SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 20-F
(Mark One)
[_] Registration statement pursuant to Section 12(b) or 12(g) of the Securities
Exchange Act of 1934
or
[X] Annual report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the fiscal year ended December 31, 2000
or
[_] Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _________ to _________
Commission file number 333-10486
TREND MICRO KABUSHIKI KAISHA
(Exact Name of Registrant as Specified in Its Charter)
TREND MICRO INCORPORATED
(Translation of Registrant's Name Into English)
JAPAN
(Jurisdiction of Incorporation or Organization)
Odakyu Southern Tower, 10F, 2-1, Yoyogi 2-Chome, Shibuya-ku, Tokyo
151-8583, Japan
(Address of Principal Executive Offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Name of Each Exchange on
Title of Each Class Which Registered
-------------------------------------- ----------------------------------------
None None
Securities registered or to be registered pursuant to Section 12(g) of the
Act:
(1) Common Stock, par value 50 Japanese yen, per share ("Shares")*
(2) American Depositary Shares ("ADSs")**
(Title of Class)
Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act:
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer's
classes of capital or common stock as of the close of the period covered by the
annual report.
As of December 31, 2000, 65,560,421 shares of common stock were
outstanding, comprised of 64,891,421 Shares and 6,690,000 American Depositary
Shares (equivalent to 669,000 Shares based on the ratio of 10 shares of Common
Stock for each American Depositary Share in effect as of the date of filing of
this annual report).***
Indicate by check mark whether the registrant: (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [_]
Indicate by check mark which financial statement item the registrant
has elected to follow.
Item 17 [_] Item 18 [X]
All information contained in this report is as of December 31, 2000 or
for the year ended December 31, 2000 unless the context otherwise indicates. In
tables appearing in this annual report, figures may not add up to totals due to
rounding.
--------------------------------------------------------------------------------
* Not for trading, but only in connection with the listing of American
Depositary Shares pursuant to the requirements of The Nasdaq National
Market.
** As of the date of this filing, each American Depositary Share represents 10
shares of Common Stock. Effective July 2, 2001 each American Depositary
Share will represent 1 share of Common Stock.
*** On account of a one-into-two stock split which took effect on March 31,
2001, there were 131,590,456 shares outstanding as of May 31, 2001. Unless
otherwise indicated, share references reflect the stock split.
2
Cautionary Statement Regarding Forward-Looking Statements
---------------------------------------------------------
The annual report contains "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. To the extent
that statements in this annual report on Form 20-F do not relate strictly to
historical or current facts, they may constitute forward-looking statements.
These forward-looking statements are based upon management's current assumptions
and beliefs in light of the information currently available to it, but involve
known and unknown risks and uncertainties. Our actual actions or results may
differ materially from those discussed in the forward-looking statements. We
undertake no obligation to publicly update any forward-looking statement after
the date of this annual report, but investors are advised to consult any further
disclosures by us in our subsequent filings pursuant to the Securities Exchange
Act of 1934.
Important risks and factors that could cause our actual results to
differ materially from our expectations are generally set forth in Item 3.D. and
include, without limitation:
. difficulties in addressing new virus and other computer security
problems;
. timing of new product introductions and lack of market acceptance
for our new products;
. the level of continuing demand for, and timing of sales of, our
existing products;
. rapid technological change within the anti-virus software industry;
. changes in customer needs for anti-virus software;
. existing products and new product introductions by our competitors
and the pricing of those products;
. declining prices for our products and services;
. difficulties in adapting our products and services to the internet;
. 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.
and other risks discussed under "Risk Factors" and elsewhere in this annual
report.
As used in this annual report, references to "Trend Micro" are to Trend Micro
Incorporated. Also, as used in this annual report, references to "we", "our" and
"us" are to Trend Micro Incorporated and, except as the context otherwise
requires, its subsidiaries.
Also, as used in this annual report:
. "dollar" or "$" means the lawful currency of the United States of
America, and "yen" or "(Yen)" means the lawful currency of Japan.
. "U.S. GAAP" means generally accepted accounting principles in the
United States, and "Japanese GAAP" means generally accepted
accounting principles in Japan.
. "ADS" means an America Depositary Share, each representing 10 shares
of Trend Micro's common stock, and "ADR" means an American
Depositary Receipt evidencing ADSs.
"fiscal 2000" and "fiscal year 2000" refer to Trend Micro's fiscal year ended
December 31, 2000, and other fiscal years are referred to in a corresponding
manner.
3
PART I
Item 1. Identity of Directors, Senior Management and Advisers.
Not applicable
Item 2. Offer Statistics and Expected Timetable.
Not applicable
Item 3. Key Information.
A. Selected Financial Data.
You should read the following selected consolidated financial
information together with the financial statements and notes to the statements
which begin on page F-2 and are in response to Item 8 and Item 18. You should
also read the Operating and Financial Review and Prospects included as Item 5.
The consolidated income statement information for the fiscal years ended
December 31, 1998, 1999 and 2000, and the consolidated balance sheet information
as of December 31, 1999 and 2000, that are identified as being in accordance
with U.S. GAAP are derived from and should be read together with our
consolidated financial statements prepared in accordance with U.S. GAAP, which
have been audited by PricewaterhouseCoopers, independent accountants, and are
included elsewhere in this annual report.
The consolidated balance sheet statement information as of December 31,
1997 and 1998 and the consolidated income statement information for the fiscal
years ended December 31, 1997 that are identified as being in accordance with
U.S. GAAP are derived from our consolidated balance sheet and our consolidated
income statement prepared in accordance with U.S. GAAP, which have been audited
by PricewaterhouseCoopers, independent accountants, and are not included in this
annual report. The consolidated income statement information for the fiscal year
ended December 31, 1996, and the consolidated balance sheet information as of
December 31, 1996, is derived from our unaudited consolidated financial
statements prepared in accordance with Japanese GAAP and is not included in this
annual report.
The consolidated income statement information for the fiscal years
ended December 31, 1997, 1998, 1999 and 2000, and the consolidated balance sheet
information as of December 31, 1997, 1998, 1999 and 2000, that are identified as
being in accordance with Japanese GAAP are derived from our consolidated
financial statements prepared in accordance with Japanese GAAP, which have been
audited by PricewaterhouseCoopers, independent accountants, and are not included
in this annual report.
4
Year Ended December 31,
-------------------------------------------------------------------------------------
1996 1997 1998 1999 2000 2000
-------------------------------------------------------------------------------------
(in millions of yen and thousands of dollars, except per share data)
Consolidated Income Statement
Information:
In accordance with Japanese GAAP
Net sales........................... (Yen)4,318 (Yen)7,943 (Yen)10,217 (Yen)13,741 (Yen)21,835 $189,868
----------- ----------- ------------ ------------ --------- --------
Operating income.................... 927 2,349 2,427 4,254 7,443 64,725
----------- ----------- ------------ ------------ --------- --------
Income before income tax............ 974 2,432 2,379 4,464 8,351 72,615
Income taxes........................ (346) (1,118) (1,325) (1,997) (3,621) (31,487)
----------- ----------- ------------ ------------ --------- --------
Net income.......................... 628 1,314 1,054 2,467 4,723 41,068
----------- ----------- ------------ ------------ --------- --------
Net income per share (basic)........ (Yen) 5.82(1) (Yen)12.17(1) (Yen)9.25(1) (Yen)19.41(1) (Yen)36.22(1) $ 0.31
=========== =========== ============ ============ ========= ========
Net income per share (diluted)...... -- -- (Yen)9.05(1) (Yen)18.87(1) (Yen)35.39(1) $ 0.31
=========== =========== ============ ============ ========= ========
Cash dividends...................... -- -- -- (Yen)1.67(2) -- --
=========== =========== ============ ============ ========= ========
Year Ended December 31,
---------------------------------------------------------------------------------------
1996 1997 1998 1999 2000 2000
---------------------------------------------------------------------------------------
(in millions of yen and thousands of dollars, except per share data)
In accordance with U.S. GAAP
Net sales......................... (Yen)7,398 (Yen)9,746 (Yen)13,633 (Yen)20,070 $174,525
Cost of sales........................ 734 560 481 1,474 12,823
-------------- -------------- ----------- ----------- --------
Gross profit...................... 6,664 9,186 13,152 18,596 161,702
-------------- -------------- ----------- ----------- --------
Operating expenses:
Selling........................... 1,316 2,526 3,454 5,445 47,349
Research and development.......... 557 960 994 2,044 17,769
General and administrative........ 2,755 4,087 4,772 5,580 48,522
-------------- -------------- ----------- ----------- --------
Total operating expenses....... 4,628 7,573 9,220 13,069 113,640
-------------- -------------- ----------- ----------- --------
Operating income..................... 2,036 1,613 3,932 5,527 48,062
-------------- -------------- ----------- ----------- --------
Other income, net.................... 82 85 67 1,365 11,866
-------------- -------------- ----------- ----------- --------
Income before income taxes, minority
interest and equity in loss of
affiliated companies.............. 2,118 1,698 3,999 6,892 59,928
-------------- -------------- ----------- ----------- --------
Income taxes......................... 1,267 1,295 1,849 3,123 27,153
-------------- -------------- ----------- ----------- --------
Income before minority interest and
equity in losses of affiliated
companies......................... 851 403 2,150 3,769 32,775
============== ============== =========== =========== ========
Minority interest in income of a
consolidated subsidiary........... -- -- -- 7 59
============== ============== =========== =========== ========
Income from consolidated companies... 851 403 2,150 3,762 32,716
============== ============== =========== =========== ========
Equity in losses of affiliated
companies............................ -- -- 3 87 762
============== ============== =========== =========== ========
Net income........................... (Yen)851 (Yen)403 (Yen)2,147 (Yen)3,675 $ 31,954
============== ============== =========== =========== ========
Net income per share (basic)......... (Yen)7.88(3) (Yen)3.54(3) (Yen)16.90(3) (Yen)28.18(3) $ 0.25
============== ============== =========== =========== ========
Net income per share (diluted)....... -- (Yen)3.46(3) (Yen)16.42(3) (Yen)27.53(3) $ 0.24
============== ============== =========== =========== ========
Weighted average common shares
outstanding (basic)............... 108,000,000(3) 113,946,182(3) 127,100,328(3) 130,388,962(3)
Weighted average common shares --
outstanding (diluted)............. -- 116,483,720(3) 130,752,652(3) 133,454,940(3)
5
Year Ended December 31,
-----------------------------------------------------------------------
1996 1997 1998 1999 2000 2000
-----------------------------------------------------------------------
(in millions of yen and thousands of dollars, except per share data)
Consolidated Balance Sheet Information
In accordance with Japanese GAAP
Cash and cash equivalents (4)........ (Yen) -- (Yen)1,444 (Yen) 9,396 (Yen)15,649 (Yen)24,435 $212,482
Total assets......................... 3,262 5,544 17,456 28,857 43,802 380,887
Total liabilities.................... 1,689 2,657 3,215 10,381 17,565 152,740
Stockholders' equity................. (Yen)1,573 (Yen)2,887 (Yen)14,241 (Yen)18,476 (Yen)26,237 $228,147
In accordance with U.S. GAAP
Cash and cash equivalents............ (Yen)1,144 (Yen) 9,396 (Yen)15,649 (Yen)24,436 $212,483
Total assets......................... 5,435 17,716 28,781 44,574 387,604
Total liabilities.................... 3,190 4,143 11,471 20,230 175,914
Shareholders' equity................. (Yen)2,245 (Yen)13,573 (Yen)17,310 (Yen)24,344 $211,690
-------------------------------
(1) Shares outstanding increased from 6,000 shares on December 31, 1996 to
18,000 shares in a one-into-three stock split effected on September 1,
1997.
Shares outstanding increased from 18,000 shares on December 31, 1997 to
20,835,600 shares on December 31, 1998 due to the following events:
. an increase to 1,800,000 shares on January 1, 1998 in connection with
a lowering of the par value of our shares,
. an increase of 16,200,000 shares in connection with a one-into-ten
stock split effected on May 7, 1998,
. issuance of 2,500,000 shares on August 18, 1998 in connection with our
initial public offering in Japan,
. issuance of 335,600 shares upon exercise of warrants issued under the
1997 and 1998 incentive plans
Shares outstanding increased from 20,835,600 shares on December 31, 1998
to 64,842,900 shares on December 31, 1999 due to the following events:
. an increase of 42,749,400 shares in connection with a one-into-three
stock split effected on September 30, 1999.
. issuance of 1,257,900 shares upon exercise of warrants issued under
the 1997 and 1998 incentive plans
Shares outstanding increased from 64,842,900 shares on December 31, 1999 to
65,560,421 shares on December 31, 2000 due to the following events:
. issuance of 717,521 shares upon exercise of warrants issued under the
1997, 1998 and 1999 incentive plans
A one-into-two stock split was effected on March 31, 2001.
All prior share and per share amounts have been restated to reflect the
stock split indicated above.
(2) Reflects an extraordinary dividend of (Yen)208.3 million paid in March
1999 to commemorate the listing of our shares on the Japanese over-the-
counter market.
As adjusted to reflect all stock splits described in (1) above, as
permitted under U.S. GAAP.
(3) Restated to reflect all stock splits indicated in (1) above.
(4) Consolidated data under Japanese GAAP for cash and cash equivalents for the
year 1996 is not available.
Exchange Rates.
In parts of this annual report, we have translated Japanese yen amounts
into U.S. dollars solely for the convenience of readers. Unless otherwise
indicated, the rate we used for the translation was (Yen) 115.00 per $1, which
was the approximate rate on December 31, 2001. The following table shows the
noon buying rates for Japanese yen expressed in Japanese yen per $1. On June 28
the noon buying rate announced by the Federal Reserve bank of New York was (Yen)
124.63 per $1.
6
Year ended/ending December 31, High Low Average Period-end
------------------------------ ----------- ----------- ----------- -------------
1996....................................... 116.13 103.92 108.78 115.77
1997....................................... 131.08 111.42 121.06 130.45
1998....................................... 147.14 113.08 130.99 113.08
1999....................................... 124.45 101.53 113.73 102.16
2000....................................... 114.62 101.70 107.80 114.80
2001 (through June 22, 2001)............... 126.75 114.73 117.77 124.65
Calendar Year 2000
------------------
December................................... 114.62 110.42 112.21 114.35
Calendar Year 2001
------------------
January ................................... 118.35 114.26 116.67 116.39
February .................................. 117.62 114.88 116.23 117.28
March ..................................... 125.54 117.33 121.51 125.54
April ..................................... 126.75 121.68 123.77 123.57
May ....................................... 123.67 118.88 121.77 118.88
B. Capitalization and Indebtedness.
Not applicable
C. Reasons for the Offer and Use of Proceeds.
Not applicable
D. Risk Factors.
The occurrence of any of the following risks could hurt our business,
financial condition or results of operations. In such case, the trading price of
our shares and the ADSs could decline and you could lose all or part of your
investment. Other risks and uncertainties not now known to us or that we think
are immaterial may also impair our business.
Major software and hardware vendors may incorporate anti-virus protection in
their product offerings, which could render our products obsolete or
unmarketable.
Major vendors of operating system software, other software such as
firewall or e-mail software or computer hardware may decide to enhance or bundle
their products with 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 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.
Because we generate substantially all of our revenue from a single product line,
we are vulnerable to decreased demand for such products.
Unlike software companies with diversified product lines, substantially
all of our net sales come 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, and our recent
acquisition of ipTrend has broadened our product line, 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, this software drop as a
result of competition, technological change or other factors such as lower
growth or a
7
contraction in the worldwide anti-virus software market, our business, financial
conditions and results of operations could materially suffer.
Our newly-acquired subsidiary, ipTrend, has a limited operating history and is
in a highly competitive business.
ipTrend's primary market is small- to medium- size businesses, which
makes its growth dependent on the information technology spending patterns of
these companies. ipTrend has never sold to small/medium- sized companies before,
and our inexperience in selling our products to small- to medium-sized
organizations could also affect our revenue growth. At present this market is a
very difficult one, and while ipTrend expects information technology spending by
small companies in Japan and Taiwan to recover, continued weakness will affect
its growth projections negatively. Furthermore, we expect growing competition
from major hardware vendors, who have considerable resources behind them. If
ipTrend can not compete with such entrants its growth prospects will be
hindered.
Because of the limited operating history of our server appliance
business, and the new and rapidly evolving market for server appliances,
ipTrend's ability to accurately forecast sales is limited, which makes it
difficult to predict the revenues that we will recognize. In addition, ipTrend
cannot forecast operating expenses based on historical results, and most of its
costs are for personnel and facilities, which are relatively fixed in the short
term. If ipTrend has a shortfall in revenues in relation to expenses, it may not
be unable to reduce its expenses quickly enough to avoid impacting our operating
results negatively.
If ipTrend is not successful we may be obliged to write-off all the goodwill
recognized in acquiring it more quickly than we currently plan.
When we acquired ipTrend we recognized a portion of the purchase price as
goodwill. Goodwill represents the difference between the purchase price and the
book value of the company being acquired. We currently plan to write off the
goodwill we recognized in our acquisition of ipTrend over a 5-year period.
However, if ipTrend does not generate sufficient revenue, we may be obliged to
write off the goodwill in fewer than 5 years. This would have a greater
negative impact on our profits in future fiscal years.
Deterioration in our relationship with SOFTBANK could result in a decrease in
sales of our products.
We depend on our relationship with SOFTBANK, which is our largest
customer and has played an instrumental role in the development of our business
in Japan. An adverse change in our relationship with SOFTBANK would result in
decreased sales to SOFTBANK and could disrupt our relationships with
distributors of our products. This could make it difficult for us to market our
products in Japan. Sales to SOFTBANK totaled approximately (Yen)2.4 billion or
24% of our net sales in 1998, (Yen)2.5 billion or 18% of our net sales in 1999
and approximately (Yen) 3.5 billion ($30.5 million) or 17% of our net sales in
2000. In addition, SOFTBANK has close relationships with many systems
integrators through which we sell our anti-virus software to corporate end users
in Japan.
Because of our dependence on SOFTBANK, the price of our shares and ADSs could
fall as a result of adverse events affecting SOFTBANK, even if the events do not
relate directly to us.
Because of our dependence on SOFTBANK, the price of our shares and ADSs
could fall as a result of adverse events affecting SOFTBANK that do not affect
us directly, such as a deterioration in SOFTBANK's business.
Because rapid technological change regularly occurs in the anti-virus software
market, our products may become obsolete.
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
8
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.
Because our competitors are more established than we are in the U.S. and
European markets, we may not be able to increase our market share in these
markets.
We believe that our share of the anti-virus software market in the U.S.
and Europe is small relative to the market shares of our principal competitors,
despite the growth of our sales in these markets in 1999 and 2000. Because our
competitors are already well-established in these key markets and have greater
financial and other resources and market recognition, we may not be able to
compete effectively for market share. If this happens, we may not be able to
increase sales or our market share in these markets, which could materially hurt
the prospects for growth in our business.
Some of our major competitors have the following important advantages
over us in the U.S. and European markets:
. greater name recognition;
. more diversified product lines;
. larger customer bases; and
. significantly greater financial, technical, marketing and other
resources.
As a result, as compared to us, our competitors may be able to:
. better withstand downturns in the anti-virus software market and
in the computer software market in general;
. adapt more quickly to new or emerging technologies or changes in
customer requirements; and
. more effectively and profitably market, sell and support their
products.
We may suffer a loss of sales and market share in our core Japanese market if
our competitors achieve success in Japan.
Our major competitors, Network Associates, Computer Asociates 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 Trend Micro, each has significantly greater
financial, marketing and other resources as a whole than we do. Additionally,
competition in our core Japanese market and in other Asian markets 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 materially harm our
business, financial condition and results of operations.
Our growth may suffer if we are not successful in establishing a new internet
service business.
One of our key strategies for long-term growth is to establish a line
of business focused on delivering network management and security services over
the internet for a fee. At present, our internet service business is in its
infancy and we generate only modest revenue from those services. We do not have
significant experience in this business area, and if we do not successfully
establish and expand this business,
9
we may lose sales to our competitors who are able to effectively establish an
internet-based service business model.
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, including our internet service business. 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 and amortization of goodwill and purchased
technology.
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.
We must adapt to the rapidly changing business environment brought on by the
widespread use of the internet.
We have been seeking to use the internet in many parts of our business,
including in the sale, distribution and support of our products. There are still
many uncertainties regarding many facets of the internet, including reliability,
security, access, tax, government regulation and cost. We also run the risk of
not adapting to the latest changes in the internet, which could harm our
business operations. If growth of the internet does not develop at the rapid
pace we expect, our business, financial condition and operating results could be
adversely affected.
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
customers or prospective customers. Capital purchases are often discretionary
and, therefore, are canceled or delayed if the customer experiences a downturn
in its business prospects or as a result of economic conditions in general. Any
cancellation or delay could adversely affect our results of operations.
If hackers gain unauthorized access to our systems, we could suffer disruptions
in our business and long-term damage to our reputation.
As an anti-virus company that delivers virus protection products over
the internet, we may be more susceptible to problems caused by hackers than
other software companies. For example, if hackers were able to cause us to
transmit computer viruses or interrupt the delivery of our anti-virus software
monitoring and security services over the internet, we could suffer substantial
disruptions in our business and material damage to our reputation. This could
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.
10
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;
. implement a new internet-based service business model; or
. exploit new market opportunities and effectively respond to
competitive pressures.
We sell our products through intermediaries who may not vigorously market our
products, have rights of return or may have difficulty in timely paying for
purchased 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 through
market and support programs, these distributors may give greater priority to
products of other suppliers, including competitors.
In light of the recent downturn in the U.S. economy, we are
experiencing, and may continue to experience, an increase in the incidence of
our products being returned.
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 accounts. Our uncollectible
accounts could exceed our current or future allowance for doubtful accounts,
which would adversely impact our operating results.
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 CEO, Steve Ming-Jang Chang. 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
the shares and the ADSs to fall.
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 the ADSs could fall.
11
Factors which could cause our interim financial results to fluctuate
include:
. Timing of sales of our products and services due to customers'
budgetary constraints, seasonal buying patterns and our
promotional activities;
. New product introductions by our competitors;
. Significant marketing campaigns, research and development efforts,
employee hirings, and other current 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.
Because of the influence of our principal shareholders, our other shareholders
may be unable to influence our business.
Our principal shareholders, including our executive officers and
directors, beneficially owned approximately 48.2% of our outstanding shares as
of March 31, 2001. 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.
Because Japan is our largest market, weakness in the Japanese economy may hurt
our business performance.
While our sales in the U.S. and Europe have increased in recent years,
we remain significantly dependent on the Japanese market. Net sales of our anti-
virus software products in Japan accounted for approximately 49% of our net
sales in 1998, approximately 43% in 1999 and approximately 33% in 2000. 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. Any further deterioration in the
condition of the Japanese economy could significantly curtail the rate of growth
in our net sales in Japan which, because of our dependence on the Japanese
markets, could impact negatively on Trend Micro's net sales.
Because we make a significant percentage of our net sales in Asia, we are more
vulnerable than our competitors to weaknesses in the economies of Asian
countries.
The economies of certain Asian countries are susceptible to sudden and
unpredictable downturns. Among other things, a decline in value of Asian
currencies, together with difficulties in obtaining credit, can significantly
limited the purchasing power of our Asian customers. For example, net sales of
our products in these countries was approximately (Yen)1.9 billion or
approximately 20% of our net sales in 1998, approximately (Yen)1.8 billion or
approximately 13% of our net sales in 1999 and approximately (Yen)2.1 billion or
approximately 11 % of our net sales in 2000. When compared with our main
competitors, we believe we make a greater portion of our total sales in these
countries. An economic downturn in Asia could hinder our growth.
Because we earn revenues denominated in a number of different currencies,
foreign exchange fluctuations could lower our results of operations.
Our reporting currency is the Japanese yen and the functional currency
of each of our subsidiaries is the currency of the country in which the
subsidiary is domiciled. However, a significant portion of our revenues and
operating expenses is denominated in currencies other than the Japanese yen,
primarily the U.S.
12
dollar 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 on Trend Micro from currency
fluctuations could become more significant if we are successful in increasing
our sales in markets outside of Japan. We do not currently engage in currency
hedging activities.
Because our business depends significantly on intellectual property,
infringement of our intellectual property could hurt our business.
Our success depends upon the development of proprietary software
technology. We rely on a combination of contractual rights and patent,
copyright, trademark and trade secret laws to establish and protect proprietary
rights in our software. If we are unable to establish and protect these rights,
our competitors may be able to use our intellectual property to compete against
us. This could limit our growth and hurt our business. At present, our U.S.
subsidiary holds four issued U.S. patents and our Taiwan subsidiary holds four
issued U.S. patents. It is possible that no additional patents will be issued to
us or any of our subsidiaries. In addition, our issued patents may not prevent
other companies from competing with us. We also enter into confidentiality
agreements with our employees and license agreements with our customers, and
limit access to our proprietary information and its distribution. However, we
cannot guarantee that any of these measures will discourage others from
misappropriating our technology or independently developing similar technology.
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.
Furthermore, our subsidiary, ipTrend, manufactures 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 these types of claims. However, in some jurisdictions these
provisions may not be enforceable or statutory, public policy or other grounds.
We currently do not carry product liability insurance covering claims arising in
the U.S. While we have not been sued on product liability grounds to date, a
successful product liability or related claim brought against us could harm our
business.
Our business faces the risk of interruption from power shortages, earthquakes
and other hazards.
We face a number of potential business interruption risks that are
beyond our control. The State of California has recently experienced
intermittent power shortages, 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.
Our corporate headquarters is located near a major earthquake fault.
The impact of a major earthquake on our facilities, infrastructure and overall
operations is not known. Safety precautions have been implemented, however there
is no guarantee that an earthquake would not seriously disturb our entire
business process. We are largely uninsured for losses and business disruptions
caused by an earthquake and other natural disasters.
13
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.
Our common shares are traded on the Tokyo Stock Exchange, which is the
principal market for the shares. Recently, the U.S. and Japanese securities
markets have experienced significant price and volume fluctuations. The market
prices of securities of high-tech companies, and internet companies in
particular, have been especially volatile. Since trading in our shares commenced
on the Tokyo Stock Exchange on August 17, 2000, our stock price has fluctuated
between a low of (Yen)3,165 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 $2.333 and a high of $15.938. The closing price
on the Tokyo Stock Exchange for our stock on May 31, 2001 was (Yen)5,140, and
the closing price on The Nasdaq National Market for our ADSs on May 31, 2001 was
$4.28 per ADS. The market price of our shares and ADSs is likely to fluctuate in
the future.
We do not expect to pay cash dividends.
We intend to retain any future earnings to finance our business and
operations and any future growth. Therefore, we do not anticipate paying any
cash dividends in the foreseeable future.
Yen-dollar fluctuations could cause the market price of the ADSs to decline,
reduce dividend amounts payable to ADS holders, if declared, and affect other
items as expressed in U.S. dollars.
Fluctuations in the exchange rate between the Japanese yen and the U.S.
dollar will affect the U.S. dollar equivalent of the Japanese yen price of the
shares on the Tokyo Stock Exchange and, as a result, are likely to affect the
market price of the ADSs. These fluctuations will also affect our earnings, the
book value of our assets and our shareholders' equity as expressed in U.S.
dollars. If in the future we decide to pay dividends on the shares, we will
declare any cash dividends in Japanese yen. Exchange rate fluctuations will also
affect the dividend amounts payable to ADS holders following conversion into
U.S. dollars of dividends paid in Japanese yen on the shares represented by the
ADSs.
The rights of small shareholders are limited under the Japanese unit share
system.
Our articles of incorporation provide that 500 shares constitute one
"unit." The Japanese Commercial Code restricts the rights of shares that do not
constitute whole units. Holders of shares constituting less than one unit do not
have the right to vote, to institute derivative actions or to examine our books
and records. Each ADS offered in the offering represents the right to receive
one-tenth of one share. A holder who owns less than 5,000 ADSs will indirectly
own less than a whole unit. Under the deposit agreement governing the rights of
ADS holders, in order to withdraw any shares, an ADS holder must surrender ADRs
evidencing 5,000 ADSs or a multiple of 5,000 ADSs. Each ADR will bear a legend
to that effect. Under the unit share system, holders of less than a unit have
the right to require us to purchase their shares. Holders of ADSs that represent
other than multiples of whole units cannot withdraw the underlying shares
representing less than one unit. They will therefore be unable, as a practical
matter, to
. exercise the right to require us to purchase the underlying
shares, or
. receive cash settlement in lieu of withdrawal.
As result, as a holder of ADSs, you will not be able to access the
Japanese markets through the withdrawal mechanism to sell shares in lots of less
than one unit. The unit share system does not affect the transferability of
ADSs, which may be transferred in any lot size.
14
As a holder of ADSs, you will have fewer rights than a shareholder has and you
will have to act through the depositary to exercise those rights.
The rights of shareholders under Japanese law to take actions,
including voting their shares, receiving dividends and distributions, bringing
derivative actions, examining the company's accounting books and records and
exercising appraisal rights are available only to holders of record. Because the
depositary, through its custodian agents, is the record holder of the shares
underlying the ADSs, only the depositary can exercise those rights in connection
with the deposited shares. The depositary will make efforts to vote the shares
underlying your ADSs as instructed by you and will pay to you the dividends and
distributions collected from us. However, in your capacity as an ADS holder, you
will not be able to bring a derivative action, examine the accounting books and
records of the company or exercise appraisal rights through the depositary.
Rights of shareholders under Japanese law may be more limited than under the law
of other jurisdictions.
Our articles of incorporation, our board of directors' regulations and
the Japanese Commercial Code govern our corporate affairs. Legal principles
relating to such matters as the validity of corporate procedures, directors' and
officers' fiduciary duties and shareholders' rights may be different from those
that would apply if we were a non-Japanese company. For example, under the
Commercial Code, only holders of 3% or more of the issued and outstanding shares
are entitled to examine our accounting books and records. Shareholders' rights
under Japanese law may not be as extensive as shareholders' rights under the law
of other countries. You may have more difficulty in asserting your rights as a
shareholder than you would as a shareholder of a corporation organized in
another jurisdiction. In addition, Japanese courts may not be willing to enforce
liabilities against us in actions brought in Japan which are based upon the
securities laws of the United States or any U.S. state.
