Form 6-K
Table of Contents

 

U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 6-K

 


 

REPORT OF FOREIGN PRIVATE ISSUER

PURSUANT TO RULE 13a-16 OR 15d-16 UNDER

THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number: 333-10486

 

For the Month of February 2006

 

Trend Micro Incorporated

(Translation of registrant’s name into English)

 


 

Shinjuku MAYNDS Tower, 1-1, Yoyogi 2-chome,

Shibuya-ku, Tokyo 151-0053, Japan

(Address of principal executive offices)

 


 

Indicate by check mark whether the registrant files or will file annual reports under cover Form 20-F or Form 40-F.

 

Form 20-F      X            Form 40-F            

 

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):    

 

Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):    

 

Indicate by check mark whether by furnishing the information contained in this Form, the registrant is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

 

Yes               No     X    

 

If “Yes” is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82-            

 



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Information furnished on this form:

 

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1. Press release dated February 9, 2006, relating to the announcement of earnings results for the fourth quarter and consolidated revenue for the fiscal year ended December 31, 2005.

 

2. Press released dated February 9, 2006, relating to the announcement of year-end cash dividends per share.

 

3. Press released dated February 9, 2006, relating to the announcement of a change of the independent auditor.

 

4. Press release dated February 9, 2006, relating to the announcement of annual earnings results for the fiscal year ended December 31, 2005.


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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

       

TREND MICRO INCORPORATED

Date:  

February 9, 2006

      By:  

/s/    MAHENDRA NEGI        


               

Mahendra Negi

Representative Director,

Chief Financial Officer and Executive Vice President


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Trend Micro Reports Record Results for 2005

 

Revenues up 18 percent driven by strong growth in the U.S. market

 

Tokyo, Japan – February 9, 2006 – Trend Micro Incorporated (TSE: 4704, NASDAQ: TMIC), a leader in network antivirus and Internet content security software and services, today announced earnings results for the fourth quarter and consolidated revenue for fiscal year 2005.

 

For the fourth quarter, Trend Micro posted a record 20.57 billion Yen ($175.1 million, 117.43JPY=1USD) in net sales, representing 16 percent growth year over year and 14 percent growth over the third quarter. Operating income for the quarter was 7.94 billion Yen ($67.6 million) and net income was 5.80 billion Yen ($49.3 million).

 

For 2005, Trend Micro posted record consolidated net sales of 73.03 billion Yen (or U.S. $621.9 million), representing an annual growth rate of 18 percent. The company also reported operating income of 27.57 billion Yen (or U.S. $234.8 million) and net income of 18.67 billion Yen (or US $159.0 million). Revenues from products and services sold to enterprise, mid-sized, and small business customers worldwide comprised 78 percent of 2005 revenues; revenue from consumer products comprised the remaining 22 percent.

 

Trend Micro continued to experience growth worldwide, most notably in North America where sales grew 30 percent annually. In particular, the region experienced 56 percent growth in consumer sales. In the Japan and Asia-Pacific regions, annual sales increased 16 and 25 percent, respectively.

 

“2005 was a significant year for our company,” said Eva Chen, CEO of Trend Micro. “We did a lot in the last year to build a strong foundation that we believe positions us for the next stage of growth and continued leadership. Our future growth will be fuelled not only by our technological innovation but by continuously understanding our customers and delivering solutions that exceed their expectations.”

 

Based on information currently available to the company, consolidated net sales for the first quarter ending March 31, 2006, is expected to be 19.5 billion Yen (or U.S. $165.3 million, based on an exchange rate of 118JPY = 1USD). Operating income and net income are expected to be 7.8 billion Yen (or U.S. $66.1 million) and 4.4 billion Yen (or U.S. $37.3 million), respectively.


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2005 Business Highlights

 

Awards and Recognitio

 

Corporate

 

    Trend Micro was listed on the Dow Jones Sustainability Indexes for the second consecutive year.

 

    For the second year in a row, VARBusiness magazine named Trend Micro Company of the Year and awarded it the Product Innovation Annual Report Card Award.

 

    In March, Trend Micro Premium Support won the SSPA STAR Award 2005 for Best Practices.

 

    For the third consecutive year, Trend Micro was acknowledged as the No.1 global brand in Taiwan, according to a study by global brand consultancy Interbrand.

 

Products

 

    Trend Micro PC-cillin Internet Security 2005 and OfficeScan achieved the industry’s first spyware certification.

 

    Trend Micro’s ScanMail was named 2005 Readers’ Choice Award Winner by Windows IT Pro in the Antivirus/Mail Server category of the 2005 Windows IT Pro Readers’ Choice Awards.

 

    In May, PC-cillin won Editor’s Choice from Entrepreneur Magazine.

 

    In January, Trend Micro was voted the “Best Solution” by Tech Data’s TechSelect Member.

 

Products and Innovation

 

In 2005, Trend Micro introduced the following new products to complement its existing multi-threat security solutions for gateways, servers, desktops, mobile devices, etc.:

 

    Anti-Spyware Solutions – Shortly after acquiring InterMute, Trend Micro, delivered versatile anti-spyware solutions that feature standalone and integrated deployment options for large enterprises, small and medium businesses, and consumers. The solutions provide multi-layered options for delivering anti-spyware protection throughout the network environment – from the gateway to the desktop.

 

    Trend Micro Network Reputation Services (Trend Micro RBL+ and Network Anti-Spam Services) – Resulting from the Kelkea acquisition, these service-based solutions provide a first line of defense that stops spam at its source — before it reaches the network. Real-time spam blocking identifies new sources of spam, including zombies and botnets, as soon as they begin spamming.

 

    Communication and Collaboration Solutions — Trend Micro launched a group of solutions offering enhanced antivirus, content, and anti-spam protection for email, instant messaging, and collaboration environments. These solutions include Trend Micro ScanMail for Exchange 7.0, Trend Micro ScanMail Lotus Domino 3.0, Trend Micro Instant Messaging Security for Microsoft Office Live Communication Server, Trend Micro PortalProtect for Microsoft SharePoint, InterScan Messaging Security Suite, and Spam Prevention Solution.


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Corporate and Business Highlights

 

    Trend Micro’s strategic alliance partner Cisco announced a number of outbreak prevention solutions, including the Cisco Incident Control System, which the two companies developed jointly.

 

    Trend Micro announced that leading computer system manufacturer Dell is offering North American customers the choice to pre-install Trend Micro PC-cillin Internet Security on new desktop and notebook systems.

 

    In August, the U.S. International Trade Commission issued a final ruling in Trend Micro’s patent infringement lawsuit against Fortinet, ordering the Sunnyvale, CA-based company to stop advertising, distributing, importing, and selling FortiGate™ products in the United States. The decision validated Trend Micro’s patent involving virus scanning at the server and gateway.

 

* On January 30, 2006, Tend Micro Inc. and Fortinet, Inc. announced that the two companies have reached a settlement in a longstanding patent dispute involving Fortinet’s alleged infringement of Trend Micro’s U.S. Patent 5,623,600.

 

    To ensure continued innovation and sharpen its focus on new and emerging threats, Trend Micro announced the appointment of three chief technologists. Raimund Genes as chief technologist for anti-malware; Ed English as chief technologist post for anti-spyware; and Dave Rand as chief technologist of Internet content security.

 

    New customers in the fourth quarter included: Chunghwa Telecom (Taiwan), Hydro One (Canada), National Library of Medicine (U.S.), North Carolina Farm Bureau Insurance Group (U.S.).

 

Notice Regarding Forward-looking Statements

 

Certain statements that we make in this release are 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. Many important factors could cause our actual results to differ materially from those expressed in our forward-looking statements. These factors include:

 

  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 antivirus software industry

 

  Changes in customer needs for antivirus software


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  Existing products and new product introductions by our competitors and the pricing of those products

 

  Declining prices for 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 and

 

  Difficulties in successfully executing our investment strategy

 

We assume no obligation to update any forward-looking statements. For more details regarding risk factors relating to our future performance, please refer to our filings with the U.S. Securities and Exchange Commission.

 

About Trend Micro, Inc.

 

Trend Micro, Inc. is a leader in network antivirus and Internet content security software and services. The Tokyo-based corporation has business units worldwide. Trend Micro products are sold through corporate and value-added resellers and managed service providers. For additional information and evaluation copies of all Trend Micro products, visit our Web site, www.trendmicro.com.

 

# # #

 

Trend Micro and the t-ball logo are trademarks or registered trademarks of Trend Micro Incorporated. TrendLabs is a service mark of Trend Micro Incorporated. All other company or product names may be trademarks or registered trademarks of their owners.

 

For additional Information:

Mr. Mahendra Negi

Chief Financial Officer/IR Officer

Phone: +81-3-5334-4899

Fax: +81-3-5334-4874

ir@trendmicro.co.jp


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Supplementary Information

 

(1) CONSOLIDATED BALANCE SHEETS

 

 

     (Thousands of yen)

Account


  

December 31,

2004


  

December 31,

2005


   Amount     %    Amount     %

<Assets>

                     

Current assets:

                     

Cash and cash equivalents

   52,908,357          59,612,577      

Time deposits

   383,276          1,435,293      

Marketable securities

   15,288,575          22,395,365      

Notes and accounts receivable, trade

–less allowance for doubtful accounts (Yen) 292,815 in FY2004 and (Yen) 282,257 in FY2005, respectively

–less sales returns (Yen) 572,123 in FY2004 and (Yen) 422,453 in FY2005, respectively

   15,245,213          19,198,870      

Inventories

   201,243          359,897      

Deferred income taxes

   6,224,972          6,727,229      

Prepaid expenses and other current assets

   1,560,058          1,925,791      
    

 
  

 

Total current assets

   91,811,694     86.0    111,655,022     84.0
    

 
  

 

Investments and other assets:

                     

Securities investments

   9,831,913          11,159,428      

Investment in and advances to affiliated companies

   175,281          321,569      

Software development costs

   438,464          1,174,691      

Other intangibles

   296,368          1,390,434      

Goodwill

   —            2,130,179      

Deferred income taxes

   1,695,771          2,033,488      

Other

   636,009          671,800      
    

 
  

 

Total investments and other assets

   13,073,806     12.3    18,881,589     14.2
    

 
  

 

Property and equipment:

                     

Office furniture and equipment

   3,323,526          4,468,891      

Other properties

   1,165,173          1,539,195      
    

      

   
     4,488,699          6,008,086      

Less: Accumulated depreciation

   (2,640,288 )        (3,609,473 )    
    

 
  

 

Total property and equipment

   1,848,411     1.7    2,398,613     1.8
    

 
  

 

Total assets

   106,733,911     100.0    132,935,224     100.0
    

 
  

 


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     (Thousands of yen)

Account


  

December 31,

2004


  

December 31,

2005


   Amount

    %

   Amount

    %

<Liabilities, minority interest and shareholders’ equity>

                     

Current liabilities:

                     

Notes payable, trade

   88,087          118,572      

Accounts payable, trade

   1,271,067          794,450      

Accounts payable, other

   2,699,762          3,208,625      

Withholding income taxes

   882,693          1,082,302      

Accrued expenses

   2,143,694          3,138,674      

Accrued income and other taxes

   7,192,085          5,476,791      

Deferred revenue

   24,634,662          31,506,315      

Other

   651,503          895,088      
    

 
  

 

Total current liabilities

   39,563,553     37.1    46,220,817     34.8
    

 
  

 

Long-term liabilities:

                     

Deferred revenue

   3,268,892          3,874,936      

Accrued pension and severance costs

   656,041          889,774      

Other

   70,665          82,056      
    

 
  

 

Total long-term liabilities

   3,995,598     3.7    4,846,766     3.6
    

 
  

 

Minority interest

   —       —      4,531     0.0
    

 
  

 

Shareholders’ equity:

                     

Common stock

                     

Authorized

                     

-December 31, 2004     250,000,000 shares (no par value)

                     

-December 31, 2005     250,000,000 shares (no par value)

                     

Issued

                     

-December 31, 2004     135,755,872 shares

   11,426,977                 

-December 31, 2005     136,603,725 shares

              12,484,849      

Additional paid-in capital

   17,359,335          18,572,063      

Retained earnings

   42,165,026          55,971,955      

Accumulated other comprehensive income

                     

Net unrealized gain (loss) on debt and equity securities

   284,348          657,885      

Cumulative translation adjustments

   (606,463 )        1,459,600      
    

      

   
     (322,115 )        2,117,485      
    

      

   

Treasury stock, at cost

                     

-December 31, 2004 2,588,439 shares

   (7,454,463 )               

-December 31, 2005 2,513,231 shares

              (7,283,242 )    
    

 
  

 

Total shareholders’ equity

   63,174,760     59.2    81,863,110     61.6
    

 
  

 

Total liabilities, minority interest and shareholders’ equity

   106,733,911     100.0    132,935,224     100.0
    

 
  

 


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(2) CONSOLIDATED STATEMENTS OF INCOME

 

 

     (Thousands of yen)

 

Account


   For the year ended
December 31, 2004


   For the year ended
December 31, 2005


   Increase
(Decrease)


 
   Amount

    %

   Amount

    %

   %

 

Net sales

   62,049,254     100.0    73,029,901     100.0    17.7  

Cost of sales:

                            

Amortization of capitalized software, and Material

   3,236,499          2,598,603             

Maintenance

   2,260,934          1,671,320             

Customer Support

   5,723,426          6,857,901             
    

 
  

 
      

Total Cost of sales

   11,220,859     18.1    11,127,824     15.2    (0.8 )
    

 
  

 
      

Operating Expense:

                            

Selling

   16,009,409          20,944,484             

Research and development

   2,597,325          4,395,207             

General and administrative

   6,143,985          8,990,611             
    

 
  

