq Marketplace Rule 4350(g) provides that each issuer solicit proxies and provide proxy statements for all meetings of shareholders and provide copies of such proxy solicitation to Nasdaq. Currently a Japanese company whose shares are listed on the securities exchanges defined in the Securities and Exchange Law, including us, may, but is not required to, solicit proxies for meetings of shareholders. If such a Japanese company solicits proxies for a meeting of shareholders, it is required to provide proxy statements and documents for reference as provided for in the Securities and Exchange Law and provide copies of such proxy statements and documents for reference to the Kanto Local Finance Bureau.

 

Nasdaq Marketplace Rule 4350(h) provides that each issuer conduct appropriate review of all related party transactions for potential conflict of interest situations on an ongoing basis and that all such transactions be approved by the issuer’s audit committee or another independent body of the board of directors. Following the requirements of the Commercial Code of Japan, we require a director to obtain the approval of the Board of Directors in order for such director to accept a transfer of a product or any other asset of Trend Micro, to transfer a product or any other asset of such director to Trend Micro, to receive a loan from Trend Micro, or to effect any other transaction with Trend Micro, for himself or a third party.

 

Nasdaq Marketplace Rule 4350(i) provides that shareholder approval be obtained prior to the issuance of designated securities under subparagraph (A), (B), (C) or (D) of Rule 4350(i). Where a Japanese joint stock company (Kabushiki-Gaisha), issues common shares or other shares, stock acquisition rights or bonds with stock acquisition rights under the Commercial Code of Japan, it is necessary for the board of directors to determine the conditions of issuance; provided, however, that this shall not apply if the Articles of Incorporation provide that such conditions shall be determined by the shareholders’ meeting. Currently, Trend Micro’s Articles of Incorporation do not provide for any such exception. Additionally, if the company issues such securities to persons other than shareholders (in case of common shares or other shares) at a specially favorable issue price or (in case of stock acquisition rights or bonds with stock acquisition rights) on specially favorable conditions, even when there are provisions related thereto in the Articles of Incorporation, some matters related to such issuance shall be resolved by special resolution of the shareholders’ meeting.

 

The rights of ADR holders, including their rights relating to corporate governance practices, are provided in the deposit agreement which is an exhibit to this annual report.

 

- 62 -


LIMITATION OF LIABILITIES OF SOME DIRECTORS

 

We have entered into an agreement with one of our directors, Hirotaka Takeuchi, that limits his liabilities to us for damages suffered by us due to his acts taken in good faith and without gross negligence, up to the higher of (a) (Yen)10 million or (b) the amount specified in the agreement, which is the aggregate amount of two years’ remunerations and other compensation received or entitled to be received by him.

 

D. Employees.

 

As of December 31, 2004, we had 2,466 employees, of whom 1,719 were located in Asia, 381 were located in the United States, 281 were located in Europe and 85 were located in other regions. And of the 2,466 employees, 421 were in administrative positions, 653 were in sales and marketing positions, 641 were in research and development positions and 751 were in technical support positions.

 

As of December 31, 2003, we had 1,890 employees, of whom 1,255 were located in Asia, 312 were located in the United States, 270 were located in Europe and 53 were located in other regions. And of the 1,890 employees, 351 were in administrative positions, 581 were in sales and marketing positions, 476 were in research and development positions and 482 were in technical support positions.

 

Our employees do not belong to any labor union. We believe that our employee relations are good.

 

E. Share Ownership.

 

See Item 6.A for information on share ownership of our directors and senior management.

 

- 63 -


2002 INCENTIVE PLAN

 

We have adopted the Trend Micro Incorporated Incentive Plan. The plan was authorized in April 2002. We have issued warrants for a total of 1,159,420 shares at an exercise price of (Yen)3,450, of which 579 shares have been redeemed as of July, 2002. As of April 30, 2005, warrants to purchase a total of 475,362shares have been exercised, The following table shows information about the warrants granted to our directors and executive officers under the plan which were outstanding as of April 30, 2005.

 

Name


   Expiration Date

  

Total

Number of Shares

Underlying


  

Aggregate Exercise

Price


Steve Chang

   4/11/2006    3,188    (Yen) 10,998,600

Eva Chen

   4/11/2006    7,246    (Yen) 24,998,700

Mahendra Negi

   4/11/2006    21,739    (Yen) 74,999,550

Directors and Executive Officers as a group (8 people)

   4/11/2006    32,173    (Yen) 110,996,850

 

- 64 -


2003 INCENTIVE PLAN

 

Our Shareholders’ Meeting and Board of Directors have authorized three incentive plans for fiscal 2003. The first plan was authorized in February, 2003. Stock acquisition rights for a total of 1,999,500 shares were issued at an exercise price of (Yen)2,230. of which 290,500 shares have been redeemed as of January, 2004. As of April 30, 2005, stock acquisition rights for total of 803,500 shares have been exercised.

 

The following table shows information about the acquisition rights granted to our directors and executive officers under the first 2003 incentive plan which were outstanding as of April 30, 2005.

 

Name


   Expiration Date

  

Total

Number of Shares

Underlying


  

Aggregate Exercise

Price


Steve Chang

   10/31/2007    1,500    (Yen) 3,345,000

Eva Chen

   10/31/2007    18,500    (Yen) 41,255,000

Mahendra Negi

   10/31/2007    21,000    (Yen) 46,830,000

Directors and Executive Officers as a group (8 people)

   10/31/2007    41,000    (Yen) 91,430,000

 

The second plan was authorized in May, 2003. Stock acquisition rights for a total of 2,500,000 shares were issued at an exercise price of (Yen)1,955, of which 215,500 shares have been redeemed as of January, 2004. As of April 30, 2005, stock acquisition rights for a total of 544,500 shares have been exercised.

 

The following table shows information about the options granted to our directors and executive officers under the second 2003 incentive plan which were outstanding as of April 30, 2005.

 

Name


   Expiration Date

  

Total

Number of Shares

Underlying


   Aggregate Exercise
Price


Steve Chang

   5/27/2008    24,000    (Yen) 46,920,000

Eva Chen

   5/27/2008    45,000    (Yen) 87,975,000

Mahendra Negi

   5/27/2008    55,000    (Yen) 107,525,000

Directors and Executive Officers as a group (8 people)

   5/27/2008    124,000    (Yen) 242,420,000

 

The third plan was authorized in November, 2003. Stock acquisition rights for a total of 1,500,000 shares were issued at an exercise price of (Yen)2,695. As of April 30, 2005, stock acquisition rights for a total of 317,500 shares have been exercised.

 

The following table shows information about the options granted to our directors and executive officers under the third 2003 incentive plan which were outstanding as of April 30, 2005.

 

Name


   Expiration Date

  

Total

Number of Shares

Underlying


   Aggregate Exercise
Price


Steve Chang

   11/13/2008    15,000    (Yen) 40,425,000

Eva Chen

   11/13/2008    38,500    (Yen) 103,757,500

Mahendra Negi

   11/13/2008    29,000    (Yen) 78,155,000

Directors and Executive Officers as a group (8 people)

   11/13/2008    82,500    (Yen) 222,337,500

 

- 65 -


2004 INCENTIVE PLAN

 

Our Shareholders’ Meeting and Board of Directors have authorized two incentive plans for fiscal 2004. The first plan was authorized in April, 2004. Stock acquisition rights for a total of 3,000,000 shares were issued at an exercise price of (Yen)4,310. The following table shows information about the acquisition rights granted to our directors and executive officers under the 2004 incentive plan which were outstanding as of April 30, 2005.

 

Name


   Expiration Date

  

Total

Number of Shares

Underlying


  

Aggregate

Exercise Price


Eva Chen

   4/27/2009    80,000    (Yen) 344,800,000

Mahendra Negi

   4/27/2009    70,000    (Yen) 301,700,000

Directors and Executive Officers as a group (8 people)

   4/27/2009    150,000    (Yen) 646,500,000

 

The second plan was authorized in October, 2004 Stock acquisition rights for a total of 2,000,000 shares were issued at an exercise price of (Yen)5,090. The following table shows information about the options granted to our directors and executive officers under the second 2004 incentive plan which were outstanding as of April 30, 2005.

 

Name


   Expiration Date

  

Total

Number of Shares

Underlying


  

Aggregate

Exercise Price


Eva Chen

   10/27/2009    80,000    (Yen) 407,200,000

Mahendra Negi

   10/27/2009    56,000    (Yen) 285,040,000

Directors and Executive Officers as a group (8 people)

   10/27/2009    136,000    (Yen) 692,240,000

 

- 66 -


Item 7. Major Shareholders and Related Party Transactions.

 

A. Major Shareholders.

 

The Securities and Exchange Law of Japan requires any company which is the issuer of securities which are, among other considerations, listed on any Japanese stock exchange in Japan to disclose information about its major shareholders, including approximately its ten largest shareholders of record as of the end of each fiscal year and each semi-annual period. Also, as explained under Item 10.D below, any person who becomes, beneficially or of record and solely or jointly, a holder of more than 5% of the total issued shares of a company listed on any Japanese stock exchange, as calculated pursuant to the Securities and Exchange Law of Japan, must file with the Local Finance Bureau having jurisdiction within five business days a report concerning such shareholding. For this purpose, shares issuable to such person upon his exchange of exchangeable securities, conversion of convertible securities or exercise of warrants or stock acquisition rights are taken into account in determining both the size of his holding and the issuer’s total issued shares.

 

As of December 31, 2004, there were four shareholders of record holding 5% or more of the total issued shares of our common stock. One of these shareholders of record, Trueway Company Limited, which held of record 20,186,500 shares, or 14.8% of the total issued shares, is a corporation controlled by Yeh Min Yuen. Another record shareholder, Gainway Enterprises Limited, which held of record 10,108,000 shares, or 7.4% of the total issued shares, is a corporation controlled by Liao Hsueh-Hsuan. These two individuals’ beneficial ownership of our common stock is disclosed in the table below.

 

Japan Trustee Service Bank and Master Trust Bank of Japan are both the custody banks of Japanese mutual funds, pension fund and other trust funds. Japan Trustee Service Bank held of record 10,188,500 shares, or 7.5% of the total issued shares. Master Trust Bank of Japan held of record 10,072,500 shares, or 7.4% of the total issued shares.

 

Within the last three years, to our knowledge, the following significant changes in the percentage ownership held by major shareholders have occurred:

 

We are aware of the filing by Merrill Lynch Investment Managers Limited that, as of March 31, 2002, it and its affiliates together owned, beneficially or of record, 9.5% of the issued shares of our common stock, as calculated pursuant to the Securities and Exchange Law of Japan. Subsequently, Merrill Lynch Investment Managers Limited made another filing, which reported that, as of May 31, 2002, it and its affiliates owned, beneficially or of record, 5.2% of the issued shares of our common stock, as calculated pursuant to the Securities and Exchange Law of Japan. Subsequently, Merrill Lynch Investment Managers Limited made another filing reporting that, as of June 30, 2002, their beneficial or record ownership fell below 5% of the issued shares of our common stock, as calculated pursuant to the Securities and Exchange Law of Japan.

 

We are aware of the filing by Barclays Global Investors that, as of March 31, 2005, it and its affiliates together owned, beneficially or of record, 6.4% of the issued shares of our common stock, as calculated pursuant to the Securities and Exchange Law of Japan.

 

- 67 -


The following table shows information known to us regarding the beneficial ownership of our common stock as of March 31, 2005, by each person known by us to beneficially own more than 5% of the outstanding shares of our Common stock.