Item 4. Information on the Company.
A. History and Development of the Company.
We were established in 1989 as a Taiwanese company. In August 1996,
we became a Japanese company and were reorganized in a series of transactions by
which we became the parent corporation of Trend Taiwan and each of the
international subsidiaries then owned by Trend Taiwan.
We are a leader in network antivirus and Internet content security
software and services. Our North American headquarters are in Cupertino, CA and
we have business units worldwide. Our products are sold through corporate,
value-added resellers and managed service providers. For additional information
and evaluation copies of all our products, visit: http://www.trendmicro.com.
-------------------------
Information contained on our website is not part of this annual report.
Our head office is located at Odakyu Southern Tower, 10F, 2-1, Yoyogi
2-Chome, Shibuya-ku, Tokyo 151-8583, Japan. Our telephone number is 81-3-5334-
3600. Our agent for service of process in the United States is Mike Conner,
Director in charge of North America and Senior Vice President, c/o Trend-Micro,
Inc., 10101 N. DeAnza Blvd., Suite 400, Cupertino, California 95014.
We expanded into a new business field by acquiring ipTrend Incorporated
(formerly Nippon Unisoft Incorporated) for the purpose of making inroads into
UNIX-based operating systems, the Internet platform technology, and especially
into Linux systems. We are allocating major resources to this new business.
Trend Micro began commercial operations in May 1989, shortly after
computer viruses were first detected, and we completed our initial public
offering on the Japanese over-the-counter market in August
15
1998. We listed American Depositary Shares on The Nasdaq National Market in July
1999 in connection with a global offering of 12,750,000 shares in the form of
shares and ADRs.
B. Business Overview.
Introduction
We develop, market and support anti-virus software and management
solutions for corporate computing systems and personal computers. Our products
deliver virus protection at each access point within the corporate network where
data files are exchanged.
Our products have recently won the following awards:
Publication Award
SC Magazine in December 2000, SC Magazine awarded
ScanMail for Exchange as "Pick of 2000"
PC Professionnell In February 2000, German magazine PC
Professionnell awarded the Editor's Choice
distinction to ServerProtect, OfficeScan
Corporate Edition and Trend Virus Control
System.
Windows NT ServerProtect won Windows NT Magazine's
Magazine Editor's Choice Award in its December 1999
InfoWorld issue. October 1998 "Test Center Hot Pick"
award for Trend Virus Control System,
ServerProtect and OfficeScan Corporate
Edition package. For products or solutions
deemed to offer stand-out technology, among
other criteria.
InfoWorld In February 1999 InfoWorld picked the same
software package as the anti-virus "Solution
of the Year" for 1998.
PC Magazine In April 1999 a package of Trend
Virus Control System, ServerProtect, ScanMail
and OfficeScan Corporate Edition earned a
"NeaTSuite/Editor's Choice" award based upon
performance tests comparing anti-virus
solutions. PC Magazine is published by Ziff-
Davis Inc., a subsidiary of SOFTBANK.
Our products operate across a range of computer operating system
platforms, including Windows NT, Windows 2000, Windows 98, NetWare, Sun Solaris
and several versions of UNIX. Corporate and government end users of our
anti-virus software and management tools include Boeing, Bank of America,
Hewlett-Packard, Chase Manhattan Bank, Lucent Technologies, GTE, Coca-Cola, MCI
WorldCom, ConAgra, Microsoft, Siemens, Bayer, Deutsche Bank, Nestle, Nissan,
Avery Dennison, Dana Corporation, GE Access, Honeywell, Hughes Space and
Aircraft, NCR, Texas Instruments, Thomson Multimedia Inc, the U.S. Department of
Justice, the U.S. State Department, the European Parliament and the European
Commission.
Industry Background
The Computer Virus Problem
Computer viruses are software programs which infect computer systems by
secretly attaching themselves to other software, self-replicating and spreading
as data from e-mail, application software files, discs and the internet. Viruses
cause varying degrees of damage, including displaying disruptive messages on a
user's screen, altering or destroying system files, and reformatting a
computer's hard drive. In corporate networks, viruses can cause
16
network servers and client computers to stop working. This can result in
significant productivity losses, damage to data files and system reconfiguration
costs.
Development of the Anti-Virus Software Market
The anti-virus software market has grown significantly in the past few
years and is expected to continue to grow in the future. International Data
Corporation, an independent research organization, estimates that worldwide
anti-virus revenues have grown from approximately $686 million in 1997 to
approximately $1.1 billion in 1998, and are expected to grow to approximately
$2.9 billion in 2002. International Data Corporation estimates that worldwide
revenue for the Anti-Virus software market is forecast to increase at a 17%
compound annual growth rate from 1999 to 2004, reaching $2.7 billon. The
International Computer Security Association published a virus prevalence survey
in 2000 which a total of 855,899 PCs and 22,440 file and application servers,
and 94.67% of the companies responding to the survey, experienced at least 1
virus encounter during the survey period. Only one company claimed not have
experienced such an encounter.
Our products have evolved with the development of the anti-virus
software market as a whole. Until recently, sales of anti-virus software
products consisted primarily of sales of our desktop programs, such as
PC-cillin/Virus Buster, which we introduced in Japan in 1991. To meet increased
demand for network-based products as companies shifted from stand-alone desktop
personal computers to client-server enterprise networks in the early 1990s, we
introduced LANprotect, our first server application, in 1993. To address the
increased risk of virus infection for enterprise networks resulting from
widespread use of the internet, we introduced InterScan VirusWall in 1997 to
provide real-time scanning at the internet gateway. The internet gateway is the
network server where data enters the network from the internet. In 1998 we
introduced Trend Virus Control System to enable network-wide anti-virus software
monitoring, updating and management from a central management console.
Challenges to Providing Comprehensive Anti-virus Protection
The evolution of computer viruses with the shift from stand-alone
personal computers to client-server enterprise networks and, most recently, the
emergence of the internet have created a number of challenges to businesses
seeking protection against viruses such as how to keep pace with the rapid
evolution and proliferation of new viruses, how to protect themselves against
infections at multiple levels and how to provide enterprise-wide protection
against rapidly evolving virus technology.
The Trend Micro Enterprise Solution
Trend Micro offers a suite of integrated anti-virus software and
anti-virus management solutions designed to provide comprehensive,
cost-effective protection at each level of the enterprise network -- from the
internet gateway to the desktop personal computer. Our anti-virus solutions
provide the following benefits:
. Advanced Protection Against New Viruses. The core of our anti-
virus solutions is our proprietary pattern matching, rules-based
and emulation detection technologies which can identify and remove
most known viruses, including boot sector, polymorphic, macro and
applet based viruses. Our Cheetah scanning engine, which
incorporates our MacroTrap virus detection technology, rapidly
detects known and some unknown macro viruses. In addition, we
continuously collect data on new viruses and offer solutions which
allow:
. important virus events to be recorded in a comprehensive
system log;
. weekly anti-virus software updates to help protect against
emerging viruses; and
. monthly anti-virus "health check" status reports.
17
. Multi-level Anti-virus Protection. Our products operate at
multiple levels in the enterprise network:
. first, at the gateway level, before data enters the network
server;
. second, at the network server, where infected files can be
detected before being transmitted to client computers; and
. finally, at the client computer itself.
We believe that protection at the gateway level is of particular
importance due to the increasingly widespread use of the internet. Our InterScan
product, with its real-time scanning technology, provides virus protection at
the network server where data enters the network from the internet.
. Web-based, Enterprise-Wide Anti-virus Updating, Monitoring and
Management. Our Trend Virus Control System technology allows
anti-virus deployment, updating and monitoring to be performed via
the internet and across the enterprise network.
We offer products, described more fully below, in the following
categories:
. enterprise-wide management;
. internet gateway virus protection;
. server level virus protection;
. desktop level virus protection;
. internet-based service solutions; and
. integrated small business solutions.
Enterprise-Wide Management
Trend Virus Control System is a management tool that allows the network
administrator to monitor, update and manage anti-virus programs on the network
from a single point, regardless of the programs' physical location or platform.
Once installed on a Windows NT server, the Trend Virus Control System registers
every anti-virus product detected on the network and delivers network-wide virus
reports and alerts to the central management console. Using technology that can
automatically update and reconfigure software from a remote location, the Trend
Virus Control System installs, configures and automatically delivers virus
pattern updates to our InterScan VirusWall, ScanMail, ServerProtect and
OfficeScan Corporate Edition anti-virus products. When used in conjunction with
our eDoctor software, the Trend Virus Control System enables network-wide
updating and management of anti-virus software by a service partner, such as a
systems integrator, through the internet. The Trend Virus Control System and
eDoctor give our product suite an important competitive advantage in Japan,
where enterprises tend to rely on remotely based systems integrators to provide
continuing anti-virus support. The Trend Virus Control System supports both
Microsoft Internet Explorer and Netscape/AOL Navigator browsers.
Internet Gateway Virus Protection
InterScan VirusWall provides real-time scanning at the network server
where data enters the network from the internet. InterScan VirusWall blocks
viruses hidden in simple mail transfer protocol, file transfer protocol and
hypertext transfer protocol internet traffic. Network administrators can set
InterScan VirusWall to respond to virus infection incidents in any or all of the
following ways:
. alerting the system administrator;
18
. isolating the infected file for later cleaning or later action;
. deleting the infected file; or
. permitting the user to download the file under controlled
conditions.
Check Point Software Technologies Ltd. in August 1998 certified that
the Sun Microsystems Solaris version of InterScan VirusWall can operate
compatibly on Check Point's FireWall-1 internet gateway server. InterScan
VirusWall was named as Best Virus Protection for its rich feature set and
overall value by NT professionals and subscribers to W2Knews, the world's
largest E-Newsletter designed for NT system managers.
In 2001, Trend Micro provided free PDA device resident virus
protection on Palm, EPOC and Pocket PC operating systems to protect users from
wireless.
InterScan eManager enables customers to block unsolicited bulk e-mail
and other unwanted e-mail and to control distribution of sensitive e-mail
content. InterScan eManager does this by combining checking of unsolicited bulk
e-mail and the content of other incoming data from the internet into the same
scanning step with InterScan's virus monitoring. InterScan eManager also allows
the system manager to optimize the use of the network's capacity to carry
information by setting priorities for the delivery of large e-mail messages. In
addition to its capability to scan incoming data from the internet, InterScan
eManager offers profile-based filtering based on customized word lists to
prevent confidential or inappropriate e-mail from being transmitted. InterScan
eManager was introduced in the U.S. and Europe in December 1998 and was released
in Japan in May 1999.
InterScan WebProtect provides anti-virus protection for Microsoft
proxy servers, a vulnerable point because internet traffic passes directly from
the proxy server to the desktop. InterScan WebProtect scans on a real-time
basis, automatically cleans infected files transferred through the internet, and
blocks unsigned and suspect code written in Authenticode, Microsoft's digital
identification software. InterScan WebProtect also blocks known malicious Java
applets and ActiveX objects. Its "intelligent virus scanning" component
automatically activates whenever internet access takes place, but can be
configured to ignore types of multimedia files that cannot contain viruses,
minimizing the program's effect on performance. InterScan WebProtect sends
customizable warning messages to senders, recipients and the network
administrator when it detects an internet mail infection and automatically
tracks all infections in a detailed activity log. InterScan WebProtect was
released in the U.S. and Europe in November 1996.
InterScan AppletTrap is the newest addition to the InterScan product
suite. It was introduced in the U.S. and Europe in March 1999. It detects and
blocks both known and unknown malicious Java and ActiveX applets with minimal
impact on internet traffic performance. InterScan AppletTrap first scans at the
proxy server to detect and block applets containing known malicious code. It
then uses patented technology to instruct the destination client personal
computer regarding acceptable behavior and shuts down applets exhibiting
malicious behavior, such as trying to access unauthorized directories, without
affecting network or client personal computer performance. Finally, unknown
applets which have exhibited malicious behavior on a client personal computer
are placed on a list to be automatically excluded at the server where data
enters the network from the internet if such applets attempt to re-enter the
network in the future. InterScan AppletTrap can be used in conjunction with
either Netscape/AOL Navigator or Microsoft Internet Explorer.
ScanMail acts at the e-mail and groupware server level to combat
computer viruses where they currently most often appear: in document files
shared via e-mail and groupware, which is software that facilitates work among
personal computers users at different remote locations. When it detects a virus,
ScanMail sends a customizable alert message to the administrator, sender and
recipient without delaying the original message. Infected files are cleaned
automatically and sent on to the intended recipients. Using ScanMail's ActiveX
program controls, the network administrator can send files containing unknown
viruses
19
to Trend eDoctor Lab for analysis and disinfection. ScanMail products are
available for Lotus Notes, Microsoft Exchange. HPOpenMail's ScanMail for Lotus
Notes v2.0 and HouseCall, Trend Micro's free online virus scanning service were
honored with certifications from ICSA for their ability to detect 100% of known
`in the wild' viruses in August 2000. ScanMail for Microsoft Exchange was named
as the "best buy" e-mail anti-virus solution in the January 2000 issue of SC
Magazine.
Server Level Virus Protection
ServerProtect offers anti-virus protection at the file and application
server level for organizations using Windows NT or Novell NetWare to manage
their local area networks. ServerProtect scans and disinfects remote servers,
sends infection notices, installs anti-virus programs on client personal
computers and automatically generates a virus report log. ServerProtect allows
administrators of local area networks to securely install and manage virus
protection on multiple servers and domains from a single console, which can be
remotely located.
Desktop Level Virus Protection
OfficeScan Corporate Edition is the desktop-based anti-virus component
of our corporate solution. While active at the desktop level, OfficeScan
Corporate Edition is centrally controlled and can be installed, managed and
upgraded using the Trend Virus Control System, or deployed through an intranet
web page, Windows NT remote server, Microsoft System Management Server or login
script. Centralized administration ensures that all users have the most
up-to-date software and virus descriptions, limits client modifications to the
software, and ensures that reports of virus activity reach the system
administrator.
PC-cillin, which is marketed in Japan as Virus Buster, is our anti-
virus product for the home personal computer and workstation. PC-cillin removes
viruses without interrupting programs then running on the user's personal
computer or workstation, when infections occur. PC-cillin includes an easy-to-
use graphic user interface, and is available in Windows NT Workstation 4.0,
Windows Me, Windows 98, Windows 95 and Windows 2000 Professional versions. PC-
cillin 2000 wins 'Win100 Awards' from WinMag.com, named among 100 Best Products
for past year, in June 2000. Virus Buster was the only product among six
personal computer anti-virus products surveyed to receive a "four-star" rating
from the Japanese magazine PC Computing in September 1998. PC Computing is
published by SOFTBANK. The latest version of PC-cillin has a function which we
call Personal Firewall which prevents a personal computer or workstation from
unauthorized web access. The latest version of Virus Buster released in Japan
also includes a one-year warranty providing for a refund of the product's price
equivalent to purchase if, under conditions set forth in the product package,
new viruses infect and cause damage to a user's files or programs. Trend Micro
is insured against liabilities, subject to certain limitations and exclusions,
arising from this warranty service.
Trend ChipAway Virus provides hardware-level protection to stop
boot-sector viruses from infecting the computer during the period before the
operating system and traditional anti-virus software load. This product works by
encoding virus protection in the basic input/output system, read-only memory
chips used to start the computer before its operating system software loads.
Internet-Based Support Services
eDoctor is an anti-virus service to which purchasers of the Trend
Virus Control System can subscribe for a monthly per-user fee. Qualified
providers of first-line support, typically systems integrators and internet
service providers, acting as "Premium Security Partners," use the management
capabilities of Trend Virus Control System to install virus protection software
on the customer's network, to resolve virus incidents and to continually
diagnose and maintain virus protection systems remotely over the internet.
eDoctor includes around-the-clock access to our engineers who work with the
Premium Security Partner and the customer in real-time to resolve virus
incidents as they occur. Premium Security Partners will receive a
20
significant portion of the monthly fee and are expected to play a key role in
marketing the service. The role of the Premium Security Partner is particularly
important in Japan, where enterprise users typically look to systems integrators
to manage their networks and to provide virus solutions. eDoctor was introduced
in Japan, the U.S. and Taiwan in December 1998. In September 1999, we also
announced the establishment of the eDoctor Global Network, a worldwide internet
anti-virus service initiative which builds malicious code protection directly
into the internet infrastructure. The eDoctor Global Network enables customers
to obtain virus protection as a value-added service from telecom companies,
internet service providers and other managed service providers. Service
providers who are part of the eDoctor Global Network include SECOM, JoS, UniSVR,
Otsuka Shokai, PSINet, Internet Security Systems, US West, MCI's UUNet division,
Sprint and Compaq Services.
Trend eDoctor Lab is a web-based virus analysis service available
generally to corporate end users to send virus-infected files via e-mail to one
of our internationally located virus analysis centers for detection and
cleaning. Files containing unusual or unknown viruses are automatically routed
to our virus expert on duty.
HouseCall is online scanning software which allows personal computer
users to have virus infections detected and removed over the web. Upon detecting
a virus, HouseCall lists its name and the infected file. If the virus cannot be
removed, HouseCall gives the user the opportunity to delete the file. The
service is accessible to all internet users from our website. HouseCall
demonstrates our anti-virus expertise and serves as a useful tool to introduce
potential customers to our family of products.
Integrated Small Business Solution
OfficeScan SBS is designed for the Microsoft Small Business Server.
OfficeScan SBS combines file server protection, e-mail and groupware server
protection for Microsoft Exchange, and desktop-based protection in a single
package. It provides centralized installation, administration and reporting for
networks of up to 25 workstations. OfficeScan 3.111 was recommended by SC
Magazine's "Buyer's Bible 2000", the leading US computer security magazine, in
December, 1999.
Technology
We believe that our innovative anti-virus technologies are an
important competitive advantage. Key technologies used in our products include
the following:
Cheetah is the core of our anti-virus technology and our newest
scanning engine. Cheetah, which is incorporated in all of our anti-virus
products, detects most known viruses, including boot-sector, polymorphic, macro
and applet-based viruses as well as some unknown viruses. When a virus is
detected, Cheetah alerts system users based upon instructions selected by a
network administrator and either blocks the virus-infected file from being
forwarded or cleans and quarantines it, with notice to the user, mail recipient
and/or network administrator. Cheetah also incorporates the following scanning
technologies and features:
. our proprietary SoftMice simulator, which traces, decrypts and
extracts polymorphic viruses;
. our DeepScan technology, which tracks a program's execution
through multiple-layered files and locates viruses buried in the
file body;
. Wildcard virus scanning capability to detect variant viruses;
. Scanning capability for 19 types of compressed files and decoding
capability for MIME, BinHex, Base64 and UUEncoded files; and
. A specific scanning module for detecting known malicious Java
code.
21
MACROTRAP is an advanced virus detection technology incorporated into
the VSAPI scanning engine. Unlike simple pattern matching detection technologies
which identify viruses by their unique software codes, MacroTrap uses rule-based
scanning to detect known macro viruses and mutated versions of macro viruses by
executing the code in a virtual environment that emulates the actual system
environment in which the code will be run. Executed code that does not match the
software code of any known virus but nonetheless violates predetermined rules of
"good behavior" is then identified as suspect and "trapped." This method is
particularly well suited for macro viruses because such viruses are very easily
created and therefore more varied. Because it uses the same technology upon
which Word and Excel files are based, MacroTrap extracts only the affected
portion of each word processing or spreadsheet file it scans. This minimizes
scanning time and the processing burden on the central processing unit.
APPLETTRAP, our newest technology, detects known and unknown malicious
ActiveX controls and Java applets with minimal impact on internet traffic
performance. AppletTrap uses pattern-matching to block known malicious ActiveX
controls and Java applets before they enter the network. AppletTrap's
patent-pending technology also enables client personal computers to terminate
unknown ActiveX controls or Java applets that are behaving in an abnormal manner
before they can damage the computers' hard drive or spread elsewhere in the
network.
INTERSCAN: Server Pipeline is our patented technology which enables
scanning of data which has been transmitted through the internet, and also the
review of the content of e-mail files. The scanning and detection functions are
performed at the server level, enabling viruses to be detected and eliminated
before they spread to client personal computers via e-mail or file exchange. The
InterScan technology forms the basis of our product suites for the enterprise,
including the InterScan VirusWall, ServerProtect, Scan Mail and eManager
products.
CASCADE UPDATE is a management program which centrally deploys
anti-virus software from intranet servers to client personal computers. Upon
installation, an IntraScan agent program remains on the client personal
computer, configured to respond to messages from the server that indicate when
new virus pattern updates or program upgrades or configuration changes are
available. The agent program automatically downloads all new anti-virus program
components from our website to the client personal computer. OfficeScan for
Microsoft Small Business Server is our first implementation of the Cascade
Update technology.
SALES AND MARKETING
We sell our products primarily to corporate end users on a site
license basis through systems integrators, distributors and value-added
resellers, with the remaining portion consisting largely of retail package
software sales through distributors. As a result, we are substantially dependent
on these third parties. Our agreements with distributors are generally
nonexclusive, do not have minimum purchase requirements and may be terminated by
either party without cause. Our current marketing efforts are targeted primarily
at large to mid-size corporations, and to a lesser extent, small businesses and
individual end users. We work with systems integrators and value-added
resellers, through which most of our sales are made, to increase the brand
recognition and visibility of our products in the network security market. We
also promote sales of our products as a suite so that corporate end users can
benefit from comprehensive anti-virus protection throughout their enterprise
networks. As part of these efforts, we also disseminate product and industry
information through our website. In addition, we advertise in trade publications
and exhibit our products at trade shows worldwide, including World PC Expo,
Windows World Expo Japan, Comdex Japan in Japan, Comdex, InfoSec, NetWorld and
Interop, Internet World, ISPCON, and the RSA Conference in the United States,
CeBit in Germany and the Network and Windows NT shows in Britain.
22
JAPAN
We sell our products in Japan to both corporate and individual end
users primarily through systems integrators and distributors, and conduct a
limited amount of direct sales to end users, including online sales through a
reseller's website. Historically, most of our revenues have been derived from
sales in Japan. We expect that sales in Japan will continue to represent a
significant percentage of our revenues in the future.
Distribution Through Systems Integrators and Distributors. Virtually
all of our sales to Japanese corporate end users are made through systems
integrators, with remaining sales coming mostly from direct sales to major
corporate customers. In Japan, systems integrators play a much larger role in
delivering management information services than in the United States, providing
primary computer support services such as installation, systems integration,
upgrades and maintenance.
Historically, a significant percentage of our net sales have been
sales to SOFTBANK. For example, sales to SOFTBANK totaled approximately (Yen)2.4
billion or 24% of net sales in 1998, (Yen)2.5 billion or 18% of net sales in
1999 and (Yen)3.5 billion ($30.5 million) or 17% of net sales in 2000. The
majority of these sales in 1998 took place through Vaccine Bank, a cooperative
marketing program which we maintained with SOFTBANK from 1997 to early 1999. The
majority of sales to SOFTBANK in 1999 and 2000 consisted of SOFTBANK's sales of
our products to systems integrators.
Relationship with SOFTBANK. Since 1996, we have entered into numerous
agreements with SOFTBANK in connection with the distribution of our products in
Japan by SOFTBANK. Currently, all distribution by SOFTBANK of our products in
Japan is covered by an October 1999 distribution agreement with SOFTBANK
COMMERCE, an indirect wholly-owned subsidiary of SOFTBANK. This distribution
agreement gives SOFTBANK COMMERCE the non-exclusive right in Japan to distribute
all of our products. It is automatically renewable for successive one-year
terms, unless either party exercises its right of non-renewal by giving prior
written notice. The October 1999 distribution agreement supersedes all prior
agreements between SOFTBANK and us relating to distribution of our products. We
make rebate payments to SOFTBANK based on SOFTBANK's achievement of sales
targets agreed upon between SOFTBANK and us.
Service Provider and Other Relationships. In December 1998, we entered
into an alliance with SECOM, a home security service provider. We certify SECOM
to provide eDoctor and other anti-virus software to update, monitor and maintain
SECOM customers' computer networks. We plan to certify additional service
providers to offer 24-hour service and support to customers. We have developed
with Hitachi Corporation a solution that allows users of Hitachi's JP1 network
management software to click on a command icon in Hitachi's JP1 product to
access our Trend Virus Control System product. We have developed a similar
solution in cooperation with Fujitsu that allows users of SystemWalker,
Fujitsu's network of operating and management software, to use Trend Virus
Control System. In September 1999, we agreed to license InterScan VirusWall
technology to PSINet K.K., a Japan internet service provider, enabling PSINet to
provide virus scanning services to its corporate customers as part of its
comprehensive security services. In March 2000, Otsuka Shokai began offering to
its "@-mail" hosting service customers a virus detection and removal service
developed jointly with Trend Micro. We formed alliances with Unisys Information
System and NTT Communications in September 2000 and December 2000, respectively,
whereby we license InterScan VirusWall technology to them so that they can
provide anti-virus services to their subscribers. We also plan to pursue
alliances with other internet service providers, which we believe are becoming
increasingly important in the Japanese market.
In October 1999, we agreed with NTT Data, Hitachi, Cisco Systems Japan
and S&T Consulting to form NTT Data Security Corporation, a joint venture which
is designed to provide comprehensive network security services. Each of the five
partners has expertise in a different area of network security, and we are
contributing our antivirus and internet security expertise to the venture. The
joint venture began its commercial operations in January 2000.
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Acquisition of ipTrend. In February 2000, we acquired a majority
ownership interest in Nippon Unisoft Corporation, a Japanese Unix software
solution provider in the networking communications and internet domain. We made
this acquisition through ipTrend Incorporated, a wholly-owned subsidiary that we
established in January 2000. As a result of the acquisition, ipTrend and Nippon
Unisoft intend to jointly promote development of their internet-focused
technology. The parties began offering Linux components and communication
protocols to major internet service providers, information-technology vendors
and communication companies in April 2000.
UNITED STATES
Our U.S. sales strategy has evolved with the development of the anti-
virus software market as a whole, moving from a focus on packaged software sales
for the personal computer to our current focus on corporate protection.
Initially, we distributed and sold mainly packaged anti-virus software for the
personal computer in the U.S. through a republisher. As a market has developed
for selling products to corporate customers with multiple users, we have shifted
our strategy to building relationships with value-added resellers and
distributors who sell to corporate customers, and to cooperating with major
hardware and software manufacturers. Our current focus in the U.S. is developing
these strategic partnerships in the server, security, groupware and router areas
to take advantage of our product strengths and partners' marketing channels and,
in the process, to increase brand awareness of our products. As of May, 2001, we
had 16 employees dedicated to strategic partner and distributor relationships
and 42 employees focusing on direct sales efforts in the U.S. Our direct sales
efforts in the U.S. focus on sales to Fortune 1000 companies and government
accounts.
Strategic Partnerships. We have entered into agreements with Check
Point, Compaq, Hewlett-Packard, IBM/Lotus, Lucent Technologies, Microsoft,
Cisco, Openwave, Sun Microsystems, SendMail and Qwest which include cooperative
marketing activities such as these vendors' referral of customers to our
products and reference to our products in their product literature and websites.
Our agreements with these vendors also typically provide for co-development and
licensing arrangements so that our and the vendors' products operate smoothly
when used together. Check Point has certified InterScan VirusWall for Solaris
and Window NT to be compatible with Check Point's Firewall-1 enterprise security
solution. Under one agreement with Compaq, our anti-virus products are described
as a compatible enterprise anti-virus solution in Compaq Active Answers, an
online information service for marketing and buying enterprise computing
solutions.
We have licensed Compaq to provide technology found in ScanMail for
Microsoft Exchange to Compaq customers who outsource this e-mail anti-virus
protection function to Compaq. Under an agreement with Hewlett-Packard, we
provide virus protection products to Hewlett-Packard's global CoVision internet
solutions program. Hewlett-Packard has also certified Trend Virus Control System
for use in conjunction with Hewlett-Packard's OpenView Node Manager, and has
agreed to resell our products and services through Hewlett-Packard's North
American Local Products Organization. This arrangement gives us access to
leading resellers of Hewlett-Packard products and allows our products and
services to be included as part of an integrated Hewlett-Packard solution. Trend
Micro is also a "Lotus Premium Business Partner" which allows us to integrate
our anti-virus solutions more closely with Lotus Notes/Domino and cc:Mail. In
December 1998, we released ScanMail for Lotus Domino for the IBM AS/400
platform. Under our April 1999 agreement with Lucent Technologies, Lucent will
promote InterScan VirusWall as a compatible anti-virus solution for use in
conjunction with Lucent's VPN Gateway and Managed Firewall network access
control system, and will facilitate marketing of our products. Our arrangement
with Qwest allows Qwest to use InterScan VirusWall to automatically scan its
customers' incoming and outgoing internet e-mail attachments for viruses.
Distributors and Value-Added Resellers. Our principal distributors and
value-added resellers in the U.S. are Ingram Micro, Tech Data, GE Access and
Interwork Technology. Value-added resellers including
24
Verisign/Secure IT, ISS, Osage Systems, Midwest Systems, Conquest and Exault
typically purchase products for resale to corporate customers, and provide
limited update services and technical support. Distributors do not provide such
additional services and support. To develop these relationships, in October 1997
we established the Trend Enterprise Security Solutions reseller channel program
which provides qualified resellers with training, marketing materials and sales
referrals. Our website matches customers with certified distributors based on
customers' geographical location. Approximately 600 resellers currently
participate in our reseller channel program, including Software House
International, Softmart, ASAP Software Express, Software Spectrum and Corporate
Software.
Other Distribution Channels. We are also pursuing sales growth through
other distribution channels including alliances with internet service providers
and other providers of internet-related services. Under an agreement with
Infonet Services Corporation, a global internet service provider, we receive a
percentage royalty based on sales of our e-mail and internet traffic virus
protection scanning services to Infonet customers. In addition, InterScan
VirusWall has been added to the virus scanning services offered by Pilot Network
Services, a provider of secure internet services to corporations. We also
distribute our Virus Buster product under the name "PC-cillin" directly to end
users who download it from our website.