 
      

Total operating expenses

   24,750,719     39.9    34,330,302     47.0    38.7  
    

 
  

 
      

Operating income

   26,077,676     42.0    27,571,775     37.8    5.7  
    

 
  

 
      

Other incomes (expenses):

                            

Interest income

   451,217          836,910             

Interest expense

   (87,464 )        (3,709 )           

Gain (loss) on sales of marketable securities

   101,199          370,326             

Foreign exchange gain (loss), net

   (183,292 )        327,257             

Other income (expense), net

   (34,350 )        5,741             
    

 
  

 
      

Total other income (expense)

   247,310     0.4    1,536,525     2.1    521.3  
    

 
  

 
      

Net income before tax

   26,324,986     42.4    29,108,300     39.9    10.6  
    

 
  

 
      

Income taxes:

                            

Current

   11,893,659          11,863,127             

Deferred

   (1,390,387 )        (1,358,568 )           
    

 
  

 
      
     10,503,272     16.9    10,504,559     14.4    0.0  
    

 
  

 
      

Income before minority interest and equity in earnings of affiliated companies

   15,821,714     25.5    18,603,741     25.5    17.6  

Minority interest in income of consolidated subsidiaries

   —       —      (338 )   0.0    —    

Equity in earnings (losses) of affiliated companies

   53,122     0.1    66,551     0.1    25.3  
    

 
  

 
      

Net income

   15,874,836     25.6    18,669,954     25.6    17.6  
    

 
  

 
      

Per share data:

                            
Net income    Yen

         Yen

            

-Basic

   120.64          139.85             

-Diluted

   118.59          137.83             


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(3) CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

     (Thousands of yen)

 

Account


   For the year
ended
December 31,
2004


    For the year
ended
December 31,
2005


 

Net income

   15,874,836     18,669,954  
    

 

Other comprehensive income (loss), before tax:

            

Unrealized gains (losses) on debt and equity securities:

            

Unrealized holding gains (loss) arising during period

   514,117     1,375,136  

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

   (143,702 )   (704,199 )
    

 

     370,415     670,937  

Foreign currency translation adjustments

   (105,517 )   2,066,063  
    

 

Total

   264,898     2,737,000  

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

   (157,032 )   (297,400 )
    

 

Other comprehensive income (loss), net of tax

   107,866     2,439,600  
    

 

Comprehensive income

   15,982,702     21,109,554  
    

 


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(4) CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

 

     (Thousands of yen)

 

Account


  

For the year ended

December 31,2004


    For the year ended
December 31,2005


 

<Common stock>

            

Balance at beginning of period

   7,396,194     11,426,977  

Exercise of stock purchase warrants and stock acquisition rights

   4,030,783     1,057,872  
    

 

Balance at end of period

   11,426,977     12,484,849  
    

 

<Additional paid-in capital>

            

Balance at beginning of period

   13,165,881     17,359,335  

Tax benefit from exercise of non-qualified stock warrants

   498,905     155,323  

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

   (312,708 )   —    

Loss on sales of treasury stock, net of tax

   (22,941 )   —    

Exercise of stock purchase warrants and stock acquisition rights

   4,030,198     1,057,405  
    

 

Balance at end of period

   17,359,335     18,572,063  
    

 

<Retained earnings>

            

Balance at beginning of period

   28,236,466     42,165,026  

Net income

   15,874,836     18,669,954  

Stock issue costs, net of tax

   (11,977 )   (3,519 )

Cash dividends

   (1,829,260 )   (4,794,028 )

Loss on sales of treasury stock, net of tax

   (105,039 )   (65,478 )
    

 

Balance at end of period

   42,165,026     55,971,955  
    

 

<Net realized gain (loss) on debt and equity securities>

            

Balance at beginning of period

   70,965     284,348  

Net change during the period

   213,383     373,537  
    

 

Balance at end of period

   284,348     657,885  
    

 

<Cumulative translation adjustments>

            

Balance at beginning of period

   (500,946 )   (606,463 )

Aggregate translation adjustments for the period

   (105,517 )   2,066,063  
    

 

Balance at end of period

   (606,463 )   1,459,600  
    

 

<Treasury stock, at cost>

            

Balance at beginning of period

   (4,416,763 )   (7,454,463 )

Purchase of treasury stock

   (3,759,507 )   (142,062 )

Sales of treasury stock

   721,807     313,283  
    

 

Balance at end of period

   (7,454,463 )   (7,283,242 )
    

 

Total shareholders’ equity

   63,174,760     81,863,110  
    

 


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(5) CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

     (Thousands of yen)

 

Account


   For the year
ended
December 31,
2004


    For the year
ended
December 31,
2005


 

Cash flows from operating activities:

            

Net income

   15,874,836     18,669,954  

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

            

Depreciation and amortization

   1,590,743     1,878,050  

Pension and severance costs, less payments

   166,649     207,109  

Deferred income taxes

   (1,390,387 )   (1,358,568 )

(Gain) loss on sales of marketable securities

   (101,199 )   (370,326 )

Equity in earnings of affiliated companies

   (53,122 )   (66,551 )

(Gain) loss on sale and disposal of fixed assets

   —       11,585  

Minority interest

   —       338  

Changes in assets and liabilities:

            

Increase (decrease) in deferred revenue

   7,293,488     6,209,680  

(Increase) decrease in accounts receivable, net of allowances

   (3,421,729 )   (3,567,924 )

(Increase) decrease in inventories

   (124,093 )   (124,971 )

Increase (decrease) in notes and accounts payable, trade

   379,882     (526,321 )

Increase (decrease) in accrued income and other taxes

   2,912,481     (1,826,959 )

(Increase) decrease in other current assets

   (90,479 )   (34,426 )

Increase (decrease) in accounts payable, other

   823,199     381,414  

Increase (decrease) in other current liabilities

   1,107,855     1,336,703  

(Increase) decrease in other assets

   110,628     (207,984 )

Other

   (178,744 )   34,809  
    

 

Net cash provided by operating activities

   24,900,008     20,645,612  
    

 

Cash flows from investing activities:

            

Payments for purchases of property and equipment

   (801,935 )   (1,153,193 )

Software development cost

   (645,166 )   (1,446,248 )

Payments for purchases of other intangibles

   (229,167 )   (216,107 )

Proceeds from sales of marketable securities

   4,986,012     22,079,575  

(Payment for)/Proceeds from marketable securities maturing within three months or less (net)

   (2,156,191 )   (189,708 )

Payments for purchases of marketable securities and security investments

   (17,240,100 )   (28,043,534 )

Payments for business acquisition

   —       (2,716,702 )

(Payments for)/Proceeds from time deposits

   57,047     (1,052,017 )
    

 

Net cash used in investing activities

   (16,029,500 )   (12,737,934 )
    

 

Cash flows from financing activities:

            

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

   8,049,004     2,111,758  

Redemption of bonds

   (6,500,000 )   —    

Proceeds from/(Purchase of) treasury stock (net)

   (3,165,679 )   105,743  

Tax benefit from exercise of non-qualified stock warrants

   498,905     155,322  

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

   (312,708 )   —    

Capital contribution from minority interest

   —       4,193  

Dividends paid

   (1,819,607 )   (4,782,764 )
    

 

Net cash used in financing activities

   (3,250,085 )   (2,405,748 )
    

 

Effect of exchange rate changes on cash and cash equivalents

   568,994     1,202,290  
    

 

Net increase (decrease) in cash and cash equivalents

   6,189,417     6,704,220  

Cash and cash equivalents at beginning of period

   46,718,940     52,908,357  
    

 

Cash and cash equivalents at end of period

   52,908,357     59,612,577  
    

 

Supplementary information of cash flow:

            

Payment for interest expense

   114,121     3,709  

Payment for income taxes

   8,990,398     13,109,985  


Table of Contents

February 9, 2006

 

        Trend Micro, Inc.
        Eva Chen, Representative Director, President,
        Chief Executive Officer
        First Section of the Tokyo Stock Exchange
        Code: 4704
        Contact: Hideki Minamibayashi
        Telephone: +813-5334-4899

 

Trend Micro Board Approves Increase of Cash Dividend in the end of fiscal year in December 2005

 

Trend Micro announced today that year-end cash dividends per share would be increased as follows. The effecting of the election is conditional on the agenda item being approved at the 17th ordinary general meeting of shareholders on March 28, 2006.

 

1. Reason for an increase of cash dividends

 

We intend to continue to return profits to shareholders based on our net profits on a consolidated basis while striving to enhance financial strength and secure inner reserves in order to deal with the significantly changing business environment and maintain a competitive edge against competitors. Since the previous dividend distribution, our basic policy on dividends has been set as 30%. We plan to pay a year-end dividend on the basis of a dividend ratio of 40%.

 

2. Revised dividends for the Year ending December 2005 (January 1 to December 31, 2005)

 

     Year-end dividends

   Basic dividend policy

      Year of 2005

(December 31, 2005)

   56 yen    Approximately 40%

 

 

Appendix

 

     Year-end dividends

   Basic dividend policy

      Year of 2004

(December 31, 2005)

   36 yen    Approximately 30%

      Year of 2003

(December 31, 2004)

   14 yen    Approximately 20%


Table of Contents

February 9, 2006

 

        Trend Micro, Inc.
        Eva Chen, Representative Director, President,
        Chief Executive Officer
        First Section of the Tokyo Stock Exchange
        Code : 4704
        Contact : Hideki Minamibayashi
        Telephone: +813-5334-4899

 

Trend Micro announces Change of Independent Auditor

 

Trend Micro announced today that it has passed a resolution at its Board of Directors meeting held on February 9, 2006, to determine a new independent auditor in charge of audits under Paragraph 1, Article 2, of the Law for Special Exceptions to the Commercial Code Concerning Audits, etc., of Limited Companies (Kabushiki-kaisha) and Paragraph 1, Article 193-2 of the Securities and Exchange Law. The effecting of this change is conditional on the resolution at the 17th ordinary general meeting of shareholders on March 28, 2006.

 

The prior consent of the Board of Corporate Auditors of the Company has been obtained with regard to the decision not to renew the engagement of the current independent auditor and for the election of the new independent auditor.

 

1. Reason for the New Election

 

The term of current engagement of ChuoAoyama PricewarterhouseCoopers, the independent auditor of the Company, will expire at the time of close of the ordinary shareholder’s meeting scheduled on March 28, 2006. At the same time, we plan to engage KPMG AZSA & Co. as the Company’s independent auditor. We have continued to utilize the same independent auditor since December 1999, but we have adopted a policy to review the hiring of an independent auditor every five years by comprehensively considering such things as the scope of its services and fees. As a result of our review based on this policy, we have decided to change the independent auditor at this time.

 

2. Independent Auditor to be Elected

Name:    KPMG AZSA & Co.
Office location:    AZSA Center Building
     1-2, Tsukudo-cho
     Shinjuku-ku, Tokyo
3. Independent Auditor before Change
Name:    ChuoAoyama PricewarterhouseCoopers
Office location:    Kasumigaseki Building, 32nd Floor
     2-5, Kasumigaseki 3-chome
     Chiyoda-Ku, Tokyo

 

4. Expected Date for Election to Take Effect

 

March 28, 2006 (expected date for the ordinary general meeting of shareholders)


Table of Contents

Feb 9, 2006

 

Report of Earning Results (Consolidated)

For Fiscal Year Ending December 31, 2005

 

[ Prepared in accordance with US GAAP ]

 

Company:    Trend Micro Incorporated    Tokyo Stock Exchange 1st Section
Code:    4704           Location : Tokyo
(URL http://www.trendmicro.co.jp/)     
Representative:            Title      Representative Director and Chief Executive Officer
             Name      Eva Chen     
Contact:            Title      Director, Corporate Affairs Department     
             Name      Hideki Minamibayashi    (Phone: 81-3-5334-3600)
Date of the board of directors authorizing the earning results:    Feb 9, 2006

 

 

1. Financial Highlights for FY2005 (January 1, 2005 through December 31, 2005)

(All figures except for per share information are rounded to millions of yen.)

 

 

(1) Consolidated Results of Operations

 

     Net Sales

   Growth rate

  

Operating

income


   Growth rate

  

Net income

before tax


   Growth rate

     Millions of yen    %    Millions of yen    %    Millions of yen    %

FY2005

   73,030    17.7    27,572    5.7    29,108    10.6

FY2004

   62,049    29.0    26,078    72.1    26,325    71.7

 

     Net Income

  

Growth

Rate


  

Net income

per share

(basic)


  

Net income

per share

(diluted)


  

Return on

shareholders’equity


   Net income before tax /
total assets ratio


  

Net income

before tax ratio


     Millions of yen    %    Yen    Yen    %    %    %

FY2005

   18,670    17.6    139.85    137.83    25.7    24.3    39.9

FY2004

   15,875    71.6    120.64    118.59    29.6    28.0    42.4

(Note)

 

1.      Equity in earnings of affiliated companies:

   67 million yen ( 53 million yen in FY2004)

2.      The company made no changes in accounting principles that had material effects on the financial position, results of operations, and cash flow position, during the period.

3.      Weighted average number of shares outstanding:

   133,498,438 shares (131,588,738 shares in FY2004)

4.      The percentage of net sales, operating income, net income before tax and net income are comparison to the prior fiscal year.