 

    

Shares of common stock

beneficially owned


 

Name


   Number

   Percentage

 

Yeh Min-Yuen

   20,186,500    14.8 %

Liao Hsueh-Hsuan

   10,108,000    7.4 %

 

As of December 31, 2004, there were 83 record shareholders with addresses in the United States, and those U.S. holders held 23,833,758 shares of our common stock including 934,800 held through our ADSs.

 

To the extent known to us, we are not directly or indirectly owned or controlled by another corporation, by the Japanese or any other government or by any other natural or legal persons severally or jointly.

 

We know of no arrangements the operations of which may at a later time result in a change of control of Trend Micro.

 

B. Related Party Transactions

 

Jenny Chang, a sister of Representative Director, President and Chief Executive Officer Eva Chen, and the spouse of Representative Director and Chairman of the Board Steve Chang, is a Senior Executive Vice President and Co-founder of Trend Micro.

 

Julie Lin is a sister of Steve Chang and is a Global Program Manager of Trend Micro U.S.

 

Elita Chen, a cousin of Eva Chen, is a Project Manager of Trend Micro Taiwan.

 

Cindia Chen, a cousin of Eva Chen, works on the general administrative staff of Trend Micro Taiwan.

 

The compensation of the above listed persons is determined by Trend Micro on no more favorable terms than those applicable to employees with equivalent qualifications and responsibilities.

 

C. Interests of Experts and Counsel.

 

Not applicable.

 

- 68 -


Item 8. Financial Statements.

 

A. Consolidated Statements and Other Financial Information.

 

Consolidated Financial Statements

 

The information required by this item has been provided beginning on page F-2.

 

Legal or Arbitration Proceedings

 

The information on legal or arbitration proceedings required by this item is set forth in Item 4.B of this annual report.

 

Dividend Policy

 

We intend to continue to return profits to shareholders based on the net profit on a consolidated basis while striving to enhance financial strength and secure inner reserve in order to deal with a volatile business environment and maintain a competitive edge against competitors. As our basic policy about dividends, we plan to pay a year-end dividend on the basis of a dividend ratio of 30%.

 

B. Significant Changes.

 

See Item 5.B of this annual report for information on the redemption of unsecured bonds.

 

- 69 -


Item 9. The Offer and Listing.

 

A. Offer and Listing Details.

 

JAPANESE OVER-THE-COUNTER MARKET AND THE TOKYO STOCK EXCHANGE

 

Our shares have been traded since August 18, 1998 on the Japanese over- the-counter market. On August 17, 2000, our shares were listed on Tokyo Stock Exchange, which is the principal trading market for the shares. Prior to August 18, 1998, there was no public market for the shares. The following table shows, for the periods indicated, the high and low closing per-share sale prices of the shares as reported by the Japan Securities Dealers Association and Tokyo Stock Exchange, retroactively taking into account the one-into-three stock split effected on September 30, 1999, and the one-into-two stock split effected on March 31, 2001.

 

     Yen Price Per Share

Japanese Over-The-Counter Market    High

   Low

1999

   12,500    1,183

2000

         

First quarter

   16,400    8,450

Second quarter

   9,550    4,750

Third quarter (until August 16)

   9,200    6,700

Tokyo Stock Exchange

         

2000

         

Third quarter (from August 17)

   9,005    6,805

Fourth quarter

   8,100    4,135

2001

   6,375    1,670

2002

   3,890    1,880

2003

   3,530    1,440

First quarter

   2,250    1,663

Second quarter

   2,120    1,440

Third quarter

   2,575    1,795

Fourth quarter

   3,530    2,300

2004

   5,730    2,815

First quarter

   3,710    2,815

Second quarter

   4,920    3,490

Third quarter

   5,050    4,070

Fourth quarter

   5,730    4,840

2005

         

January

   5,530    4,620

February

   4,930    4,530

March

   4,940    4,550

April

   4,740    3,850

 

On May 27, 2005, the closing sale price of our shares on the Tokyo Stock Exchange was (Yen) 3,520 per share.

 

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U.S. MARKET

 

Certain of our shares have been traded on The Nasdaq National Market since July 8, 1999 in the form of American Depositary Shares under the symbol “TMIC.” The following table shows, for the periods indicated, the high and low closing per-ADS sale price of the ADSs, retroactively taking into account the one-into-three stock split effected on September 30, 1999, the one-into-two stock split effected on March 31, 2001, and the ten-into-one ADR ratio change which take effect on July 2, 2001.

 

     Dollar Price Per ADS

     High

   Low

1999

         

Third quarter

   65.63    23.33

Fourth quarter

   121.25    66.88

2000

   159.38    32.50

2001

   59.38    14.50

2002

   30.90    15.55

2003

   31.65    12.16

First quarter

   18.90    14.22

Second quarter

   17.80    12.16

Third quarter

   22.50    15.00

Fourth quarter

   31.65    21.03

2004

   55.45    26.62

First quarter

   35.06    26.62

Second quarter

   44.97    31.04

Third quarter

   46.50    37.41

Fourth quarter

   55.45    44.46

2005

         

January

   54.65    44.02

February

   46.64    43.22

March

   47.20    42.48

April

   43.70    35.45

 

On May 27, 2005, the closing sale price of the ADSs on The Nasdaq National Market was $32.45 per ADS.

 

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B. Plan of Distribution.

 

Not applicable.

 

C. Markets.

 

See Item 9. A. of this annual report for information on the markets on which our common stock is listed or quoted.

 

D. Selling Shareholders.

 

Not applicable.

 

E. Dilution.

 

Not applicable.

 

F. Expenses of the Issue.

 

Not applicable.

 

 

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Item 10. Additional Information.

 

A. Share Capital.

 

Not applicable.

 

B. Memorandum and Articles of Association.

 

The following is a summary of material information concerning the shares, including summaries of material provisions of our Articles of Incorporation and share handling regulations, and of the Japanese Commercial Code and related legislation. These summaries should be read together with the Articles of Incorporation and the share handling regulations which have been filed as exhibits to our previous filings with the Securities and Exchange Commission.

 

GENERAL

 

Our authorized share capital as of March 31, 2005 is 250,000,000 shares, of which 135,968,861 shares are issued and 133,398,937 shares are outstanding as of the same date. Under the Japanese Commercial Code, shares must be registered and are transferable by delivery of share certificates. In order to assert shareholders’ rights against us, a shareholder must have its name and address registered on our register of shareholders, in accordance with our share handling regulations. The registered beneficial holder of deposited shares underlying the ADSs is the depositary for the ADSs. Accordingly, holders of ADSs will not be able to assert shareholders’ rights.

 

A holder of shares may choose, at its discretion, to participate in the central clearing system for share certificates under the Law Concerning Central Clearing of Share Certificates and Other Securities of Japan. Participating shareholders must deposit certificates representing all of the shares to be included in this clearing system with Japan Securities Depository Center. If a holder is not a participating institution in the Securities Center, it must participate through a participating institution, such as a securities company or bank having a clearing account with the Securities Center. All shares deposited with the center will be registered in the name of the Securities Center on our register of shareholders. Each participating shareholder will in turn be registered on our register of beneficial shareholders and be treated in the same way as shareholders registered on our register of shareholders. For the purpose of transferring deposited shares, delivery of share certificates is not required. Entry of the share transfer in the books maintained by the Securities Center for participating institutions, or in the book maintained by a participating institution for its customers, has the same effect as delivery of share certificates. The Securities Center system is intended to reduce paperwork required in connection with transfers of shares. Beneficial owners may at any time withdraw their shares from deposit and receive share certificates.

 

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In view of the globalization of securities trading, the Government of Japan is seeking to enhance the safety, efficiency and convenience of the clearing system for securities in Japan. For this purpose, a series of laws has been enacted to establish a unified clearing system for various types of securities and to eliminate certificates representing securities to be traded through this system. A new law to incorporate shares of stock into this “paperless clearing system” was promulgated on June 9, 2004 and will come into force and effect on a date, to be designated by a cabinet ordinance, which will occur within five years from the date of promulgation. On this effective date, the paperless clearing system is expected to become compulsorily applicable to the shares of all listed companies in Japan. On the same date, all share certificates issued by listed companies will become void and the Japan Securities Depository Center clearing system will terminate, but measures will be taken to ensure a smooth transition to the paperless clearing system with respect to all shares, whether the share certificates are then in the possession of shareholders or the Japan Securities Depository Center.

 

The paperless clearing system will be operated by a clearing organization (which may be the same entity as the Japan Securities Depository Center), and certain institutions, typically securities companies, will participate in the system directly or indirectly through other participating institutions. Following the application of the paperless clearing system to the shares of all listed companies, shareholders of each listed company will be recorded in such company’s register of shareholders. The register of shareholders will be updated at each record date for determining shareholders entitled to dividends and voting rights, and at any other date that may be designated by the company, based on information provided to the company by the clearing organization. Transfer of shares will be effected by book-entry in accounts maintained by the transferor and the transferee at participating institutions. This paperless clearing system is not yet applicable to shares of listed companies as of the date hereof.

 

In addition, the Japanese Commercial Code may change significantly in the near future. The New Commercial Code has just passed the House of Representatives and will become effective some time next year if it passes the House of Councilors.

 

DIVIDENDS

 

Under our Articles of Incorporation, our financial accounts will be closed on December 31 of each year and dividends, if any, will be paid to shareholders of record at December 31. In addition to year-end dividends, the Board of Directors may by resolution declare an interim cash dividend to shareholders of record as of June 30 of each year. Under the Japanese Commercial Code, however, we cannot declare or pay dividends unless specified financial criteria are met based on the amount of our stated capital and legal reserves.

 

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JAPANESE UNIT SHARE SYSTEM

 

In accordance with the requirements of the Japanese Commercial Code, our Articles of Incorporation provide that 500 shares constitute one “unit.” The number of shares constituting a unit is not permitted to exceed 1,000 shares or one-two-hundredth (1/200) of the number of all issued shares. The unit share system does not affect the transferability of ADSs, which may be transferred in lots of any size.

 

Under the Japanese Commercial Code and the Deposit Agreement, holders of ADSs will be able to surrender ADSs and withdraw the underlying shares from deposit only in whole unit lots of one unit or larger. A holder who owns ADRs evidencing less than 500 ADSs will indirectly own less than a whole unit. Such a holder will not be able to dispose of its shares in lots of less than one unit and will not have access to the Japanese market through surrender of their ADSs and withdrawal and sale in Japan of the underlying shares. The Japanese unit share system does not affect the transferability of ADSs, which may be transferred in lots of any size.

 

A holder of shares representing less than one unit may at any time require us to purchase such shares. Such shares will be purchased at their last reported sale price on the First Section of the Tokyo Stock Exchange on the day a request pertaining to such purchase is delivered to our transfer agent or, if no sales take place on that day, the price at which the next sale of shares is effected on the First Section of the Tokyo Stock Exchange, less applicable brokerage commissions. However, because holders of ADSs representing less than one unit are not able to withdraw the underlying shares from deposit, such holders will not be able to exercise this right as a practical matter.

 

Under our Articles of Incorporation, a holder of shares representing less than one unit has all the rights that a holder of shares representing a full unit of shares; except for the rights:

 

  to require us to issue share certificates;

 

  to require us to issue replacement certificates for lost, stolen or destroyed share certificates; and

 

  to vote.

 

A holder of shares representing less than one unit cannot exercise any voting rights pertaining to such shares. In calculating the quorum for various voting purposes, the aggregate number of shares representing less than one unit will be excluded from the number of outstanding shares. A holder of shares representing one or more whole units will have one vote for each unit held.