EUROPE
Trend Micro is represented throughout Europe. In addition to Norway
and Sweden, the company has offices in Germany, France, Italy, and Spain. The
company's European Support Centre, which is located in Munich, Germany, offers
real-time technical support and antivirus expertise to Trend Micro's channel
partners throughout the whole of Europe.
The majority of our European revenues are from sales of site licenses
to corporate users. Our principal systems integrators and distributors in Europe
are C2000, MME and Peapod Distribution.
As of May, 2001, we had 17 employees dedicated to key accounts sales
(brand name and direct) and 29 employees focusing on reseller sales efforts in
Europe.
ABOUT WORLD ONLINE
In May, 2000 Trend Micro has entered into an agreement with World
Online International, one of the leading Internet communications companies.
World Online is headquartered in the Netherlands. As of March 31st, 2000, World
Online had 2.2 million active subscribers (accounts that have been used in the
last 30 days). World Online provides internet access and a wide spectrum of
internet content and has operations in 15 countries. Its principal shareholders
include the Swiss-based Sandoz Family Foundation, Intel and Reggeborgh Beheer.
World Online has strategic alliances with companies such as Shell, Bouygues,
Microsoft, Sun, Bertelsmann, Reuters, Oracle and Vodacom (South African
affiliate of Vodafone).
SERVICE PROVIDER AND OTHER RELATIONSHIPS
In October, 2000 Dutch telecom provider Telfort, a subsidiary of BT
and one of the two full-service telecom providers in the Netherlands, has
offered its business customers a managed antivirus solution based on Trend
Micro's award winning InterScan(R) VirusWall(R) technology.
As a result of our agreement with World Oneline, World Online will be
able to deliver web-based antivirus scanning services to its customers, on a
subscription basis, via HouseCall. This service will start in the Netherlands
and expand to the 14 other countries where WOL currently operates. We also work
together with specialist TeleRelay to provide a safer electronic messaging
environment by delivering reliable, managed virus protection to the business
community.
In March, 2001 we reached an agreement with ZDNet.it, the online
provider of product reviews, computing news, columns, and live chat events to
participate in the "Antivirus Supercenter", ZDNet's new online channel in Italy.
Trend Micro South Europe and ZDNet Italy are working together to prevent the
25
spread of computer viruses and other malicious code. Part of this agreement is
the hosting on www.zdnet.it of Trend Micro's HouseCall(TM) 5.3 for the detection
and remote removal of viruses. The service, available for Windows 95, 98 and
2000 users, is free and continually updated in real time. ZDNet.it customers
will have unlimited use of Housecall.
In March 2001, we entered into an alliance with Coconut, which offers
e-mail and messaging solutions to Enterprise, SME and consumer customers
world-wide. The agreement will enable Coconut to offer a competitively priced
antivirus solution as a part of its forthcoming InterMessaging service, which
will incorporate Trend Micro's InterScan VirusWall virus protection. Coconut
becomes the latest member of the eDoctor(TM) Global Network, a worldwide
initiative of service providers that have selected Trend Micro technology to
offer their business and consumer customers virus protection as a value-added
service.
EDOCTOR(TM) GLOBAL NETWORK
Trend Micro's eDoctor(TM) Global Network is a worldwide anti-virus
service initiative designed to provide a better defense against Internet viruses
by building virus protection into the Internet infrastructure. The network is
comprised of service providers who have selected Trend Micro technology,
services and support to provide their customers with value-added Internet
anti-virus security services.
OTHER PARTS OF THE WORLD
Outside of Japan and the United States, we sell our products mostly to
corporate end users through distributors, resellers and value-added resellers,
with some direct sales to corporate end users and retail customers. A majority
of these sales in Asia were to corporate end users through systems integrators
and distributors. We have formed alliances with internet service providers in
Australia, Hong Kong and Taiwan to provide internet-based services such as
e-mail security. Trend Micro currently plans to explore additional partnerships
with internet service providers worldwide.
Potential customers accessing our website who wish to purchase
products are referred to a list of resellers, based on the country where the
customer is located. We are continuing to recruit other network security-
oriented systems integrators and value-added resellers in Europe and Asia to
target a broader range of prospective corporate customers. Our partnerships with
global major hardware and software vendors also enhance our marketing efforts in
Europe and Asia as well as in the U.S.
OPERATIONS
In Japan, we outsource assembly, packaging and shipping of all of our
anti-virus software products to value-added resellers. Our Taiwanese subsidiary
and, in some cases, third party service providers assemble, package and ship
products to be sold in the United States, Europe and Asia other than Japan.
Products are generally shipped within seven days of receipt of an order and,
accordingly, there is minimum order backlog at any time.
IPTREND
ipTrend is a technology based company focusing on Unix/ Linux
solutions for the Internet, and has developed a Linux based remotely managed
server appliance solution enabling small companies to connect to the Internet in
a secure environment. This product will enable small businesses to install and
operate their own Internet sites without requiring specialized in-house IT
expertise for maintenance and operations. Currently this product is being sold
in Japan and Taiwan under the trade name of ipStax and eStation, respectively.
The product is sold on a monthly service contract subscription basis.
LEGAL PROCEEDINGS
In May 1997, we sued Network Associates, formerly McAfee Associates,
Inc., and Symantec Corporation, a competitor, in the U.S. Federal District Court
for the Northern District of California alleging that some of their products
infringed a U.S. registered patent we held relating to a system and method for
detecting computer viruses in a network environment and seeking injunctive
relief and unspecified money damages. The products which incorporate the
patented technology are InterScan VirusWall, InterScan eManager, InterScan
WebProtect, InterScan AppletTrap, ScanMail and other of products which we sell
for inclusion in our customers' products. We settled our claims against Symantec
in April 1998 by entering into a patent cross-license arrangement which included
an agreement to exchange samples of viruses.
In June 1997, Network Associates denied infringement, alleging that
our patent was invalid, and filed counterclaims against us alleging unfair
competition, false advertising, trade libel and interference with prospective
economic advantage. These counterclaims are based primarily on Network
Associates' allegations that we made false claims about Network Associates,
products in our advertising and on our website. In April 2000, Network
Associates filed suit against us in the U.S. Federal District Court for the
Northern District of Texas, alleging that our anti-virus software packages,
including the Trend Virus Control System, infringed a Network Associates patent
which was issued on February 22, 2000. In May 2000 we settled with Network
Associates and entered into a patent cross-license arrangement with them which
included an agreement to exchange samples of viruses.
26
C. Organizational Structure.
We are not, directly or indirectly, owned or controlled by other
corporations or by the Japanese government or any foreign government. The
following table lists Trend Micro's consolidated subsidiaries, all of which are
significant except the final four.
EQUITY HELD BY
TREND-MICRO
COUNTRY OF DIRECTLY OR
NAME INCORPORATION INDIRECTLY
----------------------------------------------- ------------- --------------
Trend Micro Incorporated Taiwan 99.9
Trend Micro Inc. USA 100.0
Trend Korea Inc. Korea 99.9
Trend Micro South Europe Srl Italy 100.0
Trend Micro Deutschland Gmbh Germany 100.0
Trend Micro Australia Pty. Ltd. Australia 100.0
Trend Micro do Brasil Ltda. Brazil 99.3
Trend Micro France France 100.0
Trend Micro Hong Kong Limited Hong Kong 100.0
Trend Micro Incorporated Sdn.Bhd Malaysia 100.0
Trend Micro (UK) Limited UK 100.0
Trend Micro Latinoamerica S.A.de C.V. Mexico 100.0
Wells Antivirus Research Laboratory, Inc. USA 100.0
Trend Micro (NZ) Limited NZ 100.0
ipTrend Incorporated (Tokyo Shibuya-ku) Japan 100.0
ipTrend Incorporated (Tokyo Chuo-ku) Japan 100.0
D. Property, Plants and Equipment.
Our headquarters are located in Tokyo, Japan, where we lease 1,537
square meters of office space under a lease which expires in March 2002. We also
lease an aggregate of approximately 210 square meters of office space in Osaka
and Fukuoka.
We lease approximately 20,000 square feet of office space in
Cupertino, California under a lease which expires in July 2002. We lease office
space for our regional sales, research and development and sales office in
Taiwan and for our customer service center in the Philippines. We also lease
small sales offices in Korea, China, Hong Kong, Malaysia, Australia, Germany,
Italy, France, the United Kingdom, Mexico, Brazil and Argentina.
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
A. Operating Results.
You should read the following discussion together with the financial
statements and notes included in this Annual Report. Additionally, the following
discussion includes forward-looking statements about our business and future
performance. You should read these forward-looking statements together with the
description of the uncertainties and risks associated with these statements
contained under the heading "Cautionary Statement Regarding Forward-Looking
Statements" in this Annual Report.
OVERVIEW
Trend Micro develops, markets and supports anti-virus software and
management solutions for corporate computer systems and desktop personal
computers. Our net sales consist primarily of license and
27
license renewal fees, as well as limited sales of our products to other
companies for inclusion in their products. Site license fees for corporate end
users consist of a fee for the license itself and fees for maintenance and
support delivered over the initial license term. Maintenance and support
generally includes virus pattern updates, product version updates, telephone and
online technical support and free use of our 24-hour service centers. Upon
expiration of the initial term, corporate end users can renew the license
annually by paying a fee generally equal to one-half of the initial license fee
in Japan and 20%-50% of the initial license fee in the U.S. and elsewhere,
depending on the country. For retail purchasers of PC-cillin/Virus Buster, the
license fee includes maintenance and support for the initial one-year term only.
In order to receive maintenance and support services after the initial term,
these retail purchasers must pay a percentage, generally less than one-half, of
the original license fee.
We generally recognize revenues from product licenses when:
. the product has been shipped or electronically delivered;
. no significant vendor obligations remain; and
. collection of the resulting account receivable is probable.
In general, we record sales revenues attributable to maintenance and
support as deferred revenue and recognize such revenues ratably over the license
term. The percentage of the license fee which is deferred varies depending on
the location of the Trend Micro entity making the sale, as well as the product
sold. The weighted average percentage of license fees which were deferred was
approximately 25% and 30% in 1999 and 2000, respectively. The increase in
deferral portion of the license fee in 2000 by 5% was primarily due to increased
renewal fees under site license agreements with corporate customers in Japan. In
1999, we began to receive support fees from systems integrators who subscribe to
our eDoctor services.
Our net sales grew 47% from approximately (Yen)13.6 billion in 1999 to
approximately (Yen) 20.1 billion ($174.5 million) in 2000. Our net sales consist
primarily of sales by our operating entities in Japan, the U.S., Taiwan and
Europe. Japan, the U.S., Taiwan and Europe accounted for approximately 33%, 31%,
10% and 21%, respectively, of our net sales in 2000, and approximately 43%, 28%,
12% and 13%, respectively, in 1999.
Net sales in Japan totaled approximately (Yen)5.8 billion and (Yen)6.6
billion ($57.7 million) in 1999 and 2000, respectively, representing
approximately 43% and 33% of our total net sales in these periods. The decrease
in the percentage of our total net sales represented by our net sales in Japan
was primarily the result of increased U.S. and Europe net sales in 2000. In
absolute terms, net sales in Japan grew approximately 13% from 1999 to 2000,
primarily due to increased sales of our PC client products to corporate users.
Net sales in Japan grew approximately 22% from 1998 to 1999. Our rate of sales
growth in Japan in 1998 and 1999 was significantly lower than in 1997, when our
net sales in Japan grew approximately 84% over 1996. Our lower sales growth in
Japan in 1999 and 2000 resulted primarily from the fact that by the end of 1997
we had already established a large base of corporate end users due to rapid
growth in 1997, and consequently added new corporate customers at a slower rate
after 1998. More generally, Japanese corporations' demand for anti-virus
solutions has lagged demand elsewhere, particularly in the U.S.
Our U.S. net sales grew from approximately (Yen)3.8 billion in 1999 to
approximately (Yen)6.3 billion ($54.4 million) in 2000, an increase of
approximately 63%. Net sales in the U.S. grew approximately 105% from
approximately (Yen)1.9 billion in 1998 to approximately (Yen)3.8 billion in
1999. These annual increases in our U.S. net sales resulted largely from higher
sales of internet-based products as well as our server-based products such as
ServerProtect, primarily as a result of increased internet and server use by new
corporate end users.
Our Taiwan net sales grew from approximately (Yen)1.6 billion in 1999
to approximately (Yen)1.9 billion ($16.7 million) in 2000, an increase of
approximately 16%. Net sales decreased from approximately (Yen)1.8 billion in
1998 to approximately (Yen)1.6 billion in 1999. As the continuing recession in
Asia adversely affected
28
our net sales in Japan and other parts of Asia during 1998 and 1999, net sales
in 1999 decreased compared with 1998 and net sales in 2000 increased compared
with 1999.
Net sales in Europe grew approximately 126% from approximately (Yen)1.8
billion in 1999 to (Yen)4.1 billion ($35.9 million) in 2000. Net sales in Europe
grew approximately 124% from approximately (Yen)813 million in 1998 to (Yen)1.8
billion in 1999. We achieved a high rate of growth in sales from 1998 to 1999
and from 1999 to 2000 as we gained greater name recognition in the European
market and as a result of heightened use of anti-virus products by European
corporate customers.
Net sales outside of Japan, the U.S., Taiwan and Europe increased
approximately 9% from approximately (Yen)445 million in 1998 to approximately
(Yen)483 million in 1999, and from 1999 to 2000 increased approximately 135%
from approximately (Yen)483 million to approximately (Yen)1.1 billion ($9.9
million). Due to the establishment of the Mexico subsidiary in 2000, net sales
in 2000 greatly increased compared with 1999.
We made rebate payments to SOFTBANK of approximately (Yen)22.6 million in
1998, approximately (Yen)97.8 million in 1999 and approximately (Yen)71.5
million ($0.6 million) in 2000. The rebate amounts were based on SOFTBANK's
achievement of sales targets agreed upon between SOFTBANK and us. We record
rebate payments as deductions of sales revenue on an accrual basis.
Our consolidated financial statements are denominated in Japanese yen. All
asset and liability accounts of our foreign subsidiaries are translated into
Japanese yen at the year-end rates of exchange. We translate all income and
expense accounts at rates of exchange that approximate those prevailing at the
time of the transactions and accumulate the resulting adjustments as a separate
component of shareholders' equity. We translate foreign currency-denominated
receivables and payables into Japanese yen at year-end rates of exchange and
recognize or expense the resulting translation gains or losses on a current
basis. Fluctuations in the exchange rate between the Japanese yen and other
currencies, principally the U.S. dollar and the New Taiwan Dollar, will affect
the translation of the financial results of our foreign subsidiaries into
Japanese yen for purposes of our consolidated financial results, and will also
affect the Japanese yen value of any amounts we receive from our subsidiaries.
In the past we have recorded a majority of our expenses, and recognized a
substantial majority of our net sales, in Japanese yen.
In April and June 1998, July 1999 and June 2000 we granted warrants to
attract and retain key employees. Also, in July 1999, options were granted under
the U.S. program of our 1999 incentive plan. The warrants granted in 1998
generally commenced vesting on the first anniversary of the grantee's
employment. The warrants granted in 1999 generally commenced vesting six months
after the grant date, and the stock options granted in 1999 generally commenced
vesting one year after the grant date. The warrants granted in 2000 will
generally commence vesting one year after the grant date. Using methodology
under Accounting Principles Board Opinion No. 25, we have recorded a non-cash
compensation expense of approximately (Yen)379.8 million for the year ended
December 31, 1999 and approximately (Yen)101.5 million ($883 thousand) for the
year ended December 31, 2000 with respect to the 1998 warrants. This expense
accounts for the difference between the exercise prices of the 1998 warrants and
the deemed fair market value as of the warrants' grant date of the shares
issuable upon exercise of the warrants. The 1998 warrants are expected to
continue to vest through December 31, 2000. Had such non-cash compensation
expense for our 1998 warrants in 1998, 1999 and 2000 been determined based on
the fair value of such warrants at the grant dates, as prescribed by Statement
of Financial Accounting Standards No. 123, our pro forma net income would have
been approximately (Yen)147.6 million in 1998, approximately (Yen)1.7 billion
in 1999 and approximately (Yen)2.8 billion ($24.6 million) in 2000 and net
income per share would have been (Yen)1.30, or (Yen)1.27 on a fully diluted
basis, in 1998, (Yen)13.36, or (Yen)12.99 on a fully diluted basis, in 1999 and
(Yen)21.70 ($0.19) or (Yen)21.20 ($0.18) on a fully diluted basis, in 2000.
Those figures are significantly different than those determined under Accounting
Principles Board Opinion
29
No.25. Those differences result mainly from the current price of the shares and
their expected volatility. The impact of the pro forma value of the warrants
computed under Statement of Financial Accounting Standards No. 123 has not
affected our reported earnings or cash flows. The impact has been measured for
disclosure purposes only and is entirely non-cash in nature. See note 15 to the
financial statements.
We issued (Yen)6 billion worth of unsecured bonds due July 2002 with
detachable warrants in connection with our 1999 incentive plan in July 1999. The
bonds bear interest at the annual rate of 2.5%. (Yen)1.3 billion which was
composed of (Yen)6 billion worth of unsecured bonds issued in 1999 was redeemed
in 2000. We issued (Yen)5 billion worth of unsecured bonds due June 2003 with
detachable warrants in connection with our 2000 incentive plan in June 2000. The
bonds bear interest at the annual rate of 2.1%. We have invested the proceeds of
the bonds in cash and other short-term investments. Since these investments are
likely to yield less interest income than the interest expense on the bonds, we
will incur a net interest expense with respect to the bonds.
RESULTS OF OPERATIONS
The following table sets forth the results of operations for Trend Micro in
absolute terms and as a percentage of net sales. Our historical operating
results are not necessarily indicative of the results for any future period.
------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31
1999 1999 2000 2000 2000
------------------------------------------------------------------------------
(in thousands, except percentages)
Net sales .................................... (Yen)13,633,170 100.0% (Yen)20,070,366 100.0% $ 174,525
Cost of sales ................................ 481,574 3.5 1,474,689 7.3 12,823
--------------- ------- --------------- -------- ----------
Gross profit ............................ 13,151,596 96.5 18,595,677 92.7 161,702
--------------- ------- --------------- -------- ----------
Operating expenses:
Selling ................................. 3,453,296 25.3 5,445,167 27.2 47,349
Research and development ................ 994,340 7.3 2,043,480 10.2 17,769
General and administrative .............. 4,772,038 35.0 5,579,947 27.8 48,522
--------------- ------- --------------- -------- ----------
Total operating expenses ............ 9,219,674 67.6 13,068,594 65.2 113,640
--------------- ------- --------------- -------- ----------
Operating income ............................. 3,931,922 28.9 5,527,083 27.5 48,062
Other income (expense):
Interest income ......................... 148,487 1.1 241,133 1.2 2,097
Interest expense ........................ (66,526) (0.5) (220,960) (1.1) (1,921)
Gain on sales of marketable
securities.................................... 280,532 2.1 119,650 0.6 1,040
Foreign exchange gain (loss), net ....... (174,921) (1.3) 283,305 1.4 2,464
Other income (expense), net ............. (120,298) (1.0) 941,500 4.7 8,186
--------------- ------- --------------- -------- ----------
Total other income .................. 67,274 0.4 1,364,628 6.8 11,866
------- --------
Income before income taxes ................... 3,999,196 29.3 6,891,711 34.3 59,928
--------------- ------- --------------- -------- ----------
30
--------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31
--------------------------------------------------------------
1999 1999 2000 2000 2000
--------------------------------------------------------------
(in thousands, except percentages)
Income taxes:
Current .................................................. 2,538,455 18.6 4,701,426 23.4 40,882
Deferred ................................................. (688,988) (5.1) (1,578,889) (7.9) (13,729)
-------------- ------- -------------- ------ --------
1,849,467 13.5 3,122,537 15.5 27,153
-------------- ------- -------------- ------ --------
Income before minority interest and
equity in losses of affiliated companies....................... 2,149,729 15.8 3,769,174 18.8 32,775
============== ======= ============== ====== ========
Minority interest in income of a
consolidated subsidiary........................................ -- -- 6,845 0.1 59
============== ======= ============== ====== ========
Income from consolidated companies ............................ 2,149,729 15.8 3,762,329 18.7 32,716
Equity in losses of affiliated companies ...................... 2,356 -- 87,672 0.4 762
============== ======= ============== ====== ========
Net income .................................................... (Yen)2,147,373 15.8% (Yen)3,674,657 18.3% $ 31,954
============== ======= ============== ====== ========
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999 AND 2000
NET SALES
Net sales increased 47.2% from (Yen)13.6 billion in 1999 to (Yen)20.1
billion ($174.5 million) in 2000. The increase was primarily due to increased
sales of internet-based products such as InterScan VirusWall and ScanMail, which
grew from approximately (Yen)6.3 billion or 46% of our net sales in 1999 to
approximately (Yen)7.8 billion ($67.8 million) or 39% of our net sales in 2000.
Net sales of server-based products, primarily ServerProtect, increased from
approximately (Yen)1.5 billion or 11% of our net sales in 1999 to approximately
(Yen) 2.5 billion ($21.9 million) or 13% of our net sales in 2000, reflecting
higher corporate demand for internet-based products.
Although net sales of anti-virus software for personal computers, including
retail package sales of PC-cillin/Virus Buster, increased from approximately
(Yen)3.5 billion of net sales in 1999 to approximately (Yen)4.0 billion ($34.8
million) of net sales in 2000, net sales of anti-virus software for personal
computers, including retail package sales of PC-cillin/Virus Buster, declined
from approximately 26% of net sales in 1999 to approximately 20% of net sales in
2000, and no longer represent the largest portion of our net sales. Within the
personal computer product category, retail package sales of personal computer
software increased from approximately (Yen)0.7 billion in 1999 to approximately
(Yen)0.9 billion ($8.1 million) in 2000, due primarily to increased sales of our
products in our Asian markets. We released Virus Buster 2001 in September 2000.
Site license sales of personal computer software to corporate end users
increased from approximately (Yen)2.8 billion in 1999 to approximately (Yen)3.1
billion ($26.7 million) in 2000.
Our net sales include a limited amount of sales of our products to other
companies for inclusion in their products. Sales of these products decreased
slightly from approximately (Yen)0.7 billion in 1999 to approximately (Yen)0.4
billion ($3.5 million) in 2000, and as a percentage of net sales decreased from
5% in 1999 to 2% in 2000. Our net sales also include revenues from product
upgrade fees, maintenance fees, royalties and service sales. Sales in these
areas increased from approximately (Yen)1.5 billion in 1999 to approximately
(Yen)5.3 billion ($46.3 million) in 2000. The increase was due primarily to
increased license renewals by corporate customers and increased sales related
with ipTrend (Tokyo Chuo-ku) our new affiliate. As a percentage of net sales,
sales in these areas increased from approximately 10% in 1999 to approximately
20% in 2000. No royalties were paid in 1999. The remainder of our net sales
consists
31
of sales of other products, which totaled approximately (Yen)0.2 billion and
(Yen)1.4 billion ($12 million) or 2% and 7% of net sales in each of 1999 and
2000, respectively. The increase was primarily due to increased sales related
with ipTrend (Tokyo Chuo-ku), our new affiliate.
COST OF SALES
Cost of sales consists primarily of outbound shipping and handling costs,
costs of manuals and packaging, amortization of software development expense,
costs of job order production except software which is associated with ipTrend,
(Tokyo Chuo-ku), our new affiliate. Cost of sales increased 200.6 % from
approximately (Yen)481.6 million in 1999 to approximately (Yen) 1,474.7 million
($12.8 million) in 2000. The increase was primarily due to the increase in
retail package sales for personal computer software, and the increase in
amortization of capitalized software development costs in relation to expanded
R & D activities.
OPERATING EXPENSES
Operating expenses increased 42.3% from approximately (Yen)9.2 billion in
1999 to approximately (Yen)13.1 billion ($113.6 million) in 2000.
SELLING
Selling expenses consist primarily of advertising and selling commissions.
Selling expenses were approximately (Yen)3.5 billion in 1999 and approximately
(Yen)5.4 billion ($47.3 million) in 2000, an increase of 54.3%. The increase was
primarily due to increased personnel expenses resulting from an increase in the
number of employees from 179 in 1999 to 404 in 2000.
RESEARCH AND DEVELOPMENT
Research and development expenses consist primarily of payroll and related
expenses for software engineers who develop and update our anti-virus software
products. Research and development expenses increased 105.5% from approximately
(Yen)994.3 million in 1999 to approximately (Yen)2,043.5 million ($17.8
million) in 2000. Research and development personnel increased from 204 at
December 31, 1999 to 365 at December 31, 2000. The number of software engineers
to support product development and quality assurance increased from 204 at
December 31, 1999 to 365 at December 31, 2000. All costs relating to research
and development to establish the technological feasibility of our software
products are expensed as incurred. In our software development process,
technological feasibility is established upon completion of all significant
testing for the original English language version of the product. We produce
local language versions of our anti-virus software, such as Japanese and
Chinese, from the English language version by adding local language functions.
Localization costs, which include direct labor and overhead costs, are
capitalized and amortized over the estimated life of the product in accordance
with Statement of Financial Accounting Standards No. 86. We believe that we will
need to continue to incur costs to update current products and develop new
products to remain competitive. Accordingly, we expect our research and
development expenses to increase moderately in absolute terms in future periods.
GENERAL AND ADMINISTRATIVE
General and administrative expenses consist primarily of payroll and
related expenses, customer service, accounting and administration and other
general corporate expenses. General and administrative expenses increased 19%
from approximately (Yen)4.7 billion in 1999 to approximately (Yen)5.6 billion
($48.5 million) in 2000, representing approximately 35% and 28% of net sales for
these years. An increase in general and administrative expenses was primarily
due to increased payroll costs for newly hired employees as well as a salary
increase for existing employees. Employees engaged in activities other than
research and development increased from 315 at December 31, 1999 to 398 at
December 31, 2000. We expect general and administrative costs to increase in
absolute terms in future periods as we expand our operations.
32
OTHER INCOME (EXPENSE)
We earned interest income of approximately (Yen)148.5 million during 1999
and approximately (Yen)241.1 million ($2.1 million) during 2000. Interest income
in 1999 was primarily earned from the investment of approximately (Yen)10.2
billion in net proceeds from our August 1998 Japanese initial
public offering in Japanese money market funds and other cash equivalents, and
from interest received from our investment in bonds issued by SOFTBANK. Interest
income in 2000 is received mainly from our investment in bonds issued by
SOFTBANK.
In 2000 we recognized a gain on sales of marketable securities of
approximately (Yen)119.7 million ($1.0 million). The gain primarily resulted
from our sale in shares of common stock of March First, a Nasdaq-listed U.S.
technology company. At December 31, 2000, we held SOFTBANK bonds with an
unrealized gain of approximately (Yen)11.1 million ($96.1 thousand).
At December 31, 2000, we held common stock of Sina Com. with an unrealized
loss of approximately (Yen)245.1 million ($2.13 million).
At May 31,2000, we earned gain on settlement of litigation with Network
Associates of (Yen)1,019,734 thousand ($8,867 thousand), net of related fees for
lawyers of (Yen)307,016 thousand ($2,607 thousand) in total.
INCOME TAXES
Our statutory tax rate was 47.7% and 42.1% in 1999 and 2000, respectively.
A change in Japanese income tax regulations reduced our statutory rate to
approximately 42.1% beginning on January 1, 2000. Our effective tax rate was
46.2% in 1999 and 45.3% in 2000. The difference between our statutory and
effective tax rates resulted primarily from a decrease in valuation allowance
for deferred tax assets in 1999 and an amortization of goodwill in 2000.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1998 AND 1999
FOR THE YEAR ENDED DECEMBER 31
-----------------------------------------------------------------------
1998 1998 1999 1999 1999
-----------------------------------------------------------------------
(in thousands, except percentages)
Net sales.......................................... (Yen)9,745,664 100.0% (Yen)13,633,170 100.0% $133,449
Cost of sales...................................... 559,530 5.7 481,574 3.5 4,714
-------------- ------ --------------- ------ --------
Gross profit.................................. 9,186,134 94.3 13,151,596 96.5 128,735
-------------- ------ --------------- ------ --------
Operating expenses:
Selling....................................... 2,525,802 25.9 3,453,296 25.3 33,802
Research and development...................... 960,156 9.9 994,340 7.3 9,733
General and administrative.................... 4,086,894 41.9 4,772,038 35.0 46,712
-------------- ------ --------------- ------ --------
Total operating expenses.................. 7,572,852 77.7 9,219,674 67.6 90,247
-------------- ------ --------------- ------ --------
Operating income................................... 1,613,282 16.6 3,931,922 28.9 38,488
Other income (expense):
Interest income.................................... 44,620 0.4 148,487 1.1 1,453
Interest expense.............................. (29,279) (0.3) (66,526) (0.5) (651)
Gain on sales of marketable securities........ 146,310 1.5 280,532 2.1 2,746
Foreign exchange gain (loss), net............. (70,934) (0.7) (174,921) (1.3) (1,712)
33
FOR THE YEAR ENDED DECEMBER 31
-----------------------------------------------------------------------
1998 1998 1999 1999 1999
-----------------------------------------------------------------------
(in thousands, except percentages)
Other income (expense), net................... (6,133) (0.1) (120,298) (1.0) (1,178)
-------------- ------ -------------- ------ --------
Total other income........................ 84,584 0.8 67,274 0.4 658
-------------- ------ -------------- ------ --------
Income before income taxes......................... 1,697,866 17.4 3,999,196 29.3 39,146
-------------- ------ --------------- ------ --------
Income taxes:
Current....................................... 1,641,902 16.8 2,538,455 18.6 24,848
Deferred...................................... (347,151) (3.5) (688,988) (5.1) (6,745)
-------------- ------ --------------- ------ --------
1,294,751 13.3 1,849,467 13.5 18,103
-------------- ------ --------------- ------ --------
Income before equity in losses of affiliated
companies......................................... 403,115 4.1 2,149,729 15.8 21,043
============== ====== =============== ====== ========
Equity in losses of affiliated companies........... - - 2,356 - 23
============== ====== =============== ====== ========
Net income......................................... (Yen)403,115 4.1% (Yen)2,147,373 15.8% $21,020
============== ====== =============== ====== ========
NET SALES
Net sales increased 40% from (Yen)9.7 billion in 1998 to (Yen)13.6 billion
in 1999. The increase was primarily due to increased sales of internet-based
products such as InterScan VirusWall and ScanMail, which grew from approximately
(Yen)2.8 billion or 29% of our net sales in 1998 to approximately (Yen)6.3
billion or 46% of our net sales in 1999. Net sales of server-based products,
primarily ServerProtect, increased from approximately (Yen)1.0 billion or 10% of
our net sales in 1998 to approximately (Yen)1.5 billion or 11% of our net sales
in 1999, reflecting higher corporate demand for internet-based products.
