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, 2001
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 ("Shares")*
(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, 2001, 132,043,182 shares of common stock were outstanding,
comprised of 130,838,682 Shares and 1,204,500 American Depositary Shares
(equivalent to 1,204,500 Shares based on the ratio of 1 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, 2001 or
for the year ended December 31, 2001 unless the context otherwise indicates. In
tables appearing in this annual report, figures may not add up to totals due to
rounding.
* Not for trading, but only in connection with the registration of American
Depositary Shares, each of which represents one share of Common Stock.
-ii-
Cautionary Statement Regarding Forward-Looking Statements
This annual report on Form 20-F 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 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;
. 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.
-iii-
. "U.S. GAAP" means generally accepted accounting principles in the
United States.
. "ADS" means an America Depositary Share, each representing 1 shares of
Trend Micro's common stock, and "ADR" means an American Depositary
Receipt evidencing ADSs.
. "fiscal 2001" and "fiscal year 2001" refer to Trend Micro's fiscal year
ended December 31, 2001, and other fiscal years are referred to in a
corresponding manner.
-iv-
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, 1999, 2000 and 2001, and the consolidated balance sheet
information as of December 31, 2000 and 2001, 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 income statement information for the fiscal years
ended December 31, 1997 and 1998, and the consolidated balance sheet information
as of December 31, 1997, 1998 and 1999 are derived from our consolidated
financial statements prepared in accordance with U.S. GAAP, which have been
audited by PricewaterhouseCoopers, independent accountants, but are not included
in this annual report.
Year Ended December 31,
-----------------------------------------------------------------------------------------
1997 1998 1999 2000 2001 2001
------------ ------------ ------------ ------------ ------------ ----------
(in millions of yen and thousands of dollars, except per share data)
Sales ................................... (Yen) 7,398 (Yen) 9,746 (Yen)13,633 (Yen)20,070 (Yen)31,326 $237,321
Cost of sales ........................... 734 560 481 1,474 1,899 14,387
Gross profit ......................... 6,664 9,186 13,152 18,596 29,427 222,934
Operating expenses:
Selling. ............................. 1,316 2,526 3,454 5,445 7,178 54,375
Research and development ............. 557 960 994 2,044 2,755 20,873
General and administrative ........... 2,755 4,087 4,772 5,304 9,725 73,678
Goodwill amortization ................ - - 276 - - -
Goodwill write-off ................... - - - - 2,253 17,072
Total operating expenses ........... 4,628 7,573 9,220 13,069 21,911 165,998
Operating income ........................ 2,036 1,613 3,932 5,527 7,516 56,936
Other income, net ....................... 82 85 67 1,365 241 1,826
Income before income taxes,
minority interest and equity in
loss of affiliated companies ......... 2,118 1,698 3,999 6,892 7,757 58,762
Income taxes ............................ 1,267 1,295 1,849 3,123 3,241 24,554
Income before minority interest and
equity in losses of affiliated
companies ............................ 851 403 2,150 3,769 4,516 34,208
Minority interest in income of a
consolidated subsidiary .............. - - - 7 - -
Income from consolidated
companies ............................ 851 403 2,150 3,762 4,516 34,208
Equity in losses of
affiliated companies ................. - - 3 87 130 981
Net income .............................. (Yen) 851 (Yen) 403 (Yen) 2,147 (Yen) 3,675 (Yen) 4,386 $33,227
=========== =========== =========== =========== ===========
Net income per share (basic) ............ (Yen) 7.88 (Yen) 3.54 (Yen) 16.90 (Yen) 28.18 (Yen) 33.33 $ 0.25
=========== =========== =========== =========== ===========
Net income per share (diluted) .......... - (Yen) 3.46 (Yen) 16.42 (Yen) 27.53 (Yen) 33.02 $ 0.25
=========== =========== =========== =========== ===========
Weighted average common shares
outstanding (basic) .................. 108,000,000 113,946,182 127,100,328 130,388,962 131,594,913
Weighted average common shares
outstanding (diluted) ................ - 116,483,720 130,752,652 133,454,940 132,832,159
All prior share and per share amounts have been restated to reflect on one-into-two stock split effected on March 31, 2001.