 

GENERAL MEETING OF SHAREHOLDERS

 

We normally hold our ordinary general meeting of shareholders in March of each year in Tokyo, Japan. In addition, we may hold an extraordinary general meeting of shareholders whenever necessary by giving at least two weeks’ advance notice. Under the Japanese Commercial Code, notice of any shareholders’ meeting must be given to each shareholder having voting rights or, in the case of a non-resident shareholder, to his resident proxy or mailing address in Japan in accordance with our share handling regulations, at least two weeks prior to the date of the meeting.

 

Any shareholder or group of shareholders holding at least 300 voting rights, or 1% of the total outstanding voting rights, for a continuous period of six months or longer may propose a matter for consideration at a shareholders meeting by submitting a written request to the Directors at least eight weeks before such meeting.

 

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VOTING RIGHTS

 

A shareholder is generally entitled to one vote per unit. In general, under the Japanese Commercial Code, a resolution can be adopted at a general meeting of shareholders by a majority of the voting rights represented at the meeting. The Commercial Code and our Articles of Incorporation require a quorum for the election of directors and corporate auditors of not less than one-third of the total number of outstanding voting rights. Our shareholders are not entitled to cumulative voting in the election of directors. A corporate shareholder whose outstanding voting rights are in turn more than one-quarter directly or indirectly owned by us does not have voting rights. Shareholders may exercise their voting rights through proxies, provided that such proxies are also shareholders who have voting rights.

 

The Japanese Commercial Code and the Article of Incorporation provide that a quorum of not less than one-third of outstanding voting rights must be present at a shareholders’ meeting to approve any material corporate actions such as:

 

  amendment of the Articles of Incorporation;

 

  the removal of a director or corporate auditor;

 

  establishment of a 100% parent-subsidiary relationship by way of share exchange or share transfer;

 

  a dissolution, merger or consolidation;

 

  a company split;

 

  the transfer of the whole or an important part of our business;

 

  the taking over of the whole of the business of any other corporation;

 

  any issuance of new shares at a “specially favorable” price (or any issuance of bond with share acquisition right with “specially favorable” terms or of share acquisition right with “specially favorable” terms to persons other than shareholders.

 

  the negotiated purchase of treasury shares;

 

  a stock consolidation;

 

  limitation of liabilities of directors and corporate auditors;

 

  capital reduction; and,

 

  a continuing to exist of a company or dormant company.

 

At least two-thirds of the voting rights represented at the meeting must approve such actions.

 

The voting rights of holders of ADSs are exercised by the depositary based on instructions from such holders. An agent of the depositary is the record holder of the underlying shares.

 

- 76 -


SUBSCRIPTION RIGHTS

 

Holders of shares have no preemptive rights under our Articles of Incorporation. Under the Japanese Commercial Code, the Board of Directors may, however, determine that shareholders be given subscription rights in connection with a particular issue of new shares. In this case, such rights must be given on uniform terms to all shareholders as of a specified record date by at least two weeks’ prior public notice to shareholders of the record date. Public or individual notice must be given to each of these shareholders at least two weeks prior to the date of expiration of the subscription rights.

 

Rights to subscribe for new shares may be transferable or nontransferable as determined by the Board of Directors. If subscription rights are not transferable, a purported transfer by a shareholder who is not resident in Japan will be enforceable against us and third parties only with our prior written consent.

 

LIQUIDATION RIGHTS

 

Upon liquidation, the assets remaining after payment of all debts, liquidation expenses and taxes will be distributed among the shareholders in proportion to the number of shares they own.

 

LIABILITY TO FURTHER CALLS OR ASSESSMENTS

 

All of our currently outstanding shares, including shares represented by the ADSs, are fully paid and nonassessable.

 

INDEMNIFICATION OF DIRECTORS

 

Pursuant to the Commercial Code and our Articles of Incorporation, we may, by resolution of our Board of Directors, release the liabilities of any Directors or Executive Officers to us for damages suffered by us due to their acts taken in good faith and without gross negligence, to the extent permitted by law and our Articles of Incorporation. In addition, we may execute with outside directors agreements that limit their liabilities to us for damages suffered by us due to their acts in good faith and without gross negligence, to the extent permitted by the laws of Japan and our Articles of Incorporation.

 

TRANSFER AGENT

 

UFJ Trust and Banking Co., Limited is the transfer agent for our common stock. UFJ Trust and Banking Co.’s office is located at 4-3, Marunouchi 1-chome, Chiyoda-ku, Tokyo, 100-0005 Japan. UFJ Trust and Banking Co., maintains our register of shareholders and records transfers of record ownership upon presentation of share certificates.

 

- 77 -


REPURCHASE OF SHARES BY US

 

The Japanese Commercial Code, in principle, permits us to acquire, hold or dispose of our shares. We may acquire our shares on the First Section of the Tokyo Stock Exchange on which the shares are traded, through the Japanese stock exchange, if any, on which such shares are listed, by way of tender offer (pursuant to a resolution of a meeting of the Board of Directors, by having been provided for in the Articles of Incorporation), from a specific party (pursuant to a special resolution of an ordinary general meeting of shareholders) or from our subsidiary (pursuant to a resolution of the Board of Directors). When such acquisition is made by us from a specific party other than our subsidiary, any shareholder may make a request directly to a director, five days prior to the relevant shareholders’ meeting, that we acquire the shares held by such shareholder. Any such acquisition of shares must satisfy certain requirements, including that the total amount of the purchase price may not exceed the amount of the retained earnings available for dividend payments and the amount of any reduction of the stated capital, additional paid-in capital or legal reserve (if such reduction of the stated capital, additional paid-in capital or legal reserve has been authorized pursuant to a resolution of the relevant general meeting of shareholders), minus the amount to be paid by way of appropriation of retained earnings for the relevant fiscal year. However, if it is anticipated that the net assets on the balance sheet as at the end of the relevant fiscal year will be less than the aggregate amount of the stated capital, additional paid-in capital, the accumulated legal reserve and other certain items prescribed under the law, we may not purchase such shares. We may hold the shares acquired in compliance with the provisions of the Japanese Commercial Code, and generally, may dispose of or cancel such shares by a resolution of the Board of Directors.

 

DAILY PRICE FLUCTUATION LIMITS UNDER JAPANESE STOCK EXCHANGE RULES

 

Share prices on Japanese stock exchanges are determined on a real-time basis by the equilibrium between bids and offers. These exchanges are order-driven markets without specialists or market makers to guide price formation. To prevent excessive volatility, these exchanges set daily upward and downward price fluctuation limits for each share, based on the previous day’s closing price. Although transactions may continue at the upward or downward limit price if the limit price is reached on a particular trading day, no transactions may take place outside these limits. Consequently, an investor wishing to sell at a price above or below the relevant daily limit may not be able to sell his shares at such price on a particular trading day, or at all.

 

On May 27, 2005, the closing price of our shares on the Tokyo Stock Exchange was (Yen)3,520 per share. The following table shows the daily price limit for a stock on the Tokyo Stock Exchange with a closing price of between (Yen)3,000 and (Yen)5,000 per share, as well as the daily price limit if our per share price were to rise to between (Yen)5,000 and (Yen)10,000, or fall to between (Yen)2,000 and (Yen)3,000. Other daily price limits would apply if our per share price moved to other ranges.

 

Selected Daily Price Limits


   

Previous Day’s Closing Price or Special Quote


 

Maximum Daily

Price Movement


Over

  (Yen)  2,000   Less than   (Yen)    3,000   (Yen)     400

Over

  3,000   Less than   5,000   500

Over

  5,000   Less than   10,000   1,000

 

For a history of the trading price of our shares on the Tokyo Stock Exchange, see Item 9.A of this annual report.

 

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C. Material Contracts.

 

The information required by this item is set forth in Item 4.

 

D. Exchange Controls.

 

The Foreign Exchange and Foreign Trade Law of Japan and the cabinet orders and ministerial ordinances issued under the law govern the acquisition and holding of shares of equity securities of Japanese corporations, including Trend Micro, by exchange non-residents and by foreign investors.

 

Exchange non-residents are individuals who are not resident in Japan and corporations whose principal offices are located outside Japan. Generally, branches and other offices of non-resident corporations located within Japan are regarded as exchange residents of Japan and branches and other offices of Japanese corporations located outside Japan are regarded as exchange non-residents of Japan.

 

Foreign investors are defined to be:

 

  individuals not resident in Japan;

 

  corporations which are organized under the laws of foreign countries or whose principal offices are located outside Japan;

 

  corporations not less than 50% of the shares of which are directly or indirectly held by individuals or corporations described above; and

 

  a corporation in which a majority of the directors or similar persons having the power of representation are non-resident individuals of Japan.

 

In accordance with this amendment, with minor exceptions, all aspects of the foreign exchange and foreign trade transactions which under the previous law required licensing or other approval or prior notification to the Minister of Finance of Japan now only require reporting of such transactions after they occur. However, the Minister of Finance of Japan retains the power to impose a licensing requirement for some transactions in limited circumstances.

 

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OFFERING OF THE SHARES

 

A selling shareholder is required to file a report concerning the transfer of securities with the Minister of Finance of Japan within 20 days of the date of transfer.

 

ACQUISITION OF SHARES

 

Except as described below, there are no limits under Japanese law on the right of foreign investors to hold or vote our securities. Exchange non- residents who acquire from an exchange resident of Japan shares of a company, listed on any Japanese stock exchange or whose shares are traded on the Japanese over-the-counter market, are not required to file any notice prior to the acquisition. Under the Foreign Exchange and Foreign Trade Law the Minister of Finance may in some exceptional circumstances require prior approval for any such acquisition. An exchange resident who transfers shares of a listed company to an exchange non-resident for value exceeding (Yen)100 million must file a report concerning the transfer of securities with the Minister of Finance within 20 days of the date of such transfer.

 

If a foreign investor acquires shares of a company listed on any Japanese stock exchange or whose shares are traded on the Japanese over-the-counter market and as a result of the acquisition, such foreign investor and designated related parties hold 10% or more of the issued shares, the foreign investor must file a report of the acquisition with the Minister of Finance and other Ministers having jurisdiction over the business of the issuer within 15 days from and including the date of the acquisition. In limited circumstances, including the case of an acquisition of our shares that causes a foreign investor’s ownership to reach such percentage, however, a prior notification of the acquisition must be filed with the Minister of Finance and other Ministers having jurisdiction over the business of the issuer. These Ministers may modify or prohibit the proposed acquisition.

 

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DIVIDENDS AND PROCEEDS OF SALES

 

Under the Foreign Exchange and Foreign Trade Law, dividends paid on, and the proceeds of sales in Japan of, shares held by exchange non-residents may, in general, be converted into any foreign currency and repatriated abroad. The requirements described in “Acquisition of Shares” above do not apply to the acquisition of shares by non-residents by way of stock splits.

 

AMERICAN DEPOSITARY SHARES

 

The formalities or restrictions referred to under “—Acquisition of Shares” above do not apply to the deposit of shares by a non-resident of Japan, the issuance of ADRs evidencing the ADSs created by such deposit in exchange therefore and the withdrawal of whole units of underlying shares upon surrender of ADRs.

 

REPORTING OF SUBSTANTIAL SHAREHOLDINGS

 

The Securities and Exchange Law of Japan requires any person who becomes, beneficially or of record and solely or jointly, a holder of more than 5% of the total issued shares of a company listed on any Japanese stock exchange or whose shares are traded on the Japanese over-the-counter market to file with the Financial Services Agency within five business days a report concerning such shareholding.