 

 

(2) Consolidated Financial Position

 

As of


   Total assets

   Shareholders’ equity

   Shareholders’ equity ratio

  

Shareholders’ equity

per share


     Millions of yen    Millions of yen    %    Yen

December 31, 2005

   132,935    81,863    61.6    610.51

December 31, 2004

   106,734    63,175    59.2    474.40

(Note)

 

Number of shares outstanding:   134,090,494 shares as of December 31, 2005
    133,167,433 shares as of December 31, 2004

 

 

(3) Consolidated Cash Flow Information

 

    

Cash flows from

operating activities


  

Cash flows from

investing activities


   

Cash flows from

financing activities


   

Ending balance of

cash and cash equivalents


     Millions of yen    Millions of yen     Millions of yen     Millions of yen

FY2005

   20,646    (12,738 )   (2,406 )   59,613

FY2004

   24,900    (16,030 )   (3,250 )   52,908

 

 

(4) Basis of consolidation and application of equity method:

 

The number of consolidated subsidiaries

   20

The number of unconsolidated subsidiaries accounted by equity method

   0

The number of affiliated companies

   2

 

(5) Change in the basis of consolidation and application of equity method:

 

The number of additional consolidated subsidiaries

   2

The number of excluded consolidated subsidiaries

   1

The number of additional consolidated affiliated companies

   0

The number of excluded consolidated affiliated companies

   0

 

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2. Projected consolidated earnings

 

Projected earnings for the next quarter (January 1, 2006 through March 31, 2006)

 

     Net Sales

   Operating income

   Net income

     Millions of yen    Millions of yen    Millions of yen

1st Qtr

   19,500    7,800    4,400

(Note)        Since the business environment surrounding Trend Micro Group tends to fluctuate in the short run, it is difficult to make the highly reliable projection figures on a yearly basis. We, therefore, decided to announce the earnings on a quarterly basis in the fiscal year ending December 31, 2006 as well as earnings projection of the succeeding quarter.

 

If we found through our calculation conducted from time to time that the net sales fluctuate from the most recent quarterly projection by more than 10%, or operating income or net income fluctuates by more than 30%, we will announce the revision of the earnings projection.

 

2


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Attachment to the Report

 

1. Condition of corporate group

 

Trend Micro Group consists of Trend Micro Inc. (Japan), and its subsidiaries which develop and sell anti-virus products and offer other related services. Affiliated companies are Soft Trend Capital Corporation which manages capital funds to be invested into Internet-related ventures and NetSTAR Inc. which develops and offers URL filtering products.

 

Products related to anti-virus:

 

PC client products   LAN server products   Internet server products   All Suite products   Other products

 

The business functions in Trend Micro Group are described below.

 

Function


  

Operating Segment


    

Main companies    


Research and development    Japan      Trend Micro Inc.(Japan)
     North America      Trend Micro Inc.(U.S.A.)
     Europe      Trend Micro Deutschland GmbH (Germany)
            Trend Micro(UK)Limited
     Asia Pacific      Trend Micro Incorporated (Taiwan)
            Trend Micro(China)Incorporated
Manufacturing of the Products    Asia Pacific      Trend Micro Incorporated (Taiwan)
Sales of the Products    Japan      Trend Micro Inc.(Japan)
     North America      Trend Micro Inc.(U.S.A.)
     Europe      Trend Micro(EMEA)Limited (Ireland)
            Trend Micro Deutschland GmbH (Germany)
            Trend Micro Italy S.r.l.
            Trend Micro France SA
            Trend Micro(UK)Limited
     Asia Pacific      Trend Micro Incorporated (Taiwan)
            Trend Micro Korea Inc.
            Trend Micro Australia Pty. Ltd.
            Trend Micro Hong Kong Limited (China)
            Trend Micro(China)Incorporated
     Latin America      Trend Micro do Brasil Ltda.
            Trend Micro Latinoamerica S.A. de C.V.(Mexico)
Back office    Europe      Trend Micro(EMEA)Limited (Ireland)
     Latin America      Servicentro TMLA, S.A. de C.V.(Mexico)

 

In addition, Trend Micro Inc. (Japan) owns software copyrights and receives from its overseas subsidiaries royalties based on the respective sales of products to such subsidiaries.

 

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LOGO

(Note) All Subsidiaries are consolidated.

 

4


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2. Management Policy and Business Performance

 

MANAGEMENT POLICY

 

(1). BASIC POLICY OF MANAGEMENT

 

Our Vision:    To create a world safe for exchanging digital information.
Our Mission:    We ensure digital operational continuity against unpredictable threats.

 

Computer networks, mainly linked to the internet have already become a global infrastructure, as lifelines of the information society regardless of individual, business or national border. In the information society which is flooded with vast amounts of information, the computer network systems are used as communication methods comparable to telephones and faxes and as means to improve and rationalize business processes at companies in recent years, and the systems play a role in improving productivity and efficiency. Today many companies and individuals are being connected via the internet and it has produced various working styles, such as small offices and home offices, which enables employees to work at remote locations and business forms which establish data management operation and customer support operation, etc. in areas where labor cost is relatively low beyond the confines of country, industry or business form. The diffusion of networks on a global scale has already become the foundation for the global economy with eliminating the geological restrictions of business activities.

 

In typical homes there are many devices with internet functions and fusion of home appliance and IT is emerging as a result of the diffusion of technologies such as IP telephone, broadband high-speed communication technology and wireless communication technology. In-home networks become prevalent and several internet devices are introduced into households, and our daily life is evolving, influenced by the advanced information society.

 

In this way today’s computer network systems have much impact on the whole society to bring about changes in business forms and individual lifestyles around the world. When we think about the changes of our lives from the viewpoint of information, the benefit of worldwide networking cannot be overestimated. Non- standardized manufacturing processes as the obstacles to digital information exchanges in the past have gradually disappeared, and as a consequence, improvements in compatibility and convenience are achieved. On the other hand, with the disappearance of diversity, the possibility to use vulnerabilities for attacking the whole network system by computer viruses is acknowledged as a problem. With the standardization of the global infrastructure network, the convenience enabled by the internet, and the risks associated with it are on two sides of the same coin. Crimes carried out through the manipulation of computer networks, such as phishing and virus incidents, could have significant impact on our daily lives and economic activities. Today the threats on the network such as computer viruses, spyware and spam are not of a nature that can be predicted beforehand and treated with all possible measures. It seems there is now a requirement for enterprises and individuals to deploy security measures against new network threats and crimes which could increase causing monetary damages and flattenning networks around the world.

 

For such a great responsibility to protect the global infrastructure, we will provide strongly supportive products and services promptly beyond national boundaries for every phase of operations in the network such as vulnerability prevention, risk management, outbreak prevention, timely update of virus pattern files, assessment and restoration. We are not only protecting each enterprise and individual users from the threats over the networks without interrupting economic activities but also would like to contribute to the further development of the information society by improving the safety of the whole network system.

 

(2). BASIC POLICY OF PROFIT SHARING

 

We intend to continue to return profits to shareholders based on the net profit on the consolidated basis while striving to enhance financial strength and secure inner reserve in order to deal with significantly changing business environment and maintain competitive edge against competitors. As our basic policy about dividend, we plan to pay a year-end dividend on the basis of the dividend ratio of 40%.

 

(3). VIEWS AND POLICIES FOR INVESTMENT UNIT

 

While we recognize that securing liquidity of our shares is an important issue, we consider the current liquidity is at a satisfactory level. With that background, we conclude that reducing the investment unit which will incur considerable expense is not necessarily profitable to all shareholders.

 

We intend to review in the future the investment unit as needed taking into consideration the shareholders’ interest and influences to the liquidity of our shares.

 

(4). TARGET MANAGEMENT INDEX

 

According to a research institute, the anti-virus industry, which we belongs to, is estimated to expand at an annual growth rate of around 15% from 2005 to 2009 (December 2005, IDC, USA). Making the growth rate of our consolidated net sales to exceed the industry average without fail is an important index that decides for us whether we can grow up to a leading company which can contribute to customers in the global market as well as Japanese market or not.

 

In view of the fact that we have relatively small amount of investment in physical fixed assets such as manufacturing equipment and have no significant time-lag between accounting profit and loss and cash flow as a characteristics of software companies, have uncertainty about the long-term forecast of the whole industry which, including our company, has a relatively short history, we set target as operating income margin rate of 35 – 40% at this time.

 

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Table of Contents

(5). ISSUES TO DEAL WITH

 

In the anti-virus industry which we belong to, there have been two competitors having higher market share than ours in the US. In addition to this, Microsoft Corporation, a major OS vendor, was announced that it will come into the security market in 2006, so we will face the new big competitor in near future.

 

The company plans to start the supply of “Windows OneCareTM,” a security service for consumers and also plans to launch “Windows Vista,” a new OS which is said to have an enhanced security function. It also announced that it plans to offer a service called “Client Protection” for corporate users.

 

It is anticipated that the possibility of Microsoft Corporation’s entry into the security market will make the competition in the market more intense.

 

For such intensification of competition, we are enhancing our wide range of technologies to realize multifaceted security measures against new threats evolving day by day by acquiring InterMute Inc. which provides anti-spyware technologies and Kelkea Inc. which provides IP filtering and reputation services.

 

Meanwhile, we confirmed that a virus pattern file: 2.594.00, which we distributed on April 23, 2005, significantly slowed the performance of our customers’ computers and in some cases made their computers inaccessible right after they updated with the file. We have provided assistance for reconstruction, made the utmost effort to settle the problems, and prevent reoccurrence of such a similar incident. We will continuously work to prevent recurrence by improving the quality control system of our products and to restore the user’s trust.

 

We, an expert in the antivirus area, have formed several alliances with some of the most respected names in the IT industry including Cisco Systems, Inc. in US, the worldwide leader in networking for the internet. Starting from the US market, they have delivered the advanced prevention solution named Cisco Incident Control System (ICS) which contains a part of our anti-virus functions into Cisco’s routers, switches and security appliance products starting.

 

We believe this kind of alliance is important for our products and sales strategies, because it has potential effects from the fusion of competitive products in each other’s fields and the supplement of sales channels between affiliated vendors.

 

We would like to continue to develop original solutions faster than the competitors by concentrating our business resources and improve our superiority in products and services with advancing product specifications and performance from the viewpoint of customers. At the same time, we will aim to company growth for the future to strength our loyalty for customers with marketing development to be conscious of the customer attributes based on differences in each buying behaviour.

 

(6). CORPORATE GOVERNANCE

 

Our management system is administering business operations under the recognition that quickly corresponding to changes in the environment of our company group and securing transparency and soundness of management as well as keeping reliability of disclosures are of prime importance.

 

The Board of Directors is composed of four directors and holding the Board meetings according to circumstances so that it can quickly make decisions. One of the four directors is appointed from outside of our company to enhance supervisory function for appropriate operation of the Board.

 

An executive is appointed for each business unit to take responsibility for executing respective operation so that our management policy decided by the Board of Directors is reflected in actual operation in the business area extending into over 20 countries in the world.

 

We have appointed four corporate auditors all from outside of our company so that the Board of Auditors can audit without bias the operation of the Board of Directors and business execution by the directors. The Board of Auditors has formulated a guideline for the relationship with the external auditor in order to ensure independence of the external auditor which takes charge of audit of our consolidated financial statements. The guideline prohibits commissioning the external auditor any affair which may impair independence of the said auditor. The guideline has also established a system in which the Board of Auditors is to make advance approval according to the guideline for audit and non-audit services we receive from the said auditor.

 

As for the internal control functions of our whole group, we have established an effective internal control functions by considering our business model and the business environment surrounding our group. We have also appointed a full-time person for supervision at corporate affairs department and are developing this system in communication with the external auditor and legal advisors as well as the board of corporate auditors and the board of directors. In fiscal year 2004, we have implemented our Code of Conduct focusing on “ethical behavior”, “compliance with laws” and “full and fair disclosure” and clarified internal reporting channel and executed a survey of business process by physical inspections at major department both domestically and abroad. We will continually aim to establish internal control in the direction of strengthening our unique and global business operation which is not restricted by time, space and culture, and will also respond to the Sarbanes-Oxley Act of 2002 which is applicable to us because we are listed on the Nasdaq exchange.

 

(7). PARENT COMPANY AND OTHER RELATED COMPANIES

 

Not Applicable

 

6


Table of Contents

OPERATING RESULTS AND FINANCIAL CONDITION

 

I. OPERATING RESULTS

 

(1). REVIEW OF CURRENT PERIOD

 

     (Unit: million yen)

 
     Net Sales

   

Operating

income


   

Net income

before tax


    Net Earnings

 

FY2005

   73,030     27,572     29,108     18,670  

FY2004

   62,049     26,078     26,325     15,875  

Rate of Change

   18 %   6 %   11 %   18 %

 

     (Unit: million yen)

 
     Net Sales

 
     FY2005

   FY2004

  

Rate of Change

(%)


 

Japan

   29,416    25,443      16 %

North America

   15,417    11,891      30 %

Europe

   18,379    16,418      12 %

Asia and Pacific Reg.

   7,910    6,305      25 %

Latin America

   1,908    1,992    D 4 %

 

[Overview of Current Business Performance]

 

The Japanese economy in this term showed a slight recovery from its stagnant phase and it has kept an expanding trend. According to the Short-term Economic Survey of Enterprise in Japan (Tankan) announced in December 2005, the diffusion index of large manufacturing enterprises had improved in 3 consecutive terms and the index is at the highest level since the survey in December 2004. In addition to this, improvements were observed in non-manufacturers and the medium and small business sector. These facts seem to indicate that the Japan economic recovery is spreading to all sectors. The possibility of a future increase in corporate profit and household income, will likely lead to expansion of capital investments and consumer spending. However, considering there is a possibility of the oil price retaining current high levels, now is not a time for optimism.

 

The global economy is in the same situation. There are concerns such as a slowdown of growth due to the escalated oil price, the possibility of the increase of inflationary pressure and the growth of global imbalances.