Year Ended December 31,
-----------------------------------------------------------------------------------------
1997 1998 1999 2000 2001 2001
------------ ------------ ------------ ------------ ------------ ----------
(in millions of yen and thousands of dollars, except per share data)
Consolidated Balance Sheet Information
Cash and cash equivalents ........... (Yen) 1,144 (Yen) 9,396 (Yen)15,649 (Yen)24,436 (Yen)40,783 $308,959
Total assets. ....................... 5,435 17,716 28,781 44,574 64,729 490,369
Short-term borrowings ............... 151 72 - - - -
Current portion of long-term debt ... - - - 57 3,000 22,727
Long-term debt ...................... - - 6,000 9,800 11,500 87,121
Total liabilities ................... 3,190 4,143 11,471 20,230 33,963 257,293
Shareholders' equity ................ (Yen) 2,245 (Yen)13,573 (Yen)17,310 (Yen)24,344 (Yen)30,766 $233,076
-2-
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) 132.00 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
119.85 (Yen) per $1.
-3-
Year ended/ending December 31, High Low Average Period-end
------------------------------ -------- -------- --------- ----------
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 ...................................... 131.47 114.26 122.18 131.04
2002 (through June 28, 2002) .............. 134.77 119.38 128.86 119.85
Calendar Year 2001
December .................................. 131.47 123.90 127.59 131.04
Calendar Year 2002
January ................................... 134.64 130.93 132.68 134.06
February .................................. 134.77 132.26 133.64 133.96
March ..................................... 133.46 127.07 131.06 132.70
April ..................................... 133.40 128.13 130.77 128.45
May ....................................... 128.66 128.08 126.38 124.13
June (until June 28, 2002) ................ 125.64 119.38 123.29 119.85
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 and other software such as
firewall or e-mail software or computer hardware may decide to enhance or bundle
their products with their other products to include anti-virus functions. These
companies may offer anti-virus protection as a standard feature in their
products, at minimal or no additional cost to customers. This could render our
products obsolete or unmarketable, particularly if anti-virus products offered
by these vendors were comparable 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, 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 contraction in the
-4-
worldwide anti-virus software market, our business, financial conditions and
results of operations could materially suffer.
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)2.5 billion or
18.0% of our net sales in 1999, (Yen)3.5 billion or 17.5% of our net sales in
2000 and approximately (Yen) 7.4 billion ($55.7 million) or 23.5% of our net
sales in 2001. 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.
OUR PRODUCTS MAY BECOME OBSOLETE BECAUSE RAPID TECHNOLOGICAL CHANGE REGULARLY
OCCURS IN THE ANTI-VIRUS SOFTWARE MARKET.
The anti-virus software market is characterized by:
. rapid technological change;
. the proliferation of new and changing computer viruses;
. frequent product introductions and updates; and
. changing customer needs.
These characteristics of our market create significant risks and
uncertainties for our business success. For example, our competitors might
introduce anti-virus products that are technologically superior to our products.
Additionally, new software operating system, network system or anti-virus
software industry standards could emerge. Emerging trends in these systems and
standards currently include applications distributed over the internet and the
use of a web browser to access client-server systems. Our existing products
might be incompatible with some or all of such standards. Our business,
financial condition and results of operations could materially suffer unless we
are able to respond quickly and effectively to these developments.
OUR HARDWARE-BASED PRODUCTS FACE MANUFACTURING AND INVENTORY RISKS.