 

A similar report must also be made in respect of any subsequent change of 1% or more in any such holding. For this purpose, shares issuable to such person upon conversion of convertible securities or exercise of share subscription warrants are taken into account in determining both the number of shares held by the holder and the issuer’s total issued share capital. Copies of each such report must also be sent to the issuer of such shares and all Japanese stock exchanges on which the shares are listed

 

- 81 -


E. Taxation.

 

JAPANESE TAXATION

 

In general, for Japanese tax purposes, owners of ADRs evidencing ADSs will be treated as the owners of the shares represented by such ADSs, and no Japanese tax will be payable on exchanges of shares for ADSs, and ADSs for shares.

 

This discussion does not consider the effect of any state, local or national tax laws other than Japanese tax laws that may be applicable to a purchaser of shares or ADSs. Furthermore, the “Convention Between the United States of America and Japan for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income” (the “Treaty”), the laws, or administrative or judicial interpretation of the Treaty or the laws may change, and the changes may have retroactive effect. We urge you to consult your tax advisors regarding the Japanese and other tax consequences of owning and disposing of shares and ADSs.

 

The following summary describes the principal Japanese tax consequences relating to an investment in our shares or ADSs. This summary applies only to persons or entities which are non-residents of Japan and to non-Japanese corporations without a permanent establishment in Japan to which the relevant income is attributable.

 

Generally, Japanese withholding tax will apply to dividends paid by us to a non-resident of Japan or a non-Japanese corporation. In general, no Japanese tax is payable on stock splits.

 

Under the Treaty, as currently in force after July 1, 2004, the maximum rate of Japanese withholding tax which may be imposed on dividends paid to a United States resident or corporation not having a “permanent establishment,” which is generally a fixed place of business for industrial or commercial activity, in Japan is limited to:

 

(1) 5% of the gross amount of the dividends if the beneficial owner is a company that owns directly or indirectly, on the date on which entitlement to the dividends is determined, at least 10 % of the voting stock of the company paying the dividends; or

 

(2) 10 % of the gross amount of the dividends in all other cases.

 

Notwithstanding the above, Japanese withholding tax shall not be imposed on such dividends if the beneficial owner of the dividends is:

 

(1) a company that is a resident of the United States that has owned, directly or indirectly through one or more residents of either Japan or the United States, more than 50 % of the voting stock of the company paying the dividends for the period of twelve months ending on the date on which entitlement to the dividends is determined and that satisfies other conditions; or

 

(2) a pension fund that is a resident of the United States, provided that such dividends are not derived from the carrying on of a business, directly or indirectly, by such pension fund.

 

For purposes of the Treaty, and Japanese tax law, U.S. holders of ADRs will be treated as the beneficial owners of the shares underlying the ADSs evidenced by the ADRs.

 

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In the absence of any applicable tax treaty, convention or agreement reducing the maximum rate of withholding tax, the rate of Japanese withholding tax applicable to dividends paid by Japanese corporations to a non-resident or non-Japanese corporation is 20%. Japan has entered into income tax treaties, conventions or agreements, whereby the 20% withholding tax rate is reduced generally to 15% for portfolio investors. In addition to the United States, countries with which Japan has concluded such treaties, conventions or agreements include Australia, Belgium, Canada, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, The Netherlands, New Zealand, Norway, Singapore, Spain, Sweden, Switzerland and the United Kingdom.

 

You must file an application for reduced withholding with the Japanese tax authorities through taxpayer to claim the benefits of the reduced withholding rate on dividends under the Treaty. The application must be filed on or before the day on which the dividend is paid. If you hold ADSs, two application forms must be filed through the depositary, one form before the dividend payment and the other within eight months after our fiscal year in which the dividend is paid. To claim the reduced rate, you will need to file proof of:

 

  taxpayer status;

 

  residence; and

 

  beneficial ownership.

 

The depositary may also require you to provide other information. If you do not submit an application for reduced withholding before a dividend is paid, you may file a claim for refund of the excess tax with the Japanese tax authorities.

 

Under the Special Taxation Measures Law amended at March 31, 2003, the rate of withholding tax applicable to dividends paid to shareholders other than those holding 5% or more of the total number of issued shares, by Japanese corporations listed on any Japanese stock exchange or whose shares are traded on the Japanese over-the-counter market, on and after April 1, 2003 is reduced to 15%. Additionally, the above dividends paid on and after April 1, 2003 are applied to the privilege tax rate of 10%, from April 1, 2004 to March 31 and 7%, January 1, 2004 to March 31, 2008.

 

You will not have to pay any Japanese tax on a sale of our shares or ADSs. If you make a gift of our shares or die holding our shares, a person who receives the shares as a gift or inherits the shares may have to pay Japanese gift or inheritance tax.

 

- 83 -


UNITED STATES FEDERAL INCOME TAXATION

 

This section describes the material U.S. federal income taxation of the ownership of shares or ADSs by U.S. Holders, as defined below. It applies to you only if you hold your shares or ADSs as capital assets for tax purposes.

 

This section is based on the Internal Revenue Code of 1986, as amended (the “Code”), its legislative history, existing and proposed regulations, published rulings and court decisions, all as currently in effect, as well as on the Treaty. These laws are subject to change, possibly on a retroactive basis. In addition, this section is based in part upon the representations of the Depositary and the assumption that each obligation in the Deposit Agreement and any related agreement will be performed in accordance with its terms.

 

For purposes of the Treaty and the Code, U.S. holders of ADRs will be treated as the owners of the shares underlying the ADSs evidenced by the ADRs. Exchanges of shares for ADRs, and ADRs for shares, generally will not be subject to U.S. federal income tax. For purposes of this discussion, you are a U.S. holder if you are a beneficial owner of shares or ADSs and you are for United States federal income tax purposes (i) a citizen or resident of the United States, (ii) a domestic corporation, (iii) an estate whose income is subject to United States federal income tax regardless of its source, (iv) a trust if a United States court can exercise primary supervision over the trust’s administration and one or more United States persons are authorized to control all substantial decisions of the trust; (v) you do not maintain a permanent establishment or fixed base in Japan to which shares or ADSs are attributable and through which you carry on or have carried on business (or in the case of an individual, performs or has performed independent personal services) and (vi) you are not otherwise ineligible for benefits under the Treaty with respect to income and gain from the shares or ADSs.

 

This section does not apply to you if you are a member of a special class of holders subject to special rules, including a dealer in securities, a trader in securities that elects to use a mark-to-market method of accounting for your securities holdings, a tax-exempt organization, a life insurance company, a person liable for alternative minimum tax, a person that actually or constructively owns 10% or more of the voting stock of Trend Micro, a person that holds shares or ADSs as part of a straddle or a hedging or conversion transaction, or a U.S. holder whose functional currency is not the U.S. dollar.

 

This summary is not a comprehensive description of all the tax considerations that may be relevant with respect to your shares or ADSs. You should consult your own tax advisor regarding the U.S. federal, state and local and other tax consequences of owning and disposing of shares and ADSs in your particular circumstances.

 

- 84 -


Taxation of Dividends.

 

Under the U.S. federal income tax laws, and subject to the passive foreign investment company (“PFIC”) rules discussed below, if you are a U.S. holder, the gross amount of any dividend that Trend Micro pays out of its current or accumulated earnings and profits (as determined for U.S. federal income tax purposes) is subject to United States federal income taxation. You must include any Japanese tax withheld from the dividend payment in this gross amount even though you do not in fact receive it. Dividends paid to a noncorporate U.S. holder in taxable years beginning before January 1, 2009 that constitute qualified dividend income will be taxable to such holder at a maximum tax rate of 15% provided that the noncorporate U.S. holder holds the shares or ADSs for more than 60 days during the 121-day period beginning 60 days before the ex-dividend date and meets other holding period requirements. Dividends that Trend Micro pays with respect to the shares or ADSs will generally be qualified dividend income.

 

The dividend is taxable to you when you, in the case of shares, or the Depositary, in the case of ADSs, receive the dividend, actually or constructively. The dividend will not be eligible for the dividends-received deduction generally allowed to U.S. corporations in respect of dividends received from other U.S. corporations. The amount of the dividend distribution that you must include in your income as a U.S. holder will be the U.S. dollar value of the Japanese yen payments made, determined at the spot Japanese yen/U.S. dollar rate on the date of the dividend distribution, regardless of whether the payment is in fact converted into U.S. dollars. Generally, any gain or loss resulting from currency exchange fluctuations during the period from the date you include the dividend payment in income to the date you convert the payment into U.S. dollars will be treated as ordinary income or loss and will not be eligible for the special tax rate applicable to qualified dividend income. The gain or loss generally will be income or loss from sources within the U.S. for foreign tax credit limitation purposes. Distributions in excess of current and accumulated earnings and profits, as determined for U.S. federal income tax purposes, will be treated as a non-taxable return of capital to the extent of your basis in the shares or ADSs and thereafter as capital gain.

 

Subject to certain limitations, the Japanese tax withheld in accordance with the Treaty and paid over to Japan will be creditable against your United States federal income tax liability. Special rules apply in determining the foreign tax credit limitation with respect to dividends that are subject to the maximum 15% tax rate. To the extent a refund of the tax withheld is available to you under Japanese law or under the Treaty, the amount of tax withheld that is refundable will not be eligible for credit against your United States federal income tax liability. Please see “Japanese Taxation,” above, for the procedures for obtaining a reduced rate of withholding under a treaty or a tax refund.

 

Dividends will be income from sources outside the United States, but dividends paid in taxable years beginning before January 1, 2007 generally will be “passive” or “financial services” income and dividends paid in taxable years beginning after December 31, 2006 will, depending on your circumstances, be “passive” or “general” income which is, in either case, treated separately from other types of income for purposes of computing the foreign tax credit allowable to you.

 

Distributions of additional shares to you with respect to shares or ADSs that are made as part of a pro rata distribution to all shareholders of Trend Micro generally will not be subject to United States federal income tax.

 

- 85 -


Taxation of Capital Gains

 

Subject to the PFIC rules discussed below, if you are a U.S. holder and you sell or otherwise dispose of your shares or ADSs, you will recognize capital gain or loss for U.S. federal income tax purposes equal to the difference between the U.S. dollar value of the amount that you realize and your tax basis, determined in U.S. dollars, in your shares or ADSs. Capital gain of a noncorporate U.S. holder that is recognized before January 1, 2009 will generally be taxed at a maximum rate of 15% where the holder has a holding period greater than one year. The gain or loss will generally be income or loss from sources within the U.S. for foreign tax credit limitation purposes.

 

PFIC Rules

 

We believe that shares and ADSs should not be treated as shares of a PFIC for U.S. federal income tax purposes, but this conclusion is a factual determination that is made annually and thus may be subject to change. Moreover, this determination will be based in part on circumstances that are beyond our control, such as, for example, our market capitalization. If we were to be treated as a PFIC, unless a U.S. holder elects to be taxed annually on a mark-to-market basis with respect to the shares or ADSs, gain realized on the sale or other disposition of your shares or ADSs would in general not be treated as capital gain. Instead, if you are a U.S. holder, you would be treated as if you had realized such gain and certain “excess distributions” ratably over your holding period for the shares or ADSs and would be taxed at the highest tax rate in effect for each such year to which the gain was allocated, together with an interest charge in respect of the tax attributable to each such year. With certain exceptions, shares or ADSs will be treated as stock in a PFIC if Trend Micro were a PFIC at any time during your holding period in your shares or ADSs. Dividends that a U.S. holder receives from Trend Micro will not be eligible for the special tax rates applicable to qualified dividend income if Trend Micro is a PFIC either in the taxable year of the distribution or the preceding taxable year, but instead will be taxable at rates applicable to ordinary income.