 

In the network security industry, the number of damages has been on a declining trend on a global basis since two years ago and the number of infection damages in this period is bellow that of the same period last year both in Japan and overseas.

 

The number of virus infection damages in this term in Japan was 45,208 reports and the number decreased substantially from that in the same period last year (63,657 reports) and the number was also slightly less than that in the year before last (45,238 reports). In 2005 the change in the trend of malicious code has clearly occurred. There was no specific type of virus which caused a global outbreak and stood out, but the damages due to virus became dispersed. It can be said that the trend has shifted to small scale infections and reports caused by various types of viruses. The background of this shift might be the change in the virus writers. It was said that the virus writers were criminals for pleasure in the past, but their purpose has now shifted to get concrete gains such as money. Different from the intention to cause disturbances in the public by spreading infections to the general public, the malicious code which is intended to steal passwords and the likes and use them for wrong purposes began to launch pinpoint attacks against their targets.

 

We, Trend Micro, predict future damage will be caused by traditional viruses and malicious code, and new threats including phishing and spyware and also BOT attacks - where third parties other than the authorized users take control of machines by remote control, creating a network of infected computers that they use to commit misdeeds. Attacks such as viruses and malicious code and new threats will cause varied types of damage, as the network comes under increasing numbers and types of malicious threats. The attacks and the damage they cause, have become more focused on monetary gain, on fraud and identity theft. The costs associated with those damages will also become enormous. Such a trend which became prominent in 2005 will further accelerate in the future.

 

Under such environment our group’s business conditions are as follows.

 

First of all, in Japan our sales showed healthy movement in the beginning of this period by maintaining the good sales of the previous fiscal year. Especially, with the full enforcement of the personal information protection law from April 2005, it was thought that the demand for the security products would spread to not only to major companies but also to medium to small companies. The introduction of the anti-virus products and content security products to the corporate market should have progressed further since April. In such circumstances, we had the incident of virus pattern file in the same month. As a result, this affected our local sales, especially, in the consumer market during the second quarter. In addition to the decrease in the sales of the consumer retail products due to our voluntary restraint on over-the-counter sales, there was also a concern about the influence on corporate customers. However, the sales of the corporate products maintained growth and we announced the termination of the incident on June 23, 2 months after the occurrence of it. As for the new version of our personal products “Virus Buster”, called “PC-Cillin” for Japan, launched in last November, its demand was increased by providing further functional enhancement and support service with the increase of damages by phishing and its sales showed an increase. On the other hand, the sales of our corporate products also were continuously steady and showed a healthy growth, and the demands for the service products including support increased. In addition to this, we launched a new product for medium and small companies and it has contributed to the growth.

 

Despite such influence, the amount of sales for this period was 29,416 million yen (16% increase from the same period in previous year).

 

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In the North American region, its economy kept a brisk growth with the support of improved employment during the later part of the last year despite the hovering of high oil prices and concerns on the ending of the appreciation of housing investment and the movements of the expenditures related to the restoration from the hurricane damages. Under the circumstance with a downwind due to backgrounds such as a strong personal consumption throughout the year, the sales in the region where we had had an advantage in the products for corporate customers showed a substantial increase in the consumer market for which we had implemented reinforcement measures of sales channels. In the North American region under such circumstances, we acquired InterMute Inc. which provides anti-spyware technologies and Kelkea Inc. which provides IP filtering and Reputation service in view of the fact that the demand for the measures against the new threats mainly from spyware was significantly increased. We are enhancing our wide varieties of technologies to realize a multifaceted security measures against new threats that evolve every day. The demand for the medium and small companies’ business market continued to be strong and the sales for this period in the area came to 15,417 million yen (30% increase from the previous period).

 

In the European region, its economy was in a recovery phase led by foreign demand and began to show a gradual economic recovery. The European Central Bank (ECB) raised its interest rate at the end of 2005 for the first time in recent 5 years and fixed its ultralow interest policy that had kept with the stagnant economy in the background. Although there was a sign of the recovery of consumer spending, the economic outlook in this region was still in a situation that could not be optimistic. The unemployment rate of Germany and France were still at a high level and it has still uncertain abound whether the economic recovery tone leaded by foreign demand have an impact on domestic demand or not. Under these circumstances, security demand has been continued to show a steady increase in small and medium business solution of mainly France and Italy. Finally the sales of the region increased on a yearly basis despite our initial prediction for weak movement of European market. The sales for this period in the area came to 18,379 million yen (12% increase from the previous period).

 

In Asia and Pacific regions, the sales in Taiwan were expanded and the sales in Australia, where personal products showed excellent sales, were substantially expanded and its growth rate was comparable to that of the US. The net sales for this period in the regions came to 7,910 million yen (25% increase from the previous period).

 

At Latin America region, the net sales for this period in the region came to 1,908 million yen (4% decrease from the previous period) that was slight decrease as that in the last year due to the review of the government businesses.

 

As a result, the consolidated net sales for this period came to 73,030 million yen (18% increase from the previous period).

 

Meanwhile, operating expenses came to 34,330 million yen (39% increase from the previous period) due to the increases in the expense to deal with the pattern file incident and reorganization that will newly start in 2006. As a result, the consolidated operating income for this period came to 27,572 million yen (6% increase from the previous period) and the consolidated net income for this period came to 18,670 million yen (18% increase from the previous period effected by other operating income, changing the rate of tax, and others.

 

In addition, we plan to pay 565 yen for year-end cash dividend per share (the previous year-end cash dividend: 36 yen per share).

 

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(2). Projection for the First Quarter of the fiscal year 2006 (from January 1, 2006 to March 31, 2006)

 

The business environment tends to drastically change over a short term. Consequently, it is difficult to calculate highly reliable values about the projection for the whole financial year. Instead, we make it a rule to announce a business forecast for the coming quarter term at the time of reporting quarterly results.

 

In the event forecast numbers are revised by more than 10% for net sales or 30% for operating income and net income from the last forecast, we will announce revision of the earnings forecast.

 

Business Forecast for the First Quarter of FY2006 (January 1 2006 – March 31 2006)

 

Consolidated Net Sales

   19,500 million yen

Consolidated Operating income

   7,800 million yen

Consolidated Current Net income

   4,400 million yen

 

In development of the business forecasts the main assumed exchange rates are as follows.

 

1 US $

   118 yen

1 Euro

   139 yen

 

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II. FINANCIAL CONDITION

 

CASH FLOW

 

     (Unit: million yen)

     FY2005

   FY2004

  

Increase

(Decrease)


Cash Flows from Operating Activities

     20,646      24,900    D 4,254

Cash Flows from Investing Activity

   D 12,738    D 16,030      3,292

Cash Flows from Financing Activity

   D 2,406    D 3,250      844

Effect of Exchange Rate Changes on Cash and Cash Equivalents

     1,202      569      633

Net increase (Decrease) in Cash and Cash Equivalents

     6,704      6,189      515

Cash and Cash Equivalents at end of period

     59,613      52,908      6,704

 

    [Overview of Cash Flow]

 

For the cash flows from operating activity for this period, income was decreased 4,254 million yen compared with the previous period and the balance was ended with a surplus of 20,646 million yen. This decrease in income is mainly due to increases in net income and substantial decrease in accrued income and other taxes.

 

For the cash flows from investing activity, expenditure was decreased 3,292 million yen compared with the previous period and the balance was ended with a deficit of 12,738 million yen. This decrease in expenditure is mainly due to substantial increase in income for proceeds from sales of marketable securities, etc.

 

For the cash flows from financing activity, expenditure was decreased 844 million yen compared with the previous period and the balance was ended with a deficit of 2,406 million yen. This decrease in expenditure is mainly due to there are no redemption of bonds and treasury stock related cash flow changed from net payments to net proceeds, etc.

 

Taking these increase and decrease and the effect of exchange rate changes on cash and cash equivalents into account, the cash and cash equivalents at end of this period was 59,613 million yen and was increased 6,704 million yen compared with the previous period.

 

[Trends of Cash Flow Indexes]

 

 

     (US GAAP)

     FY2003

   FY2004

   FY2005

Shareholder’s equity Ratio (%)

   54.1    59.2    61.6

Capital Adequacy Ratio on Market Value Basis (%)

   462.2    690.0    449.9

Debt Redemption Period (years)

   0.4    —      —  

Interest Coverage Ratio

   103.3    218.2    5,566.4

 

     (Japan GAAP)

     FY2001

   FY2002

Shareholder’s equity Ratio (%)

   47.3    50.0

Capital Adequacy Ratio on Market Value Basis (%)

   626.7    360.4

Debt Redemption Period (years)

   1.2    0.8

Interest Coverage Ratio

   44.2    49.4

Note

 

Shareholder’s equity Ratio:

  (Total shareholder’s Equity)/(Total Assets)

Capital Adequacy Ratio on Market Value Basis:

  (Total Market Value of Shares)/( Total Assets)

Debt Redemption Period:

  (Interest-bearing Debt)/(Operating Cash Flow)

Interest Coverage Ratio:

  (Operating Cash Flow)/(Interest Payment)

 

  * All indexes are calculated from the financial values on a consolidated basis.
  * “Total Market Value of Shares” is calculated as follows; “closing share price at the term end” multiplies by “number of shares issued at the term end “(net treasury stocks).
  * “Operating Cash Flow” is “Net cash flows provided by operating activity” in the consolidated statement of cash flows. “Interest-bearing Debt” is all debts with interest payments among the debts reported on consolidated balance sheet. “Interest Payment” is the amount of payment for interest expense in the consolidated statement of cash flows
  * With the enforcement of revision of “Rules on the terms, forms and making method of a consolidated financial statement” in March 2002, consolidated financial statements had been prepared based on USGAAP from the year ended December 31, 2003.

 

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III. 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.

 

Microsoft Corp., a major operating system vendor, has acquired some security vendors such as GeCAD Software Srl., an anti-virus software vendor in Romania. Microsoft Corp. announced that they would provide anti-virus products or services such as named “Windows OneCare” or “Client Protection” in 2006. At this time, we do not know the details of those services or products, but if in fact Microsoft will launch those products or services, and/or, if anti-virus functions were to be included in its operating system products, this could have a material adverse effect on our business, financial condition and results of operations.

 

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)9.2 billion, or 19.1%, of our net sales in fiscal 2003, approximately (Yen)10.4 billion, or 16.8%, of our net sales in fiscal 2004 and approximately (Yen)10.6 billion, or 14.5%, of our net sales in fiscal 2005. 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.

 

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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.

 

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 US 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 US 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 2004 and 2005. 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 US 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.

 

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WE MAY SUFFER A LOSS OF SALES AND MARKET SHARE IN OUR CORE JAPANSE 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.

 

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.

 

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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.

 

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 hiring, 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 US and Europe have increased in recent years, we remain significantly dependent on the Japanese market. Net sales in Japan accounted for approximately 42% of our net sales in fiscal 2003, approximately 41% in fiscal 2004 and approximately 40% in fiscal 2005. 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 US 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 US consolidated subsidiary holds seven issued US patents and our Taiwan consolidated subsidiary holds four issued US 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.

 

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 US 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.

 

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WE MAY HAVE TO CONSTRAIN OUR BUSINESS ACTIVITIES TO AVOID BEING DEEMED AN INVESTMENT COMPANY UNDER THE US 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 US Investment Company Act of 1940. We do not believe that we are an investment company as defined under the US 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 US listing or other sponsorship promoting a US 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.

 

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 34.4% of our outstanding shares as of December 31, 2005. 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 US 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 December 30, 2005 was (Yen) 4,460, and the closing price on the Nasdaq National Market for our ADSs on December 30, 2005 was $38.45 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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3 CONSOLIDATED FINANCIAL STATEMENTS

 

(1) CONSOLIDATED BALANCE SHEETS

 

     (Thousands of yen)

    

December 31,

2004


  

December 31,

2005


Account


   Amount

            %        

   Amount

            %        

<Assets>

                     

Current assets:

                     

Cash and cash equivalents

   52,908,357          59,612,577      

Time deposits

   383,276          1,435,293      

Marketable securities

   15,288,575          22,395,365      

Notes and accounts receivable, trade

–less allowance for doubtful accounts
(Yen) 292,815 in FY2004 and
(Yen) 282,257 in FY2005, respectively

–less sales returns
(Yen) 572,123 in FY2004 and
(Yen) 422,453 in FY2005, respectively

   15,245,213          19,198,870      

Inventories

   201,243          359,897      

Deferred income taxes

   6,224,972          6,727,229      

Prepaid expenses and other current assets

   1,560,058          1,925,791      
    

 
  

 

Total current assets

   91,811,694     86.0    111,655,022     84.0
    

 
  

 

Investments and other assets:

                     

Securities investments

   9,831,913          11,159,428      

Investment in and advances to affiliated companies

   175,281          321,569      

Software development costs

   438,464          1,174,691      

Other intangibles

   296,368          1,390,434      

Goodwill

   —            2,130,179      

Deferred income taxes

   1,695,771          2,033,488      

Other

   636,009          671,800      
    

 
  

 

Total investments and other assets

   13,073,806     12.3    18,881,589     14.2
    

 
  

 

Property and equipment:

                     

Office furniture and equipment

   3,323,526          4,468,891      

Other properties

   1,165,173          1,539,195      
    

      

   
     4,488,699          6,008,086      

Less: Accumulated depreciation

   (2,640,288 )        (3,609,473 )    
    

 
  

 

Total property and equipment

   1,848,411     1.7    2,398,613     1.8
    

 
  

 

        Total assets

   106,733,911     100.0    132,935,224     100.0
    

 
  

 

 

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     (Thousands of yen)

    

December 31,

2004


  