Net sales of anti-virus software for personal computers, including retail
package sales of PC-cillin/Virus Buster, declined from approximately (Yen)3.7
billion or 38% of net sales in 1998 to approximately (Yen)3.5 billion or 26% of
net sales in 1999, and no longer represent the largest portion of our net sales.
Within the personal computer product category, retail package sales of personal
computer software decreased from approximately (Yen)1.6 billion in 1998 to
approximately (Yen)0.7 billion in 1999, due primarily to decreased sales of our
products in our Asian markets. We released Virus Buster 2000 in September 1999.
Site license sales of personal computer software to corporate end users
increased from approximately (Yen)2.1 billion in 1998 to approximately (Yen)2.8
billion in 1999.
Our net sales include a limited amount of sales of our products to other
companies for inclusion in their products. Sales of these products decreased
slightly from approximately (Yen)1.0 billion in 1998 to approximately (Yen)0.7
billion in 1999, and as a percentage of net sales decreased from 10% in 1998 to
5% in 1999. The decrease was due primarily to lower sales of our Trend Chip-Away
Virus product.
Our net sales also include revenues from product upgrade fees, maintenance
fees, royalties and service sales. Sales in these areas increased from
approximately (Yen)0.6 billion in 1998 to approximately (Yen)1.5 billion in
1999. The increase was due primarily to increased license renewals by corporate
customers and Virus Buster updates in September 1999. As a percentage of net
sales, sales in these areas increased from approximately 6% in 1998 to
approximately 10% in 1999. Royalties totaled approximately (Yen)0.5 billion or
5% of net sales in 1998. No royalties were paid in 1999. The decrease was due to
termination in 1998 of license agreements for a third party to sell PC-cillin
under that
34
party's brand name and for another third party to license scan engine
technology. The remainder of our net sales consists of sales of other products,
which totaled approximately (Yen)0.2 billion or 2% of net sales in each of 1998
and 1999.
COST OF SALES
Cost of sales consists primarily of outbound shipping and handling costs,
costs of manuals and packaging, and amortization of software development costs.
Cost of sales decreased 14% from approximately (Yen)559.5 million in 1998 to
approximately (Yen)481.6 million in 1999. The decrease was primarily due to the
decrease in retail package sales for personal computer software, which has
lowered costs by reducing the amount of packaging required for our net sales.
OPERATING EXPENSES
Operating expenses increased 22% from approximately (Yen)7.6 billion in
1998 to approximately (Yen)9.2 billion in 1999.
Selling
Selling expenses consist primarily of advertising and selling commissions.
Selling expenses were approximately (Yen)2.5 billion in 1998 and approximately
(Yen)3.5 billion in 1999, an increase of 40%. The increase was primarily a
result of increased advertising expenditures in Japan and the U.S.
Research and development
Research and development expenses consist primarily of payroll and related
expenses for software engineers who develop and update our anti-virus software
products. Research and development expenses increased 4% from approximately
(Yen)960.2 million in 1998 to approximately (Yen)994.3 million in 1999. Research
and development personnel increased from 152 at December 31, 1998 to 204 at
December 31, 1999. Our research and development expenses in 1999 grew at a
slower rate than our 1999 net sales largely due to our substantially increased
research and development spending in 1998, the benefits of which carried over
into 1999. All costs relating to research and development to establish the
technological feasibility of our software products are expensed as incurred. In
our software development process, technological feasibility is established upon
completion of all significant testing for the original English language version
of the product. We produce local language versions of our anti-virus software,
such as Japanese and Chinese, from the English language version by adding local
language functions. Localization costs, which include direct labor and overhead
costs, are capitalized and amortized over the estimated life of the product in
accordance with Statement of Financial Accounting Standards No. 86. We believe
that we will need to continue to incur costs to update current products and
develop new products to remain competitive. Accordingly, we expect our research
and development expenses to increase moderately in absolute terms in future
periods.
General and administrative
General and administrative expenses consist primarily of payroll and
related expenses, customer service, accounting and administration and other
general corporate expenses. General and administrative expenses increased 17%
from approximately (Yen)4.1 billion in 1998 to approximately (Yen)4.8 billion
in 1999, representing approximately 42% and 35% of net sales for these years.
The increase in general and administrative expenses was primarily due to higher
payroll costs due to new hires and existing employees. Employees engaged in
activities other than research and development increased from 252 at December
31, 1998 to 398 at December 31, 1999. We expect
35
general and administrative costs to increase in absolute terms in future periods
as we expand our operations.
OTHER INCOME (EXPENSE)
We earned interest income of approximately (Yen)44.6 million during 1998
and approximately (Yen)148.5 million during 1999. Interest income in 1999 was
primarily earned from the investment of approximately (Yen)10.2 billion in net
proceeds from our August 1998 Japanese initial public offering in Japanese money
market funds and other cash equivalents, and from interest received from our
investment in bonds issued by SOFTBANK.
In 1999 we recognized a gain on sales of marketable securities of
approximately (Yen)280.5 million. The gain primarily resulted from our sale in
shares of common stock of USWeb/CKS, a Nasdaq-listed U.S. technology company. At
December 31, 1999, we held common stock of USWeb/CKS with an unrealized gain of
approximately (Yen)412.4 million. In March 2000, pursuant to Whittman-Hart's
acquisition of USWeb/CKS in a stock-for-stock merger transaction, we received
common shares of MarchFirst, the renamed Whittman-Hart parent entity following
the merger, in exchange for our remaining holdings of USWeb/CKS common stock.
INCOME TAXES
Our statutory tax rate was 51.4% in 1998 and 47.7% in 1999. A change in Japanese
income tax regulations reduced our statutory rate to approximately 42.1%
beginning on January 1, 2000. Our effective tax rate was 76.3% in 1998 and 46.2%
in 1999. The difference between our statutory and effective tax rates in 1998
and 1999 resulted largely from changes in the valuation allowances relating to
tax-deferred assets held by our U.S. subsidiary, and non-tax deductible expenses
in the form of non-cash warrant compensation expense of approximately (Yen)397.5
million in 1998 and approximately (Yen)379.8.
B. Liquidity and Capital Resources.
At December 31, 2000, we had cash and cash equivalents and marketable
securities of approximately (Yen)26.3 billion ($228.9 million), up from
approximately (Yen)16.2 billion at December 31, 1999. The increase was primarily
due to operating activities and proceeds from our issuance of bonds.
Net cash provided by operating activities of approximately (Yen)6.1 billion
($52.9 million) in 2000 and (Yen)1.5 billion in 1999. The increase from 1999 to
2000 was primarily due to an increase of net income, an increase in deferred
revenue associated with increased net sales, an increase in accrued income and
other taxes associated with increased net income, and an increase of
depreciation and amortization. These increases were primarily offset by an
increase of accounts receivable relating to increased net sales.
Net cash used in investing activities was approximately (Yen)2.7 billion in
1999 and approximately (Yen)4.1 billion ($36.0 million) in 2000. The increase
from 1999 to 2000 was primarily due to a (Yen)2.5 billion ($21.8 million)
increase in investments in subsidiaries. This increase was partially offset by a
(Yen)2.1 billion ($18.7 million) decrease of proceeds from sales of marketable
securities, a (Yen)1.0 billion ($8.7 million) decrease of proceeds from
maturities of marketable securities, and a (Yen)4.9 billion ($42.2 million)
decrease of payments for purchases of marketable securities and security
investments.
Net cash provided by financing activities was approximately (Yen)7.6
billion in 1999 and approximately (Yen)6.5 billion ($56.5 million) in 2000. Net
cash provided by financing activities in 1999 and 2000 consisted primarily of
proceeds from our issuance of bonds in connection with our 1999 and 2000
warrants.
36
In 1998, we entered into three overdraft agreements with Japanese
commercial banks, under which we are able to obtain short-term financing at
prevailing interest rates for periods not in excess of one year. The aggregate
amount available under these overdraft agreements is (Yen)800 million. Each of
the overdraft agreements has an initial one-year term and is automatically
renewed for additional one-year terms unless otherwise notified by either party.
At December 31, 2000, no amounts were outstanding under these overdraft
agreements.
During the year ended December 31, 1998, our Taiwan subsidiary entered into
three lines of credit. Under these lines of credit, an aggregate of (Yen)1.3
billion was available. We cancelled these lines of credit during 1999, and no
amounts were outstanding on December 31, 1999.
In July 1999, we issued (Yen)6 billion worth of unsecured bonds in
connection with our 1999 incentive plan and in June 2000, we issued (Yen)5
billion worth of unsecured bonds in connection with our 2000 incentive plan.
(Yen)1.3 billion which was composed of (Yen)6 billion worth of unsecured bonds
issued in 1999 was redeemed in 2000. We used the proceeds of the bond issuance
for working capital and general corporate purposes.
Our capital requirements depend on numerous factors, including
. market acceptance of our products,
. the resources we devote to developing, marketing, selling and
supporting our products, and
. the extent to which we are able to establish relationships with
strategic partners in the U.S., Europe and elsewhere.
We plan to devote additional capital resources to hire additional engineers and
other employees and expand our product development, support, and sales and
marketing organizations, to expand marketing programs, establish additional
facilities worldwide and for other general corporate activities. Additionally,
in the future we may make acquisitions and strategic investments in order to
grow our business. We believe that our current cash balance, cash flow from
operations and existing credit facilities will satisfy our working capital and
capital expenditure requirements for the next 12 months. However, we cannot be
sure that we will not require additional funding during the next 12 months
or in the future. If we do need additional funding during the next 12 months
or in the future, such funding may not be available on commercially reasonable
terms, if at all. Even if no such additional funds are required, we may seek
additional equity or debt financing.
C. Research and Development, Patents and Licenses, etc.
RESEARCH AND PRODUCT DEVELOPMENT
Trend Micro's research and product development activities focus on the
development of new anti-virus and security software, enhancements to existing
products and integration of products to enable monitoring, updating and
management via the internet. We conduct research and development at our Tokyo
headquarters and our U.S. and Taiwan subsidiaries and have a research staff of
147 engineers. Complementing our internal development efforts, we are members of
industry-level initiatives such as the Association of Anti-virus Asia
Researchers group launched in Hong Kong in September 1998. Our engineers'
participation in this group gives us additional access to information regarding
newly discovered viruses.
37
Research and development expenditures, consisting primarily of software
development costs and research and development staff salaries and benefits,
increased from (Yen)557.0 million in 1997 to (Yen)960.2 million ($8.5 million)
in 1998 and (Yen)994.3 million ($9.7 million) in 1999.
INTELLECTUAL PROPERTY
Our ability to compete successfully depends in part on our ability to
protect the proprietary technology contained in our software products. We rely
upon a combination of patent, trademark, copyright and trade secret laws and
contractual provisions to establish and protect proprietary rights in our
software.
Our U.S. and Taiwanese subsidiaries hold the following principal
patents relating to core technologies:
REGISTRATION REGISTRATION
NAME STATUS DATE NUMBER APPLICANT/PATENTEE
------------------------------ ---------- ------------ ------------ ------------------------------
MacroAgent pre-boot Patented 8/22/1995 5,444,850 Trend Micro Incorporated (USA)
authentication
Network and Workstation Patented 10/21/1997 5,680,547 Trend Micro Incorporated (Taiwan)
Access pre-boot
Apparatus and method for e-mail Patented 3/30/1999 5,889,943 Trend Micro Incorporated (Taiwan)
virus detection and elimination
InterScan: Server pipeline Patented 4/22/1999 5,623,600 Trend Micro Incorporated (USA)
System apparatus and method for Patented 9/14/1999 5,951,698 Trend Micro Incorporated (Taiwan)
macro virus detection and removal
Event-triggered iterative virus Patented 9/28/1999 5,960,170 Trend Micro Incorporated (Taiwan)
detection
Computer network malicious code Patented 11/9/1999 5,983,348 Trend Micro Incorporated (USA)
scanner
The duration of these patents is 17 years from the date of registration. We plan
to transfer the ownership of these patents to Trend Micro.
We do not typically enter into signed license agreements with our
corporate, government and institutional customers who license products directly
from us. We include an electronic version of a "shrinkwrap" license in all of
our electronically distributed software and a printed license in the box for our
packaged products in order to protect our copyrights in those products. The
enforceability of these licenses generally is uncertain in the United States as
well as in foreign jurisdictions. In addition, the laws of some foreign
countries either do not protect proprietary rights or offer only limited
protection for those rights.
38
In addition, as is common in the software industry, third parties may
sue us for alleged infringement of their intellectual property rights. We may
also have to take legal action to defend our intellectual property from
infringement.
We also generally enter into confidentiality agreements with our
employees, and limit access to and distribution of proprietary information.
D. Trend Information.
The information required by this Item is set forth in Item 5.A of this
annual report.
Item 6. Directors, Senior Management and Employees
A. Directors and Senior Management.
The following table shows information regarding our directors and
executive officers as of March 31, 2001.
Month in Number of Shares
which Current owned as of
Name Age Position(s) Term Expires March 31, 2001
---- --- ----------- ------------ --------------
Steve Ming-Jang Chang 45 Representative Director; President, March, 2003 2,604,000
Chief Executive Officer and Chairman of
the Board
Toshihiro Watanabe 39 Representative Director and Executive March, 2003 0
Vice President
Eva Yi-Fen Chiang 42 Director; Chief Technology Officer and March, 2003 1,488,000
Executive Vice President
Mahendra Negi 41 Director, Chief Financial Officer and March, 2003 0
Executive Vice President
Mike Conner 46 Director in charge of North America and March, 2003 0
Senior Vice President
Edward Tian 38 Director March, 2003 0
Fumio Hasegawa 61 Statutory Auditor March, 2002 0
Mitsuo Sano 44 Statutory Auditor March, 2002 0
Sadatoshi Nakayama 49 Statutory Auditor March, 2002 0
Yasuo Kameoka 45 Statutory Auditor March, 2002 0
Eva Yi-Fen Chiang is one of our co-founders. She is currently executive
vice president and a director and has been our chief technology officer since
May 1988. She is also Steve Ming-Jang Chang's sister-in-law.
Steve Ming-Jang Chang is the founder and chief officer of Trend Micro.
Chang formed Trend Micro, in California, in 1988, with the goal of developing
antivirus software for personal computers. Prior to launching Trend Micro,
Chang worked as an engineer at Hewlett Packard and later founded AsiaTek, Inc.,
- a Taiwan-based UNIX software design company. Steve Chang received his B.S. in
Applied Mathematics from Fu-Jen Catholic University in Taiwan and his M.S. in
Computer Science from Lehigh University, Pennsylvania.
Toshiro Watanabe is the vice president of sales and marketing at Trend
Micro Japan. Watanabe first worked with us as an outside business consultant in
1996. In 1997, he joined us as vice president of sales and administration, where
he had responsibility for conducting shareholder meetings, recruiting staff, and
setting
39
up the Human Resources Department. Later, Watanabe moved into sales and
marketing, and helped Trend Micro penetrate the security software market. He
also became Director of New Business Development in 1999. Watanabe currently
serves on NTT Data Security's Board of Directors.
Mahendra Negi is the chief financial officer of Trend Micro, and sits
on the Board of Directors. He is also the COO and CFO of Trend Micro's
wholly-owned subsidiary ipTrend, Inc., a Linux-based Internet appliance
development company. His responsibilities at ipTrend include sales, marketing,
finance, human resources and administration. Negi joined Trend Micro in May 2000
from Merrill Lynch. Negi started his career in the petroleum industry, and then
moved to commercial banking before joining Merrill Lynch. He holds a Master's
degree in Physics from Nagpur University in India in addition to his Master's
degree in Management from the London Business School.
Mike Conner is president of North American Operations and sits on the
Board of Directors. Mike Conner's responsibilities include sales, marketing,
technical support, finance, and human resources for Trend Micro's United States
business unit. He joined Trend Micro in 1997 as vice president of North American
sales. Mike Conner, 44, brings more than 12 years of corporate and channel sales
experience, including seven years at Software Publishing Corporation (SPC).
After leaving SPC, Mike served as Borland's senior director of Channel Sales and
Customer Service and then joined GoldDisk as VP of Sales before coming to Trend
Micro. Mike Conner graduated from Western Illinois University with a B.S.
degree.
Dr. Edward Suning Tian is the President and CEO of China Netcom, a
young Chinese telecommunications carrier in China, jointly founded by the
Academy of Sciences, Ministry of Railways, National Bureau of Broadcasting, File
and Television, and Shanghai Municipal Government. Prior to joining China Netcom
in June 1999, Dr. Tian co-founded the first internet technology provider - Asia
Info. Dr. Tian holds a Ph.D. in Environmental Management from Texas Tech
University. He also received an M.S. from the Chinese Academy of Sciences in
Beijing. He is a frequent speaker at major events and a contributor to many
publications on Internet technology and the new economy.
Fumio Hasegawa graduated in 1967 from Chuo University with a degree
from the commercial science department. He has worked for Shell Oil and Tokyo
Shell Pack. He became one of our statutory auditors in March, 2000.
Mitsuo Sano graduated from Yokohama National University's department of
economics in 1982. He has worked for PriceWaterhouse and SOFTBANK. He is
currently a statutory auditor for Yahoo, SOFTBANK and, since March 1997, for us.
Sadatoshi Nakayama graduated from Kyoto University's department of
science in March 1977. He has worked for the Chuo Audit Corporation (now the
ChuoAoyama Audit Corporation) and is currently the head of Sadatoshi Nakayama
CPA Office and became one of our statutory auditors in March 2001.
Yasuo Kameoka graduated from Sohka University's department of economics
in 1978. He joined PriceWaterhouse in 1978 and Tokuichi Hayashi CPA Office in
1988. Currently he is the representative employee of Daikoh Audit Corporation.
He became one of our statutory auditors in March 2001.
B. Compensation
For the fiscal year ended December 31, 2000, the aggregate compensation
of all directors and executive officers paid or accrued by Trend Micro was
(Yen)74.5 million ($647,826 thousand). Under the Japanese Commercial Code and
local practice, we may make severance payments to a retired director or
statutory auditor with shareholder approval, if our management proposes such
payments based on a resolution of our board of directors. However, we do not
intend to make such a proposal for directors. We have an internal formula to
determine the amounts of severance payments to directors and statutory auditors
if we were to make such a proposal for statutory auditors. We have not recorded
any liabilities relating to severance payments to directors and statutory
auditors as of December 31, 1998, 1999 and 2000 because we have no liabilities
to directors, and related liabilities to statutory auditors were insignificant.
C. Board Practices.
Directors are elected at a general meeting of shareholders, and the
normal term of office of directors is two years, although they may serve any
number of consecutive terms. We do not have an audit or recommendation
committee, as is standard practice in Japan. We do not have any service
contracts with any of our directors providing for benefits upon termination of
employment. We have not established a retirement plan or corporate pension plan
for our directors or employees.
In accordance with the requirements of the Commercial Code of Japan,
our articles of incorporation provide for not less than three corporate
auditors. Corporate auditors, of whom at least one must be from outside of the
company, are elected at a general meeting of shareholders, and the normal term
of office of a
40
corporate auditor is three years, although they may serve any number of
consecutive terms. Corporate auditors are under a statutory duty to oversee the
administration of our affairs by the directors, to examine our financial
statements and business reports to be submitted by the board of directors to the
general meetings of shareholders and to report their opinions thereon to the
shareholders. They are entitled to attend meetings of the board of directors and
to express their opinions, but they are not entitled to vote. Corporate auditors
also have a statutory duty to provide their report on the audit report prepared
by our independent certified public accountants to the board of corporate
auditors, which must submit its auditing report to the board of directors. The
board of corporate auditors will also determine matters relating to the duties
of the corporate auditors, such as audit policy and methods of investigation of
our affairs.
Our directors serve on the board for two year terms and statutory
auditors serve for three year terms. Our executive officers serve at the
discretion of the board. The terms of Messrs. Chang, Watanabe, Negi, Conner and
Tian and Ms. Chiang expire upon the completion of our ordinary shareholders'
meeting in 2003. The terms of Messrs. Hasegawa, Sano, Nakayama and Kameoka
expire upon completion of our ordinary shareholders' meeting in 2002.
D. Employees.
As of May, 2001, we had 1,388 employees, of whom 930 are located in
Asia, 223 are located in the United States, 149 are located in Europe and 86 are
located in other regions.
As of May, 2001, we had 1,449 employees, including 61 temporary or
part-time employees. Of the 1,388 full-time employees, 188 were in
administrative positions, 442 were in sales and marketing positions, 489 were in
research and development positions and 269 were in technical support positions.
On average we employed approximately 73 temporary or part-time employees at any
given time during fiscal 2000.
As of December 31, 2000, we had 1,253 employees, including 86 temporary
or part-time employees. Of the 1,167 full-time employees, 180 were in
administrative positions, 404 were in sales and marketing positions, 364 were in
research and development positions and 219 were in technical support positions.
As of December 31, 1999, we had 750 employees, including 51 temporary
or part-time employees. Of the 699 full-time employees, 204 were in sales and
marketing positions, 207 were in research and development positions, 117 were in
administrative positions and 174 were in technical support positions.
Our employees do not belong to any labor union. We believe that our
employee relations are good.
E. Share Ownership.
See Item 6.A Directors, Senior Management and Employees for information
on share ownership of our directors and senior management.
1997 Incentive Plan and 1998 Incentive Plans
Our 1997 incentive plan and 1998 incentive plans provide for the grant
of warrants to purchase shares to employees and directors. All directors and
employees of Trend Micro and its subsidiaries, other than directors or employees
residing in California and holding more than 10% of the outstanding shares, were
eligible to participate in the incentive plans.
All of the warrants authorized under the incentive plans, representing
an aggregate of 10,653,600 shares, have been issued. As of May 31, 2001,
warrants to purchase a total of 7,918,200 shares have been exercised, warrants
to purchase a total of 748,800 shares have been retired, and warrants to
purchase a total of 1,986,600 shares remain issued and outstanding. All warrants
issued to date under the incentive plans were issued with an exercise price of
(Yen)142.5 per share. Under the incentive plans, any warrants that have been
retired, expired, become unexercisable or forfeited for any reason are not
available for any future issuances.
41
If required by applicable regulations, the exercise price of a warrant
will be not less than 85% of the fair market value of the shares issuable upon
exercise of the warrant on the date of grant. The warrants are exercisable at a
rate determined by the board of directors in its sole discretion. However, the
incentive plans provide that in no event will any warrant become exercisable at
a rate less than 20% per year for each of the first five years from its issue
date, and no warrant is exercisable after 10 years from its issue date.
The board of directors may amend the incentive plans and warrants and
may assume, repurchase or resell outstanding warrants at any time in compliance
with applicable laws, but any amendment or modification which materially alters
or impairs a warrant holder's rights requires the warrant holder's prior written
consent. The incentive plans permit the board of directors to impose transfer
restrictions on the shares issuable upon exercise of the warrants, including a
right of first refusal to purchase the shares. Each of the incentive plans
terminates ten years after its respective date of adoption.
Due to restrictions under the Japanese Commercial Code, the warrants
were not issued directly to eligible employees but were initially issued as
unsecured bonds with detachable warrants with a face value equal to the exercise
price of the warrants. The bonds were issued and sold to SOFTBANK, upon which we
fully redeemed the bonds and repurchased the warrants. Following these
transactions, we transferred some of the warrants to our Japanese employees and
sold the remaining warrants to our subsidiaries for transfer to employees at our
subsidiaries.
1999 Incentive Plan
We have adopted the Trend Micro Incorporated 1999 incentive plan. The
1999 incentive plan has two components:
. we have issued warrants to acquire up to 1,875,000 newly-issued
shares to employees in Japan and employees of our non-U.S.
subsidiaries; and
. under the U.S. program of the plan, STG Incentive Company L.L.C.,
a Delaware limited liability company organized by Gainway
Enterprises Limited, Trueway Company Limited and Steve Ming-Jang
Chang, has issued options directly to employees and directors of
Trend U.S. to acquire up to 1,620,000 shares from STG Incentive
Company L.L.C.
The exercise price per share for the warrants and the options issued
under the 1999 incentive plan is the fair market value of the shares on the date
on which the exercise price was determined. We have issued the warrants in the
form of unsecured bonds with detachable warrants. Immediately following issuance
of the bonds, we repurchased the warrants and issued some of the warrants to our
Japanese employees and sold the remaining warrants to our subsidiaries for
issuance to employees outside of Japan and the United States. The terms of the
warrants issued under our 1999 incentive plan are substantially identical to
those of the warrants issued under the 1997 and 1998 incentive plans.
Trend U.S. determines the allocation of and vesting for options.
Options are granted by STG Incentive Company L.L.C. at the direction of Trend
U.S. Each option gives the option holder the right to purchase one unit of 500
shares during the four-year period from the date of grant. The options will not
be transferable other than by inheritance or under a domestic relations order by
a court. Upon exercise of an option, the option holder will deposit the
underlying shares into the ADS facility and receive ADSs. The custodian will
return shares underlying options which have not been exercised as of the end of
the option term to STG Incentive Company L.L.C. for distribution to Trueway,
Gainway and Mr. Chang.
The following table shows information about the warrants and options
granted to our directors and executive officers under our 1999 incentive plan
which are outstanding as of May 31, 2001.
Total Number of
Shares Underlying
Name Expiration Date Warrants/Options Aggregate Exercise Price (1)
---- --------------- ---------------- ----------------------------
Toshihiro Watanabe 7/22/2002 17,182 (Yen)54,998,400
Eva Yi-Fen Chiang 7/12/2003 102,000 $2,560,200
Mike Conner 7/12/2003 54,000 $1,355,400
Directors and Executive 7/22/2002 173,187 $3,915,600 (Yen)54,998,400
Officers as a group (10 persons) 7/12/2003
(1) Yen figures represent aggregate yen-denominated exercise prices for
warrants, and dollar figures represent aggregate dollar-denominated
exercise prices for options.
2000 Incentive Plan
We have adopted the Trend Micro Incorporated incentive plan. Under the
2000 incentive plan we have issued warrants to acquire up to 636,942 newly-
issued shares to our employees
The exercise price per share for the warrants issued under the 2000
incentive plan is the fair market value of the shares on the date on which the
exercise price was determined. We have issued warrants in the form of unsecured
bonds with detachable warrants. Immediately after these bonds were issued, we
repurchased the warrants and issued a portion of them to our Japanese employees
and sold the remaining warrants to our subsidiaries for issuance to employees
outside of Japan and the United States. The terms of the warrants issued under
our 2000 incentive plan are substantially identical to those of the warrants
issued under the 1997, 1998 and 1999 incentive plans.
The following table shows information about the warrants granted to our
directors and executive officers which are outstanding as of May 31, 2001 under
our 2000 incentive plan.
Total Number of
Shares Underlying Aggregate
Name Expiration Date Warrants Exercise Price
---- --------------- ---------------- --------------
Toshihiro Watanabe 6/19/2003 5,859 45,993,150
------------------
Eva Yi - Fen Chiang 6/19/2003 6,878 53,992,300
-------------------
Mahendra Negi 6/19/2003 30,318 237,996,300
-------------
Mike Conner 6/19/2003 8,662 67,996,700
-----------
Directors and Executive 6/19/2003 51,717 405,978,450
-----------------------
Officers as a group (10 persons)
--------------------------------
42
Our Board of Directors has authorized two incentive plans for the fiscal
year 2001. The first plan was authorized in February 2001. Warrants for a total
of 881,057 shares were issued at an exercise price of (Yen) 5,675, of which
7,929 have been redeemed. The following table shows information about the
warrants granted to our directors and executive officers under the first 2001
incentive plan.
Total Number of
---------------
Shares Underlying Aggregate
----------------- ---------
Name Expiration Date Warrants/Options Exercise Price
---- --------------- ---------------- --------------
Mahendra Negi 3/12/2004 13,920 78,996,000
-------------
Directors and Executive 3/12/2004 13,920 78,996,000
-----------------------
Officers as a group (10 persons)
--------------------------------
The second plan was authorized by our Board of Directors in May, 2001. Warrants
for a total of 260,416 shares and options for a total of 713,500 shares were
issued at an exercise price of (Yen) 5,760. The following table shows
information about the warrants granted to our directors and executive officers
under the first 2001 incentive plan.
Total Number of
---------------
Shares Underlying Aggregate Exercise
----------------- ------------------
Name Expiration Date Warrants/Options Price
---- --------------- ---------------- -----
Toshihiro Watanabe 5/28/2004 7,176 41,276,160
12/31/2004
Eva Yi - Fen Chiang 5/28/2004 9,722 55,998,720
Mike Conner 5/28/2004 8,000 46,080,000
Directors and Executives 5/28/2004 24,888 143,354,880
Officers as a group (10 persons) 12/31/2004
43
Item 7. Major Shareholders and Related Party Transactions.
A. Major Shareholders.*
The Securities and Exchange Law of Japan requires any company which is the
issuer of securities which are, among other considerations, listed on any
Japanese stock exchange or are traded on the over-the-counter market in Japan to
disclose information about its major shareholders, including approximately its
ten largest shareholders of record as of the end of each fiscal year and each
semi-annual period. Also, as explained under Item 10.D below, any person who
becomes, beneficially and solely or jointly, a holder of more than 5% of the
total issued shares of a company listed on any Japanese stock exchange or whose
shares are traded on the Japanese over-the-counter-market, as calculated
pursuant to the Securities and Exchange Law of Japan, must file with the Local
Finance Bureau having jurisdiction within five business days a report concerning
such shareholding. For this purpose, shares issuable to such person upon his
exchange of exchangeable securities, conversion of convertible securities or
exercise of warrants are taken into account in determining both the size of
his holding and the issuer's total issued shares.