 

- 86 -


F. Dividends and Paying Agents.

 

Not applicable

 

G. Statements by Experts.

 

Not applicable

 

H. Documents on Display.

 

We are subject to the informational requirements of the Securities Exchange Act of 1934 and, in accordance therewith, we file periodic reports and other information with the Securities and Exchange Commission. These reports and other information can be inspected at the public reference room at the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington, D.C. 20549. You can also obtain copies of such material by mail from the public reference room of the Securities and Exchange Commission at prescribed fees. You may obtain information on the operation of the Securities and Exchange public reference room by calling the Securities and Exchange Commission in the United States at 1-800-SEC-0330. The Securities and Exchange Commission also maintains a web site at www.sec.gov that contains reports, proxy statements and other information regarding registrants that file electronically with the Securities and Exchange Commission. As a foreign private issuer, we are exempt from the rules under the Securities Exchange Act of 1934 prescribing the furnishing and content of proxy statements to shareholders.

 

I. Subsidiary Information.

 

Not applicable

 

Item 11. Quantitative and Qualitative Disclosures About Market Risk.

 

As discussed in Note 17 to the consolidated financial statements, we have a policy of not utilizing any derivative financial instruments with off-balance sheet risk. The financial instruments other than derivatives as of December 31, 2004 were cash and cash equivalents, time deposits, marketable debt and equity securities, notes and accounts receivable, trade, notes and account payable, trade and long-term debt. Among these financial instruments, we do not have significant market sensitive instruments with significant exposure to market risk. When we acquired ipTrend, we acquired two derivative instruments which ipTrend held. One of those instruments has expired during the fiscal year 2004 and the other has also expired at January 2005. At the expiration, we did not suffer any material losses from those instruments. However, this has not altered our policy of not utilizing derivative financial statements.

 

Item 12. Description of Securities Other than Equity Securities.

 

Not applicable

 

- 87 -


PART II

 

Item 13. Defaults, Dividend Arrearages and Delinquencies.

 

None

 

Item 14. Material Modifications to the Rights of Security Holders and Use of Proceeds.

 

None

 

Item 15. Controls and Procedures.

 

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the U.S. Securities Exchange Act of 1934) as of December 31, 2004. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of that date.

 

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) under the U.S. Securities Exchange Act of 1934) occurred during the year ended December 31, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

- 88 -


Item 16A. Audit Committee Financial Expert.

 

Our Board of Corporate Auditors has determined that we do not have an “audit committee financial expert” as defined in Item 16A of Form 20-F serving on the Board of Corporate Auditors. We believe that the combined knowledge, skills and experience of the Board of Corporate Auditors enables them, as a group, to act effectively in the fulfillment of their tasks and responsibilities, including those under the Sarbanes-Oxley Act of 2002. In addition, the Corporate Auditors have the power and authority to engage outside experts as they deem appropriate to provide them with advice on matters related to their responsibilities.

 

Item 16B. Code of Ethics.

 

We have adopted a code of conduct applicable to all of our employees, including our Chief Executive Officer, Chief Financial Officer, Group Controller and other senior finance officers. A copy of our code of conduct is attached as an exhibit to this report.

 

Item 16C. Principal Accountant Fees and Services.

 

The following table sets forth the aggregate fees billed or to be billed to us by PricewaterhouseCoopers, our principal accountant, for the following categories of fees from each of the last two fiscal years.

 

     Fiscal 2003

   Fiscal 2004

     (in millions of yen)

Audit fees

   (Yen) 83.88    (Yen) 95.36

Audit-related fees (1)

     0.01      5.00

Tax fees (2)

     37.81      28.82

All Other fees (3)

     1.02      1.29
    

  

Total Fees

   (Yen) 122.71    (Yen) 130.47
    

  

 

(1)

  Audit-related fees include fees relating to advisory services relating to Section 404 of the Sarbanes-Oxley Act.

(2)

  Tax fees consist of fees relating to tax compliance, tax advice and tax planning services.

(3)

  All Other fees include fees relating to lectures to the Board of Corporate Auditors about U.S. GAAP and SEC regulations.

 

Our Board of Corporate Auditors has adopted guidelines for pre-approving all audit and non-audit services performed by our principal accountant and its affiliates in accordance with Rule 2-01(c)(7)(i)(A) under Regulation S-X. Under those guidelines, the Board of Corporate Auditors must pre-approve individual audit and non-audit services before they are provided by our principal accountant and its affiliates to us. Those guidelines also describe prohibited services that may never be provided. Our Board of Corporate Auditors does not use the provisions of Rule 2-01(c)(7)(i)(B) under Regulation S-X for pre-approving audit and non-audit services.

 

None of the services described above in this Item 16C were waived from the pre-approval requirements pursuant to Rule 2-01(c)(7)(i)(C) of Regulation S-X.

 

Item 16D. Exemptions from the Listing Standards for Audit Committees.

 

Not applicable

 

- 89 -


Item 16E. Purchases of Equity Securities by the Issuer and Affiliated Purchasers.

 

The following table sets forth certain information with respect to purchases we made of our shares during the year ended December 31, 2004.

 

Period


  

(a)

Total Number of
Shares


   (b)
Average Price
Paid per
Share


  

(c)

Total Number of Shares
Purchased as Part of
Publicly Announced Plans

or Programs


   (d)
Maximum Number of
Shares that May Yet Be
Purchased Under the
Plans or Programs


January 1 to January 31, 2004

   15,443  (Shares)    3,107  (Yen)    - (Shares)    - (Shares)

February 1 to February 29, 2004

   10,507  (Shares)    3,096  (Yen)    - (Shares)    - (Shares)

March 1 to March 31, 2004

   82,077  (Shares)    3,519  (Yen)    - (Shares)    - (Shares)

April 1 to April 30, 2004

   68,042  (Shares)    4,161  (Yen)    - (Shares)    - (Shares)

May 1 to May 31, 2004

   282,630  (Shares)    3,887  (Yen)    263,500  (Shares)    736,500  (Shares)

June 1 to June 30, 2004

   209,508  (Shares)    4,131  (Yen)    111,500  (Shares)    - (Shares)

July 1 to July 31, 2004

   48,584  (Shares)    4,571  (Yen)    - (Shares)    - (Shares)

August 1 to August 31,2004

   29,716  (Shares)    4,440  (Yen)    - (Shares)    - (Shares)

September 1 to September 30, 2004

   61,042  (Shares)    4,917  (Yen)    - (Shares)    - (Shares)

October 1 to October 31, 2004

   46,264  (Shares)    5,005  (Yen)    - (Shares)    - (Shares)

November 1 to November 30, 2004

   41,980  (Shares)    5,300  (Yen)    - (Shares)    - (Shares)

December 1 to December 31, 2004

   6,499  (Shares)    5,332  (Yen)    - (Shares)    - (Shares)

Total

   902,292  (Shares)    4,167  (Yen)    375,000  (Shares)    - (Shares)

 

Footnotes:

 

a. The date each plan or program was announced: May 19th, 2004.
b. The share amount approved: 1,000,000 shares.
c. The expiration date of each plan or program: June 23rd, 2004.
d. Each plan or program that expired during the period covered by the table: The plan referred to in note a. above.
e. Each plan or program the issuer has determined to terminate prior to expiration, or under which the issuer does not intend to make further purchases: None.

 

- 90 -


PART III

 

Item 17. Financial Statements.

 

In lieu of responding to this item, we have responded to Item 18 of this annual report.

 

Item 18. Financial Statements.

 

The information required by this item is set forth beginning on page F-2 of this annual report.

 

Item 19. Exhibits.

 

Exhibits

 

Exhibit
Number


   

Document


1.1     Articles of Incorporation of Trend Micro (English translation)
1.2 *   Share Handling Regulations of Trend Micro, as amended (English translation)
1.3     Regulations of the Board of Directors of Trend Micro, as amended (English translation)
1.4 *   Regulations of the Board of Corporate Auditors of Trend Micro, as amended (English translation)
2.1 **   Specimen Common Stock Certificates
2.2 ***   Form of Deposit Agreement among Trend Micro, The Bank of New York as depositary and all owners and holders from time to time of American Depositary Receipts, including the form of American Depositary Receipt
4.1 ****+   Basic Agreement on Continual Sale and Purchase of Goods dated October 1, 1999, between Trend Micro Incorporated and SOFTBANK BB (formerly known as SOFTBANK COMMERCE CORP.), and related agreements
4.2     Limited Liability Agreement dated April 21, 2005, between Trend Micro Incorporated and Hirotaka Takeuchi
8.1     List of subsidiaries of Trend Micro
11.1 *   Code of Conduct
12.1     Certification of the principal executive officer of Trend Micro required by Rule 13a-14(a)
12.2     Certification of the principal financial officer of Trend Micro required by Rule 13a-14(a)
13.1     Certification of the chief executive officer required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code
13.2     Certification of the chief financial officer required by Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code
15.1     Consent of Independent Registered Public Accounting Firm

* Incorporated by reference to the corresponding exhibit to our annual report of Form 20-F (File No. 333-10486) filed on June 1, 2004.
** Incorporated by reference to the corresponding exhibit to our annual report on Form 20-F (File No. 333-10486) filed on June 29, 2001.
*** Incorporated by reference to the corresponding exhibit to our Amendment No. 1 to Registration Statement on Form F-6 (File No. 333-10492) filed on June 22, 2001.
**** Incorporated by reference to the corresponding exhibit to our Amendment No. 2 to the Form F-1 Registration Statement (File No. 333-10568) filed on May 22, 2000.
+ Confidential treatment granted for a portion of these documents.

 

We have not included as exhibits certain instruments with respect to our long-term debt, the amount of debt authorized under each of which does not exceed 10% of our total assets, and we agree to furnish a copy of any such instrument to the Securities and Exchange Commission upon request.

 

- 91 -


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

     Page

Report of independent registered public accounting firm.

   F-2

Consolidated balance sheets at December 31, 2003 and 2004.

   F-3

Consolidated statements of income for the years ended December 31, 2002, 2003 and 2004

   F-5

Consolidated statements of comprehensive income for the years ended December 31, 2002, 2003 and 2004

   F-6

Consolidated statements of shareholders’ equity for the years ended December 31, 2002, 2003 and 2004

   F-7

Consolidated statements of cash flows for the years ended December 31, 2002, 2003 and 2004

   F-9

Notes to consolidated financial statements

   F-11

Financial statement schedule for the years ended December 31, 2002, 2003 and 2004:

    

Schedule II—Valuation and qualifying accounts.

   F-36

 

All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or the notes thereto.