December 31,

2005


Account


   Amount

    %

   Amount

    %

<Liabilities, minority interest and shareholders’ equity>

                     

Current liabilities:

                     

Notes payable, trade

   88,087          118,572      

Accounts payable, trade

   1,271,067          794,450      

Accounts payable, other

   2,699,762          3,208,625      

Withholding income taxes

   882,693          1,082,302      

Accrued expenses

   2,143,694          3,138,674      

Accrued income and other taxes

   7,192,085          5,476,791      

Deferred revenue

   24,634,662          31,506,315      

Other

   651,503          895,088      
    

 
  

 

Total current liabilities

   39,563,553     37.1    46,220,817     34.8
    

 
  

 

Long-term liabilities:

                     

Deferred revenue

   3,268,892          3,874,936      

Accrued pension and severance costs

   656,041          889,774      

Other

   70,665          82,056      
    

 
  

 

Total long-term liabilities

   3,995,598     3.7    4,846,766     3.6
    

 
  

 

Minority interest

   —       —      4,531     0.0
    

 
  

 

Shareholders’ equity:

                     

Common stock

                     

Authorized

                     

-December 31, 2004    250,000,000 shares (no par value)

                     

-December 31, 2005    250,000,000 shares (no par value)

                     

Issued

                     

-December 31, 2004    135,755,872 shares

   11,426,977                 

-December 31, 2005    136,603,725 shares

              12,484,849      

Additional paid-in capital

   17,359,335          18,572,063      

Retained earnings

   42,165,026          55,971,955      

Accumulated other comprehensive income

                     

Net unrealized gain (loss) on debt and equity securities

   284,348          657,885      

Cumulative translation adjustments

   (606,463 )        1,459,600      
    

      

   
     (322,115 )        2,117,485      
    

      

   

Treasury stock, at cost

                     

-December 31, 2004    2,588,439 shares

   (7,454,463 )               

-December 31, 2005    2,513,231 shares

              (7,283,242 )    
    

 
  

 

Total shareholders’ equity

   63,174,760     59.2    81,863,110     61.6
    

 
  

 

Total liabilities, minority interest and shareholders’ equity

   106,733,911     100.0    132,935,224     100.0
    

 
  

 

 

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Table of Contents

(2) CONSOLIDATED STATEMENTS OF INCOME

 

     (Thousands of yen)

 
     For the year ended
December 31, 2004


   For the year ended
December 31, 2005


   Increase
(Decrease)


 

Account


   Amount

            %        

   Amount

    %

   %

 

Net sales

   62,049,254     100.0    73,029,901     100.0    17.7  

Cost of sales:

                            

Amortization of capitalized software, and Material

   3,236,499          2,598,603             

Maintenance

   2,260,934          1,671,320             

Customer Support

   5,723,426          6,857,901             
    

 
  

 
      

Total Cost of sales

   11,220,859     18.1    11,127,824     15.2    (0.8 )
    

 
  

 
      

Operating Expense:

                            

Selling

   16,009,409          20,944,484             

Research and development

   2,597,325          4,395,207             

General and administrative

   6,143,985          8,990,611             
    

 
  

 
      

Total operating expenses

   24,750,719     39.9    34,330,302     47.0    38.7  
    

 
  

 
      

Operating income

   26,077,676     42.0    27,571,775     37.8    5.7  
    

 
  

 
      

Other incomes (expenses):

                            

Interest income

   451,217          836,910             

Interest expense

   (87,464 )        (3,709 )           

Gain (loss) on sales of marketable securities

   101,199          370,326             

Foreign exchange gain (loss), net

   (183,292 )        327,257             

Other income (expense), net

   (34,350 )        5,741             
    

 
  

 
      

Total other income (expense)

   247,310     0.4    1,536,525     2.1    521.3  
    

 
  

 
      

Net income before tax

   26,324,986     42.4    29,108,300     39.9    10.6  
    

 
  

 
      

Income taxes:

                            

Current

   11,893,659          11,863,127             

Deferred

   (1,390,387 )        (1,358,568 )           
    

 
  

 
      
     10,503,272     16.9    10,504,559     14.4    0.0  
    

 
  

 
      

Income before minority interest and equity in earnings of affiliated companies

   15,821,714     25.5    18,603,741     25.5    17.6  

Minority interest in income of consolidated subsidiaries

   —       —      (338 )   0.0    —    

Equity in earnings (losses) of affiliated companies

   53,122     0.1    66,551     0.1    25.3  
    

 
  

 
      

Net income

   15,874,836     25.6    18,669,954     25.6    17.6  
    

 
  

 
      

Per share data:

                            
     Yen

         Yen

            

Net income

                            

-Basic

   120.64          139.85             

-Diluted

   118.59          137.83             

 

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(3) CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

     (Thousands of yen)

 

Account


   For the year ended
December 31, 2004


    For the year ended
December 31, 2005


 

Net income

   15,874,836     18,669,954  
    

 

Other comprehensive income (loss), before tax:

            

Unrealized gains (losses) on debt and equity securities:

            

Unrealized holding gains (loss) arising during period

   514,117     1,375,136  

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

   (143,702 )   (704,199 )
    

 

     370,415     670,937  

Foreign currency translation adjustments

   (105,517 )   2,066,063  
    

 

Total

   264,898     2,737,000  

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

   (157,032 )   (297,400 )
    

 

Other comprehensive income (loss), net of tax

   107,866     2,439,600  
    

 

Comprehensive income

   15,982,702     21,109,554  
    

 

 

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(4) CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

     (Thousands of yen)

 

Account


  

For the year ended

December 31, 2004


   

For the year ended

December 31, 2005


 

<Common stock>

            

Balance at beginning of period

   7,396,194     11,426,977  

Exercise of stock purchase warrants and stock acquisition rights

   4,030,783     1,057,872  
    

 

Balance at end of period

   11,426,977     12,484,849  
    

 

<Additional paid-in capital>

            

Balance at beginning of period

   13,165,881     17,359,335  

Tax benefit from exercise of non-qualified stock warrants

   498,905     155,323  

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

   (312,708 )   —    

Loss on sales of treasury stock, net of tax

   (22,941 )   —    

Exercise of stock purchase warrants and stock acquisition rights

   4,030,198     1,057,405  
    

 

Balance at end of period

   17,359,335     18,572,063  
    

 

<Retained earnings>

            

Balance at beginning of period

   28,236,466     42,165,026  

Net income

   15,874,836     18,669,954  

Stock issue costs, net of tax

   (11,977 )   (3,519 )

Cash dividends

   (1,829,260 )   (4,794,028 )

Loss on sales of treasury stock, net of tax

   (105,039 )   (65,478 )
    

 

Balance at end of period

   42,165,026     55,971,955  
    

 

<Net realized gain (loss) on debt and equity securities>

            

Balance at beginning of period

   70,965     284,348  

Net change during the period

   213,383     373,537  
    

 

Balance at end of period

   284,348     657,885  
    

 

<Cumulative translation adjustments>

            

Balance at beginning of period

   (500,946 )   (606,463 )

Aggregate translation adjustments for the period

   (105,517 )   2,066,063  
    

 

Balance at end of period

   (606,463 )   1,459,600  
    

 

<Treasury stock, at cost>

            

Balance at beginning of period

   (4,416,763 )   (7,454,463 )

Purchase of treasury stock

   (3,759,507 )   (142,062 )

Sales of treasury stock

   721,807     313,283  
    

 

Balance at end of period

   (7,454,463 )   (7,283,242 )
    

 

Total shareholders’ equity

   63,174,760     81,863,110  
    

 

 

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(5) CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     (Thousands of yen)

 

Account


  

For the year ended

December 31, 2004


   

For the year ended

December 31, 2005


 

Cash flows from operating activities:

            

Net income

   15,874,836     18,669,954  

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

            

Depreciation and amortization

   1,590,743     1,878,050  

Pension and severance costs, less payments

   166,649     207,109  

Deferred income taxes

   (1,390,387 )   (1,358,568 )

(Gain) loss on sales of marketable securities

   (101,199 )   (370,326 )

Equity in earnings of affiliated companies

   (53,122 )   (66,551 )

(Gain) loss on sale and disposal of fixed assets

   —       11,585  

Minority interest

   —       338  

Changes in assets and liabilities:

            

Increase (decrease) in deferred revenue

   7,293,488     6,209,680  

(Increase) decrease in accounts receivable, net of allowances

   (3,421,729 )   (3,567,924 )

(Increase) decrease in inventories

   (124,093 )   (124,971 )

Increase (decrease) in notes and accounts payable, trade

   379,882     (526,321 )

Increase (decrease) in accrued income and other taxes

   2,912,481     (1,826,959 )

(Increase) decrease in other current assets

   (90,479 )   (34,426 )

Increase (decrease) in accounts payable, other

   823,199     381,414  

Increase (decrease) in other current liabilities

   1,107,855     1,336,703  

(Increase) decrease in other assets

   110,628     (207,984 )

Other

   (178,744 )   34,809  
    

 

Net cash provided by operating activities

   24,900,008     20,645,612  
    

 

Cash flows from investing activities:

            

Payments for purchases of property and equipment

   (801,935 )   (1,153,193 )

Software development cost

   (645,166 )   (1,446,248 )

Payments for purchases of other intangibles

   (229,167 )   (216,107 )

Proceeds from sales of marketable securities

   4,986,012     22,079,575  

(Payment for)/Proceeds from marketable securities maturing within three months or less (net)

   (2,156,191 )   (189,708 )

Payments for purchases of marketable securities and security investments

   (17,240,100 )   (28,043,534 )

Payments for business acquisition

   —       (2,716,702 )

(Payments for)/Proceeds from time deposits

   57,047     (1,052,017 )
    

 

Net cash used in investing activities

   (16,029,500 )   (12,737,934 )
    

 

Cash flows from financing activities:

            

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

   8,049,004     2,111,758  

Redemption of bonds

   (6,500,000 )   —    

Proceeds from/(Purchase of) treasury stock (net)

   (3,165,679 )   105,743  

Tax benefit from exercise of non-qualified stock warrants

   498,905     155,322  

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

   (312,708 )   —    

Capital contribution from minority interest

   —       4,193  

Dividends paid

   (1,819,607 )   (4,782,764 )
    

 

Net cash used in financing activities

   (3,250,085 )   (2,405,748 )
    

 

Effect of exchange rate changes on cash and cash equivalents

   568,994     1,202,290  
    

 

Net increase (decrease) in cash and cash equivalents

   6,189,417     6,704,220  

Cash and cash equivalents at beginning of period

   46,718,940     52,908,357  
    

 

Cash and cash equivalents at end of period

   52,908,357     59,612,577  
    

 

Supplementary information of cash flow:

            

Payment for interest expense

   114,121     3,709  

Payment for income taxes

   8,990,398     13,109,985  

 

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Table of Contents

NOTES TO CONSOLIDATED FINANCIAL INFORMATION

 

1. Accounting Principles, Accounting Procedures and Methods for Presenting Consolidated Financial Statements

 

The accompanying consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), including Accounting Principles Board Opinion (“APB”), Statement of Financial Accounting Standards (“SFAS”), Emerging Issues Task Force Consensus (“EITF”) and the American Institute of Certified Public Accountants Statement of Position (“SOP”). The Company listed on the NASDAQ in July 1999, and prepares its consolidated financial statements pursuant to the terminology, forms and preparation methods required in order to issue American Depositary Shares, which are registered with the U.S. Securities and Exchange Commission. The Company maintains its books and records in conformity with accounting principles and practices generally accepted in Japan (“Japan GAAP”), and its foreign subsidiaries in conformity with those 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.

 

The significant differences between accounting principles, accounting procedures and methods of presentation which are adopted by the Company and its subsidiaries (U.S. GAAP) and those in Japan (Japan GAAP) are as follows. However, the effect on income before income tax caused by the GAAP differences indicated below, are immaterial.

 

(1) Pension Accounting

 

The Company and subsidiaries account for the retirement benefit plan in accordance with SFAS No. 87 “Employers’ Accounting for Pensions”. The transitional difference, when SFAS No. 87 is first applied, shall be amortized on a straight-line basis over the average remaining service period. However, in our non-consolidated financial statements, the transitional difference was all charged to income in the first year of application of local pension accounting, in accordance with Japan GAAP.

 

(2) Disclosure of the loss on disposal of fixed assets

 

Under Japan GAAP, the loss on disposal of fixed assets is disclosed in “unusual profit and loss”. We have disclosed this amount in “Other incomes (expenses)” in our consolidated statement of income.

 

(3) Common stock issue costs

 

Common stock issue costs are directly charged to retained earnings, net of tax, in the accompanying consolidated financial statements. Under Japan GAAP, these costs are charged to income as incurred.

 

(4) Goodwill

 

The Company accounts for goodwill in accordance with SFAS 142, “Goodwill and Other Intangible Assets” which requires the discontinuance of amortization for goodwill and at least an annual test for impairment.

 

2. Summary of 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.

 

Consolidated subsidiaries:

 

All subsidiaries which are composed of the following 20 companies are consolidated:

 

[North America]

Trend Micro Inc.(USA)

 

[Europe]

Trend Micro (EMEA) Limited (Ireland)

Trend Micro France SA

Trend Micro Deutschland Gmbh (Germany)

Trend Micro Italy S.r.l.

Trend Micro (UK) Limited

 

[Asia Pacific]

Trend Micro Australia Pty.Ltd.

Trend Micro (China) Incorporated

Trend Micro Hong Kong Limited (China)

Trend Micro India Private Limited

Trend Micro Korea Inc.

Trend Micro Malaysia Sdn. Bhd.