As of March 31, 2001, there were three shareholders of record holding 5% or
more of the total issued shares of our common stock. One of these shareholders
of record, Trueway Company Limited, which as of March 31, 2001 held of record
12,759,000 shares, or 19.4% of the total issued shares, is a corporation
controlled by Yeh Min Yuen. Another record shareholder, Gainway Enterprises
Limited, which as of March 31, 2001 held of record 6,597,000 shares, or 10.0% of
the total issued shares, is a corporation controlled by Liao Hsueh-Hsuan. These
two individuals' beneficial ownership of our common stock is disclosed in the
table below. The third shareholder of record, MLPFS Custody Account No. 2,
which as of March 31, 2001 held of record 7,542,000 shares, or 11.5% of the
total issued shares, is a trust holding shares of our common stock for
individuals residing in Taiwan and other countries. To our knowledge, as of
March 31, 2001, none of these individuals beneficially owned, through this trust
or otherwise, 5% or more of the total issued shares of our common stock.
Within the last three years, to our knowledge, the following significant
changes in the percentage ownership held by major shareholders have occurred:
(1) At the time of our initial public offering in Japan in August 1998,
SOFTBANK was our largest shareholder. Since then, SOFTBANK has reduced its
holding of shares of our common stock. In March 2000, SOFTBANK sold all of
its remaining shares of our common stock. To our knowledge, SOFTBANK
currently does not beneficially own shares of our common stock.
(2) We are aware of the filing by Jardine Fleming Investment Management that,
as of December 31, 1999, it and its affiliates together owned, beneficially
and jointly, 5.6% of the issued shares of our common stock, as calculated
pursuant to the Securities and Exchange Law of Japan. Subsequently,
Jardine Fleming Investment Management made another filing reporting that,
as of September 30, 2000, their beneficial and joint ownership fell below
5% of the issued shares of our common stock, as calculated pursuant to the
Securities and Exchange Law of Japan.
The following table shows information known to us regarding the beneficial
ownership of our common stock as of March 31, 2001, by each person known by us
to beneficially own more than 5% of the outstanding shares of our Common Stock.
Shares of common stock
beneficially owned
------------------------
Name Number Percentage
---- ------ ----------
Yeh Min Yuen.............................. 12,759,000 19.4%
Liao Hsueh-Hsuan.......................... 6,597,000 10.0%
* In this section, share references do not reflect the one-to-two stock split
which took effect on March 31, 2001.
44
As of March 31, 2001, there were 48 record shareholders of Trend Micro
with addresses in the United States, and those U.S. holders held 2,266,900
shares of our common stock.
To the extent known to us, we are not directly or indirectly owned or
controlled by another corporation, by the Japanese or any other government or by
any other natural or legal persons severally or jointly.
We know of no arrangements the operations of which may at a later time
result in a change of control of Trend Micro.
B. Related Party Transactions.
Transactions with SOFTBANK
Acquisition of SOFTBANK bonds. Between October 1998 and December 1998,
Trend Micro purchased in the public market an aggregate of 12,000,000 units of
bonds issued by SOFTBANK, for a total purchase price of (Yen)1,200,826,000. Of
these bonds, 11,000,000 units had a maturity date of October 18, 1999 and a 2.3%
annual interest rate. Semi-annual interest payments under these bonds were made
on April 18 and October 18 of each year. The remaining 1,000,000 units matured
in October 2000. We also currently own 17,000,000 units of SOFTBANK bonds which
we purchased for (Yen)1.7 billion in March 1999. These bonds are due March 24,
2003 and bear 3% interest. Semi-annual interest payments under these bonds are
due March 24 and September 24 of each year. In each instance, we purchased the
SOFTBANK bonds at the then current fair market value of these bonds and in
brokered transactions.
Issuance of Bonds to SOFTBANK in Connection with Incentive Plans. In
connection with the 1998 incentive plan, we issued unsecured bonds with
detachable warrants to SOFTBANK in the following amounts: on April 15, 1998,
(Yen)412.9 million; and on June 15, 1998, (Yen)196.6 million. We immediately
fully redeemed the bonds on their dates of issuance at their face value. We also
repurchased all of the detachable warrants upon issuance of each bond and
immediately distributed such warrants, at the fair market price on the date of
issuance, to our and our subsidiaries' participating employees.
We issued approximately (Yen)6 billion worth of unsecured bonds with
detachable warrants to SOFTBANK, which may include affiliated companies, in
connection with the 1999 incentive plan. We have also repurchased the detachable
warrants and distributed them, with an exercise price equal to the fair market
value of the underlying shares on the date of issuance, to our and our non-U.S.
subsidiaries' employees. The bonds will bear interest at the annual rate of
2.5%. (Yen)1.3 billion of these bonds were redeemed in 2000, (Yen)3 billion were
sold in January, 2001 and 8 million were redeemed in June, 2001.
At the time we entered into these transactions, members of our management
either were or had been members of SOFTBANK's management.
Investment in SoftTrend Capital and Softbank Internet Fund. In December
1999, Trend Micro invested (Yen)12.5 million in SoftTrend Capital Corporation.
As of April 30, 2000, Trend Micro is a 20%
45
shareholder of SoftTrend Capital. SoftTrend Capital is indirectly owned by
SOFTBANK, and acts as manager for the SOFTBANK Internet Fund. The SOFTBANK
Internet Fund is a venture capital fund established in July 1999 for the purpose
of making investments in internet-related companies. In December 1999, Trend
Micro also made an investment of (Yen)960 million in the SOFTBANK Internet Fund
and in December, 2000 this investment is (Yen)928 million. Yoshitaka Kitao
served on the board of directors of both Trend Micro and SOFTBANK and was
president and chief executive officer of SoftTrend Capital when we entered into
this transaction.
Transactions with Information Security One limited
We own 2.836% of the outstanding shares of Information Security One
Limited (formerly Internet Security One Limited) as of December 31, 2000 and our
CEO, Steve Chang, is a member of Information Security One Limited's board of
directors. Information Security One Limited is a holding company of a group
which is the leading provider of enterprise solutions and professional services
that secure the integrity of information infrastructure in the PRC and Hong
Kong. In January, 2001, we lent Information Security One Limited (Yen)35.6
million, due January 15, 2002, at an interest rate of 10%. The entire amount is
currently outstanding. In the fiscal year 2000, Trend Micro had about (Yen)80
million net sales to Information Security One Limited on regular commercial
terms.
Trend Micro has the option of the purchase of Information Security One
Limited stock. If Trend Micro exercises this option, Trend Micro will own 5.09%
of the outstanding shares of Information Security One Limited approximately.
Item 8. Financial Statements.
The information required by this item has been provided beginning on
page F-2.
Item 9. The Offer and Listing.
Japanese Over-The-Counter Market and the Tokyo Stock Exchange
Our shares have been traded since August 18, 1998 on the Japanese over-
the-counter market. On August 17, 2000 our shares were listed on Tokyo Stock
Exchange, which is the principal trading market for the shares. Prior to August
18, 1998, there was no public market for the shares. The following table shows,
for the periods indicated, the high and low closing per-share sale prices of the
shares as reported by the Japan Securities Dealers Association, retroactively
taking into account the one-into-three stock split effected on September 30,
1999, and the one-into-two stock split effected on March 31, 2001.
Japanese Over-The-Counter Market
Yen Price Per Share
-------------------
High Low
------ -----
1998 (from August 18)...................................... 1,417 697
1999....................................................... 12,500 1,183
First quarter..................................... 2,550 1,183
Second quarter.................................... 3,400 1,900
Third quarter..................................... 6,450 2,783
Fourth quarter.................................... 12,500 7,000
2000
First quarter..................................... 16,400 8,450
Second quarter.................................... 9,550 4,750
Third quarter (until August 16)................... 9,200 6,700
46
Tokyo Stock Exchange
2000
Third quarter (from August 17).................... 9,005 6,805
Fourth quarter.................................... 8,100 4,135
2001
First quarter..................................... 6,375 3,165
Second quarter (through June 22, 2001)............ 6,290 4,500
Calendar Year 2000
December.......................................... 6,350 4,135
Calendar Year 2001
January........................................... 6,300 3,165
February.......................................... 6,375 5,250
March............................................. 5,640 4,155
April............................................. 5,640 5,100
May............................................... 6,290 5,140
On June 22, 2001, the closing sale price of our shares on the Tokyo
Stock Exchange was (Yen)5,130 per share.
U.S. Market
Certain of our shares have been traded on The Nasdaq National Market
since July 8, 1999 in the form of American Depositary Shares under the symbol
"TMIC." The following table shows, for the periods indicated, the high and low
closing per-ADS sale price of the ADSs and the average daily trading volume of
the ADSs, retroactively taking into account the one-into-three stock split
effected on September 30, 1999, the one-into-two stock split effected on March
31, 2001 and the two-into-one ADR ratio change which will take effect on July 2,
2001 and the ten-into-one ADR ratio change which will take effect on July 2,
2001.
Dollar Price Per ADS
--------------------
High Low
------- ------
1999....................................................... $121.25 $23.33
Third quarter..................................... 65.63 23.33
Fourth quarter.................................... 121.25 66.88
2000....................................................... 159.38 32.5
First quarter..................................... 159.38 82.5
Second quarter.................................... 85.94 50.00
Third quarter..................................... 86.95 59.38
Fourth quarter.................................... 74.38 32.5
2001
First quarter..................................... 59.38 28.75
Second quarter (through June 22, 2001)............ 51.5 37.7
Calendar Year 2000
December.......................................... 57.5 32.5
Calendar Year 2001
January........................................... 51.56 28.75
February.......................................... 59.38 44.06
March............................................. 46.56 33.75
April............................................. 47.5 38.75
May............................................... 51.5 42.4
On June 22, 2001, the closing sale price of the ADSs on The Nasdaq
National Market was $40.2 per ADS.
47
Item 10. Additional Information.
A. Share Capital
Not applicable.
B. Memorandum and Articles of Association.
The following is a summary of material information concerning the
shares, including summaries of material provisions of our articles of
incorporation and share handling regulations, and of the Japanese Commercial
Code and related legislation. These summaries should be read together with the
articles and the share handling regulations which have been filed as exhibits to
our previous filings with the Securities and Exchange Commission. The discussion
of the Commercial Code below takes into account certain amendments to the
Commercial Code (the "2001 Amendments") that were passed by the Diet of Japan on
June 22, 2001. The 2001 Amendments will become effective from a date within six
month from their proclamation. Such date will be separately prescribed.
General
Our authorized share capital as of May 31, 2001 is 250,000,000 shares,
of which 131,590,456 (taking into account the one-to-two stock split in March
31, 2001) shares with par value of (Yen)50 per share are issued and outstanding
as of the same date. After the 2001 Amendments become effective, the concept of
the "par-value" of the shares will be abolished. Under the Commercial Code,
shares must be registered and are transferable by delivery of share
certificates. In order to assert shareholders' rights against us, a shareholder
must have its name and address registered on our register of shareholders, in
accordance with our share handling regulations. The registered beneficial holder
of deposited shares underlying the ADSs is the depositary for the ADSs.
Accordingly, holders of ADSs will not be able to assert shareholders' rights.
A holder of shares may choose, at its discretion, to participate in the
central clearing system for share certificates under the Law Concerning Central
Clearing of Share Certificates and Other Securities of Japan. Participating
shareholders must deposit certificates representing all of the shares to be
included in this clearing system with Japan Securities Depository Center. If a
holder is not a participating institution in the Securities Center, it must
participate through a participating institution, such as a securities company or
bank having a clearing account with the Securities Center. All shares deposited
with the center will be registered in the name of the Securities Center on our
register of shareholders. Each participating shareholder will in turn be
registered on our register of beneficial shareholders and be treated in the same
way as shareholders registered on our register of shareholders. For the purpose
of transferring deposited shares, delivery of share certificates is not
required. Entry of the share transfer in the books maintained by the Securities
Center for participating institutions, or in the book maintained by a
participating institution for its customers, has the same effect as delivery of
share certificates. The Securities Center system is intended to reduce paperwork
required in connection with transfers of shares. Beneficial owners may at any
time withdraw their shares from deposit and receive share certificates.
Dividends
Under our articles, our financial accounts will be closed on December 31
of each year and dividends, if any, will be paid to shareholders of record at
December 31. In addition to year-end dividends, the board of directors may by
resolution declare an interim cash dividend to shareholders of record as of June
30 or each year. Under the Commercial Code, however, we cannot declare or pay
dividends unless specified financial criteria are met based on the amount of our
stated capital and legal reserves.
Japanese Unit Share System
In accordance with the requirements of the Commercial Code, our articles
of incorporation provide that 500 shares constitute one "unit."
Transferability of Shares Representing Less Than One Unit. Under the
Commercial Code and the Deposit Agreement, holders of ADSs will be able to
surrender ADSs and withdraw the underlying shares from deposit only in whole
unit lots of one unit or larger. A holder who owns ADRs evidencing less than
5,000 ADSs will indirectly own less than a whole unit. Such a holder will not be
able to dispose of its shares in lots of less than one unit and will not have
access to the Japanese market through surrender of their ADSs and withdrawal and
sale in Japan of the
48
underlying shares. The Japanese unit share system does not affect the
transferability of ADSs, which may be transferred in lots of any size.
Rights of Holder of Shares Representing Less Than One Unit to Require
Trend Micro to Purchase Such Shares. A holder of shares representing less than
one unit may at any time require Trend Micro to purchase such shares. Such
shares will be purchased at their last reported sale price on the Japanese over-
the-counter market on the day a request pertaining to such purchase is delivered
to our transfer agent or, if no sales take place on that day, the price at which
the next sale of shares is effected in the Japanese over-the-counter market,
less applicable brokerage commissions. However, because holders of ADSs
representing less than one unit are not able to withdraw the underlying shares
from deposit, such holders will not be able to exercise this right as a
practical matter.
Other Rights of Holder of Shares Representing Less Than One Unit. A
holder of shares representing less than one unit has the following rights:
. to receive dividends (including interim dividends);
. to receive shares and/or cash by way of a stock split, upon
consolidation or subdivision of shares or upon a capital decrease or
merger;
. to be allotted rights to subscribe for new shares and other
securities when such rights are granted to shareholders;
. to participate in any distribution of surplus assets upon the
liquidation of Trend Micro; and
. to require us to issue replacement certificates for lost, stolen or
destroyed share certificates.
A shareholder who owns shares representing less than one unit will not
be able to exercise any other rights, including voting rights, the right to
institute derivative actions and the right to examine our accounting books and
records.
Voting Rights of a Holder of Shares Representing Less Than One Unit. A
holder of shares representing less than one unit cannot exercise any voting
rights pertaining to such shares. In calculating the quorum for various voting
purposes, the aggregate number of shares representing less than one unit will be
excluded from the number of outstanding shares. A holder of shares representing
one or more whole units will have one vote for each share held, except as stated
in "--Voting Rights" below.
NEW UNIT SHARE SYSTEM
General
After the 2001 amendments become effective, the unit share system described
above will be abolished and a new unit share system called, "tangen-kabu" will
be introduced. Unless otherwise determined by amendments to our Articles of
Incorporation, upon the 2001 Amendments coming into effect our Articles of
Incorporation will be deemed to have been amended such that 500 shares (being
the number of shares constituting one new unit under our Articles of
Incorporation pursuant to the current unit share system) will constitute one new
unit. Although the number of shares constituting a new unit will be included in
our Articles of Incorporation, if adopted, the board of directors will be
permitted to reduce the number of shares that will constitute a new unit or
abolish the new unit share entirely. The number of shares constituting a new
unit will not be permitted to exceed 1,000 shares or one-two hundredth (1/200)
of the number of all issued shares. The new unit share system does not affect
the transferability of ADSs, which may be transferred in lots of any size.
Voting rights under the new "unit" share system
Under the new unit share system, the shareholders shall have one voting right
for each unit of shares that they hold. Any number of shares less than a full
unit will carry no voting rights.
Share certificates for less than a unit of shares
Under the 2001 Amendments, if the Articles of Incorporation state that no share
certificates are issued with respect to any number of shares constituting less
than one unit, no certificates for a number of shares other than a full unit or
an integral multiple thereof will in general be issued. If our Articles of
Incorporation do not so state, upon the 2001 Amendments coming into effect, our
Articles of Incorporation will be deemed to have been amended to so provide. As
the transfer of shares normally requires delivery of the certificates therefor,
any fraction of a unit for which no share certificates are issued are not
transferable.
Repurchase by the Company of shares constituting less than a full unit
A holder of shares constituting less than one unit may require us to purchase
such shares at their market value.
49
Ordinary General Meeting of Shareholders
We normally hold our ordinary general meeting of shareholders in March
of each year in Tokyo, Japan. In addition, we may hold an extraordinary general
meeting of shareholders whenever necessary by giving at least two weeks' advance
notice. Under the Commercial Code, notice of any shareholders' meeting must be
given to each shareholder having voting rights or, in the case of a non-resident
shareholder, to his resident proxy or mailing address in Japan in accordance
with our share handling regulations, at least two weeks prior to the date of the
meeting.
Any shareholder or group of shareholders (after the 2001 Amendments
become effective, 300 voting rights or 1% of the total outstanding voting
rights) holding at least 300 units of shares, or 1% of the total outstanding
shares, for a continuous period of six months or longer may propose a matter for
consideration at a shareholders meeting by submitting a written request to the
board of directors at least six weeks before such meeting.
Voting Rights
A shareholder is generally entitled to one vote per share except in
those instances described in this paragraph and under "--Japanese Unit Share
System" above. In general, under the Commercial Code, a resolution can be
adopted at an ordinary meeting of shareholders by a majority of the shares
having voting rights represented at the meeting. The Commercial Code and our
articles of incorporation require a quorum for the election of directors and
statutory auditors of not less than one-third of the total number of outstanding
shares having voting rights. Our shareholders are not entitled to cumulative
voting in the election of directors. A corporate shareholder whose outstanding
shares are in turn more than one-quarter directly or indirectly owned by Trend
Micro does not have voting rights. Shareholders may exercise their voting rights
through proxies, provided that such proxies are also shareholders who have
voting rights.
The Commercial Code provides that a quorum of the majority of
outstanding shares with voting rights must be present at a shareholders' meeting
to approve any material corporate actions such as:
. amendment of the articles of incorporation;
. the removal of a director or statutory auditor;
. establishment of a 100% parent-subsidiary relationship by way of
share exchange or share transfer;
. a dissolution, merger or consolidation;
. a company split;
. the transfer of the whole or an important part of our business;
. the taking over of the whole of the business of any other
corporation; and
. any issuance of new shares at a "specially favorable" price (or any
issuance of convertible bonds or debentures with "specially
favorable" conversion conditions or of bonds or debentures with
warrants or rights to subscribe for new shares with "specially
favorable" conditions) to persons other than shareholders.
At least two-thirds of the shares having voting rights represented at
the meeting must approve such actions.
The voting rights of holders of ADSs are exercised by the depositary
based on instructions from such holders. An agent of the depositary is the
record holder of the underlying shares.
50
Subscription Rights
Holders of shares have no preemptive rights under our articles of
incorporation. Under the Commercial Code, the board of directors may, however,
determine that shareholders be given subscription rights in connection with a
particular issue of new shares. In this case, such rights must be given on
uniform terms to all shareholders as of a specified record date by at least two
weeks' prior public notice to shareholders of the record date. Public or
individual notice must be given to each of these shareholders at least two weeks
prior to the date of expiration of the subscription rights.
Rights to subscribe for new shares may be transferable or
nontransferable as determined by the board of directors. If subscription rights
are not transferable, a purported transfer by a shareholder who is not resident
in Japan will be enforceable against Trend Micro and third parties only with our
prior written consent.
Liquidation Rights
Upon a liquidation of Trend Micro, the assets remaining after payment of
all debts, liquidation expenses and taxes will be distributed among the
shareholders in proportion to the number of shares they own.
Liability to Further Calls or Assessments
All of our currently outstanding shares, including shares represented by
the ADSs, are fully paid and nonassessable.
Transfer Agent
The Toyo Trust and Banking Company, Limited is the transfer agent for
the Common Stock. Toyo Trust's office is located at 4-3, Marunouchi 1-chome,
Chiyoda-ku, Tokyo, 100-0005 Japan. Toyo Trust maintains our register of
shareholders and records transfers of record ownership upon presentation of
share certificates.
Repurchase by Trend Micro of Shares
In addition to repurchase of shares constituting less than one unit, our
articles of incorporation permit us to repurchase up to 4.8 million of our
shares. Pursuant to the Law concerning Exceptions to the Commercial Code
relating to Procedures for Cancellation of Shares (the "Special Cancellation
Law").
After the 2001 Amendments become effective, the Special Cancellation Law
will be abolished.
The 2001 Amendments will, in principle, permit us to acquire, hold or
dispose of our shares. After the 2001 Amendments become effective, we may
acquire our shares through the over-the-counter market on which the shares are
traded, through the Japanese stock exchange, if any, on which such shares are
listed, by way of tender offer (pursuant to an ordinary resolution of an
ordinary general meeting of shareholders), from a specific party (pursuant to a
special resolution of an ordinary general meeting of shareholders) or from our
subsidiary (pursuant to a resolution of the board of directors). When such
acquisition is made by us from a specific party other than our subsidiary, any
shareholder may make a request directly to a representative director, five days
prior to the relevant shareholders' meeting, that we acquire the shares held by
such shareholder. Any such acquisition of shares must satisfy certain
requirements, including that the total amount of the purchase price may not
exceed the amount of the retained earnings available for dividend payments and
the amount of any reduction of the stated capital, additional paid-in capital or
legal reserve (if such reduction of the stated capital, additional paid-in
capital or legal reserve has been authorized pursuant to a resolution of the
relevant general meeting of shareholders), minus the amount to be paid by way of
appropriation of retained earnings for the relevant fiscal year. However, if it
is anticipated that the net assets on the balance sheet as at the end of the
relevant fiscal year will be less than the aggregate amount of the stated
capital, additional paid-in capital, the accumulated legal reserve and other
certain items prescribed under the law, we may not purchase such shares. We may
hold the shares acquired in compliance with the provisions of the Commercial
Code (as amended by the 2001 Amendments), and generally, may dispose of or
cancel such shares by a resolution of the board of directors after 1 April 2002.
C. Material Contracts.
The information required by this item is set forth in Item 4.
Information on the Company of this annual report.
D. Exchange Controls.
The Foreign Exchange and Foreign Trade Law of Japan and the cabinet
orders and ministerial ordinances issued under the law govern the acquisition
and holding of shares of equity securities of Japanese corporations, including
Trend Micro, by exchange non-residents and by foreign investors.
Exchange non-residents are individuals who are not resident in Japan and
corporations whose principal offices are located outside Japan. Generally,
branches and other offices of non-resident corporations located within Japan are
regarded as exchange residents of Japan and branches and other offices of
Japanese corporations located outside Japan are regarded as exchange non-
residents of Japan.
51
Foreign investors are defined to be:
. individuals not resident in Japan;
. corporations which are organized under the laws of foreign countries
or whose principal offices are located outside Japan;
. corporations not less than 50% of the shares of which are held by
individuals or corporations described above; and
. a corporation in which a majority of the directors or similar persons
having the power of representation are non-resident individuals of
Japan.
On May 23, 1997 the Foreign Exchange and Foreign Trade Law was amended
with effect from April 1, 1998. In accordance with this amendment, with minor
exceptions, all aspects of the foreign exchange and foreign trade transactions
which under the previous law required licensing or other approval or prior
notification to the Minister of Finance of Japan now only require reporting of
such transactions after they occur. However, the Minister of Finance of Japan
retains the power to impose a licensing requirement for some transactions in
limited circumstances.
Offering of the Shares
A selling shareholder is required to file a report concerning the
transfer of securities with the Minister of Finance of Japan within 20 days of
the date of transfer.
Acquisition of Shares
Except as described below, there are no limits under Japanese law on the
right of foreign investors to hold or vote our securities. Exchange non-
residents who acquire from an exchange resident of Japan shares of a company,
listed on any Japanese stock exchange or whose shares are traded on the Japanese
over-the-counter market, are not required to file any notice prior to the
acquisition. Under the Foreign Exchange and Foreign Trade Law the Minister of
Finance may in some exceptional circumstances require prior approval for any
such acquisition. An exchange resident who transfers shares of a listed company
to an exchange non-resident for value exceeding (Yen)100 million must file a
report concerning the transfer of securities with the Minister of Finance within
20 days of the date of such transfer.
If a foreign investor acquires shares of a company listed on any
Japanese stock exchange or whose shares are traded on the Japanese
over-the-counter market and as a result of the acquisition, such foreign
investor and designated related parties hold 10% or more of the issued shares,
the foreign investor must file a report of the acquisition with the Minister of
Finance and other Ministers having jurisdiction over the business of the issuer
within 15 days from and including the date of the acquisition. In limited
circumstances, including the case of an acquisition of our shares that causes a
foreign investor's ownership to reach such percentage, however, a prior
notification of the acquisition must be filed with the Minister of Finance and
other Ministers having jurisdiction over the business of the issuer. These
Ministers may modify or prohibit the proposed acquisition.
Dividends and Proceeds of Sales
Under the Foreign Exchange and Foreign Trade Law, dividends paid on, and
the proceeds of sales in Japan of, shares held by exchange non-residents may, in
general, be converted into any foreign currency and repatriated abroad. The
requirements described in "--Acquisition of Shares" above do not apply to the
acquisition of shares by non-residents by way of stock splits.
American Depositary Shares
The formalities or restrictions referred to under "--Acquisition of
Shares" above do not apply to the deposit of shares by a non-resident of Japan,
the issuance of ADRs evidencing the ADSs created by such
52
deposit in exchange therefor and the withdrawal of whole units of underlying
shares upon surrender of ADRs.
Reporting of Substantial Shareholdings
The Securities and Exchange Law of Japan requires any person who has
becomes, beneficially and solely or jointly, a holder of more than 5% of the
total issued shares of a company listed on any Japanese stock exchange or whose
shares are traded on the Japanese over-the-counter market to file with the
Financial Services Agency within five business days a report concerning such
shareholding.
A similar report must also be made in respect of any subsequent change
of 1% or more in any such holding. For this purpose, shares issuable to such
person upon conversion of convertible securities or exercise of share
subscription warrants are taken into account in determining both the number of
shares held by the holder and the issuer's total issued share capital. Copies of
each such report must also be furnished to the issuer of such shares and all
Japanese stock exchanges on which the shares are listed or, in the case of
shares traded in the Japanese over-the-counter market, the Japan Securities
Dealers Association.
E. Taxation.
Japanese Taxation
In general, for Japanese tax purposes, owners of ADRs evidencing ADSs
will be treated as the owners of the shares represented by such ADSs, and no
Japanese tax will be payable on exchanges of shares for ADSs, and ADSs for
shares.
This discussion does not consider the effect of any state, local or
national tax laws other than Japanese tax laws that may be applicable to a
purchaser of shares or ADSs. Furthermore, the "Convention Between the United
States of America and Japan for the Avoidance of Double Taxation and the
Prevention of Fiscal Evasion with Respect to Taxes on Income" (the "Treaty"),
the laws, or administrative or judicial interpretation of the Treaty or the laws
may change, and the changes may have retroactive effect. We urge you to consult
your tax advisors regarding the Japanese and other tax consequences of owning
and disposing of shares and ADSs.
The following summary describes the principal Japanese tax consequences
relating to an investment in Trend Micro shares or ADSs. This summary applies
only to persons or entities which are non-residents of Japan and to non-Japanese
corporations without a permanent establishment in Japan to which the relevant
income is attributable.
Generally, Japanese withholding tax will apply to dividends paid by
Trend Micro to a non-resident of Japan or a non-Japanese corporation. In
general, no Japanese tax is payable on stock splits.
Under the Treaty, as currently in force, the maximum rate of Japanese
withholding tax which may be imposed on dividends paid to a United States
resident or corporation not having a "permanent establishment," which is
generally a fixed place of business for industrial or commercial activity, in
Japan is limited to:
(1) 15% of the gross amount actually distributed; or
(2) if the recipient is a corporation, 10% of the gross amount
actually distributed, if
(a) during the part of the paying corporation's taxable year
which precedes the date of payment of the dividend and
during the whole of its prior taxable year if any, at least
53
10% of the voting shares of the paying corporation were
owned by the recipient corporation, and
(b) not more than 25% of the gross income of the paying
corporation for such prior taxable year, if any, consists of
interest or dividends as defined in the treaty.
For purposes of the Treaty, and Japanese tax law, U.S. holders of ADRs
will be treated as the owners of the shares underlying the ADSs evidenced by the
ADRs.
In the absence of any applicable tax treaty, convention or agreement
reducing the maximum rate of withholding tax, the rate of Japanese withholding
tax applicable to dividends paid by Japanese corporations to a non-resident or
non-Japanese corporation is 20%. Japan has entered into income tax treaties,
conventions or agreements, whereby the 20% withholding tax rate is reduced
generally to 15% for portfolio investors. In addition to the United States,
countries with which Japan has concluded such treaties, conventions or
agreements include Australia, Belgium, Canada, Denmark, Finland, France,
Germany, Ireland, Italy, Luxembourg, The Netherlands, New Zealand, Norway,
Singapore, Spain, Sweden, Switzerland and the United Kingdom.
You must file an application for reduced withholding with the Japanese
tax authorities to claim the benefits of the reduced withholding rate on
dividends under the Treaty. The application must be filed on or before the day
before the dividend is paid. If you hold ADSs, two application forms must be
filed through the depositary, one form before the dividend payment and the other
within eight months after Trend Micro's fiscal year in which the dividend is
paid. To claim the reduced rate, you will need to file proof of:
. taxpayer status;
. residence; and
. beneficial ownership.
The depositary may also require you to provide other information. If you
do not submit an application for reduced withholding before a dividend is paid,
you may file a claim for refund of the excess tax with the Japanese tax
authorities.
You will not have to pay any Japanese tax on a sale of Trend Micro
shares or ADSs. If you make a gift of Trend Micro shares or die holding Trend
Micro shares, a person who receives the shares as a gift or inherits the shares
may have to pay Japanese gift or inheritance tax.