 

F-1


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Shareholders and Board of Directors of

Trend Micro Kabushiki Kaisha

(“Trend Micro Incorporated”):

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Trend Micro Incorporated and its subsidiaries at December 31, 2003 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

/s/ ChuoAoyama PricewaterhouseCoopers

 

Tokyo, Japan

March 25, 2005, except for Note 23,

which is as of June 10, 2005

 

F-2


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

    December 31,

  December 31,

    2003

  2004

  2004

    Thousands of yen  

Thousands of

U.S. dollars

ASSETS

             

Current assets:

             

Cash and cash equivalents

  (Yen)46,718,940   (Yen)52,908,357   $ 513,673

Time deposits

  440,323   383,276     3,721

Marketable securities

  4,769,935   15,288,575     148,433

Notes and accounts receivable, trade—less allowance for doubtful accounts and sales returns of (Yen) 1,023,734 and (Yen) 864,938 ($) 8,397 in 2003 and 2004, respectively

  11,681,457   15,245,213     148,012

Inventories

  77,950   201,243     1,954

Deferred income taxes

  4,894,387   6,224,972     60,437

Prepaid expenses and other current assets

  1,397,821   1,560,058     15,146
   
 
 

Total current assets

  69,980,813   91,811,694     891,376
   
 
 

Investments and other assets:

             

Securities investments

  6,107,872   9,831,913     95,455

Investment in and advances to affiliate companies

  119,591   175,281     1,702

Software development costs

  505,616   438,464     4,257

Other intangibles

  311,756   296,368     2,877

Deferred income taxes

  1,806,760   1,695,771     16,464

Other

  734,533   636,009     6,175
   
 
 

Total investments and other assets

  9,586,128   13,073,806     126,930
   
 
 

Property and equipment:

             

Office furniture and equipment

  2,823,506   3,323,526     32,267

Other properties

  1,038,524   1,165,173     11,313
   
 
 

    3,862,030   4,488,699     43,580

Less: Accumulated depreciation

  (2,157,884)   (2,640,288)     (25,634)
   
 
 

Total property and equipment

  1,704,146   1,848,411     17,946
   
 
 

Total assets

  (Yen)81,271,087   (Yen)106,733,911   $ 1,036,252
   
 
 

 

The accompanying notes are an integral part of these statements.

 

F-3


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

     December 31,

   December 31,

     2003

   2004

   2004

     Thousands of yen   

Thousands of

U.S. dollars

LIABILITIES AND SHAREHOLDERS’ EQUITY

                  

Current liabilities:

                  

Current portion of long-term debt

   (Yen)6,500,000    (Yen) —      $ —  

Notes payable, trade

   96,204      88,087      855

Accounts payable, trade

   899,508      1,271,067      12,340

Accounts payable, other

   1,326,244      2,699,762      26,211

Withholding income taxes

   490,315      882,693      8,570

Accrued expenses

   1,984,175      2,143,694      20,813

Accrued income and other taxes

   4,280,797      7,192,085      69,826

Deferred revenue

   17,486,298      24,634,662      239,172

Other

   557,050      651,503      6,325
    
  

  

Total current liabilities

   33,620,591      39,563,553      384,112
    
  

  

Long-term liabilities:

                  

Deferred revenue

   3,017,105      3,268,892      31,737

Accrued pension and severance costs

   487,409      656,041      6,369

Other

   194,185      70,665      686
    
  

  

Total long-term liabilities

   3,698,699      3,995,598      38,792
    
  

  

Shareholders’ equity:

                  

Common stock

                  

Authorized

                  

—2003 and 2004 250,000,000 shares (no par value)

                  

Issued

                  

—2003 132,620,100 shares

   7,396,194              

—2004 135,755,872 shares

          11,426,977      110,942

Additional paid-in capital

   13,165,881      17,359,335      168,537

Retained earnings

   28,236,466      42,165,026      409,369

Accumulated other comprehensive income—

                  

Net unrealized gain (loss) on debt and equity securities

   70,965      284,348      2,761

Cumulative translation adjustments

   (500,946)      (606,463)      (5,888)
    
  

  

     (429,981)      (322,115)      (3,127)
    
  

  

Treasury stock, at cost (2003-1,958,647 shares; 2004-2,588,439 shares)

   (4,416,763)      (7,454,463)      (72,373)
    
  

  

Total shareholders’ equity

   43,951,797      63,174,760      613,348
    
  

  

Commitments and contingent liabilities

                  

Total liabilities and shareholders’ equity

   (Yen)81,271,087    (Yen) 106,733,911    $ 1,036,252
    
  

  

 

The accompany notes are an integral part of these statements.

 

F-4


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME

 

     Years ended December 31,

    Year ended
December 31,


 
     2002

    2003

    2004

    2004

 
     Thousands of yen    

Thousands of

U.S. dollars

 

Net sales

   (Yen)42,979,637     (Yen)48,088,347     (Yen)62,049,254     $ 602,420  

Cost of sales

   2,353,862     3,168,467     3,236,499       31,422  
    

 

 

 


Gross profit

   40,625,775     44,919,880     58,812,755       570,998  
    

 

 

 


Operating expenses:

                          

Selling

   15,051,702     15,360,532     16,009,409       155,431  

Research and development and maintenance

   3,505,565     3,919,024     4,858,259       47,168  

Customer Support

   3,857,957     4,830,660     5,723,426       55,567  

General and administrative

   4,344,433     5,656,168     6,143,985       59,651  
    

 

 

 


Total operating expenses

   26,759,657     29,766,384     32,735,079       317,817  
    

 

 

 


Operating income

   13,866,118     15,153,496     26,077,676       253,181  
    

 

 

 


Other income (expenses):

                          

Interest income

   410,245     412,635     451,217       4,381  

Interest expense

   (277,328 )   (173,830 )   (87,464 )     (849 )

Gain (Loss) on sales of marketable securities

   (259,293 )   (65,259 )   101,199       983  

Impairment loss of securities investments

   (804,661 )   (7,360 )   —         —    

Foreign exchange gain (loss), net

   52,424     120,650     (183,292 )     (1,780 )

Other income (expense), net

   110,778     (111,345 )   (34,350 )     (334 )
    

 

 

 


Total other income (expenses)

   (767,835 )   175,491     247,310       2,401  
    

 

 

 


Net income before tax

   13,098,283     15,328,987     26,324,986       255,582  
    

 

 

 


Income taxes:

                          

Current

   6,938,456     7,437,576     11,893,659       115,472  

Deferred

   (1,542,750 )   (1,334,998 )   (1,390,387 )     (13,499 )
    

 

 

 


     5,395,706     6,102,578     10,503,272       101,973  
    

 

 

 


Income before equity in earnings of affiliated companies

   7,702,577     9,226,409     15,821,714       153,609  

Equity in earnings of affiliated companies

   11,189     23,623     53,122       516  
    

 

 

 


Net income

   (Yen)7,713,766     (Yen)9,250,032     (Yen)15,874,836     $ 154,125  
    

 

 

 


     Yen

    Yen

    Yen

    U.S. dollars

 

Per share data:

                          

Net income —basic

   (Yen)58.39     (Yen)70.11     (Yen)120.64     $ 1.17  

                     —diluted

   58.22     69.95     118.59       1.15  

Cash dividends

   —       —       14.00       0.14  

 

The accompanying notes are an integral part of these statements.

 

F-5


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

     Years ended December 31,

   

Year ended

December 31,


 
     2002

    2003

    2004

    2004

 
     Thousands of yen     Thousands of
U.S. dollars
 

Net income

   (Yen)7,713,766     (Yen)9,250,032     (Yen)15,874,836     $ 154,125  
    

 

 

 


Other comprehensive income (loss), before tax:

                          

Unrealized gains (losses) on debt and equity securities:

                          

Unrealized holding gains (losses) arising during period

   (191,661 )   135,323     514,117       4,991  

Less reclassification adjustment for (gains) losses included in net income

   507,954     132,701     (143,702 )     (1,395 )
    

 

 

 


     316,293     268,024     370,415       3,596  

Foreign currency translation adjustments

   (563,794 )   (786,025 )   (105,517 )     (1,024 )
    

 

 

 


Total

   (247,501 )   (518,001 )   264,898       2,572  

Income tax expense related to unrealized gains (losses) on debt and equity securities

   (89,690 )   (113,182 )   (157,032 )     (1,525 )
    

 

 

 


Other comprehensive income (loss), net of tax

   (337,191)     (631,183)     107,866       1,047  
    

 

 

 


Comprehensive income

   (Yen)7,376,575     (Yen)8,618,849     (Yen)15,982,702     $ 155,172  
    

 

 

 


 

The accompanying notes are an integral part of these statements.

 

F-6


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

     Years ended December 31,

 

Year ended

December 31,


     2002

  2003

  2004

  2004

     Thousands of yen  

Thousands of

U.S. dollars

Common stock:

                  

Balance at beginning of year

   (Yen)6,833,678   (Yen)7,257,060   (Yen)7,396,194   $ 71,808

Exercise of stock purchase warrants and stock acquisition rights

   423,382   139,134   4,030,783     39,134
    
 
 
 

Balance at end of year

   7,257,060   7,396,194   11,426,977     110,942
    
 
 
 

Additional paid-in capital:

                  

Balance at beginning of year

   12,144,908   13,021,554   13,165,881     127,824

Tax benefit from exercise of non-qualified stock warrants

   446,809   233,277   498,905     4,844

Tax recognition derived from elimination of reversed warrant related with stock option plan

   12,934   (228,085)   (312,708)     (3,036)

Loss on sales of treasury stock, net of tax

   (6,466)   —     (22,941)     (223)

Exercise of stock purchase warrants and stock acquisition rights

   423,369   139,135   4,030,198     39,128
    
 
 
 

Balance at end of year

   13,021,554   13,165,881   17,359,335     168,537
    
 
 
 

Retained earnings:

                  

Balance at beginning of year

   11,277,576   18,986,701   28,236,466     274,140

Net income

   7,713,766   9,250,032   15,874,836     154,125

Stock issue costs, net of tax

   (4,641)   (267)   (11,977)     (116)

Cash dividends

   —     —     (1,829,260)     (17,760)

Loss on sales of treasury stock, net of tax

   —     —     (105,039)     (1,020)
    
 
 
 

Balance at end of year

   18,986,701   28,236,466   42,165,026     409,369
    
 
 
 

Net unrealized gain (loss) on debt and equity securities:

                  

Balance at beginning of year

   (310,480)   (83,877)   70,965     689

Net change during the year

   226,603   154,842   213,383     2,072
    
 
 
 

Balance at end of year

   (83,877)   70,965   284,348     2,761
    
 
 
 

 

F-7


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

     Years ended December 31,

  Year ended
December 31,


     2002

  2003

  2004

  2004

     Thousands of yen  

Thousands of

U.S. dollars

Cumulative translation adjustments:

                  

Balance at beginning of year

   848,873   285,079   (500,946)     (4,864)

Aggregate translation adjustments for the year

   (563,794)   (786,025)   (105,517)     (1,024)
    
 
 
 

Balance at end of year

   285,079   (500,946)   (606,463)     (5,888)
    
 
 
 

Treasury stock, at cost:

                  

Balance at beginning of year

   (28,529)   (2,322,287)   (4,416,763)     (42,881)

Purchase of treasury stock

   (2,300,224)   (2,094,476)   (3,759,507)     (36,500)

Sales of treasury stock

   6,466   —     721,807     7,008
    
 
 
 

Balance at end of year

   (2,322,287)   (4,416,763)   (7,454,463)     (72,373)
    
 
 
 

Total Shareholders’ equity

   (Yen)37,144,230   (Yen)43,951,797   (Yen)63,174,760   $ 613,348
    
 
 
 

 

The accompanying notes are an integral part of these statements.