Trend Micro (NZ) Limited (New Zealand)

Trend Micro (Singapore) Private Limited

Trend Micro Incorporated (Taiwan)

ipTrend Incorporated (Taiwan)

Trend Micro (Thailand) Limited

 

[Latin America]

Trend Micro do Brasil Ltda. (Brazil)

Servicentro TMLA,S.A.de C.V.(Mexico)

Trend Micro Latinoamerica S.A.de C.V. (Mexico)

 

ipTrend Incorporated (Taiwan) was liquided during the year ended December 31, 2005.

 

During the FY2005, the Company acquired 100% of the outstanding capital shares of Trend Micro Braintree Inc. (former InterMute, Inc.,) and Trend Micro San Jose, Inc (former Kelkea Inc.) in purchase business combinations. These acquisitions are intended to expand our service offerings for advanced data privacy protection and advanced IP filtering and reputation services technologies. The aggregate purchase price was (Yen) 2,746,505 thousand and (Yen) 2,130,179 thousand has been recorded as goodwill. All of (Yen) 2,130,179 thousand goodwill was allocated to North America Segment. As of December 31, 2005, these subsidiaries were merged with Trend Micro Inc.(USA). With the merger with Trend Micro Braintree, Inc., the Company has contingent consideration remaining in the amount of USD10,500 thousands (equivalent of (Yen) 1,239,735 thousand as converted using the year end exchange rate of ¥118.07/US$), subject to the predecessor company’s achievement of specified sales for the period beginning with the closing of the acquisition and ending twelve months thereafter. If this extra payment is made, the carrying amount of goodwill will be adjusted.

 

Affiliated companies:

 

The equity method of accounting is applied to investments in the following affiliated companies.

 

Soft Trend Capital Corporation (Japan)

Net STAR, Inc. (Japan)

 

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Table of Contents

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 are taken into 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.

 

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.

 

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Table of Contents

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 securities, equity securities and mutual funds. Debt securities, equity securities and mutual funds 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.

 

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.

 

Goodwill and other intangible assets

 

Goodwill is the excess of the purchase price of the acquired business over the fair value of its net tangible and identifiable intangible assets. Other intangible assets consist primarily of existing technology purchased by business acquisition.

 

We account for goodwill in accordance with SFAS 142, “Goodwill and Other Intangible Assets”. SFAS 142 requires, among other things, the discontinuance of amortization for goodwill and at least an annual test for impairment. An impairment review may be performed more frequently in the event circumstances indicate that the carrying value may not be recoverable.

 

SFAS 142 also requires that intangible assets with estimable useful lives be amortized over their respective estimated useful lives. Existing technology is amortized over 4 years.

 

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.

 

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Table of Contents

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 SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148.

 

In October 1995, SFAS 123 established a fair value based method of accounting for employee stock based compensation. If compensation cost for the stock options with warrants, and the stock options with Stock acquisition rights been determined based on the fair value at the grant dates, as prescribed by SFAS 123, the Company’s pro forma net income and net income per share would have been as follows:

 

     (Thousands of Yen, except per share data)

 
    

    For the year ended    

December 31, 2004


   

For the year ended    

December 31, 2005    


 

Net income:

            

As reported

   15,874,836     18,669,954  

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

   (3,249,180 )   (3,771,794 )
    

 

Pro forma net income

   12,625,656     14,898,160  
    

 

Net income per share:

            

As reported—

            

Basic

   (Yen)120.64     (Yen)139.85  

Diluted

   118.59     137.83  

Pro forma net income—

            

Basic

   (Yen)95.95     (Yen)111.60  

Diluted

   94.32     109.99  

 

Pro forma stock-based compensation expense has been revised to reflect the corrections in the amortization period, expected life term of the option and volatilities used to determine compensation expense. This correction impacts the pro forma net income and net income per share previously presented for fiscal 2004. As a result, the pro forma net income for fiscal 2004 decreased by (Yen) 609,159 thousand and the pro forma basic net income per share and pro forma diluted net income per share decreased by (Yen) 4.63 and (Yen) 4.55, respectively, compared to the amounts previously presented.

 

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 year ended December 31, 2004 and 2005;

 

    

For the year ended

December 31, 2004


  

For the year ended

December 31, 2005


Expected life (Years)

   2.83-3.01    3.06

Volatility

   53.44%-56.36%    47.69%-48.77%

Dividend yield

   0.28%-0.32%    0.91%-0.94%

Risk-free interest rate

   0.27%-0.28%    0.16%-0.47%

 

The fair value per share of options granted above during fiscal 2004 and 2005 were (Yen) 1,556 to 1,802 and (Yen) 1,203 to 1,225, respectively.

 

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.

 

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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 rating 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.

 

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3. Reclassifications

 

The Company disclosed the total of research and development costs and maintenance costs as “Research and development and maintenance” in a operating expense section of the consolidated profit and loss, and the details of these costs are noted. For FY2005, maintenance costs are included in costs of sales and prior year figures have been reclassified. In addition, customer support expense, which was disclosed as a part of operating expenses, are included in cost of sales for FY2005 and prior year figures have been reclassified.

 

 

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 year ended December 31, 2004 and 2005, is as follows:

 

    

For the year ended

December 31, 2004


  

For the year ended

December 31, 2005


     Thousands of Yen

Net income available to common stock holders

   (Yen)15,874,836    (Yen)18,669,954
     Thousands of Shares

Weighted-Average shares

   131,589    133,498

Effect of dilutive securities:

         

Stock options

   2,274    1,958

Weighted-Average shares for diluted EPS computation

   133,863    135,456
     Yen

Basic EPS:

   (Yen)120.64    (Yen)139.85

Diluted EPS:

   118.59    137.83

 

 

Shareholders’ equity per share as of December 31,2004 and 2005 were as follows:

 

     (Yen)

    

December 31,

2004


  

December 31,

2005


Shareholders’ equity per share

   474.40    610.51

 

 

5. Cash and cash equivalents

 

Cash and cash equivalents as of December 31,2004 and 2005 were as follows:

 

 

     (Thousands of yen)

    

December 31,

2004


  

December 31,

2005


Cash

   49,189,396    52,665,059

Time deposits with original maturities of three months or less

   3,718,961    6,947,518
    
  
     52,908,357    59,612,577
    
  

 

 

6. Time deposits

 

Our U.S. subsidiary had (Yen) 26,720 thousand and (Yen) 31,751 thousand of restricted cash set aside in accordance with the terms of building lease agreements as at December 31, 2004 and 2005, respectively. The restricted cash is included in time deposits.

 

 

7. Marketable securities and securities investments

 

Marketable securities and securities investments 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 31,2004 and 2005, were as follows:

 

 

< Available for sale: >   

(Thousands of yen)


     December 31, 2004

     Cost

   Gains

   Losses

   Fair value

Mutual funds

   6,823,896    466,020    —      7,289,916

Equity securities

   —      —      —      —  

Debt securities

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

Total

   23,965,987    692,577    185,123    24,473,441
    
  
  
  

 

 

< Available for sale: >    (Thousands of yen)

     December 31, 2005

     Cost

   Gains

   Losses

   Fair value

Mutual funds

   8,825,910    310,291    —      9,136,201

Equity securities

   —      —      —      —  

Debt securities

   22,985,181    263,558    138,138    23,110,601
    
  
  
  

Total

   31,811,091    573,849    138,138    32,246,802
    
  
  
  

 

 

The contractual maturities of available-for-sale debt securities as of December 31, 2005 were as follows:

 

     (Thousands of yen)

     Aggregated Par value

   Estimated Fair Value

Due less than one year

   12,514,039    12,488,684

Due after one to two years

   6,284,669    6,262,444

Due after two to three years

   3,401,564    3,334,781

Due after three years

   1,000,000    1,024,692
    
  

Debt securities

   23,200,272    23,110,601
    
  

 

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The net unrealized gain on “available-for-sale” securities included in the separate component of shareholders’ equity, net of applicable taxes, increased by (Yen) 197,606 thousand and decreased by (Yen) 65,902 thousand, for the year ended December 31, 2004 and 2005, respectively.

 

Proceeds from sales of “available-for-sale” securities for the year ended December 31,2004 and 2005 were (Yen) 4,986,012 thousand and (Yen)22,079,575 thousand, respectively. Realized gains (losses) on sales of “available-for-sale” securities for the year ended December 31, 2004 and 2005 were (Yen) 101,199 thousand and (Yen) 370,326 thousand, respectively.

 

The following table shows our investment’s gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31,2004 and 2005.

 

     (Thousands of yen)

     December 31, 2004

         
     Less than 12 months

   12 Months or More

   Total

     Fair Value

   Unrealized
Losses


   Fair Value

   Unrealized
Losses


   Fair Value

  

Unrealized

Losses


Available for sale:

                             

Mutual funds

   —      —      —      —      —      —  

Equity securities

   —      —      —      —      —      —  

Debt securities

   9,308,944    25,410    833,114    159,713    10,142,058    185,123
    
  
  
  
  
  

Total

   9,308,944    25,410    833,114    159,713    10,142,058    185,123
    
  
  
  
  
  

 

Investments, which were in an unrealized loss positions as of December 31, 2004, are comprised of U.S. dollar and Euro denominated public debts. The Company concluded that the impairments of these securities are not other than temporary in consideration of fluctuation of exchange rates and high credit rating of the issuers.

 

     (Thousands of yen)

     December 31, 2005

         
     Less than 12 months

   12 Months or More

   Total

     Fair Value

   Unrealized
Losses


   Fair Value

   Unrealized
Losses


   Fair Value

   Unrealized
Losses


Available for sale:

                             

Mutual funds

   —      —      —      —      —      —  

Equity securities

   —      —      —      —      —      —  

Debt securities

   10,766,393    84,372    3,223,769    53,766    13,990,162    138,138
    
  
  
  
  
  

Total

   10,766,393    84,372    3,223,769    53,766    13,990,162    138,138
    
  
  
  
  
  

 

Investments, which were in an unrealized loss positions as of December 31, 2005, are comprised of U.S. dollar and Euro denominated public debts. The Company concluded that the impairments of these securities are not other than temporary in consideration of fluctuation of exchange rates and high credit rating of the issuers.

 

The aggregate cost of the Company’s cost method investments totaled (Yen) 123,648 thousand at December 31, 2005. All the cost method investments were not evaluated for impairment because (a) the Company did not estimate the fair value of those investments in accordance with paragraphs 14 and 15 of SFAS 107 and (b) the Company did not identify any events or changes in circumstances that may have had a significant adverse effect on the fair value of those investments.

 

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8. Research and development and maintenance costs, and software development costs

 

Research and development costs incurred up to the point where all substantial testing for the original English version product is complete, are charged to income as operating expense. Such research and development costs charged to income were (Yen) 2,597,325 thousand, (Yen) 4,395,207 thousand for the years ended December 31, 2004 and 2005, respectively.

 

Maintenance costs are fees, which relate to product version updates to enable product to cope with newly prevailing computer viruses and bug fixing, are recorded as cost of sales. The maintenance costs included in cost of sales were (Yen) 2,260,934 thousand, (Yen) 1,671,320 thousand, for the years ended December 31, 2004 and 2005, respectively.

 

Software development costs relating to the local language related functions (representing software development costs as shown in consolidated balance sheets) after netting the related accumulated amortization, are capitalized and amortized to cost of sales as follows:

 

     (Thousands of yen)

 
    

For the year ended

December 31, 2004


   

For the year ended

December 31, 2005


 

Software development costs:

            

Balance at beginning of year

   505,616     438,464  

Additions, at cost

   645,166     1,446,248  

Amortization for the year

   (712,318 )   (710,021 )
    

 

Balance at end of year

   438,464     1,174,691  
    

 

 

 

9. Debt

 

Debt comprises the following:

 

     (Thousands of yen)

 
    

December 31,

2004


   

December 31,

2005


 

Unsecured 1.9% bonds, due 2006 with detachable warrants

   4,000,000     4,000,000  
    

 

     4,000,000     4,000,000  

Less – treasury bonds:

            

Unsecured 1.9% bonds, due 2006 with detachable warrants

   (4,000,000 )   (4,000,000 )
    

 

     —       —    
    

 

 

Based on the Company’s incentive plans, the parent company issued unsecured bonds with detachable warrants and bought all of the warrants at the same time for the purpose of distributing such instruments to the directors and certain employees of the parent company and its subsidiaries as a part of their remuneration.

 

The Japanese Commercial Code restricts redemptions and extinguishments of these bonds in case the amount of each outstanding bond is less than the aggregate amount of exercise price of each outstanding warrant. Therefore, in order to reduce interest costs, the parent company repurchased a part of the bonds through the market with an intention to hold the treasury bonds until they can be extinguished legally. However, 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 consolidated balance sheets. There was no repurchase transaction for the year ended December 31, 2004 and 2005.

 

 

10. Stock Option

 

Based on the Company’s 2002 incentive plans, the Company issued the following bonds with detachable warrants to the public.

 

1.    Board meeting approval    March 26,2002 and April 2,2002
2.    Date of bond issuance    April 18, 2002
3.    Maturity date    April 18, 2006
4.    Amount of each bond (Thousands of yen)    4,000,000
5.    Issued to    Public
6.    Date on which the bonds were fully redeemed    —  
7.    Exercise price per each warrant    (Yen)3,450
8.    Warrant exercise period    From April 3, 2003 to April 11, 2006
9.    Number of shares represented by warrants    1,159,420
10.    Outstanding as of December 31, 2004    737,391
11.    Outstanding as of December 31, 2005    575,942

 

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Upon issuance of bond, the Company bought all of the warrants and distributed such instruments to the directors and certain employees of the Company and its subsidiaries as a part of their remuneration.