United States Federal Income Taxation
This section describes the material U.S. federal income taxation of the
ownership of shares or ADSs by U.S. Holders, as defined below. It applies to you
only if you hold your shares or ADSs as capital assets for tax purposes.
This section is based on the Internal Revenue Code of 1986, as amended
(the "Code"), its legislative history, existing and proposed regulations,
published rulings and court decisions, all as currently in effect, as well as on
the Treaty. These laws are subject to change, possibly on a retroactive basis.
In addition, this section is based in part upon the representations of the
Depositary and the assumption that each obligation in the Deposit Agreement and
any related agreement will be performed in accordance with its terms.
For purposes of the Treaty and the Code, U.S. holders of ADRs will be
treated as the owners of the Common Shares underlying the ADSs evidenced by the
ADRs. Exchanges of shares for ADSs, and ADSs for shares, generally will not be
subject to U.S. federal income tax. For purposes of this discussion, a "U.S.
holder" is a holder that (i) is a resident of the United States for purposes of
the Treaty, (ii) a citizen of the United States, (iii) does not maintain a
permanent establishment or fixed base in Japan to which shares or ADSs are
attributable and through which the beneficial owner carries on or has carried on
business (or in the
54
case of an individual, performs or has performed independent personal services)
and (iv) who is not otherwise ineligible for benefits under the Treaty with
respect to income and gain from the shares or ADSs.
This section does not apply to you if you are a member of a special
class of holders subject to special rules, including a dealer in securities, a
trader in securities that elects to use a mark-to-market method of accounting
for your securities holdings, a tax-exempt organization, a life insurance
company, a person liable for alternative minimum tax, a person that actually or
constructively owns 10% or more of the voting stock of Trend Micro, a person
that holds shares or ADSs as part of a straddle or a hedging or conversion
transaction, or a person whose functional currency is not the U.S. dollar.
This summary is not a comprehensive description of all the tax
considerations that may be relevant with respect to your shares or ADSs. You
should consult your own tax advisor regarding the U.S. federal, state and local
and other tax consequences of owning and disposing of shares and ADSs in your
particular circumstances.
U.S. Federal Tax Consequences of Options
The following summarizes only the U.S. federal income tax consequences
of the options granted under the U.S. program of the 1999 incentive plan. State
and local tax consequences may differ.
The grant of a nonqualified stock option under the U.S. program of the
1999 incentive plan will not result in any federal income tax consequences to
the optionee, to Trend Micro or to Trend U.S. Upon exercise of a nonqualified
stock option, the optionee is subject to income taxes at the rate applicable to
ordinary compensation income on the difference between the option price and the
fair market value of the shares on the date of exercise. This income is subject
to withholding for federal and state income and employment tax purposes, and
Trend U.S. may withhold such amounts from other compensation of the optionee, or
may require the optionee to pay to Trend U.S. an amount sufficient to satisfy
the withholding obligation. At the time an option is exercised, Trend U.S. is
entitled to an income tax deduction in the amount of the income recognized by
the optionee.
Any gain or loss on the optionee's subsequent disposition of the shares
will be taxable as short-term or long-term capital gain or loss, depending on
whether the shares are held for more than one year following exercise. The
maximum marginal rate at which long-term capital gains are taxed is 20%
generally. Trend U.S. does not receive an income tax deduction for any such gain
recognized by the shareholder.
Taxation of Dividends.
Under the U.S. federal income tax laws, and subject to the passive
foreign investment company ("PFIC") rules discussed below, if you are a U.S.
holder, you must include in your gross income the gross amount of any dividend
paid by Trend Micro out of its current or accumulated earnings and profits (as
determined for U.S. federal income tax purposes). You must include any Japanese
tax withheld from the dividend payment in this gross amount even though you do
not in fact receive it. The dividend is ordinary income that you must include in
income when you, in the case of shares, or the Depository, in the case of ADSs,
receive the dividend, actually or constructively. The dividend will not be
eligible for the dividends-received deduction generally allowed to U.S.
corporations in respect of dividends received from other U.S. corporations. The
amount of the dividend distribution that you must include in your income as a
U.S. holder will be the U.S. dollar value of the Japanese yen payments made,
determined at the spot Japanese yen/U.S. dollar rate on the date the dividend
distribution, regardless of whether the payment is in fact converted into U.S.
dollars. Generally, any gain or loss resulting from currency exchange
fluctuations during the period from the date you include the dividend payment in
income to the date you convert the payment into U.S. dollars will be treated as
ordinary income or loss. The gain or loss generally will be income or loss from
sources within the U.S. for foreign tax credit limitation purposes.
Distributions in excess of current and accumulated earnings and profits, as
determined for U.S. federal income tax purposes, will be treated as a
non-taxable return of capital to the extent of your basis in the shares or ADSs
and thereafter as capital gain.
55
Subject to certain limitations, the Japanese tax withheld in accordance
with the Treaty and paid over to Japan will be creditable against your United
States federal income tax liability. To the extent a refund of the tax withheld
is available to you under Japanese law or under the Treaty, the amount of tax
withheld that is refundable will not be eligible for credit against your United
States federal income tax liability. Please see "Japanese Taxation," above, for
the procedures for obtaining a reduced rate of withholding under a treaty or a
tax refund.
Dividends will be income from sources outside the United States, but
generally will be "passive income" or "financial services income" which is
treated separately from other types of income for purposes of computing the
foreign tax credit allowable to you.
Distributions of additional shares to you with respect to shares or ADSs
that are made as part of a pro rata distribution to all shareholders of Trend
Micro generally will not be subject to United States federal income tax.
Taxation of Capital Gains
Subject to the PFIC rules discussed below, if you are a U.S. holder and
you sell or otherwise dispose of your shares or ADSs, you will recognize capital
gain or loss for U.S. federal income tax purposes equal to the difference
between the U.S. dollar value of the amount that you realize and your tax basis,
determined in U.S. dollars, in your shares or ADSs. Capital gain of a
noncorporate U.S. holder is generally taxed at a maximum rate of 20% where the
property is held more than one year, and 18% where the property is held for more
than five years. The gain or loss will generally be income or loss from sources
within the U.S. for foreign tax credit limitation purposes.
PFIC Rules
We believe that shares and ADSs should not be treated as shares of a
PFIC for U.S. federal income tax purposes, but this conclusion is a factual
determination that is made annually and thus may be subject to change. If we
were to be treated as a PFIC, unless a U.S. holder elects to be taxed annually
on a mark-to-market basis with respect to the shares or ADSs, gain realized on
the sale or other disposition of your shares or ADSs would in general not be
treated as capital gain. Instead, if you are a U.S. Holder, you would be treated
as if you had realized such gain and certain "excess distributions" ratably over
your holding period for the shares or ADSs and would be taxed at the highest tax
rate in effect for each such year to which the gain was allocated, together with
an interest charge in respect of the tax attributable to each such year.
F. Dividends and Paying Agents.
Not applicable
G. Statements by Experts.
Not applicable
H. Documents on Display.
Our 20-F, 6-K reports and other filings with the SEC can be inspected
and copied without charge at the SEC's public reference room at 450 Fifth
Street, N.W., Washington, D.C. 20549 and at the SEC's regional offices located
at 7 World Trade Center, Suite 1300, New York, New York 10048 and 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. You may also get copies by
calling the SEC at 1-800-SEC-0330 or by writing the SEC upon payment of a
prescribed fee.
In addition, documents referred to in this 20-F filing may be inspected
at our Tokyo headquarters, located at Odakyu Southern Tower, 10F, 2-1, Yoyogi
2-Chome, Shibuya-ku, Tokyo 151-8583, Japan.
56
I. Subsidiary Information.
Not applicable
Item 11. Quantitative and Qualitative Disclosures About Market Risk.
As discussed in Note 19 to the consolidated financial statements, we
have a policy of not utilizing any derivative financial instruments with
off-balance sheet risk. The financial instruments other than derivatives as of
December 31, 2000 were cash and cash equivalents including money market funds,
marketable debt and equity securities, accounts receivable and payable and
short-term borrowings. Among these financial instruments, we do not have
significant market sensitive instruments with significant exposure to market
risk. When we acquired IpTrend we acquired two derivative instruments which
IpTrend held. We cannot currently dispose of those instruments. However, this
has not altered our policy of not utilizing derivative financial statements and
we believe that neither the fair value of those instruments nor potential future
losses in connection with those instruments has or will have a material impact
on our financial condition.
Item 12. Description of Securities Other than Equity Securities.
Not applicable
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies.
None
Item 14. Material Modifications to the Rights of Security Holders and Use of
Proceeds
E. Use of Proceeds
Not applicable.
Item 15. [Reserved]
None
Item 16. [Reserved]
None
PART III
Item 17. Financial Statements.
Not applicable
Item 18. Financial Statements.
The information required by this item has been provided on page F-2.
57
Item 19. Exhibits.
(b) Exhibits
Exhibit Sequentially
Number Document Numbered Page
=============== ================================================================ ====================
1.1 Articles of Incorporation of Trend Micro (English translation)
1.2 Share Handling Regulations of Trend Micro (English translation)
1.3 Regulations of the Board of Directors of Trend Micro (English
translation)
1.4 Regulations of the Board of Statutory Auditors of Trend Micro
(English translation)
2.1 Specimen Common Stock Certificates
2.2** Form of Deposit Agreement among Trend Micro, The Bank of New
York as depositary and all owners and holders from time to
time of American Depositary Receipts, including the form of
American Depositary Receipt.
4.1*+ Basic Agreement on Continual Sale and Purchase of Goods dated
October 1, 1999, between Trend Micro Incorporated and SOFTBANK
COMMERCE CORP., and related agreements
4.2* Agreements relating to Acquisition of Nippon Unisoft Corporation
8.1* Subsidiaries of Trend Micro
___________________________
* Incorporated by reference to the corresponding exhibit to Trend Micro's
Amendment No. 2 to the Form F-1 Registration Statement (File No. 333-
10568) filed on May 22, 2000.
** Incorporated by reference to the corresponding exhibit to Trend Micro's
Amendment No. 1 to Registration Statement on Form F-6 (File No. 333-10492)
filed on June 22, 2001.
+ Confidential treatment granted for a portion of these documents.
58
SIGNATURE
Pursuant to the requirements of Section 12 of the Securities Exchange
Act of 1934, the registrant certifies that it meets all of the requirements for
filing on Form 20-F and has duly caused this annual report to be signed on its
behalf by the undersigned, thereunto duly authorized.
TREND MICRO INCORPORATED
By: /s/ Steve Ming-Jang Chang
------------------------------------------
Name: Steve Ming-Jang Chang
Title: Representative Director;
President, Chief Executive Officer
and Chairman of the Board
(Principal Executive Officer)
Date: June 29, 2001
59
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of independent accountants........................................................... F-2
Consolidated balance sheets at December 31, 1999 and 2000................................... F-3
Consolidated statements of income for the years
ended December 31, 1998, 1999 and 2000...................................................... F-5
Consolidated statements of comprehensive income for the years
ended December 31, 1998, 1999 and 2000...................................................... F-6
Consolidated statements of shareholders' equity for the years
ended December 31, 1998, 1999 and 2000...................................................... F-7
Consolidated statements of cash flows for the years
ended December 31, 1998, 1999 and 2000...................................................... F-10
Notes to consolidated financial statements.................................................. F-11
Financial statement schedule for the years
ended December 31, 1998, 1999 and 2000:
Schedule II - Valuation and qualifying accounts............................................. F-41
All other schedules are omitted because they are not applicable or the required
information is shown in the financial statements or the notes thereto.
Financial statements of majority - owned subsidiaries of Trend Micro not
consolidated and of 50% or less owned persons accounted for by the equity method
have been omitted because Trend Micro's proportionate share of the income from
continuing operations before income taxes, and the total assets of each such
company is less than 20% of the respective consolidated amounts, and the
investment in and advances to each company is less than 20% of consolidated
total assets.
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
---------------------------------
To the Shareholders and Board of Directors of
Trend Micro Kabushiki Kaisha
("Trend Micro Incorporated"):
In our opinion, the consolidated financial statements and financial statement
schedule listed in the accompanying index present fairly, in all material
respects, the financial position of Trend Micro Incorporated and its
consolidated subsidiaries at December 31, 1999 and 2000, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 2000, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PricewaterhouseCoopers
PricewaterhouseCoopers
Tokyo, Japan
June 7, 2001
F-2
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Thousands of
Thousands of yen U.S. dollars
------------------------------- --------------
December 31 December 31,
--------------------------------
1999 2000 2000
--------------- --------------- --------------
ASSETS
Current assets:
Cash and cash equivalents.......................................... (Yen)15,648,881 (Yen)24,435,503 $ 212,483
Marketable securities.............................................. 624,328 1,893,475 16,465
Notes and accounts receivable, trade - less
allowance for doubtful accounts and sales returns of (Yen) 382,973
and (Yen) 646,566 ($5,622)....................................... 5,674,199 8,133,700 70,728
Inventories........................................................ 64,036 318,188 2,767
Deferred income taxes.............................................. 922,061 2,687,913 23,373
Prepaid expenses and other current assets.......................... 771,577 607,142 5,279
--------------- --------------- -------------
Total current assets..................................... 23,705,082 38,075,921 331,095
--------------- --------------- -------------
Investments and other assets:
Securities investments............................................. 3,078,406 1,335,849 11,616
Investment in and advances to affiliate company.................... 70,144 182,473 1,587
Goodwill and intangibles .......................................... 440,252 2,740,827 23,833
Deferred income taxes.............................................. 276,609 446,004 3,878
Other.............................................................. 461,125 570,742 4,963
--------------- --------------- -------------
4,326,536 5,275,895 45,877
--------------- --------------- -------------
Property and equipment:
Office furniture and equipment..................................... 998,126 1,536,444 13,360
Other properties................................................... 222,094 443,102 3,853
--------------- --------------- -------------
1,220,220 1,979,546 17,213
Less: Accumulated depreciation.................................... (470,435) (756,898) (6,581)
--------------- --------------- -------------
749,785 1,222,648 10,632
--------------- --------------- -------------
(Yen)28,781,403 (Yen)44,574,464 $ 387,604
=============== =============== =============
The accompanying notes are an integral part of these statements.
F-3
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Thousands of U.S.
Thousands of yen dollars
------------------------------------ -----------------
December 31 December 31,
---------------------------------
1999 2000 2000
--------------- --------------- -----------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ............................ (Yen) - (Yen) 57,200 $ 497
Notes payable, trade ......................................... 137,803 132,499 1,152
Accounts payable, trade ...................................... 578,332 796,782 6,929
Accounts payable, other ...................................... 633,806 517,247 4,498
Withholding income taxes ..................................... 119,791 120,994 1,052
Accrued expenses ............................................. 343,243 615,850 5,355
Accrued income and other taxes ............................... 981,899 2,014,589 17,518
Deferred revenue ............................................. 2,185,659 5,043,425 43,856
Other ........................................................ 139,326 415,372 3,612
--------------- --------------- -----------------
Total current liabilities ......................... 5,119,859 9,713,958 84,469
--------------- --------------- -----------------
Long-term liabilities:
Long term debt ............................................... 6,000,000 9,799,900 85,217
Deferred revenue ............................................. 226,365 548,225 4,767
Accrued pension and severance costs .......................... 125,246 168,032 1,461
--------------- --------------- -----------------
6,351,611 10,516,157 91,445
--------------- --------------- -----------------
Shareholders' equity:
Common stock
Authorized
- 1999 83,000,000 shares ((Yen)50 par value)
- 2000 250,00,000 shares ((Yen)50 par value)
Issued and outstanding
- 1999 129,685,800 shares .................................. 5,414,660
- 2000 131,120,842 shares .................................. 6,183,266 53,768
Additional paid-in capital ................................... 9,198,712 11,631,591 101,144
Legal reserve ................................................ 149,991 149,991 1,304
Deferred compensation ........................................ (101,528) - -
Retained earnings ............................................ 3,082,302 6,745,769 58,659
Accumulated other comprehensive income -
Net unrealized gain (loss) on debt and equity securities.... 215,922 (168,277) (1,463)
Cumulative translation adjustments ......................... (632,988) (169,616) (1,475)
--------------- --------------- -----------------
(417,066) (337,893) (2,938)
--------------- --------------- -----------------
Treasury stock, at cost (1999 - 1,750 shares; 2000
- 5,262 shares) ............................................ (17,138) (28,375) (247)
--------------- --------------- -----------------
17,309,933 24,344,349 211,690
--------------- --------------- -----------------
Commitments and contingent liabilities ......................... - - -
--------------- --------------- -----------------
Total liabilities and shareholders' equity ........ (Yen)28,781,403 (Yen)44,574,464 $ 387,604
=============== =============== =================
The accompany notes are an integral part of these statements.
F-4
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Thousands of
Thousands of yen U.S. dollars
-------------------------------------------------------- -----------------
For the year
For the year ended ended
December 31 December 31,
--------------------------------------------------------
1998 1999 2000 2000
------------------ ------------------ ----------------- -----------------
Net sales ....................................... (Yen)9,745,664 (Yen)13,633,170 (Yen)20,070,366 $174,525
Cost of sales ................................... 559,530 481,574 1,474,689 12,823
-------------- --------------- --------------- --------
Gross profit ................................. 9,186,134 13,151,596 18,595,677 161,702
-------------- --------------- --------------- --------
Operating expenses:
Selling ...................................... 2,525,802 3,453,296 5,445,167 47,349
Research and development ..................... 960,156 994,340 2,043,480 17,769
General and administrative ................... 4,086,894 4,772,038 5,579,947 48,522
-------------- --------------- --------------- --------
7,572,852 9,219,674 13,068,594 113,640
-------------- --------------- --------------- --------
Operating income ............................. 1,613,282 3,931,922 5,527,083 48,062
-------------- --------------- --------------- --------
Other income (expenses):
Interest income .............................. 44,620 148,487 241,133 2,097
Interest expense ............................. (29,279) (66,526) (220,960) (1,921)
Gain on sales of marketable securities ....... 146,310 280,532 119,650 1,040
Foreign exchange gain (loss), net ............ (70,934) (174,921) 283,305 2,464
Other income (expense), net .................. (6,133) (120,298) 941,500 8,186
-------------- --------------- --------------- --------
84,584 67,274 1,364,628 11,866
-------------- --------------- --------------- --------
Income before income taxes, minority interest and
equity in loss of affiliated companies ....... 1,697,866 3,999,196 6,891,711 59,928
-------------- --------------- --------------- --------
Income taxes:
Current ...................................... 1,641,902 2,538,455 4,701,426 40,882
Deferred ..................................... (347,151) (688,988) (1,578,889) (13,729)
-------------- --------------- --------------- --------
1,294,751 1,849,467 3,122,537 27,153
-------------- --------------- --------------- --------
Income before minority interest and equity in
losses of affiliated companies ............... 403,115 2,149,729 3,769,174 32,775
-------------- --------------- --------------- --------
Minority interest in income of a consolidated
subsidiary ................................... - - 6,845 59
-------------- --------------- --------------- --------
Income from consolidated companies .............. 403,115 2,149,729 3,762,329 32,716
Equity in losses of affiliated companies ........ - 2,356 87,672 762
-------------- --------------- --------------- --------
Net income ...................................... (Yen)403,115 (Yen)2,147,373 (Yen)3,674,657 $31,954
============== =============== =============== ========
Yen Yen Yen U.S. dollars
------------------ ------------------ ----------------- -----------------
Per share data:
Net income - basic........................... (Yen)3.54 (Yen)16.90 (Yen)28.18 $0.25
- diluted......................... 3.46 16.42 27.53 0.24
Cash dividends................................ -- 1.67 -- --
The accompanying notes are an integral part of these statements.
F-5
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Thousands of U.S.
Thousands of yen dollars
------------------------------------------------- -----------------
For the year
For the year ended ended
December 31 December 31,
--------------------------------------------------
1998 1999 2000 2000
------------ -------------- -------------- -----------------
Net income....................................... (Yen)403,115 (Yen)2,147,373 (Yen)3,674,657 $31,954
------------ -------------- -------------- -----------------
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on debt and equity
securities:
Unrealized holding gains (losses) arising
during period................................ 366,657 168,711 (560,025) (4,870)
Less reclassification adjustment for gains
included in net income....................... (35,340) (204,017) (119,649) (1,040)
------------ -------------- -------------- -----------------
331,317 (35,306) (679,674) (5,910)
Foreign currency translation adjustments........ (138,397) (354,466) 463,372 4,029
------------ -------------- -------------- -----------------
Other comprehensive income, before tax........... 192,920 (389,772) (216,302) (1,881)
Income tax expense related to items of other
comprehensive income............................ (154,092) 16,630 295,475 2,569
------------ -------------- -------------- -----------------
Other comprehensive income, net of tax........... 38,828 (373,142) 79,173 688
------------ -------------- -------------- -----------------
Comprehensive income............................. (Yen)441,943 (Yen)1,774,231 (Yen)3,753,830 $32,642
============ ============== ============== =================
The accompanying notes are an integral part of these statements.
F-6
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Thousands of U.S.
Thousands of yen dollars
------------------------------------------------------ -----------------
For the year ended December 31 December 31,
------------------------------------------------------
1998 1999 2000 2000
-------------- -------------- -------------- -----------------
Common stock:
Balance at beginning of year............ (Yen) 900,000 (Yen)5,081,714 (Yen)5,414,660 $ 47,084
New share offering...................... 4,038,078 - - -
Exercise of stock purchase warrants..... 143,636 332,946 768,606 6,684
-------------- -------------- -------------- -----------------
Balance at end of year.................. 5,081,714 5,414,660 6,183,266 53,768
-------------- -------------- -------------- -----------------
Additional paid-in capital:
Balance at beginning of year............ 465,150 7,735,744 9,198,712 79,989
New share offering...................... 6,175,578 - - -
Deferred compensation related to
stock warrants.......................... 878,798 - - -
Tax benefit from exercise of
non-qualified stock warrants........... 70,048 1,048,435 1,702,289 14,802
Gain (loss) on sales of treasury
stock, net of tax...................... - 76,187 (39,013) (339)
Exercise of stock purchase warrants..... 146,170 338,346 769,603 6,692
-------------- -------------- -------------- -----------------
Balance at end of year.................. 7,735,744 9,198,712 11,631,591 101,144
-------------- -------------- -------------- -----------------
Legal reserve:
Balance at beginning of year............ - 129,157 149,991 1,304
Transfers from retained earnings........ 129,157 20,834 - -
-------------- -------------- -------------- -----------------
Balance at end of year.................. 129,157 149,991 149,991 1,304
-------------- -------------- -------------- -----------------
Deferred compensation:
Balance at beginning of year............ - (481,331) (101,528) (883)
Deferred compensation related to
stock warrants......................... (878,798) - - -
Amortization of deferred
compensation related
to stock warrants...................... 397,467 379,803 101,528 883
-------------- -------------- -------------- -----------------
Balance at end of year.................. (481,331) (101,528) - -
-------------- -------------- -------------- -----------------
Retained earnings:
Balance at beginning of year............ 962,810 1,164,100 3,082,302 26,802
Net income.............................. 403,115 2,147,373 3,674,657 31,954
Stock issue costs, net of tax........... (56,907) - (11,190) (97)
Transfers to legal reserve.............. (129,157) (20,834) - -
Cash Dividends.......................... - (208,337) - -
Loss on sales of treasury stock, net
of tax................................. (15,761) - - -
-------------- -------------- -------------- -----------------
Balance at end of year.................. 1,164,100 3,082,302 6,745,769 58,659
-------------- -------------- -------------- -----------------
Net unrealized gain (loss) on debt
and equity securities:
Balance at beginning of year............ 57,373 234,598 215,922 1,878
Net change during the year.............. 177,225 (18,676) (384,199) (3,341)
-------------- -------------- -------------- -----------------
Balance at end of year.................. 234,598 215,922 (168,277) (1,463)
-------------- -------------- -------------- -----------------
The accompanying notes are an integral part of these statements.
F-7
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Cumulative translation adjustments:
Balance at beginning of year......... (140,125) (278,522) (632,988) (5,504)
Aggregate translation adjustments
for the year........................ (138,397) (354,466) 463,372 4,029
---------------- ---------------- --------------- ---------------
Balance at end of year............... (278,522) (632,988) (169,616) (1,475)
---------------- ---------------- --------------- ---------------
Treasury stock, at cost:
Balance at beginning of year......... - (12,880) (17,138) (149)
Purchases of treasury stock.......... (183,269) (1,260,011) (1,573,609) (13,684)
Sales of treasury stock.............. 170,389 1,255,753 1,562,372 13,586
---------------- ---------------- --------------- ---------------
Balance at end of year............... (12,880) (17,138) (28,375) (247)
---------------- ---------------- --------------- ---------------
Total shareholders' equity....... (Yen)13,572,580 (Yen)17,309,933 (Yen)24,344,349 $211,690
================ ================ =============== ===============
The accompanying notes are an integral part of these statements.
F-8
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Thousands of
Thousands of yen U.S. dollars
-------------------------------------------------- ------------------
For the year ended For the year
December 31 ended
-------------------------------------------------- December 31,
1998 1999 2000 2000
--------------- --------------- --------------- --------------
Cash flows from operating activities:
Net income................................................ (Yen)403,115 (Yen)2,147,373 (Yen)3,674,657 $ 31,954
Adjustments to reconcile net income to net cash
provided by operating activities -
Amortization of deferred compensation related to
stock warrants......................................... 397,467 379,803 101,528 883
Depreciation and amortization........................... 265,857 428,238 1,014,281 8,820
Pension and severance costs, less payments.............. 41,541 58,579 40,361 351
Loss on disposal of fixed assets........................ 11,009 1,192 5,571 48
Deferred income taxes................................... (347,151) (688,988) (1,578,889) (13,729)
Gain on sales of marketable securities.................. (146,310) (280,532) (119,650) (1,040)
Minority interest in income of a consolidated
subsidiary............................................. - - 6,845 59
Equity in losses of affiliated companies................ - 2,356 87,672 762
Changes in assets and liabilities:
Increase in deferred revenue........................... 760,031 1,123,053 2,975,760 25,876
Increase in accounts receivable,
net of allowances.................................... (2,066,603) (1,945,194) (1,849,641) (16,084)
(Increase) decrease in inventories..................... 2,750 (541) (234,841) (2,042)
Increase (decrease) in notes and
accounts payable trade............................... 57,960 377,869 51,234 445
Increase (decrease) in accrued income and other taxes.. (326,889) 273,696 1,141,049 9,922
(Increase) decrease in other current assets............ (13,613) (370,227) 425,223 3,698
Increase (decrease) in other current liabilities....... 672,749 (42,540) (133,267) (1,159)
(Increase) decrease in other assets.................... (249,949) 23,729 - -
Other................................................... (72,479) - 477,940 4,156
--------------- --------------- --------------- --------------
Net cash provided by (used in)
operating activities.............................. (610,515) 1,487,866 6,085,833 52,920
--------------- --------------- --------------- --------------
Cash flows from investing activities:
Payments for purchases of fixed assets.................... (440,304) (620,218) (876,964) (7,626)
Payments for acquisitions of software..................... (190,464) (185,455) (488,577) (4,248)
Proceeds from sales of marketable securities.............. 321,011 2,388,480 239,486 2,082
Proceeds from maturities of marketable securities......... - 1,101,846 100,000 870
Payments for purchases of marketable securities and....... (1,200,826) (5,264,042) (407,012) (3,539)
security investments...................................
Acquisition, net of cash acquired......................... - - (2,508,248) (21,811)
Investments in affiliated companies....................... - (72,500) (200,000) (1,739)
Other..................................................... 59,850 92 - -
--------------- --------------- --------------- --------------
Net cash used in investing activities............... (Yen)(1,450,733) (Yen)(2,651,797) (Yen)(4,141,315) ($36,011)
--------------- --------------- --------------- --------------
The accompanying notes are an integral part of these statements.
F-9
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Thousands of
Thousands of yen U.S. dollars
---------------------------------------------------- --------------
For the year
For the year ended ended
December 31 December 31,
----------------------------------------------------
1998 1999 2000 2000
---------------------------------------------------- --------------
Cash flows from financing activities:
Issuance of common stock pursuant to
new share offering, net of issuance costs............... (Yen)10,156,171 (Yen) - (Yen) - $ -
Issuance of common stock pursuant to exercise of stock
warrants................................................ 287,514 671,292 1,527,019 13,278
Tax benefit from exercise of non-qualified stock warrants. 70,048 1,048,435 1,702,289 14,803
Proceeds from issuance of bonds........................... 609,615 6,000,000 5,000,000 43,478
Redemption of bonds....................................... (609,615) - (1,300,000) (11,304)
Decrease in short-term borrowings......................... - - (226,000) (1,965)
Decrease in long-term borrowings.......................... - - (127,685) (1,110)
Purchase of / proceeds from sales of treasury stock, net.. (76,145) (70,600) (78,617) (684)
Dividends paid............................................ - (208,337) - -
Other..................................................... (28,641) 141,415 (1,426) (13)
--------------- --------------- --------------- ----------
Net cash provided by financing activities.................. 10,408,947 7,582,205 6,495,580 56,483
--------------- --------------- --------------- ----------
Effect of exchange rate changes on cash and cash
equivalents............................................... (95,391) (165,870) 346,524 3,013
--------------- --------------- --------------- ----------
Net increase in cash and cash equivalents.................. 8,252,308 6,252,404 8,786,622 76,405
Cash and cash equivalents at beginning of year............. 1,144,169 9,396,477 15,648,881 136,078
--------------- --------------- --------------- ----------
Cash and cash equivalents at end of year................... (Yen)9,396,477 (Yen)15,648,881 (Yen)24,435,503 $212,483
=============== =============== =============== ==========
The accompanying notes are an integral part of these statements.
F-10
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of operations
Trend Micro Incorporated (the "parent company") and its subsidiaries
(collectively "the Company") are primarily engaged in the development,
production and sale of anti-virus software and providing management solutions
for corporate computer systems. The Company develops its software in Japan,
Taiwan, the United States, and Germany, and its products are marketed by sales
subsidiaries throughout the world.