 

F-8


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Years ended December 31,

   

Year ended

December 31,


 
     2002

    2003

    2004

    2004

 
     Thousands of yen    

Thousands of

U.S. dollars

 

Cash flows from operating activities:

                          

Net income

   (Yen)7,713,766     (Yen)9,250,032     (Yen)15,874,836     $ 154,125  

Adjustments to reconcile net income to net cash provided by operating activities—

                          

Depreciation and amortization

   1,910,246     2,266,356     1,590,743       15,444  

Pension and severance costs, less payments

   82,007     140,661     166,649       1,618  

Deferred income taxes

   (1,542,750 )   (1,334,998 )   (1,390,387 )     (13,499 )

(Gain) loss on sales of marketable securities

   259,293     65,259     (101,199 )     (983 )

Impairment loss of securities investments

   804,661     7,360     —         —    

Equity in earnings of affiliated companies

   (11,189 )   (23,623 )   (53,122 )     (516 )

Changes in assets and liabilities:

                          

Increase (decrease) in deferred revenue

   5,608,143     5,036,872     7,293,488       70,811  

(Increase) decrease in accounts receivable, net of allowances

   (118,016)     (446,201)     (3,421,729)       (33,221)  

(Increase) decrease in inventories

   (137,030)     278,751     (124,093)       (1,205)  

Increase (decrease) in notes and accounts payable trade

   (201,989)     (52,021)     379,882       3,688  

Increase (decrease) in accrued income and other taxes

   730,629     193,227     2,912,481       28,277  

(Increase) decrease in other current assets

   141,170     (67,898)     (90,479)       (878)  

Increase (decrease) in accounts payable, other

   (171,645)     (11,962)     823,199       7,992  

Increase (decrease) in other current liabilities

   96,567     602,296     1,107,855       10,756  

(Increase) decrease in other assets

   (361,945)     (324,879)     110,628       1,074  

Other

   (58,822)     87,072     (178,744)       (1,736)  
    

 

 

 


Net cash provided by operating activities

   14,743,096     15,666,304     24,900,008       241,747  
    

 

 

 


Cash flows from investing activities:

                          

Payments for purchases of property and equipment

   (811,632 )   (715,901 )   (801,935 )     (7,785 )

Software development cost

   (1,025,516 )   (788,760 )   (645,166 )     (6,264 )

Payments for purchases of other intangibles

   (306,573 )   (270,570 )   (229,167 )     (2,225 )

Proceeds from sales of marketable securities

   292,607     2,945,331     4,986,012       48,408  

Payments for purchases of marketable securities maturing within three months or less (net)

   —       —       (2,156,191)       (20,934)  

Payments for purchases of marketable securities and security investments

   (1,326,512)     (10,248,908)     (17,240,100)       (167,380)  

(Payments for) / Proceeds from time deposits

   5,046     (374,601)     57,047       554  
    

 

 

 


Net cash used in investing activities

   (3,172,580 )   (9,453,409 )   (16,029,500 )     (155,626 )
    

 

 

 


 

F-9


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Years ended December 31,

 

Year ended

December 31,


     2002

  2003

  2004

  2004

     Thousands of yen   Thousands of
U.S. dollars

Cash flows from financing activities:

                  

Issuance of common stock pursuant to exercise of stock purchase warrants and stock acquisition rights

   842,110   278,002   8,049,004     78,146

Proceeds from issuance of bonds

   4,000,000   —     —       —  

Purchase of treasury bonds

   (4,008,800)   —     —       —  

Redemption of bonds

   (3,000,000)   (5,000,000)   (6,500,000)     (63,107)

Purchase of treasury stock, net

   (2,293,758)   (2,094,476)   (3,165,679)     (30,735)

Tax benefit from exercise of non-qualified stock warrants

   446,809   233,277   498,905     4,844

Tax recognition derived from elimination of reversed warrant related with stock option plan

   12,934   (228,085)   (312,708)     (3,036)

Dividend paid

   —     —     (1,819,607)     (17,666)

Other

   (6,744)   —     —       —  
    
 
 
 

Net cash provided / (used) by financing activities

   (4,007,449)   (6,811,282)   (3,250,085)     (31,554)
    
 
 
 

Effect of exchange rate changes on cash and cash equivalents

   (515,896)   (512,494)   568,994     5,524
    
 
 
 

Net increase (decrease) in cash and cash equivalents

   7,047,171   (1,110,881)   6,189,417     60,091

Cash and cash equivalents at beginning of year

   40,782,650   47,829,821   46,718,940     453,582
    
 
 
 

Cash and cash equivalents at end of year

   (Yen)47,829,821   (Yen)46,718,940   (Yen)52,908,357   $ 513,673
    
 
 
 

Supplementary information of cash flow:

                  

Payment for interest expense

   (Yen)307,999   (Yen)151,623   (Yen)114,121   $ 1,108

Payment for income taxes

   5,835,904   7,102,721   8,990,398     87,285
    
 
 
 

 

The accompanying notes are an integral part of these statements.

 

F-10


TREND MICRO INCORPORATED

AND CONSOLIDATED SUBSIDIARIES

 

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

1. Nature of operations

 

Trend Micro Incorporated (the “parent company”) and its subsidiaries (collectively “the Company”) are primarily engaged in the development, production and sale of anti-virus software and providing management solutions for corporate computer systems. The Company develops its software in Japan, Taiwan, the United States, Germany, UK and China, and its products are marketed by sales subsidiaries throughout the world.

 

2. Summary of significant accounting policies

 

The parent company and its subsidiaries in Japan maintain their records and prepare their financial statements in accordance with accounting principles generally accepted in Japan, and its foreign subsidiaries maintain their records and prepare their financial statements in conformity with accounting principles generally accepted in the respective countries of their domicile. Certain adjustments and reclassifications, including those relating to the tax effects of temporary differences, valuation of debt and equity securities and revenue on post-contract support, have been incorporated in the accompanying consolidated financial statements to conform with accounting principles generally accepted in the United States of America (“U.S. GAAP”). These adjustments were not recorded in the statutory books of account.

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

(1) Significant accounting policies:

 

Basis of consolidation

 

The consolidated financial statements include the accounts of the parent company and those of its majority-owned subsidiaries. All intercompany transactions and accounts are eliminated on consolidation.

 

Investments in affiliated companies (20 to 50 percent-owned companies) in which the ability to exercise significant influence exists are stated at cost plus the equity in undistributed earnings (losses). Net consolidated income includes the company’s equity in the current net earnings (losses) of such companies, after elimination of unrealized intercompany profit.

 

Translation of foreign currencies

 

All asset and liability accounts of foreign subsidiaries are translated into Japanese yen at year-end rates of exchange and all income and expense accounts are translated at rates of exchange that approximate to those prevailing at the time of the transactions. The resulting translation adjustments are included in accumulated other comprehensive income (loss).

 

Foreign currency denominated receivables and payables are translated into Japanese yen at year-end rates of exchange and the resulting translation gains or losses included in current income.

 

Revenue recognition

 

The Company’s revenue is derived primarily from product revenue, which includes software product license and post- contract customer support services. Other revenue is composed of hardware revenue, royalty revenue and supplementary service revenue. Royalty revenue is comprised of fees from ‘Application service providers’ and ‘Internet service providers’ and supplementary services are comprised of fees from services based on ‘Premium support program’ and ‘Service level agreement’. Product revenue includes the type of limited sales of our products to other companies for inclusion in their products.

 

The Company licenses its software products under perpetual licenses. The Company sells its products and services via its direct sales force and through domestic and foreign intermediaries.

 

The Company applies the provisions of SOP 97-2, “Software Revenue Recognition”, as amended by SOP 98-9 “Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain Transactions” to all transactions involving the sale of software products and hardware transactions where software is not incidental. For hardware transactions where software is not incidental, the Company does not bifurcate the fee and apply separate accounting guidance to the hardware and software elements.

 

F-11


Revenue from the Company’s software product license and hardware where software is not incidental is recognized when persuasive evidence of an arrangement exists, the product has been delivered, the fee is fixed and determinable, and collection of the resulting receivable, net of allowances for doubtful accounts and sales returns, is reasonably assured. Post-contract customer support services revenue which includes virus pattern updates, unspecified product version updates, telephone and online technical support and supplementary services revenue are deferred and recognized ratably over the service period. The Company allocates revenue to post-contract customer support services based on the fair value of the post-contract customer support services, which are determined based on separate sales of renewals to customers. Royalty revenue is recognized as earned unless collection of the related receivables is not assured in which case, it is recognized upon receipt of cash.

 

For all sales, the Company uses either a binding purchase order or signed license agreement as evidence of an arrangement. Sales through our intermediaries are evidenced by a master agreement governing the relationship together with binding purchase orders on a transaction-by-transaction basis.

 

At the time of the transaction, the Company assesses whether the fee associated with our revenue transactions is fixed and determinable and whether or not collection is reasonably assured. The Company assesses whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, which are 30 to 90 days from the invoice date, the Company accounts for the fee as not being fixed and determinable. In these cases, the Company recognizes revenue as the fees become due. The Company assesses collection based on a number of factors, including past transaction history with the customer and the credit-worthiness of the customer. The Company does not request collateral from our customers. If the Company determines that collection of a fee is not reasonably assured, the Company defers the fee and recognizes revenue at the time collection becomes reasonably assured, which is generally upon receipt of cash.

 

The Company recognizes revenue from sales to intermediaries when products have been delivered to the intermediary. The Company primarily sells retail packages through intermediaries. After sale of a retail package, the Company may approve certain returns from intermediaries or end-users; therefore, the Company makes an estimate of returns from intermediaries or end-users based on its historical experience. The provision for estimated returns is recorded as a reduction to revenue at the time of the sale.

 

Cash and cash equivalents

 

Cash and cash equivalents include cash on hand, cash on deposit with banks and all highly liquid investments, with original maturities of three months or less, that are readily convertible to known amounts of cash and are so near maturity that they present insignificant risk of changes in value because of changes in interest rates.

 

Marketable securities and Security investments

 

Marketable securities and security investments consist of debt and equity securities. Debt and equity securities designated as available-for-sale are carried at fair value with unrealized gains or losses included in accumulated other comprehensive income (loss), net of applicable taxes. Debt securities designated as held-to-maturity are carried at amortized cost. The Company classifies “available for sale” debt securities with maturities longer than one year as Securities investments in investments and other assets. Individual securities classified as either available-for-sale or held-to-maturity are reduced to net realizable value for other than temporary declines in market value. Realized gains and losses, which are determined on the average cost method, are reflected in income.

 

Inventories

 

Finished products and raw materials are valued at the lower of weighted average cost or net realizable value. Work in process is stated at accumulated production costs.

 

Property and equipment

 

Property and equipment are stated at cost less accumulated depreciation. Major renewals and improvements are capitalized; minor replacements, maintenance and repairs are charged to current operations. Depreciation of property and equipment is computed on the declining-balance method for the parent company and on the straight-line method for foreign subsidiaries at rates based on estimated useful lives of the assets according to general class, type of construction and use. Estimated useful lives range mainly from 3 to 6 years for office furniture and equipment, and mainly from 3 to 6 years for other properties.

 

F-12


Intangible assets

 

Intangible assets, which mainly consist of software development costs and purchased software, are amortized on a straight-line basis over the estimated economic lives of the products, generally over twelve-month period for software development costs and a five-year period for purchased software and other intangibles.

 

Impairment of long-lived assets

 

The Company evaluates long-lived assets and definite lived intangible assets to be held and used whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Determination of recoverability is based on the sum of expected future cash flows (undiscounted and without interest charges) from the use and eventual disposition of the asset. If the fair value is less than the carrying amount of the asset, an impairment loss is recognized, based on the fair value of the asset.

 

Research and development costs and software development costs

 

All costs relating to research and development, to establish the technological feasibility of software products, are expensed as incurred. Under the Company’s software development process, technological feasibility is established on completing all substantial testing for the original English language version of the software. Local language versions of software, such as Japanese or Chinese, are produced from the English language version, by adding Japanese language or Chinese language related functions. Production costs for such local language versions of software product masters, incurred subsequent to the availability of original English language version software, are capitalized. Production costs of the local language software product masters, which include direct labor and overhead costs, are amortized to cost of sales using the straight-line method over the current estimated economic lives of the products, generally up to twelve months.