 

These transactions were accounted for as issuance of debt to the public, as an issuance of warrants to the directors and certain employees of the Company and its subsidiaries. The issuance of warrants to the directors and employees was accounted for under APB 25.

 

Warrant activity was as follows:

 

     Thousands of shares
represented by warrants


Outstanding at December 31, 2004

   737

Granted

   —  

Exercised

   161

Expired

   —  

Cancelled

   —  
    

Outstanding at December 31, 2005

   576
    

Exercisable Stock warrants at December 31, 2005

   576

 

The grants of April 18, 2002 did not result in deferred compensation.

 

Based on the resolution of the extraordinary general shareholders’ meeting of the Company on September 12, 2002, Trend Micro adopted at the meeting of the board of directors on February 4, 2003 the following resolutions regarding Stock acquisition rights and its subsidiaries in order to introduce the stock option plan. In accordance with the terms of this plan, the Company granted options to purchase up to 1,999,500 shares of the Company’s common stock to certain directors and employees of the Company and its subsidiaries on February 12,2003. The options granted are exercisable from November 1, 2003 through October 31, 2007.

 

Based on the resolution of the fourteenth ordinary general shareholders’ meeting of the Company on March 26, 2003, Trend Micro adopted at the meeting of the board of directors on May 20, 2003 the following resolutions regarding Stock acquisition rights in order to introduce the stock option plan. In accordance with the terms of this plan, the Company granted options to purchase up to 2,500,000 shares of the Company’s common stock to certain directors and employees of the Company and its subsidiaries on May 28,2003. The options granted are exercisable from May 28, 2004 through May 27, 2008.

 

Based on the resolution of the fourteenth ordinary general shareholders’ meeting of the Company on March 26, 2003, Trend Micro adopted at the meeting of the board of directors on November 6, 2003 the following resolutions regarding Stock acquisition rights in order to introduce the stock option plan. In accordance with the terms of this plan, the Company granted options to purchase up to 1,500,000 shares of the Company’s common stock to certain directors and employees of the Company and its subsidiaries on November 14, 2003. The options granted are exercisable from November 14, 2004 through November 13, 2008.

 

Based on the resolution of the fifteenth ordinary general shareholders’ meeting of the Company on March 25, 2004, Trend Micro adopted at the meeting of the board of directors on April 20, 2004 the following resolutions regarding Stock acquisition rights in order to introduce the stock option plan. In accordance with the terms of this plan, the Company granted options to purchase up to 3,000,000 shares of the Company’s common stock to certain directors and employees of the Company and its subsidiaries on April 28, 2004. The options granted are exercisable from April 28, 2005 through April 27, 2009.

 

Based on the resolution of the fifteenth ordinary general shareholders’ meeting of the Company on March 25, 2004, Trend Micro adopted at the meeting of the board of directors on October 20, 2004 the following resolutions regarding Stock acquisition rights in order to introduce the stock option plan. In accordance with the terms of this plan, the Company granted options to purchase up to 2,000,000 shares of the Company’s common stock to certain directors and employees of the Company and its subsidiaries on October 28, 2004. The options granted are exercisable from October 28, 2005 through October 27, 2009.

 

Based on the resolution of the sixteenth ordinary general shareholders’ meeting of the Company on March 25, 2005, Trend Micro adopted at the meeting of the board of directors on July 14, 2005 the following resolutions regarding Stock acquisition rights in order to introduce the stock option plan. In accordance with the terms of this plan, the Company granted options to purchase up to 3,457,500 shares of the Company’s common stock to certain directors and employees of the Company and its subsidiaries on July 22, 2005. The options granted are exercisable from July 22, 2006 through July 21, 2010.

 

Based on the resolution of the sixteenth ordinary general shareholders’ meeting of the Company on March 25, 2005, Trend Micro adopted at the meeting of the board of directors on December 6, 2005 the following resolutions regarding Stock acquisition rights in order to introduce the stock option plan. In accordance with the terms of this plan, the Company granted options to purchase up to 2,500,000 shares of the Company’s common stock to certain directors and employees of the Company and its subsidiaries on December 14, 2005. The options granted are exercisable from December 14, 2006 through December 13, 2010.

 

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Option activity under this plan was as follows:

 

     Thousands of shares
represented by warrants


Outstanding at December 31, 2004

   9,037

Granted

   5,958

Exercised

   796

Expired

   —  

Cancelled

   1,289
    

Outstanding at December 31, 2005

   12,910
    

Exercisable Stock acquisition rights at December 31, 2005

   3,128
    

 

The grants of Stock acquisition rights to the directors and employees were accounted for under APB No.25. The exercise price per share for the rights granted of (Yen)2,230 issued on February 12, 2003, (Yen)1,955 issued on May 28, 2003, (Yen) 2,695 issued on November 14, 2003, (Yen)4,310 issued on April 28,2004, (Yen)5,090 issued on October 28,2004, (Yen)3,840 issued on July 22,2005 and (Yen)3,950 issued on December 14,2005 was determined as equivalent to the fair market value of the Company’s share at the time of the grants. Consequently, the grant of the Stock acquisition rights did not result in deferred compensation.

 

 

11. Employee benefit plans

 

Pension and severance plans

 

The parent company has an unfunded retirement allowance plan (“Plan”) covering substantially all of its employees who meet eligibility requirements under the Plan. Under the Plan, employees whose service with the company is terminated are, under most circumstances, entitled to lump-sum severance indemnities, determined by reference to current basic rate of pay, length of service and conditions under which the termination occurs.

 

Additionally, the parent company has been a member of Kanto IT Software welfare pension plan, which is categorized as multi-employer pension plan. Total pension expense for multi-employer pension plan was (Yen) 83,833 thousand in 2004 and (Yen) 116,081 thousand in 2005, respectively.

 

Effective from March 1, 1998, the Taiwan subsidiary introduced a defined benefit pension plan, which covers substantially all of its employees. Under the plan, only employees who are 55 years or older with services for more than 15 years or who have been employed for more than 25 years at the retirement date are entitled to receive benefits. Benefits awarded under the plan are based primarily on current rate of pay and length of service.

 

Effective from July 2005, Taiwan subsidiaries had a defined contribution pension plan called Labor Pension Act (LPA). Some employees who had joined a defined benefit pension plan transferred to the new plan. New employees who joined the Taiwan subsidiary after July 2005 can choose the new pension plan only.

 

Effective from July 1, 1998, the parent company’s U.S. subsidiary has a 401(k) retirement plan, which covers substantially all of its employees. Under the plan, employees contribute a certain percentage of their pre-tax salary up to the maximum dollar limitation prescribed by the United States Internal Revenue Code.

 

Certain other subsidiaries have defined benefit pension plans or retirement plans, which cover substantially all of their employees, under which the cost of benefits is currently funded or accrued. Benefits awarded under these plans are based primarily on current rate of pay and length of service.

 

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Information regarding the Japanese defined benefit pension plans of the Company based on unfunded plan is shown below:

 

     (Thousands of yen)

 
    

December 31,

2004


   

December 31,

2005


 

Change in benefit obligation:

            

Benefit obligation at beginning of year

   437,883     467,571  

Service cost

   143,711     128,935  

Interest cost

   6,383     6,731  

Actuarial (gain)/loss

   (73,381 )   (7,486 )

Benefits paid

   (47,025 )   (28,174 )
    

 

Projected benefit obligation at end of year

   467,571     567,577  
    

 

Unrecognized net actuarial gain (loss)

   30,498     37,984  

Unrecognized net transition obligation

   —       —    
    

 

Accrued benefit cost

   498,069     605,561  
    

 

     (Thousands of yen)

 
    

For the years ended

December 31, 2004


   

For the years ended

December 31, 2005


 

Components of net periodic benefit cost:

            

Service cost

   143,711     128,935  

Interest cost

   6,383     6,731  

Amortization of unrecognized transition obligation

   311     —    

Recognized actuarial loss

   —       —    
    

 

Net periodic pension cost

   150,405     135,666  
    

 

     (Thousands of yen)

 
    

December 31,

2004


   

December 31,

2005


 

Accumulated benefit obligation

   309,559     404,187  
    

December 31,

2004


   

December 31,

2005


 

Assumptions used to determine benefit obligations at December 31:

            

Discount rate

   1.50 %   1.00 %

Rate of compensation increase

   5.50 %   4.32 %
    

For the years ended

December 31, 2004


   

For the years ended

December 31, 2005


 

Assumptions used to determine net periodic benefit cost for years ended December 31:

            

Discount rate

   1.50 %   1.50 %

Rate of compensation increase

   5.50 %   5.50 %

 

The following benefit payments, which reflected expected future service, as appropriate, are expected to be paid:

 

     Thousands of yen

Estimated Future Benefit Payments Year ending December 31:

    

2006

   40,455

2007

   47,944

2008

   58,950

2009

   70,984

2010

   71,777

2011-2015

   474,757

 

The measurement date used to determine above plans are November 30, 2004 and November 30, 2005, respectively.

 

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Information regarding the defined benefit pension plans for consolidated foreign subsidiaries is shown below:

 

     (Thousands of yen)

 
    

December 31,

2004


   

December 31,

2005


 

Change in benefit obligation:

            

Benefit obligation at beginning of year

   296,439     442,716  

Service cost

   78,024     56,546  

Interest cost

   9,220     16,135  

Actuarial (gain)/loss

   56,903     128,070  

Benefits paid

   (2,516 )   —    

Foreign currency exchange impact

   4,646     48,542  
    

 

Projected benefit obligation at end of year

   442,716     692,009  
    

 

Change in plan assets:

            

Fair value of plan assets at beginning of year

   (95,322 )   (124,552 )

Actual return on plan assets

   (1,305 )   (2,231 )

Employer contribution

   (28,637 )   (28,464 )

Benefits paid

   2,516     —    

Foreign currency exchange impact

   (1,804 )   (13,111 )
    

 

Fair value of plan assets at end of year

   (124,552 )   (168,358 )
    

 

Funded status

   318,164     523,651  

Unrecognized prior service cost

   (49,923 )   (31,059 )

Unrecognized net actuarial loss

   (110,269 )   (249,439 )
    

 

Accrued benefit cost

   157,972     243,153  
    

 

     (Thousands of yen)

 
    

For the years ended

December 31, 2004


   

For the years ended

December 31, 2005


 

Components of net periodic benefit cost:

            

Service cost

   78,024     56,546  

Interest cost

   9,220     16,135  

Expected return on plan assets

   (3,614 )   (4,943 )

Amortization of prior service cost

   2,444     2,953  

Recognized actuarial loss

   1,004     3,341  

Amendments

   —       20,220  
    

 

Net periodic pension cost

   87,078     94,252  
    

 

     (Thousands of yen)

 
    

December 31,

2004


   

December 31,

2005


 

Accumulated benefit obligation

   209,810     324,192  
    

 

    

December 31,

2004


   

December 31,

2005


 

Assumption used to determine benefit obligation at December 31:

            

Discount rate

   3.25 %   2.50 %

Rate of compensation increase

   4.00 %   4.00 %
    

For the years ended

December 31, 2004


   

For the years ended

December 31, 2004


 

Assumptions used to determine net periodic benefit cost for years ended December 31:

            

Discount rate

   3.25 %   3.25 %

Expected return on plan assets

   3.25 %   3.25 %

Rate of compensation increase

   3.75 %   4.00 %

 

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Asset Allocation

 

    

December 31,

2005


     Allocation (%)

Type of investment:

    

Cash

   49.32

Government Loan

   5.80

Equity

   20.05

Notes

   13.90

Bonds

   10.93
    

Total

   100.00
    

 

The Company has no control over the investment, since a government appointed manager and custodian manages them.

 

Expected return on assets of 3.25% used to determine net periodic benefit cost for years ended December 31, 2005 was determined based on the information provided by the above-mentioned government appointed manager and custodian. Historical returns are taken into consideration.

 

The Company expects to contribute (Yen) 29,531 thousand to its pension plan in 2006.

 

The following benefit payments, which reflected expected future service, as appropriate, are expected to be paid:

 

     Thousands of yen

Estimated Future Benefit Payments Year ending December 31:

    

2006

   275

2007

   293

2008

   314

2009

   339

2010

   368

2011-2015

   21,609

 

The measurement date used to determine above plans are December 31, 2004 and December 31, 2005, respectively.

 

Under the Japanese Commercial Code and local practice, the Company may make severance payments to a retired director or corporate auditor with shareholder approval, if the Company’s management proposes such payments based on a resolution of the Board of Directors. The Company does have an internal rule to determine the amounts of severance payments to corporate auditors, and in accordance with this rule, retirement benefits for corporate auditors are provided at an estimate of the amount to be paid if all eligible corporate auditors resigned at the balance sheet date.

 

Post-retirement benefits other than pensions and post-employment benefits

 

The Company does not provide health care or life insurance benefits to retired employees, nor does it provide benefits to former or inactive employees after employment but before retirement.

 

12. Financial instruments

 

(1) Derivative instruments

 

The Company has a policy not to utilize any derivative financial instruments with off-balance sheet risk. In accordance with the policy, the parent company and its subsidiaries did not employ any derivative financial instruments.

 

(2) Fair value of financial instruments

 

Other than debt and equity securities, the fair value of which are disclosed in “Marketable securities and securities investments”, the Company’s involvement in financial assets and liabilities with market risk is limited to cash and cash equivalents, time deposits, notes and accounts receivable, trade, notes and accounts payable, trade, and long-term debt. The estimated fair value of cash and cash equivalents, time deposits, notes and accounts receivable, trade, and notes and accounts payable, trade are carried at amounts, which approximate fair value. At December 31,2004 and 2005, there was substantially no long-term debt including the current portion.