In February 2000, the parent company expanded into a new business field
through a new corporation ipTrend Incorporated (Tokyo Chuo-ku) (formerly Nihon
Unisoft Incorporated) for the purpose of making inroads into UNIX-based
operating systems, and Internet platform technology, especially into Linux
systems. Trend Micro Group has allotted a major part into this new business.
2. Summary of significant accounting policies
The parent company and its subsidiaries in Japan maintain their records and
prepare their financial statements in accordance with accounting principles
generally accepted in Japan, and its foreign subsidiaries maintain their records
and prepare their financial statements in conformity with accounting principles
generally accepted in the respective countries of their domicile. Certain
adjustments and reclassifications, including those relating to the tax effects
of temporary differences, valuation of debt and equity securities and revenue on
post-contract support, have been incorporated in the accompanying consolidated
financial statements to conform with accounting principles generally accepted in
the United States of America ("U.S. GAAP"). These adjustments were not recorded
in the statutory books of account.
The preparation of financial statements in conformity with U.S. GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
Significant accounting policies are as follows:
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.
The accompanying notes are an integral part of these statements.
F-11
The excess of the cost over the underlying net equity of investments in
consolidated subsidiaries and affiliated companies accounted for on an equity
basis is allocated to identifiable assets acquired and liabilities assumed based
on fair values at the date of the acquisition. The unassigned residual value of
the excess of the cost over the underlying net equity is recognized as goodwill
and is amortized on the straight-line basis over a 5-year period except for
minor items which are charged to income immediately. Goodwill at December 31,
1998 and 1999 was not significant.
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 accumulated as a separate component of shareholders' equity.
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
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements". The adoption of SAB101 did not have a material effect on the
Company's financial position or result of operations.
The Company recognizes revenue from product licenses upon delivery of
software when no significant vendor obligations remain and collection of the
receivable, net of allowances for doubtful accounts and sales returns, is
probable. The Company estimates and recognizes allowances for doubtful accounts
and sales returns at the time the related sale is recognized and treats them as
revenue reductions. The portion of the license fee attributable to post-
contract support is deferred and recognized as revenue over the license
agreement term. Royalty revenues are recognized as earned unless collection of
the related receivables is not assured. When collection is not assured,
revenues are recognized when payments are received.
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
Marketable securities consist of debt and equity securities. Debt and
equity securities designated as available-for-sale are carried at fair value
with unrealized gains or losses included as a component of shareholders' equity,
net of applicable taxes. Debt securities designated as held-to-maturity are
carried at amortized cost. 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.
The accompanying notes are an integral part of these statements.
F-12
Inventories
Finished products and raw materials are valued at the lower of weighted
average cost or net realizable value.
Property and equipment
Property and equipment are stated at cost. 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 from 3 to 5 years for office furniture and equipment, and from 4 to
24 for other properties.
Goodwill and intangibles
Goodwill recognized on an acquisition accounted for as a purchase is being
amortized on a straight-line basis over a 5-year period.
Intangibles, which mainly consist of software development costs and
purchased software rights, are amortized on a straight-line basis principally
over a twelve-month period for software development costs and a five-year period
for purchased software rights and other intangibles.
The Company evaluates the amortization period of goodwill and intangibles
on an ongoing basis in light of any changes in business conditions, events or
circumstances that may indicate potential impairment of those assets.
Long-lived assets
The Company evaluates long-lived assets, certain identifiable intangibles
and goodwill related to those assets to be held and used whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. When the sum of expected future cash flows (undiscounted and
without interest charges) is less than the carrying amount of the asset, an
impairment loss is recognized, based on the fair value of the asset. The fair
value of the asset is determined using discounted cash flows analysis.
Goodwill not identified with assets that are subject to an impairment loss
is evaluated using the discounted cash flow method.
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
The accompanying notes are an integral part of these statements.
F-13
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.
Stock-based compensation
The Company accounts for its stock-based incentive awards in accordance
with the intrinsic value method as per Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees." The Company complies with the
disclosure provisions of Statement of Financial Accounting Standards No. 123
("SFAS No. 123"), "Accounting for Stock-Based Compensation".
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 liabilities and assets for
the expected future tax consequences of temporary differences between the
carrying amounts and the tax bases of assets and liabilities. Valuation
allowances are recorded to reduce deferred tax assets when it is more likely
than not that a tax benefit will not be realized.
Derivative financial 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 do not employ any derivative financial
instruments with the exception of ipTrend Incorporated which was acquired during
the year ended December 31, 2000.
ipTrend Incorporated (Tokyo Chuo-ku) has entered into an interest rate swap
arrangement and a cap arrangement to manage its exposure to interest rate
movements by effectively converting a portion of its debt from fixed to variable
rates. Subsequent to the acquisition, ipTrend Incorporated (Tokyo Chuo-ku)
repaid the underlying hedged debt without settling the interest rate swap and
cap arrangements. Those arrangements which did not qualify for hedge accounting
were marked to market.
Net income per share
Basic EPS is computed based on the average number of shares of common stock
outstanding for the period. Diluted EPS 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 may make a free distribution of common stock to
its shareholders which is accounted for either by a transfer of the applicable
par value from
The accompanying notes are an integral part of these statements.
F-14
additional paid-in capital to the common stock account or with no entry if free
shares are distributed from the portion of previously issued shares accounted
for as excess of par value in the common stock account. 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 Generally Accepted Accounting Principles 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 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 money market funds and marketable securities and places its
investments with high quality financial institutions. The Company performs
ongoing credit evaluations of its customers' financial condition and maintains
an allowance for uncollectible accounts receivable, if any, based upon the
expected collectibility of accounts receivable.
Recent pronouncements
Derivative instruments and hedging activities
---------------------------------------------
From the fiscal year beginning January 1, 2001, The Company adopted FAS 133
"Accounting for Derivative Instruments and Hedging Activities" as amended by FAS
No. 138 "Accounting for Certain Derivative Instruments and Certain Hedging
Activities - an Amendment of FASB statement No. 133". FAS No. 133, as amended,
establishes accounting and reporting standards for derivative instruments.
Specifically, FAS No. 133 requires an entity to recognize all derivatives as
either assets or liabilities in the balance sheet and to measure those
instruments at fair value. Additionally, the fair value adjustments will affect
either stockholders' equity or net income depending on whether the derivative
instrument qualifies as a
The accompanying notes are an integral part of these statements.
F-15
hedge for accounting purposes and, if so, the nature of the hedging activity.
The adoption of FAS 133 did not have an effect on the Company's financial
position or results of operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the 2000
presentation.
3. U.S. dollar amounts
U.S. dollar amounts presented in the financial statements are included
solely for the convenience of the reader. These translations should not be
construed as representations that the yen amounts actually represent, or have
been or could be converted into U.S. dollars. As the amounts shown in U.S.
dollars are for convenience only, the approximate current rate at December 31,
2000 ((Yen)115.00 = U.S. $1) has been used for the purpose of presentation of
the U.S. dollar amounts in the accompanying consolidated financial statements.
4. Acquisitions
On February 29, 2000, the Company acquired 66.7% of the outstanding shares
of Nihon Unisoft Incorporated (subsequently renamed ipTrend Incorporated (Tokyo
Chuo-ku) for (Yen)1,600,000 thousand ($13,913 thousand) in cash through ipTrend
Incorporated (Tokyo Shibuya-ku), a wholly-owned subsidiary of the Company
established on January 18, 2000. On November 19, 2000, the Company acquired the
remaining shares of ipTrend Incorporated (Tokyo Chuo-ku) for (Yen)1,200,000
thousand ($10,435 thousand) in cash and thereby completed the acquisition.
ipTrend Incorporated (Tokyo Chuo-ku) has been a Japanese Unix software solution
provider in the networking communications and Internet domain since November 1,
1983. The purpose of the acquisition was to develop internet-based technology
and to expand sales of the products and services using that technology. This
acquisition was accounted for as a purchase and, accordingly, the consolidated
statements of income include the results of operations of ipTrend Incorporated
(Tokyo Chuo-ku) from February 29, 2000. The purchase price of (Yen)2,800,000
thousand ($24,348 thousand) was allocated to assets acquired of (Yen)3,441,254
thousand and liabilities assumed of (Yen)641,254 thousand ($5,576 thousand),
including goodwill of (Yen)2,527,636 thousand ($21,979 thousand) to be amortized
over 5 years on a straight-line basis.
Pro forma information reflecting this acquisition is not included as the
impact of this acquisition is not material.
The accompanying notes are an integral part of these statements.
F-16
5. Reconciliation of the difference between basic and diluted net income per
share ("EPS")
Reconciliation of the differences between basic and diluted EPS for the
years ended December 31, 1998, 1999 and 2000, is as follows:
Thousands Thousands
of yen of shares Yen
--------------- ----------------- ----------------
Weighted-
Net average
income shares EPS
--------------- ----------------- ----------------
For the year ended December 31, 1998
------------------------------------
Basic EPS:
Net income available to common stock holders... (Yen)403,115 113,946 (Yen)3.54
--------------- ----------------- ----------------
Effect of dilutive securities:
Shares issuable from assumed exercise of
stock warrants................................ - 2,538
--------------- -----------------
Diluted EPS:
Net income for computation..................... (Yen)403,115 116,484 (Yen)3.46
================ ================== ================
Thousands Thousands
of yen of shares Yen
------------------ ------------------ ---------------
Weighted-
Net average
income shares EPS
------------------ ------------------ ---------------
For the year ended December 31, 1999
------------------------------------
Basic EPS:
Net income available to common stock holders... (Yen)2,147,373 127,100 (Yen)16.90
--------------- ----------------- ----------------
Effect of dilutive securities:
Shares issuable from assumed exercise of
stock warrants................................ - 3,653
--------------- -----------------
Diluted EPS:
Net income for computation..................... (Yen)2,147,373 130,753 (Yen)16.42
================ ================== ================
Thousands Thousands
of yen of shares Yen Dollars
------------------ ------------------ --------------- ------------
Weighted-
Net average
income shares EPS EPS
------------------ ------------------ --------------- ------------
For the year ended December 31, 2000
------------------------------------
Basic EPS:
Net income available to common stock holders... (Yen)3,674,657 130,389 (Yen)28.18 $0.25
--------------- ----------------- ---------------- ------------
Effect of dilutive securities:
Shares issuable from assumed exercise of stock
warrants...................................... - 3,066
--------------- -----------------
Diluted EPS:
Net income for computation..................... (Yen)3,674,657 133,455 (Yen)27.53 $0.24
================ ================== ================ ============
The accompanying notes are an integral part of these statements.
F-17
6. Cash and cash equivalents
Cash and cash equivalents as of December 31, 1999 and 2000 comprised:
Thousands of
Thousands of yen U.S. dollars
------------------------------------------- ------------------
December 31 December 31,
-------------------------------------------
1999 2000 2000
------------------- -------------------- ------------------
Cash....................................... (Yen) 4,308,566 (Yen)14,388,599 $125,119
Time deposits.............................. 11,340,284 10,046,873 87,364
Money market funds......................... 31 31 0
------------------- -------------------- -------------------
(Yen)15,648,881 (Yen)24,435,503 $212,483
=================== ==================== ===================
7. Supplemental cash flow information
Cash payments for income taxes were (Yen)1,690,391 thousand, (Yen)2,247,816
thousand and (Yen)1,827,638 thousand ($15,893 thousand) for the years ended
December 31, 1998, 1999 and 2000, respectively; in these respective periods,
interest payments were (Yen)17,147 thousand, (Yen)2,417 thousand and
(Yen)217,922 thousand ($1,895 thousand).
The accompanying notes are an integral part of these statements.
F-18
8. Marketable securities
Cash equivalents, marketable securities and securities investments include
money market funds, 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, 1999 and 2000, were as
follows:
Thousands of yen
------------------------------------------------------------------------------------------
December 31, 1999
------------------------------------------------------------------------------------------
Gross unrealized
------------------------------------------
Cost Gains Losses Fair value
-------------------- ------------------- ------------------ --------------------
Available for sale:
Money market funds............. (Yen) 31 (Yen) - (Yen) - (Yen) 31
Mutual funds................... 960,806 - - 960,806
Equity securities.............. 529,076 412,392 - 941,468
Debt securities................ 1,800,000 460 - 1,800,460
-------------------- ------------------- ------------------ --------------------
Total....................... (Yen)3,289,913 (Yen)412,852 (Yen) - (Yen)3,702,765
==================== =================== ================== ====================
Thousands of yen
------------------------------------------------------------------------------------------
December 31, 2000
------------------------------------------------------------------------------------------
Gross unrealized
------------------------------------------
Cost Gains Losses Fair value
-------------------- ------------------- ------------------ --------------------
Available for sale:
Money market funds............. (Yen) 31 (Yen) - (Yen) - (Yen) 31
Mutual funds................... 970,802 - 32,747 938,055
Equity securities.............. 825,344 - 245,124 580,220
Debt securities................ 1,700,000 11,050 - 1,711,050
-------------------- ------------------- ------------------ --------------------
Total....................... (Yen)3,496,177 (Yen)11,050 (Yen)277,871 (Yen)3,229,356
==================== =================== ================== ====================
Thousands of U.S. dollars
----------------------------------------------------------------------------------------
December 31, 2000
----------------------------------------------------------------------------------------
Gross unrealized
-----------------------------------------
Cost Gains Losses Fair value
------------------ ------------------ ------------------ --------------------
Available for sale:
Money market funds............. $ 0 $ - $ - $ 0
Mutual funds................... 8,442 - 285 8,157
Equity securities.............. 7,177 - 2,132 5,045
Debt securities................ 14,783 96 - 14,879
------------------ ------------------ ------------------ --------------------
Total....................... $30,402 $ 96 $2,417 $28,081
================== ================== ================== ====================
The fair value of money market funds and mutual funds approximate to cost
due to the short-term maturities of the investments.
The accompanying notes are an integral part of these statements.
F-19
The cost and fair value of "available-for sale" debt securities by
contractual maturity at December 31, 2000, were as follows.:
Thousands of yen Thousands of U.S. dollars
------------------------------------------ --------------------------------------------
Available-for sale Available-for sale
------------------------------------------ --------------------------------------------
Cost Fair value Cost Fair value
-------------------- ------------------ ------------------- ---------------------
Due within one year.......... (Yen) - (Yen) - $ - $ -
Due after one year........... 1,700,000 1,711,050 14,783 14,879
-------------------- ------------------ ------------------- ---------------------
(Yen)1,700,000 (Yen)1,711,050 $14,783 $14,879
==================== ================== =================== =====================
The debt securities were issued by SOFTBANK, a related party of the
Company.
The net unrealized gain on "available-for-sale" securities included in the
separate component of shareholders' equity, net of applicable taxes, increased
by (Yen)177,225 thousand in the year ended December 31, 1998 and decreased by
(Yen)18,676 thousand and (Yen)384,199 thousand ($3,341 thousand) in the years
ended December 31, 1999 and 2000, respectively.
Proceeds from sales of "available-for-sale" securities for the years ended
December 31, 1998 , 1999 and 2000 were (Yen)321,011 thousand, (Yen)2,388,480
thousand and (Yen)239,486 thousand ($2,082 thousand), respectively. Gross
realized gains on sales of "available-for-sale" securities for the year ended
December 31, 1998, 1999 and 2000 were (Yen)146,310 thousand, (Yen)280,532
thousand, and (Yen)119,650 thousand ($ 1,040 thousand) respectively.
9. Inventories
Inventories as at December 31, 1999 and 2000 were (Yen)64,036 thousand and
(Yen)318,188 thousand ($2,767 thousand), respectively, and mainly consisted of
finished products and manuals.
10. Investments in affiliated companies
The investees accounted for using the equity method are NTT Data Security
Corporation (20.0%) ,SOFT TREND CAPITAL CORPORATION (20.0%) and JCN CO
Ltd. (24.4%) at December 31, 2000, and NTT Data Security Corporation and
SOFT TREND CAPITAL CORPORATION at December 31, 1999.
Summarized financial information of the affiliated companies accounted for
using the equity method is shown below:
Thousands of yen Thousands of yen Thousands of
U.S. dollars
-------------------- -------------------- ------------------
December 31, December 31, December 31,
1999 2000 2000
-------------------- -------------------- ------------------
Current assets..................... (Yen)1,778,451 (Yen)2,081,103 $18,097
Non-current assets including
property, plant and equipment..... 967,329 1,129,182 9,819
-------------------- -------------------- ------------------
Total assets..................... (Yen)2,745,780 (Yen)3,210,285 $27,916
==================== ==================== ==================
Current liabilities................ (Yen)2,395,058 (Yen)2,702,376 $23,499
Shareholders' equity............... 350,722 507,909 4,417
-------------------- -------------------- ------------------
The accompanying notes are an integral part of these statements.
F-20
Total liabilities and
shareholders' equity............ (Yen)2,745,780 (Yen)3,210,285 $27,916
============== ============== ============
Thousands of Thousands of Thousands of
yen yen U.S. dollars
------------ ------------ ------------
For the year For the year For the year
ended ended ended
December 31, December 31, December 31,
1999 2000 2000
------------ ------------ ------------
Sales.............................. (Yen)553,500 (Yen)1,624,782 $14,129
============ ============== ============
Net loss........................... (Yen) 11,778 (Yen) 318,966 $ 2,774
============ ============== ============
A summary of transactions and balances with the affiliated companies accounted
for using the equity method is presented below:
Thousands of Thousands of Thousands of
yen yen U.S. dollars
------------ ------------ ------------
For the year For the year For the year
ended ended ended
December 31, December 31, December 31,
1999 2000 2000
------------ ------------ ------------
Sales (Yen) - (Yen)196,517 1,709
============ ============ ============
Purchases (Yen)960,806 (Yen) - $ -
============ ============ ============
The accompanying notes are an integral part of these statements
F-21
Thousands of Thousands of Thousands of
yen yen U.S dollars
--------------- --------------- -------------
December 31, December 31, December 31,
1999 2000 2000
--------------- --------------- ------------
Notes and accounts receivable, trade....... (Yen) - (Yen)182,347 $1,586
============ ============ ============
Other receivables.......................... (Yen) 4,731 (Yen) - $ -
============ ============ ============
11. Goodwill and intangibles
Intangibles comprise the following:
Thousands of
Thousands of yen U.S. dollars
---------------------------------- ------------
December 31 December 31,
----------------------------------
1999 2000 2000
-------------- ----------------- ------------
Goodwill (Yen) - (Yen)2,527,637 $21,979
Software development costs................. 504,029 468,456 4,074
Purchased software rights.................. 144,093 144,093 1,253
Other...................................... 137,331 231,412 2,012
------------- -------------- ------------
785,453 3,371,598 29,318
Less - Accumulated amortization............ (345,201) (630,771) (5,485)
------------- -------------- ------------
(Yen) 440,252 (Yen)2,740,827 $23,833
============= ============== ============
12. Research and development 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. Such research and development costs charged to income were
(Yen)960,156 thousand, (Yen)994,340 thousand and (Yen)2,043,480 thousand
($17,769 thousand) for the years ended December 31, 1998, 1999 and 2000,
respectively.
Software development costs relating to the local language related functions
(representing software development costs as shown in Note 10 above) after
netting the related accumulated amortization, are capitalized and amortized to
cost of sales as follows:
Thousands of
Thousands of yen U.S. dollars
------------------------------------------------------ ------------
Year ended
Year ended December 31 December 31,
------------------------------------------------------
1998 1999 2000 2000
-------------- ---------------- ---------------- ------------
Software development costs, net of
accumulated amortization:
Balance at beginning of year....... (Yen)107,699 (Yen)250,734 (Yen)304,897 $ 2,651
Additions, at cost................. 190,464 185,455 488,577 4,249
Amortization for the year.......... (47,429) (131,292) (448,181) (3,897)
------------ ------------ ------------ ------------
Balance at end of year............. (Yen)250,734 (Yen)304,897 (Yen)345,293 $ 3,003
============ ============ ============ ============
The accompanying notes are an integral part of these statements.
F-22
13. Transactions with related parties
Transactions with SOFTBANK
Stock Sale
In December 1996, SOFTBANK purchased 37,800,000 shares of common stock of
the Company from the Company's founders for approximately (Yen)92.5 per share,
or an aggregate of (Yen)3.5 billion. At the time of the sale, the shares sold
represented 35% of the Company's outstanding shares. Pursuant to a price
adjustment provision in the stock sale/purchase agreement, SOFTBANK paid an
additional (Yen)5 billion at the time of the Company's initial public offering
in Japan, which occurred in August 1998. SOFTBANK sold 6,000,000 shares to an
unaffiliated third party in September 1998 and, through Softbank America, Inc.,
a wholly-owned subsidiary of SOFTBANK, owned 31,800,000 shares, representing
approximately a 25% equity interest in the Company as of December 31, 1998.
In July 1999, Softbank America, Inc. sold 25,500,000 shares to an
unaffiliated third party and owned 6,300,000shares, representing approximately a
4.9% equity ownership interest in the Company as of December 31, 1999.
In March 2000, Softbank America, Inc. sold the remaining 6,300,000 shares,
and consequently, SOFTBANK and its affiliates do not have equity ownership
interest in the Company at December 31, 2000
Distribution
Based on two distribution agreements between the Company and SOFTBANK,
SOFTBANK was granted a non-exclusive right to distribute all of the Company's
anti-virus software products in Japan. Individual sales of products to SOFTBANK
under the agreements have been effected on a purchase-order basis.
Purchase of bonds
Between October 1998 and December 1998, the Company purchased in the public
market an aggregate of 12,000,000 units of 2.3% yen bonds issued by SOFTBANK for
a total purchase price of (Yen)1,200,826 thousand. 11,000,000 units were
redeemed on October 18, 1999 and remaining 1,000,000 units were redeemed on
October 18, 2000. In March 1999, the Company purchased in the public market an
aggregate of 17,000,000 units of 3% yen bonds due March 24, 2003 issued by
SOFTBANK for (Yen)1,700,000 thousand ($14,783 thousand).
Investment
In December 1999, the Company invested (Yen)12.5 million in SoftTrend
Capital Corporation in which majority of equity ownership interests were
indirectly held by SOFTBANK. At December 31, 2000, the Company has a 20% equity
ownership interest in SoftTrend Capital Corporation. The investment was
accounted for using the equity method.
Account balances and transactions with SOFTBANK and its affiliated company
are as follows:
The accompanying notes are an integral part of these statements.
F-23
Thousands of yen Thousands of
------------------------------------------------
December 31 U.S. dollars
------------------------------------------------ ------------
December 31,
1998 1999 2000 2000
-------------- -------------- -------------- ------------
Accounts receivable, trade...................... (Yen) 847,431 (Yen) 852,004 (Yen)1,072,768 $ 9,328
Securities investments.......................... 1,200,826 1,800,000 1,700,000 14,783
Accounts payable, other......................... 38,338 18,943 16,435 143
Sales for the year.............................. 2,386,654 2,453,538 3,507,641 30,501
Purchases and expenses for the year............. - - 69,104 601
Interest income on security investments 1,437 82,608 53,113 462
The Company believes that each of these transactions was negotiated on an
arm's length basis on terms no less favorable to it than would have been
available from third parties.
The Company made rebate payments to SOFTBANK amounting to (Yen)22,600
thousand, (Yen)97,758 thousand and (Yen) 71,545 thousand ($622 thousand) for the
years ended December 31, 1998, 1999 and 2000, respectively. These rebate
amounts were determined based on SOFTBANK's achievement of sales targets as per
the distribution agreements. The rebate payments were recorded as deductions
from sales revenue on an accrual basis.
14. Short-term borrowings and long-term debt
At December 31, 2000, the Company had unused lines of credit amounting to
(Yen)800,000 thousand relating to bank overdraft and other short-term loan
agreements. Under these overdraft agreements, the Company is authorized to
obtain short-term financing at prevailing interest rates for periods not in
excess of one year.
Long-term debt comprises the following:
Thousands of yen Thousands of
--------------------------------
December 31 U.S. dollars
-------------------------------- --------------
December 31,
1999 2000 2000
-------------- -------------- --------------
Unsecured bank loan of a consolidated
subsidiary due 2001 with a weighted
average interest rate of 2.175% per
annum..................................... (Yen) - (Yen) 57,200 $ 497
Unsecured bank loan of a consolidated
subsidiary due 2003 with a weighted
average interest rate of 2.175% per
annum..................................... - 99,900 869
Unsecured 2.5% bonds, due 2002 with
detachable warrants....................... 6,000,000 4,700,000 40,870
Unsecured 2.1% bonds, due 2003 with
detachable warrants....................... - 5,000,000 43,478
-------------- -------------- --------------
6,000,000 9,857,100 85,714
Less - portion due within one year......... - 57,200 497
-------------- -------------- --------------
(Yen)6,000,000 (Yen)9,799,900 $85,217
============== ============== ==============
The accompanying notes are an integral part of these statements.
F-24
Aggregate amounts of annual maturities of long-term debt during the next
five years are as follows:
Year ending Dollars in
December 31 Yen in thousands thousands
---------------- ------------------ --------------
2001 (Yen)57,200 $ 497
2002 4,757,200 41,367
2003 5,042,700 43,850
2004 - -
2005 - -
The accompanying notes are an integral part of these statements.
F-25
15. Stock warrants
Based on the Company's 1998, 1999 and 2000 incentive plans, the Company
issued the following bonds with detachable warrants to SOFTBANK or the public.
1. Shareholders' meeting /
board meeting approval.......... September 29, 1997 March 28, 1998 May 29, 1998 June 30, 1999 June 1, 2000
2. Date of bond issuance........... October 17, 1997 April 15, 1998 June 15, 1998 July 29, 1999 June 26, 2000
3. Maturity date................... October 17, 2001 April 15, 2002 June 17, 2002 July 29, 2002 June 26, 2003
4. Amount of each bond
(Thousands of yen).............. (Yen)908,523 (Yen)412,965 (Yen)196,650 (Yen)6,000,000 (Yen)5,000,000
5. Issued to....................... SOFTBANK SOFTBANK SOFTBANK Public Public
5. Date on which the bonds were
fully redeemed.................. October 17, 1997 April 15, 1998 June 15, 1998 - -
6. Exercise price per
each warrant.................... (Yen)142.5 (Yen)142.5 (Yen)142.5 (Yen)3,200 (Yen)7,850
7. Warrant exercise period......... October 27, 1997 April 27, 1998 June 25, 1998 August 20, 1999 July 21, 2000
to October 12, to April 5, to June 7, to July 22, to June 19,
2001 2002 2002 2002 2003
8. Number of shares represented
by warrants..................... 6,375,600 2,898,000 1,380,000 1,875,000 636,942
9. Outstanding as of
December 31, 1998............... 4,638,000 2,058,600 1,194,600 - -
10. Outstanding as of
December 31, 1999............... 1,454,400 1,029,600 813,600 1,875,000 -
11. Outstanding as of
December 31, 2000............... 940,200 682,200 597,000 1,439,494 636,942
Upon issuance of each 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 SOFTBANK or
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, 1997............................ 6,376
Granted.................................................... 4,278
Exercised.................................................. (2,014)
Redeemed................................................... (749)
-------------
Outstanding at December 31, 1998............................ 7,891
Granted.................................................... 1,875
Exercised.................................................. (4,672)
Redeemed................................................... --
-------------
Outstanding at December 31, 1999............................ 5,094
Granted.................................................... 637
Exercised.................................................. (1,435)
Redeemed................................................... --
-------------
Outstanding at December 31, 2000............................ 4,296
=============
The accompanying notes are an integral part of these statements.
F-26
Balances are as follows:
Thousands of shares
-------------------------------
December 31
-------------------------------
1999 2000
------------ ------------
Authorized and outstanding.............. 5,094 4,296
Exercisable............................. 2,616 2,958
For the above stock warrants granted on April 15, 1998 and June 15, 1998,
management calculated deferred compensation expenses of (Yen)878,798 thousand
during fiscal 1998. Such deferred compensation will be amortized over the
vesting period which is generally 24 months. Approximately (Yen)397,467
thousand, (Yen)379,803 thousand and (Yen)101,528 ($ 883 thousand) was amortized
during fiscal 1998, 1999 and 2000 respectively. The grants of October 17, 1997,
July 29, 1999 and June 26, 2000,with respect to which the vesting period is
generally 24 months, did not result in deferred compensation.
In July 1999, the subsidiary in the United States introduced the U.S.
program of the Company's incentive plan. Under the U.S. program, STG Incentive
Company L.L.C., a Delaware limited company organized for the program by three
principal shareholders of the Company, grants stock options to purchase shares
of the Company's common stock, which vest one year from the date of grant and
which are exercisable for the 3 years subsequent to the vesting date, to
directors and certain employees of the subsidiary in the United States. The
grants of options to the directors and employees were accounted for under APB
25. Option activity under the U.S. program for the year ended December 31, 1999
and 2000 was as follows:
Thousands of shares
represented by options
---------------------------------
Granted..................................... 1,620
Exercised................................... --
Redeemed.................................... --
-------------
Outstanding at December 31, 1999.............. 1,620
Granted..................................... --
Exercised................................... (113)
Redeemed.................................... --
-------------
Outstanding at December 31, 2000.............. 1,507
=============
The exercise price per share for the options granted was determined as
equivalent to the fair market value of the Company's shares at the time of the
grants. The weighted average exercise price per share for the option granted
for the year ended December 31, 1999 was (Yen)3,067. Consequently, the grants of
the option did not result in deferred compensation.
Certain pro forma disclosures
In October 1995, SFAS 123 established a fair value based method of
accounting for employee stock based compensation. Had compensation cost for the
Company's stock warrants
The accompanying notes are an integral part of these statements.
F-27
and the stock options under the U.S. program 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:
Year ended December 31
----------------------------------------------------------------------------------
1998 1999 2000 2000
---------------- ------------------ ------------------ ------------------
(in thousands, except per share data)
Net income:
As reported....................... (Yen) 403,115 (Yen) 2,147,373 (Yen)3,674,657 $31,954
Pro forma net income.............. 147,610 1,698,432 2,829,475 24,604
Net income per share:
As reported -
Basic........................... (Yen) 3.54 (Yen) 16.90 (Yen) 28.18 $ 0.25
Diluted......................... 3.46 16.42 27.53 0.24
Pro forma net income -
Basic........................... (Yen) 1.30 (Yen) 13.36 (Yen) 21.70 $ 0.19
Diluted......................... 1.27 12.99 21.20 0.18
The fair value of each warrant grant was estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants during the years ended December 31, 1998, 1999 and
2000; expected life of two years, volatility of 88.6% and dividend yield of 0.0%
for 1998, expected life of three years, volatility of 25.8% and dividend yield
of 0.0% for 1999; expected life of three years, volatility of 17.030% and
dividend yield of 0.0% for 2000 and risk-free interest rates ranging from 1.235%
to 1.765% for options granted during the years ended December 31,1998, and the
rate of 0.75% for options granted during the year ended December 31, 1999, and
the rate of 0.741% for options granted during the year ended December 31, 2000.