 

Management considers the Company’s capitalized software development costs to be fully recoverable from future product sales. Management estimates are based upon supporting facts and circumstances, and may be significantly impacted based upon subsequent changes in business conditions.

 

Advertising costs

 

Advertising costs are expensed as incurred.

 

Stock-based compensation

 

The Company accounts for its stock-based incentive awards in accordance with the intrinsic value method as per APB No. 25, “Accounting for Stock Issued to Employees” and related interpretations. The Company complies with the disclosure provisions of FAS No. 123, “Accounting for Stock-Based Compensation”, as amended by FAS No. 148.

 

In October 1995, FAS 123 established a fair value based method of accounting for employee stock based compensation. If compensation cost for the stock options with warrants, the stock options under the U.S. program, which was expired in July 2003, the stock options with subscription right which qualified under Article 280-19 of the unrevised Japanese Commercial Code, and the stock options with Stock acquisition rights had been determined based on the fair value at the grant dates, as prescribed by FAS 123, the Company’s pro forma net income and net income per share would have been as follows:

 

     Years ended December 31,

     2002

   2003

   2004

   2004

     (in thousands, except per share data)

Net income:

                     

As reported

   (Yen)7,713,766    (Yen)9,250,032    (Yen)15,874,836    $ 154,125

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

   (860,662)    (1,351,384)    (2,640,021)      (25,631)

Pro forma net income

   6,853,104    7,898,648    13,234,815      128,494

Net income per share:

                     

As reported—

                     

Basic

   (Yen)58.39    (Yen)70.11    (Yen)120.64    $ 1.17

Diluted

   58.22    69.95    118.59      1.15

Pro forma net income—

                     

Basic

   (Yen)51.87    (Yen)59.87    (Yen)100.58    $ 0.98

Diluted

   51.72    59.73    98.87      0.96

 

The fair values of the stock options with Stock acquisition rights were estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions used for grants during the years ended December 31, 2002, 2003 and 2004;

 

     2002

   2003

   2004

Expected life (Years)

   4.0    4.7-5.0    5.0

Volatility

   18.0%    44.870%-60.240%    51.71%-59.57%

Dividend yield

   0.00%    0.48%-0.66%    0.39%-0.43%

Risk-free interest rate

   0.361%    0.160%-0.612%    0.634%-0.674%

 

The fair value per share of options granted above during fiscal 2002, 2003 and 2004 were (Yen) 518, (Yen)777-1,313 and (Yen)2,190-2,235 ($21.26-21.70), respectively.

 

F-13


Income taxes

 

The current provision for income taxes is computed based on the pretax income included in the consolidated statement of income. The asset and liability approach is used to recognize deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and the tax bases of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred assets (including deferred tax assets and liabilities on net unrealized gain or loss on debt and equity securities) of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

 

Net income per share

 

Basic net income per share is computed based on the average number of shares of common stock outstanding for the period. Diluted net income per share assumes the dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock, or resulted in the issuance of common stock. Net income per share is appropriately adjusted for any stock splits or free distributions of common stock.

 

Free distribution of common stock

 

On occasion, the Company has made free distributions of common stock to its shareholders which have been accounted for either by a transfer of the applicable par value from additional paid-in capital to the common stock account or with no entry if free shares were distributed from the portion of previously issued shares accounted for as excess of par value in the common stock account in accordance with the Japanese Commercial Code. However, as a result of the amendments to the Japanese Commercial Code in 2001 where the concept of par-value of shares was eliminated effective from October 1, 2001, a free distribution of common stock to its shareholders is accounted for with no accounting entry. Under the Japanese Commercial Code, a stock dividend which is paid out of profits can be effected by an appropriation of retained earnings to the common stock account by resolution of the general shareholders’ meeting, followed by a free distribution with respect to the amount as appropriated by resolution of the Board of Directors.

 

Common stock issue costs

 

Common stock issue costs are directly charged to retained earnings, net of tax, in the accompanying consolidated financial statements as the Japanese Commercial Code prohibits charging such stock issue costs to capital accounts, which is the prevailing practice in the United States of America.

 

Comprehensive income

 

Other comprehensive income refers to revenues, expenses, gains and losses that under U.S. GAAP are included in comprehensive income but are excluded from net income as these amounts are recorded directly as adjustments to shareholders’ equity. The Company’s other comprehensive income primarily comprises unrealized gains or losses on debt and equity securities and foreign currency translation adjustments.

 

Market and credit risks

 

The anti-virus software market is characterized by rapid technological change and evolving industry standards in computer hardware and software technology. In addition, the markets for the Company’s products are highly competitive and rapidly changing. The Company could incur substantial operating losses if it is unable to offer products, which address technological and market place change in the anti-virus software industry.

 

Other financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash equivalents, marketable securities and accounts receivable. The Company invests primarily in time deposits, money market funds and marketable securities and places its investments with high quality financial institutions. The Company performs ongoing credit evaluations of its customers’ financial condition and maintains an allowance for uncollectible accounts receivable, if any, based upon the expected collectibility of accounts receivable.

 

F-14


(2) Recent pronouncements:

 

In November 2004, the FASB issued SFAS No. 151 “Inventory Costs — an amendment of ARB No. 43, Chapter 4”. This Statement amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). The provisions of SFAS No. 151 shall be effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The standard will not have a material effect on the Company’s financial position and results of operations.

 

In December 2004, the FASB revised SFAS No.123 “Share-Based Payment” This new SFAS No.123 focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement is effective as of the beginning of the first fiscal year that starts after June 15, 2005. We intend to adopt the provisions on FAS 123(R) effective January 1, 2006. The Company is currently evaluating which transition method and valuation technique to be used upon adoption. The Company’s pro forma net income and net income per share for the year ended December 31, 2004 based on the fair values of the stock options with Stock acquisition rights, which were estimated on the date of grant using the Black-Scholes option pricing model in accordance with the original SFAS No.123, are disclosed in Note 2 (1) “Significant accounting policies—Stock-based compensation.”

 

In December 2004, the FASB issued SFAS No. 152 “Accounting for Real Estate Time-Sharing Transactions — an amendment of FASB Statements No. 66 and 67”. This Statement amends FASB Statement No. 66, Accounting for Sales of Real Estate, to reference the financial accounting and reporting guidance for real estate time-sharing transactions that is provided in AICPA Statement of Position (SOP) 04-2, Accounting for Real Estate Time-Sharing Transactions. This Statement also amends FASB Statement No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, to state that the guidance for (a) incidental operations and (b) costs incurred to sell real estate projects does not apply to real estate time-sharing transactions. The accounting for those operations and costs is subject to the guidance in SOP 04-2. This Statement is effective for financial statements for fiscal years beginning after June 15, 2005. The standard will not have a material effect on the Company’s financial position and results of operations.

 

In December 2004, the FASB issued SFAS No. 153 “Exchanges of Nonmonetary Assets — an amendment of APB Opinion No. 29”. The guidance in APB Opinion No. 29, Accounting for Nonmonetary Transactions, is based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions to that principle. This Statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The provisions of this Statement shall be effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15. The standard will not have a material effect on the Company’s financial position and results of operations.

 

(3) Reclassifications

 

Previously, the Company has disclosed all of “available for sale” debt securities as Marketable securities in current assets. However, since the balance of cash and cash equivalents has increased, in fiscal 2004, the possibility of sales before maturity of “available for sale” debt securities classified into working capital has decreased. Therefore, from fiscal 2004, the Company discloses “available for sale” debt securities with maturities longer than one year as Securities investments in investments and other assets.

 

Fiscal 2003 balance sheet has been prepared on a consistent basis for reference. As a result, “available for sale” debt securities of (Yen) 5,483,094 thousand is reclassified from current assets to investments and other assets. In addition, related deferred taxes of (Yen) 2,522 thousand are reclassified from current liabilities to long-term liabilities.

 

F-15


3. U.S. dollar amounts

 

U.S. dollar amounts presented in the financial statements are included solely for the convenience of the reader. These translations should not be construed as representations that the yen amounts actually represent, or have been or could be converted into U.S. dollars. As the amounts shown in U.S. dollars are for convenience only, the approximate current rate at December 31, 2004 ((Yen)103.00 = U.S. $1) has been used for the purpose of presentation of the U.S. dollar amounts in the accompanying consolidated financial statements.

 

4. Reconciliation of the difference between basic and diluted net income per share (“EPS”)

 

Reconciliation of the differences between basic and diluted EPS for the years ended December 31, 2002, 2003 and 2004, is as follows:

 

     2002

  2003

  2004

  2004

     Thousands of Yen

 

Thousands of

U.S. dollars


Net income available to common stock holders

   (Yen)7,713,766   (Yen)9,250,032   (Yen)15,874,836   $ 154,125
     Shares

   

Weighted-Average shares

   132,111   131,940   131,589      

Effect of dilutive securities:

                  

Stock options

   383   295   2,274      

Weighted-Average shares for diluted EPS computation

   132,494   132,235   133,863      
     Yen

  U.S. dollars

Basic EPS:

   (Yen)58.39   (Yen)70.11   (Yen)120.64   $ 1.17

Diluted EPS:

   58.22   69.95   118.59   $ 1.15

 

Shareholders’ equity per share as of December 31, 2003 and 2004 were as follows:

 

     December 31,

   December 31,

     2003

   2004

   2004

     Yen    U.S. dollars

Shareholders’ equity per share

   (Yen) 336.38    (Yen) 474.40    $ 4.61

 

5. Cash and cash equivalents

 

Cash and cash equivalents as of December 31, 2003 and 2004 comprised:

 

     December 31,

  December 31,

     2003

  2004

  2004

     Thousands of yen  

Thousands of

U.S. dollars

Cash

   (Yen)44,032,813   (Yen)49,189,396   $ 477,567

Time deposits with original maturities of three months or less

   2,686,127   3,718,961     36,106
    
 
 

     (Yen)46,718,940   (Yen)52,908,357   $ 513,673
    
 
 

 

6. Time deposits

 

The U.S. subsidiary had (Yen)59,354 thousand and (Yen)26,720 thousand, ($259 thousand) of restricted cash set aside in accordance with the terms of building lease agreement as at December 31, 2003 and 2004, respectively. The restricted cash is included in time deposits.

 

F-16


7. Marketable securities and Securities investments

 

Marketable securities include mutual funds and debt and equity securities for which the aggregate fair value, gross unrealized gains and losses and cost pertaining to “available-for-sale” investments as of December 31, 2003 and 2004, were as follows:

 

    December 31, 2003

        Gross unrealized

   
    Cost

  Gains

  Losses

  Fair value

    Thousands of yen

Available for sale:

                       

Mutual funds

  (Yen) 3,606,521   (Yen) 89,943   (Yen) —     (Yen) 3,696,464

Equity securities

    —       —       —       —  

Debt securities

    6,484,630     196,533     124,598     6,556,565
   

 

 

 

Total

  (Yen) 10,091,151   (Yen) 286,476   (Yen) 124,598   (Yen) 10,253,029
   

 

 

 

    December 31, 2004

        Gross unrealized

   
    Cost

  Gains

  Losses

  Fair value

    Thousands of yen

Available for sale:

                       

Mutual funds

  (Yen) 6,823,896   (Yen) 466,020   (Yen) —     (Yen) 7,289,916

Equity securities

    —       —       —       —  

Debt securities

    17,142,091     226,557     185,123     17,183,525