 

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Table of Contents

13. Commitments and contingent liabilities

 

The Company provides a service based on ‘Service level agreement’ (“the Agreement”) where the Company guarantees a certain level of services rendered to customers. The Company is required to pay penalties up to the limited amounts defined in the Agreement if the Company cannot perform the services as specified in the Agreement. Based on yearly experiences of payment, the Company has established no liabilities for specific liabilities as of December 31, 2004 and 2005.

 

Effect on Our Results of Operations from Distribution of a Defective Virus Pattern File in April 2005

 

On April 23 2005, the Company distributed a defective virus pattern file that resulted in damage to the computers of our customers who downloaded the file. As a result, we took steps to resolve our customers’ problems and ensure that a similar problem would not reoccur. We have incurred (Yen) 991 million related to this issue for the year ended December 31, 2005 as operating expenses. There is some possibility of incurring further cost, however Management expects additional cost will be insignificant.

 

14. Segment Information

 

The Company specializes in the ‘Security software business’.

 

The Company discloses Operating Segment information as required by FAS 131 “Disclosures about Segments of an Enterprise and Related Information”. The information provided to the chief operating decision maker for assessing the Company’s performance includes 5 regional segments and a corporate segment. The five operating segments by region are Japan, North America, Europe, Asia Pacific and Latin America. The other operating segment is Corporate, which is comprised of Research and development, Marketing, Customer support and Administrative departments that operate and bring benefits to the Company worldwide.

 

Below is summarized information of our operating segments’ sales and operating income (loss). These figures comply with the accounting policies disclosed in the Notes to these consolidated financial statements.

 

     (Thousands of yen)

 
     Net sales to external customers

   Operating income (loss)

 
    

For the year ended

December 31, 2004


  

For the year ended

December 31, 2005


  

For the year ended

December 31, 2004


   

For the year ended

December 31, 2005


 

Japan

   25,443,297    29,416,077    16,599,993     18,636,462  

North America

   11,891,452    15,416,991    7,543,325     10,483,801  

Europe

   16,417,611    18,379,304    9,732,567     10,330,980  

Asia Pacific

   6,304,675    7,909,753    1,678,826     2,836,044  

Latin America

   1,992,219    1,907,776    1,282,044     1,092,793  

Corporate

   —      —      (10,759,079 )   (15,808,305 )
    
  
  

 

Consolidated Total

   62,049,254    73,029,901    26,077,676     27,571,775  
    
  
  

 

 

Significant customer

 

     (Thousands of yen)

 
    

For the year ended

December 31, 2004


   

For the year ended

December 31, 2005


 

Customer


   Net Sales

   Ratio

    Net Sales

   Ratio

 

SOFTBANK BB

   10,396,225    16.8 %   10,604,947    14.5 %

 

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Table of Contents

15. Deferred Revenue by Region

 

     (Thousands of yen)

     As of December 31, 2004

   As of December 31, 2005

     Current

   Non-current

   Current

   Non-current

Japan

   10,797,359    1,571,325    12,429,867    1,542,109

North America

   5,149,233    447,905    7,529,743    856,903

Europe

   6,348,575    1,120,078    7,779,059    1,289,305

Asia Pacific

   1,838,870    129,584    2,579,002    186,619

Latin America

   500,625    —      1,188,644    —  
    
  
  
  

Total

   24,634,662    3,268,892    31,506,315    3,874,936
    
  
  
  

 

16. Subsequent events

 

On January 27th 2006, a settlement agreement for a suit of infringement of a patent was concluded. Based on a principal term of the agreement, the company will receive USD 15,000 thousands (equivalent of (Yen) 1,766,250 thousands).

 

17. Status of manufacturing and actual sales

 

(1) Manufacturing result

 

    Period    (Thousands of Yen)
   

Product                                


 

For the year ended

December 31, 2004


  

For the year ended

December 31, 2005


PC client

  93,039    226,606

LAN server

  34,351    104,232

Internet server

  250,983    359,633

All Suite products

  —      —  

Other products

  130,456    392,499
   
  

Total

  508,829    1,082,970
   
  

(Note)

 

1. Amount is based on manufacturing cost.
2. Consumption tax is not included in the amount above.
3. All Suite products were manufactured as separate products and sold as All Suite products. Therefore there is no capitalization of All Suite products for the year ended December 31, 2004 and 2005.

 

(2) Sales result

 

     Period    (Thousands of Yen)
    

Product                                


  

For the year ended

December 31, 2004


  

For the year ended

December 31, 2005


PC client

   16,889,881    19,714,453

LAN server

   3,310,419    3,278,568

Internet server

   16,647,154    18,373,789

All Suite products

   18,596,603    24,484,969

Other products

   1,890,719    3,494,862
    
  

Sub-total

   57,334,776    69,346,641

Other service

   4,714,478    3,683,260
    
  

Total

   62,049,254    73,029,901
    
  

 

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Table of Contents

February 9 2006

 

Report of Earning Results (Non-consolidated)

for Fiscal Year Ended December 31, 2005

 

[ Prepared in accordance with Japan GAAP ]

 

Company:    Trend Micro Incorporated                            Tokyo Stock Exchange 1st Section
Code:    4704                                 Location : Tokyo

(URL http://www.trendmicro.co.jp/)

    

Representative:

  

        Title

  

Representative Director and Chief Executive Officer

    

        Name

  

Eva Cheng

Contact:

  

        Title

  

Controller, Finance & Accounting Department and

General Manager, Business Support Department

    

        Name

  

Yuzuru Nanami

                           (Phone: 81-3-5334-3600)

Date of the board of directors meeting

Date of shareholder’s meeting

  

                        February 9, 2006

                        March 28, 2006

 

The company can distribute semi-annual cash dividends based on the Articles of corporation.

The company adopts Unit Stock method. (One unit: 500 shares)

 

 

1. Financial Highlights for FY2005 (January 1, 2005 through December 31, 2005)

 

 

(1) Results of operations (All figures are rounded down to millions of yen.)

 

     Sales

  

(Compared to

the previous year)


    Operating
income


  

(Compared to

the previous year)


   

Ordinary

Income


   (Compared to
the previous year)


 
     Millions of yen    %     Millions of yen    %     Millions of yen    %  

FY2005

   48,228    (21.3 )   21,823    (12.9 )   22,423    (14.8 )

FY2004

   39,771    (27.8 )   19,327    (56.7 )   19,530    (55.9 )

 

     Net income

   (Compared to the
previous year)


   

Net income

per share

(Basic)


  

Net income
per share

(Diluted)


  

Return on

shareholders’
equity


  

Ordinary income/

total assets ratio


   Ordinary income
ratio


     Millions of yen    %     Yen    Yen    %    %    %

FY2005

   13,122    (9.7 )   98.30    96.88    24.8    28.9    46.5

FY2004

   11,965    (55.3 )   90.93    89.38    30.3    30.4    49.1

(Note)
1. Number of weighted average shares outstanding:  

133,498,438 shares (FY2005)

131,588,738 shares (FY2004)

2. Change in accounting principle:            None    
3. The percentage of sales, operating income, ordinary income and net income are compared with the prior fiscal year.

 

 

(2) Cash dividends

 

     Annual cash dividends per share

  

Total dividends

(Annual)


   Dividend-payout
ratio


   Dividend/stockholders’
equity ratio


          As of June end

   As of Dec end

        
     Yen    Yen    Yen    Millions of Yen    %    %

FY2005

   56.00    0.00    56.00    7,509    57.0    12.8

FY2004

   36.00    0.00    36.00    4,794    39.6    10.1

 

 

(3) Financial Position

 

     Total assets

   Shareholders’ equity

   Shareholders’ equity
ratio


   Shareholders’ equity
per share


     Millions of yen    Millions of yen    %    Yen

FY2005

   83,692    58,515    69.9    436.39

FY2004

   71,344    47,499    66.6    349.89

(Note)

1. Number of shares issued at the end of fiscal year:   134,090,494 shares (FY2005)
    135,755,872 shares (FY2004)
2. Number of treasury stocks at the end of fiscal year:   2,513,231 shares (FY2005)
    2,588,439 shares (FY2004)

 

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Table of Contents

Non–consolidated Financial Statements

 

(1) Condensed non-consolidated balance sheets

 

          (Thousands of yen)

     Period

  

FY2004

(As of December 31, 2004)


  

FY2005

(As of December 31, 2005)


Account


   Note

   Amount

   Percentage

   Amount

   Percentage

(Assets)                                   

Current assets

                                  

1         Cash and bank deposits

             35,147,820              36,425,321     

2         Accounts receivable, trade

   2         10,188,334              11,158,987     

3         Marketable securities

             988,103              5,919,607     

4         Product

             62,536              83,715     

5         Raw material

             9,106              10,171     

6         Stores

             15,146              31,008     

7         Intercompany short-term loan receivables

             30,259              34,552     

8         Prepaid expense

             102,858              116,588     

9         Other receivables

   2         95,921              182,357     

10       Deferred tax assets

             5,743,800              5,886,541     

11       Others

   2         466,603              842,434     

12       Allowance for bad debt

             D32,231              D56,094     
              
            
    

           Total current assets

             52,818,259    74.0         60,635,190    72.4

Non-current assets

                                  

1         Tangible fixed assets

                                  

(1)    Buildings

        390,519              419,840          

Accrued depreciation

        149,697    240,821         187,198    232,642     
         
            
         

(2)    Fixtures and fittings

        667,596              650,041          

Accrued depreciation

        405,642    261,954         414,064    235,976     
         
  
       
  
    

           Total Tangible fixed assets

             502,775    0.7         468,619    0.6

2         Intangible fixed assets

                                  

(1)    Software

             301,144              1,032,322     

(2)    Software in progress

             170,715              432,456     

(3)    Others

             13,473              627,551     
              
            
    

        Total intangible fixed assets

             485,333    0.7         2,092,330    2.5

3         Investments and other non-current assets

                                  

(1)      Investments in securities

             13,162,002              16,779,345     

(2)      Investments in subsidiaries and affiliates

             2,225,347              2,152,563     

(3)      Investments in capital funds

             535,875              —       

(4)      Investments in capital of affiliates

             5,277              5,277     

(5)      Intercompany long-term loan receivables

             51,871              59,231     

(6)      Security deposits

             325,181              324,894     

(7)      Member ship

             —                4,000     

(8)      Deferred tax assets

             1,295,405              1,292,730     

(9)      Allowance for bad debt

             D51              D59,231     

(10)    Allowance for loss on investments in subsidiaries and affiliates

             D62,365              D62,365     
              
            
    

Total investments and other non-current assets

             17,538,546    24.6         20,496,446    24.5
              
            
    

Total non-current assets

             18,526,655    26.0         23,057,396    27.6
              
            
    

Total assets

             71,344,914    100.0         83,692,587    100.0
              
            
    

 

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Table of Contents
     Period

  

FY2004

(As of December 31, 2004)


  

FY2005

(As of December 31, 2005)


Account


   Note

   Amount

   Percentage

   Amount

   Percentage

(Liabilities)                         

Current liabilities

                        

1         Accounts payable, trade

   2    181,971         150,183     

2         Account payables, other

   2    3,007,008         5,757,523     

3         Accrued corporate tax and others

        5,944,000         3,574,476     

4         Accrued consumption taxes

        428,479         151,867     

5         Accrued expenses

        367,211         377,944     

6         Advances received

        161,295         48,674     

7         Deposits received

        77,805         76,356     

8         Allowance for sales return

        357,039         144,289     

9         Warrants

        381,600         298,050     

10       Deferred revenue

        10,797,358         12,429,867     

11       Others

        21,849         32,987     
         
       
    

  Total current liabilities

        21,725,619    30.5    23,042,220    27.5

Non-current liabilities

                        

1         Deferred revenue

        1,571,324         1,542,109     

2         Allowance for retirement benefits

        548,028         586,482     

3         Allowance for retirement benefits for directors and

           corporate auditors

        —           5,836     
         
       
    

Total non-current liabilities

        2,119,353    2.9    2,134,428    2.6
         
       
    

Total liabilities

        23,844,973    33.4    25,176,648    30.1
         
       
    

(Shareholders’ equity)

                        

Common stock

   1, 6    11,426,977    16.0    12,484,849    14.9

Capital surplus

                        

1         Capital reserve

        13,946,348    19.5    15,087,304    18.0

Accumulated earnings

                        

1         Legal reserve

        20,833    0.0    20,833    0.0

2         Unappropriated retained earnings at the end of the period

        29,254,795    41.0    37,517,773    44.9

Valuated difference on other securities

   4    305,450    0.5    688,420    0.8

Treasury stock

   5    D7,454,463    10.4    D7,283,242    8.7
         
       
    

  Total shareholders’ equity

        47,499,941    66.6    58,515,938    69.9
         
       
    

  Total liabilities and shareholders’ equity

        71,344,914    100.0    83,692,587    100.0
         
       
    

 

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Table of Contents

(2) Condensed non-consolidated income statements

 

          (Thousands of yen)

     Period

  

FY2004

(As of December 31, 2004)


  

FY2005

(As of December 31, 2005)


Account


   Note

   Amount

   Percentage

   Amount

   Percentage

Total sales                                   

1       Sales

        25,443,345              29,416,076          

2       Royalty

   1    14,327,811    39,771,157    100.0    18,812,881    48,228,958    100.0
         
            
         
Cost of sales                                   

1       Beginning inventory

        30,877              62,536          

2       Cost of development

        508,829              1,082,970          

3       Amount of goods purchased

        1,264,363              892,925          

4       Transferred from other accounts

        712,318              573,202          
         
            
         

Total

        2,516,388              2,611,635          

5       Transferred to other accounts

        516,134              1,091,591          

6       Ending inventory