The weighted average fair value per share of options granted above during fiscal
1998, 1999 and 2000 were (Yen)279, (Yen) 474 and (Yen) 1,005 ($9), respectively.
16. 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.
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 whose service exceeds 15 years or more and who are 55 years
or older 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.
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.
The accompanying notes are an integral part of these statements.
F-28
Information regarding the defined benefit pension plans for the Company and
its consolidated subsidiaries is shown below:
Thousands of
Thousands of yen U.S. dollars
------------------------------------------------- --------------
December 31 December 31,
-------------------------------------------------
1998 1999 2000 2000
------------- ------------- ------------- --------------
Change in benefit obligation:
Benefit obligation at beginning of year............... (Yen) 38,230 (Yen) 130,173 (Yen) 174,184 $1,515
Service cost.......................................... 48,190 62,451 66,643 579
Interest cost......................................... 2,659 4,978 6,659 58
Amendments............................................ 27,309 - - -
Actuarial (gain)/loss................................. 21,035 (16,136) 9,259 81
Benefits paid......................................... (7,250) (1,077) (4,100) (36)
Foreign currency exchange impact...................... - (6,205) (949) (8)
------------- ------------- ------------- --------------
Projected benefit obligation at end of year....... 130,173 174,184 251,696 2,189
------------- ------------- ------------- --------------
Change in plan assets:
Fair value of plan assets at beginning of year........ - (6,771) (13,063) (114)
Actual return on plan assets.......................... (33) (678) (1,304) (11)
Benefits paid......................................... - 1,077 4,100 36
Employer contribution................................. (6,738) (11,342) (19,303) (168)
Foreign currency exchange impact...................... - 4,651 288 2
------------- ------------- ------------- --------------
Fair value of plan assets at end of year.......... (6,771) (13,063) (29,282) (255)
------------- ------------- ------------- --------------
Funded status
Unrecognized prior service cost........................ (26,361) (24,802) (23,213) (202)
Unrecognized net actuarial loss........................ (20,372) (6,313) (27,521) (239)
Unrecognized net transition obligation................. (5,872) (4,760) (3,648) (32)
------------- ------------- ------------- --------------
Accrued benefit cost................................... (Yen) 70,797 (Yen) 125,246 (Yen) 168,032 $1,461
============= ============= ============= ==============
Thousands of yen
-------------------------------------------------
December 31
-------------------------------------------------
1998 1999 2000
------------- ------------- -------------
Weighted-average assumptions as of December 31:
Discount rate......................................... 4.60% 4.50% 4.20%
Expected return on plan assets........................ 7.00% 6.50% 6.50%
Rate of compensation increase......................... 4.00% 5.25% 5.02%
Thousands of
Thousands of yen U.S. dollars
------------------------------------------------- --------------
December 31 December 31,
-------------------------------------------------
1998 1999 2000 2000
------------- ------------- ------------- --------------
Components of net periodic benefit cost:
Service cost.......................................... (Yen) 48,190 (Yen) 62,451 (Yen) 66,643 $ 579
Interest cost......................................... 2,659 4,978 6,659 58
Expected return on plan assets........................ (162) (808) (1,419) (12)
Amortization of unrecognized transition obligation.... 1,112 1,112 1,112 10
Amortization of prior service cost.................... 948 1,130 (153) (1)
Recognized actuarial loss............................. - 697 1,107 9
The accompanying notes are an integral part of these statements.
F-29
--------------- -------------- --------------- -------------
Net periodic pension cost............................. (Yen)52,747 (Yen)69,560 (Yen)73,949 $643
=============== ============== =============== =============
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.
Under the Japanese Commercial Code and local practice, the Company may
make severance payments to a retired director or statutory auditor with
shareholder approval, if the Company's management proposes such payments based
on a resolution of the Board of Directors. However, the Company has no intention
to make such a proposal. The Company does have an internal formula to determine
the amounts of severance payments to directors and statutory auditors if the
Company were to make such a proposal for statutory auditors. The Company has not
recorded any liabilities relating to severance payments to directors or
statutory auditors as of December 31, 1999 and 2000 since the Company has no
liabilities to directors, and related liabilities to statutory auditors are
insignificant.
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.
17. Income taxes
Income before income taxes and provision for income taxes comprise the
following:
Thousands of
Thousands of yen U.S. dollars
-------------------------------------------------------------------------
Year ended December 31 Year ended
------------------------------------------------------ December 31,
1998 1999 2000 2000
--------------- ---------------- ---------------- ---------------
Income before income taxes:
Domestic.................. (Yen) 934,475 (Yen)2,541,761 (Yen)2,485,562 $ 21,614
Foreign subsidiaries...... 763,391 1,457,435 4,406,149 38,314
--------------- ---------------- ---------------- -------------
(Yen)1,697,866 (Yen)3,999,196 (Yen)6,891,711 $ 59,928
=============== ================ ================ =============
Income taxes, current:
Domestic.................. (Yen)1,276,505 (Yen)1,245,851 (Yen)2,156,067 $ 18,748
Foreign subsidiaries...... 365,397 1,292,604 2,545,359 22,134
--------------- ---------------- ---------------- -------------
(Yen)1,641,902 (Yen)2,538,455 (Yen)4,701,426 $ 40,882
=============== ================ ================ =============
Income taxes, deferred:
Domestic.................. (Yen)(360,324) (Yen)(34,536) (Yen)(963,777) $ (8,380)
Foreign subsidiaries...... 13,173 (654,452) (615,112) (5,349)
--------------- ---------------- ---------------- ------------
(Yen)(347,151) (Yen)(688,988) (Yen)(1,578,889) $(13,729)
=============== =============== ================ ============
The accompanying notes are an integral part of these statements.
F-30
The Company is subject to a number of different income taxes which, in
aggregate, indicate a statutory tax rate in Japan of approximately 51.4% for the
year ended December 31, 1998, approximately 47.7% for the year ended December
31, 1999 and approximately 42.1% for the year ended December 31, 2000.
Amendments to Japanese tax regulations were enacted into law on March 31, 1998
and on March 24, 1999. As a result of these amendments, the statutory tax rate
was reduced from approximately 51.4% to 47.7% effective from the Company's
fiscal year beginning January 1, 1999 and from approximately 47.7% to 42.1%
effective from the Company's fiscal year beginning January 1, 2000.
The accompanying notes are an integral part of these statements.
F-31
Reconciliation of the differences between the statutory tax rate and
the effective income tax rate is as follows:
December 31
--------------------------------------------------
1998 1999 2000
-------------- ------------- -----------
Statutory tax rate: 51.4% 47.7% 42.1%
Increase (reduction) in rate resulting from -
Different tax rates applied to
foreign subsidiaries..................... (1.4) (3.5) (3.6)
Effect of change in normal
statutory tax rate in Japan............. - 2.3 -
State income taxes, net of federal tax..... - (1.1) 1.8
Permanent difference....................... 4.5 2.5 0.8
Amortization of deferred compensation
related to stock warrants................ 10.1 2.6 0.6
Current tax on undistributed earnings...... 5.1 - -
Change in deferred tax valuation 10.3 (4.9) 1.5
allowance................................
Tax credit relating to research and
development costs........................ (8.4) (1.4) (0.5)
Operating loss of subsidiaries............. 3.6 - -
Goodwill amortization - - 1.7
Other...................................... 1.1 2.0 0.9
Effective income tax rate........................ 76.3% 46.2% 45.3%
The significant components of defered income tax assets and liabilities
at December 31, 1999 and 2000 were as follows:
Thousands of
Thousands of yen U.S. dollars
------------------------------------- -----------------
December 31
------------------------------------- December 31,
1999 2000 2000
----------------- ----------------- -----------------
Deferred tax assets:
Deferred revenue................................... (Yen)831,759 (Yen)1,998,724 $17,380
Allowance for doubtful accounts and sales returns.. 134,971 280,568 2,440
Accrued enterprise tax............................. 42,370 112,694 980
Accrued liabilities................................ 76,150 107,626 936
Intercompany profit................................ 52,932 - -
Tax loss carry forward............................. 126,731 236,689 2,058
Unrealized loss on debt and equity securities...... - 103,075 896
Other.............................................. 118,033 415,823 3,616
--------------- -------------- -------------
Gross deferred tax assets....................... 1,382,946 3,255,199 28,306
Less: Valuation allowance...................... (10,465) (116,630) (1,014)
--------------- -------------- -------------
1,372,481 3,138,569 27,292
--------------- -------------- -------------
Deferred tax liabilities
Unrealized gain on debt and equity securities...... (173,811) (4,652) (41)
--------------- -------------- -------------
(173,811) (4,652) (41)
--------------- -------------- -------------
Net deferred tax assets............................... (Yen)1,198,670 (Yen)3,133,917 $27,251
=============== ============== =============
The accompanying notes are an integral part of these statements.
F-32
Net deferred tax assets are included in the consolidated balance sheets
as follows:
Thousands of
Thousands of yen U.S. dollars
-------------------------------- ------------
December 31 December 31
--------------------------------
1999 2000 2000
-------------- -------------- ------------
Current assets-Deferred income taxes................ (Yen) 922,061 (Yen)2,687,913 $23,373
Other assets-Deferred income taxes.................. 276,609 446,004 3,878
-------------- -------------- ------------
Net deferred tax assets............................. (Yen)1,198,670 (Yen)3,133,917 $27,251
============== ============== ============
The valuation allowance mainly relates to deferred tax assets of
consolidated subsidiaries with operating loss carry forwards for tax purposes
that are not expected to be realized. The net changes in the total valuation
allowance for the years ended December 31, 1998, 1999 and 2000 were an increase
of (Yen)163,003 thousand, a decrease of (Yen)201,586 thousand and an increase of
(Yen)106,165 ($ 923 thousand), respectively.
Operating loss carryforwards for tax purposes of consolidated
subsidiaries at December 31, 2000 amounted to approximately (Yen)806,889
thousand ($7,016 thousand) and are available as an offset against future taxable
income of the subsidiary. These carryforwards expire at various dates up to
December 31, 2005. Realization is dependent on these subsidiaries generating
sufficient taxable income prior to expiration of the loss carryforwards.
Although realization is not assured, management believes it is more likely than
not that all of the deferred tax assets, less the valuation allowance, will be
realized. The amount of such net deferred tax assets considered realizable,
however, could change in the near term if estimates of future taxable income
during the carry forward period change.
At December 31, 2000, no deferred income taxes have been provided on
undistributed earnings of foreign subsidiaries not expected to be remitted in
the foreseeable future totaling (Yen)3,625,188 thousand ($31,523 thousand), as
management of the Company intends to reinvest undistributed earnings of the
Company's foreign subsidiaries. The unrecognized deferred tax liabilities as of
December 31, 2000 for such temporary differences amounted to (Yen)732,598
thousand ($6,370 thousand).
18. Shareholders' equity
Changes in the number of shares of common stock outstanding have
resulted from the following:
For the year ended
December 31
-----------------------------------------------
1998 1999 2000
----------- ----------- -----------
Shares of common stock outstanding:
Balance at beginning of year................ 108,000,000 125,013,600 129,685,800
New share offering.......................... 15,000,000 - -
Exercise of stock purchase warrants......... 2,013,600 4,672,200 1,435,042
----------- ----------- -----------
Balance at end of year...................... 125,013,600 129,685,800 131,120,842
=========== =========== ===========
The accompanying notes are an integral part of these statements.
F-33
As approved at an ordinary meeting of shareholders on March 28, 1998, each share
of the Company's (Yen)500 par value common stock was split into 10 shares of par
value (Yen)50 common stock. Also approved, the authorized number of shares was
increased from 7.2 million shares to 72 million shares.
As approved at an ordinary meeting of shareholders on March 11, 1999, the
authorized number of shares was increased from 72 million shares to 83 million
shares.
As approved at an ordinary meeting of shareholders on March 23, 2000,
the authorized number of shares was increased from 83 million shares to 250
million shares.
On August 19, 1999, the board of directors of the Company decided and
declared a stock split in the ratio of three-for-one for which the record date
was September 30, 1999. All share and per share data in the consolidated
financial statements have been adjusted to give effect to the stock splits made
on March 28, 1998 and September 30, 1999.
Effective from August 18, 1998, the common stock of the Company was
registered for trading in the Japanese Over-the-Counter Market. Upon
registration, 15,000,000 shares were issued based on resolutions of the Board of
Directors on July 28, 1998. As a result, the common stock account and the paid-
in capital account of the Company increased by (Yen)4,038,078 thousand and
(Yen)6,175,578 thousand, respectively.
Effective from August 17, 2000, the common stock of the Company was
listed in the First Section on the Tokyo Stock Exchange and registration in the
Japanese Over-the-Counter Market terminated at the same time.
Upon exercise of stock warrants, 2,013,600 shares of common stock at an
exercise price of (Yen)142.5 per share were issued and the common stock account
and the additional paid-in capital account of the Company increased by
(Yen)143,636 thousand and (Yen)146,170 thousand, respectively, in the year ended
1998.
Upon exercise of stock warrants, 4,672,200 shares of common stock at an
exercise price of (Yen)142.5 per share were issued and the common stock account
and the additional paid-in capital account of the Company increased by
(Yen)332,946 thousand and (Yen)338,346 thousand, respectively, in the year ended
1999.
Upon exercise of stock warrants, 999,600 shares of common stock at an
exercise price of (Yen)142.5 per share and 435,442 shares of common stock at an
exercise price of (Yen)3,200 per share were issued and the common stock account
and the additional paid-in capital account of the Company increased by
(Yen)768,606 thousand ($6,684 thousand) and (Yen) 769,603 thousand ($ 6,692
thousand), respectively, in the year ended 2000.
The accompanying notes are an integral part of these statements.
F-34
share data in the consolidated financial statements have been adjusted to give
effect to the stock split made on March 31, 2001.
Under the Japanese Commercial Code, at least 50% of the issue price of
new shares, with a minimum of the par value of those shares, is required to be
designated as common stock. The portion which is to be designated as common
stock is determined by resolution of the Board of Directors. Proceeds in excess
of the amounts designated as common stock are credited to additional paid-in
capital. The parent company may transfer portions of additional paid-in capital
to common stock by resolution of the Board of Directors.
Under the Japanese Commercial Code, the amount available for dividends is
based on retained earnings as recorded in the books of the Company prepared in
accordance with Japanese Commercial Code requirements. However, certain
adjustments, not recorded in the Company's books, are reflected in the financial
statements as described in Note 2.
The Japanese Commercial Code provides that an amount equal to at least
10% of cash dividends and other distributions from retained earnings paid by the
parent company and its Japanese subsidiaries be appropriated as a legal reserve.
No further appropriation is required when the legal reserve equals 25% of the
stated capital. The amounts of statutory retained earnings of the parent company
available for the payment of dividends to stockholders as of December 31, 1999
and 2000 were (Yen)2,866,888 thousand and (Yen)4,853,408 thousand ($42,204
thousand), respectively.
According to the Articles of Incorporation of the Taiwan subsidiary, the
annual net income should be used initially to cover any accumulated deficit;
then, 10% of the remaining annual net income should be set aside as a legal
reserve until it reaches 100% of the contributed capital. Under the law in
Taiwan, the legal reserve can be exclusively used to cover accumulated deficits
or, if the balance of the reserve exceeds 50% of the contributed capital, to
increase capital (not to exceed 50% of the reserve balance) and shall not be
used for any other purpose.
When distributing retained earnings, the Taiwan subsidiary should
distribute 0.5% of the total distribution as an employee bonus. The distribution
of the retained earnings shall be made by a resolution passed by the Board of
Directors and approved by the shareholders.
The Japanese Commercial Code permits a Company to distribute profits by
way of interim or year-end dividends under certain conditions. Year-end
dividends of (Yen)208,337 thousand for the year ended December 31, 1998 were
approved at a general stockholders' meeting held on March 11 1999. Such
dividends are reflected in the accompanying consolidated financial statements
for the year ended December 31,1999.
Total accumulated other comprehensive income as of December 31, 1998,
1999 and 2000, which in each case was a net debit balance, was (Yen)43,924
thousand, (Yen)417,066 thousand and (Yen)337,893 thousand ($2,938 thousand),
respectively.
19. Financial instruments
Other than marketable debt and equity securities, the Company's
involvement in financial assets and liabilities with market risk is limited to
cash and cash equivalents, notes and accounts receivable, short-term borrowings,
notes and accounts payable and long-term debt. At December 31, 1999, the
carrying amounts of the Company's financial assets and liabilities with
The accompanying notes are an integral part of these statements.
F-35
market risk other than marketable debt and equity securities approximated to
their fair values which were estimated based on the discounted amounts of future
cash flows.
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 do not employ any derivative financial
instruments, with the exception of ipTrend Incorporated (Tokyo Chuo-ku) which
was acquired during the year ended December 31, 2000.
ipTrend Incorporated (Tokyo Chuo-ku) has entered into an interest rate
swap arrangement which matures in 2005 and a interest rate cap arrangement which
matures in 2004 to manage its exposure to interest rate movements by effectively
converting a portion of its debt from fixed to variable rates. Subsequent to the
acquisition, ipTrend Incorporated (Tokyo Chuo-ku) repaid the underlying hedged
debt without settling the interest rate swap and cap arrangements. At December
31, 2000, the notional principal amount of the interest rate swap arrangement
and the interest rate cap arrangement were (Yen)200,000 thousand and
(Yen)100,000 thousand, respectively. Those arrangements which did not qualify
for hedge accounting were marked to market. At December 31, 2000, the aggregate
carrying amount of the arrangements and the related fair market value were a
debit balance of (Yen)2,275 thousand ($20 thousand) and a credit balance of
(Yen)6,751 thousand ($59 thousand), respectively. The unrealized loss from the
arrangements was charged to income for the year then ended.
20. Advertising costs
Advertising costs are expensed as incurred. Advertising costs included
in selling, general and administrative expenses were (Yen)1,540,715 thousand,
(Yen)2,164,630 thousand and (Yen)2,004,749 thousand ($17,433 thousand) for the
years ended December 31, 1998, 1999 and 2000, respectively.
21. Leased assets
Rental expenses under operating leases for the years ended December 31,
1998, 1999 and 2000 were (Yen)292,214 thousand, (Yen)422,727 thousand and
(Yen)644,343 thousand ($5,603 thousand), respectively. The minimum rental
payments required under operating leases that have initial or remaining non-
cancelable lease terms in excess of one year at December 31, 2000 are as
follows:
Thousands of
Year ending December 31: Millions of yen U.S. dollars
----------------- -------------
2001.................................. (Yen)367,385 $ 3,195
2002.................................. 224,613 1,953
2003.................................. 304,319 2,646
2004.................................. 393,604 3,423
2005.................................. 409,186 3,558
2006.................................. 35,345 307
----------------- -------------
Total minimum future lease payments...... (Yen)1,734,452 $15,082
================= ==============
The accompanying notes are an integral part of these statements.
F-36
22. Commitments and contingent liabilities
There were no significant commitments outstanding at December 31, 2000.
In May 1997, Trend Micro Incorporated (TMI), the parent company's U.S.
subsidiary, sued Network Associates (formerly McAfee Associates, Inc.) in the
U.S. Federal District Court for the Northern District of California alleging
that their products infringe TMI's U.S. Patent No. 5,623,600 relating to a
system and method for detecting computer viruses in a network environment, and
sought injunctive relief and unspecified money damages. In June 1997, Network
Associates denied infringement, alleging the Company's patent is invalid, and
filed counterclaims against TMI alleging unfair competition, false advertising,
trade libel and interference with prospective economic advantage. In April 2000,
Network Associates filed a suit against TMI in the U.S. Federal District Court
for the Northern District of Texas, alleging that TMI's anti-virus software
packages, including the Trend Virus Control System, infringes a Network
Associates patent which was issued on February 22, 2000.
On May 31, 2000, the parties entered into a settlement agreement and
cross-license agreement pursuant to which they agreed, among other things, to
dismiss all outstanding litigation between each other and to cross-license
certain rights in their respective patent portfolios. Based upon the agreements,
Network Associates paid (Yen)1,326,750 thousand ($11,537 thousand) to the
Company in consideration for its past patent license from the Company. The
Company recorded a gain on settlement of the litigation of (Yen)1,019,734
thousand ($8,867 thousand), net of related fees for lawyers of (Yen)307,016
thousand ($2,670 thousand) in total, as "other income".
At December 31, 2000, the Company and its subsidiaries had no material
litigation or claims outstanding, nor was there any pending or threatened
against them.
23. Segment information
The Company and its consolidated subsidiaries operate principally in
two industry segments: the "Security software business" and the
"Internet-related products/service business". The internet-related products and
services are operated by ipTrend Incorporated (Tokyo Chuo-ku) which was acquired
by the Company during the year ended December 31, 2000. However, industry
segment information is not currently disclosed since more than 90% of sales,
operating income and assets in all segments are from the "security software
business". Sales and operating revenue to external customers in the
"Internet-related products/service business" amounted to (Yen) 1,218,955
thousand ($ 10,600 thousand) for the year ended December 31, 2000.
Net revenue, attributed to countries based on location of the Company
and consolidated subsidiaries, and long-lived assets for the years ended
December 31, 1998, 1999 and 2000 are as follows:
The accompanying notes are an integral part of these statements.
F-37
Geographic information -
Thousands of
Thousands of yen U.S. dollars
--------------------------------------------------- ------------
Year ended December 31 Year ended
--------------------------------------------------- December 31,
1998 1999 2000 2000
-------------- --------------- --------------- ------------
Net sales to external customers:
Japan................................ (Yen)4,811,608 (Yen) 5,847,188 (Yen) 6,633,573 $ 57,683
U.S.A................................ 1,866,747 3,830,589 6,258,300 54,420
Taiwan............................... 1,808,742 1,646,550 1,918,175 16,680
Europe............................... 813,962 1,825,699 4,126,420 35,882
Other................................ 444,605 483,144 1,133,898 9,860
-------------- --------------- --------------- ------------
Total........................... (Yen)9,745,664 (Yen)13,633,170 (Yen)20,070,366 $174,525
============== =============== =============== ============
Long-lived assets:
Japan................................ (Yen) 884,543 (Yen) 1,002,116 (Yen) 3,465,387 $ 30,134
U.S.A................................ 147,469 320,497 402,324 3,498
Taiwan............................... 204,672 248,637 515,829 4,486
Europe............................... 38,333 52,779 109,517 952
Other................................ 39,016 27,133 41,160 358
-------------- --------------- --------------- ------------
Total........................... (Yen)1,314,033 (Yen) 1,651,162 (Yen) 4,534,217 $ 39,428
============== =============== =============== ============
Intercompany sales between geographic areas are made at arms-length prices.
Long-lived assets are those assets used in the geographic segment.
Long-lived assets are included in the consolidated balance sheets as
follows:
Thousands of
Thousands of yen U.S. dollars
--------------------------------------------------- ------------
Year ended
Year ended December 31 December 31,
---------------------------------------------------
1998 1999 2000 2000
-------------- --------------- --------------- ------------
Investments and other assets:
Goodwill and intangibles............. (Yen)438,366 (Yen)440,252 (Yen)2,740,827 $23,833
Other................................ 380,253 461,125 570,742 4,963
Property and equipment, less
accumulated depreciation............. 495,414 749,785 1,222,648 10,632
-------------- --------------- --------------- ------------
Total........................... (Yen)1,314,033 (Yen)1,651,162 (Yen)4,534,217 $39,428
============== =============== =============== ============
Significant customers
SOFTBANK and its affiliates accounted for more than 10% of net sales to
external customers for the years ended December 31, 1998, 1999 and 2000. Net
sales to SOFTBANK and its affiliates for the years ended December 31, 1998, 1999
and 2000 were (Yen)2,386,654 thousand, (Yen)2,453,538 thousand and
(Yen)3,507,641 thousand ($30,501 thousand), respectively.
The accompanyings notes are an integral part of these statements.
F-38
24. Subsequent events
Stock split
On February 15 2001, the Board of Directors of the Company decided and
declared a stock split in the ratio of two-for-one for which the record date was
March 31, 2001. All prior share and per share amounts in these financial
statements and accompanying notes have been restated to reflect this stock
split.
Issuance of unsecured bonds with detachable warrants
As approved by the Company's Board of Directors on February 15, 2001
and May 16, 2001, the Company issued the following bonds with detachable
warrants to the public based on the Company's 2001 incentive plan.
1. Approval by the board of directors........ February 15, 2001 May 7, 2001
2. Date of bond issuance..................... March 19, 2001 June 4, 2001
3. Maturity date............................. March 19, 2004 June 4, 2004
4. Amount of each bond....................... (Yen)5,000,000 thousand (Yen)1,500,000 thousand
($43,478 thousand) ($13,043 thousand)
5. Interest rate per annum................... 1.75% 1.5%
6. Exercise price per each warrant........... (Yen)5,675 (Yen)5,760
7. Warrant exercise period................... April 12, 2001 to May 17, 2002 to
March 12, 2004 May 28, 2004
8. Number of shares represented
by warrants............................... 881,057 260,416
Upon issuance of each bond, the Company bought all of the warrants and
distributed such instruments to the directors and certain employees of the
Company and its subsidiaries, excluding the subsidiary in the United States, as
a part of their remuneration. These transactions were accounted for as issuance
of debt to the public and as an issuance of warrants to the directors and
certain employees of the Company and its subsidiaries. The issuance of the
warrants to the directors and employees was accounted for under APB 25. The
exercise price per share for the warrants granted was determined as equivalent
to the fair market value of the Company's shares at the time of the grants.
Consequently, the grants of the option did not result in deferred compensation.
Stock Options
Based on the resolution at the shareholders' meeting on March 27, 2001,
the Company introduced an incentive stock option plan which qualified under the
Japanese Commercial Code and the Industrial Revitalization Special Measures Law.
In accordance with the terms of this plan,
The accompanyings notes are an integral part of these statements.
F-39
the Company granted options to purchase up to 713,500 shares of the Company's
common stock to certain directors and employees of the Company and its
subsidiaries on May 17, 2001. The options granted are exercisable from April 1,
2002 through March 31, 2009.
The grants of options to the directors and employees were accounted for
under APB 25. The exercise price per share for the options granted of (Yen)5,760
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 options did not result in
deferred compensation.
The accompanying notes are an integral part of these statements.
F-40
SCHEDULE II
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Thousands of yen
------------------------------------------------------------------------------------------
Additions
Balance at charged to Additions Balance at
beginning costs and charged to Deductions Other end of
of period expenses net sales (Note 1) (Note 2) period
-------------- -------------- -------------- --------------- -------------- -------------
Year ended December 31, 1998:
Allowance for doubtful
accounts and sales returns...... (Yen)204,745 (Yen)192,922 (Yen)22,227 (Yen)(52,657) (Yen)(28,356) (Yen)338,881
============= ============== ============== ============= ============ ============
Year ended December 31, 1999:
Allowance for doubtful
accounts and sales returns...... (Yen)338,881 (Yen)97,102 (Yen)145,099 (Yen)(151,716) (Yen)(46,393) (Yen)382,973
============= ============== ============== ============= ============ ============
Year ended December 31, 2000:
Allowance for doubtful
accounts and sales returns...... (Yen)382,973 (Yen)67,589 (Yen)232,414 (Yen)(57,174) (Yen)20,764 (Yen)646,566
============= ============== ============== ============= ============ ============
Notes: 1. Amounts written off.
2. Translation adjustment.
Thousands of yen
----------------------------------------------------------------------------------
Balance at
beginning of Balance at
period Additions Deductions Other end of period
---------------- -------------- ------------- ------------- --------------
Year ended December 31, 1998:
Valuation allowance
- Deferred tax assets............ (Yen)49,048 (Yen)188,819 (Yen) - (Yen)(25,816) (Yen)212,051
================ ============== ============= ============ ==============
Year ended December 31, 1999:
Valuation allowance
- Deferred tax assets............ (Yen)212,051 (Yen) - (Yen)(198,599) (Yen)(2,987) (Yen)10,465
================ ============== ============= ============ ==============
Year ended December 31, 2000:
Valuation allowance
- Deferred tax assets............ (Yen)10,465 (Yen)116,630 (Yen)(10,465) (Yen) - (Yen)116,630
================ ============== ============= ============ ==============
The accompanying notes are an integral part of these statements.
F-41
INDEX OF EXHIBITS
Exhibit
Number Description
------- -----------
1.1 -- Articles of Incorporation of Trend Micro (English translation)
1.2 -- Share Handling Regulations of Trend Micro (English translation)
1.3 -- Regulations of the Board of Directors of Trend Micro (English
translation)
1.4 -- Regulations of the Board of Statutory Auditors of Trend Micro
(English translation)
2.1 -- Specimen Common Stock Certificates
2.2** -- Form of Deposit Agreement among Trend Micro, The Bank of New York
as depositary and all owners and holders from time to time of
American Depositary Receipts, including the form of American
Depositary Receipt.
4.1*+ -- Basic Agreement on Continual Sale and Purchase of Goods dated
October1, 1999, between Trend Micro Incorporated and SOFTBANK
COMMERCE CORP., and related agreements
4.2* -- Agreements relating to Acquisition of Nippon Unisoft Corporation
8.1* -- Subsidiaries of Trend Micro
________________________
* Incorporated by reference to the corresponding exhibit to Trend Micro's
Amendment No. 2 to the Form F-1 Registration Statement (File No. 333-10568)
on May 22, 2000.
** Incorporated by reference to the corresponding exhibit to Trend Micro's
amendment No. 1 to Registration Statement on Form F-6 (File No. 333-10492)
filed on June 22, 2001.
+ Confidential treatment granted for a portion of these documents.