We rely on a small number of third parties to manufacture some of our
hardware-based products, such as our Gatelock product. We expect our reliance on
third-party manufacturers to become more important as the number of our
hardware-based products increases. Reliance on third-party manufacturers
involves a number of risks, including a lack of control over the manufacturing
process and the potential absence or unavailability of adequate capacity. If any
of our third-party manufacturers cannot or will not manufacture our products in
required volumes, on a cost-effective basis, in a timely manner, or at all, we
will have to secure additional manufacturing capacity. The unexpected loss of
any of our manufacturers could disrupt our business. Furthermore, our
hardware-based products contain critical components supplied by a single or a
limited number of third parties. Any significant shortage of components or the
failure of the third-party supplier to maintain or enhance these products could
lead to cancellation of customer orders or delays in the placement of orders.
WE MAY NOT BE ABLE TO INCREASE OUR MARKET SHARE IN THE U.S. AND EUROPEAN MARKETS
BECAUSE OUR COMPETITORS ARE MORE ESTABLISHED THAN WE ARE IN THESE MARKETS.
We believe that our share of the anti-virus software market in the U.S.
and Europe is small relative to the market shares of our principal competitors,
despite the growth of our sales in these markets in 2000 and 2001. 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:
-5-
. better withstand downturns in the anti-virus software market
and in the computer software market in general;
. adapt more quickly to new or emerging technologies or changes
in customer requirements; or
. more effectively and profitably market, sell and support their
products.
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, Symantec Corporation and
Computer Associates 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. For example, we licensed our InterScan VirusWall
technology to internet service providers in Japan which enables them to provide
virus scanning service to their subscribers. We also entered into eDoctor
agreements with systems integrators which we call Premium Security Partners to
allow them to provide anti-virus outsourcing service to their customers. A
Premium Security Partner provides services including administrating its
customers' anti-virus products, monitoring virus infection and sending
network-wide virus reports. 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, 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, amortization of goodwill and
purchased technology and possible recognition of impairment
charge.
If we make such an acquisition using stock, our current shareholders'
ownership interests will be diluted. Any of these factors could materially hurt
our business, financial condition and results of operations.
-6-
For example, in 2000, we acquired ipTrend to start a new business
selling a Linux based remotely managed server appliance solution to small and
medium sized companies. However, ipTrend performed poorly and was liquidated in
December 2001. Due to the liquidation of ipTrend, (Yen) 2.3 billion ($17.1
million) was booked as goodwill write-off in 2001.
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, including broadband and wireless
infrastructures, does not develop at the rapid pace we expect, our business,
financial condition and operating results could be adversely affected.
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 software 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.
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,
-7-
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.
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.
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 Chief Executive Officer, 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.
Factors which could cause our quarterly financial results to fluctuate
include:
. Timing of sales of our products and services due to customers'
budgetary constraints, seasonal buying patterns and our
promotional activities;
. New product introductions by our competitors;
. Significant marketing campaigns, research and development
efforts, employee hirings, and other 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.
-8-
WEAKNESS IN THE JAPANESE ECONOMY MAY HURT OUR BUSINESS PERFORMANCE BECAUSE JAPAN
IS OUR LARGEST MARKET.
While our sales in the U.S. and Europe have increased in recent years,
we remain significantly dependent on the Japanese market. Net sales of our anti-
virus software products in Japan accounted for approximately 43% of our net
sales in 1999, approximately 33% in 2000 and approximately 39% in 2001. 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.
WE ARE MORE VULNERABLE THAN OUR COMPETITORS TO WEAKNESSES IN THE ECONOMIES OF
ASIAN COUNTRIES BECAUSE WE MAKE A SIGNIFICANT PERCENTAGE OF OUR NET SALES IN
ASIA.
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)1.8 billion or
approximately 13% of our net sales in 1999, approximately (Yen)2.1 billion or
approximately 11% of our net sales in 2000 and approximately (Yen)2.3 billion or
approximately 7 % of our net sales in 2001. 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.
FOREIGN EXCHANGE FLUCTUATIONS COULD LOWER OUR RESULTS OF OPERATIONS BECAUSE WE
EARN REVENUES DENOMINATED IN A NUMBER OF DIFFERENT CURRENCIES.
Our reporting currency is the Japanese yen and the functional currency
of each of our subsidiaries is the currency of the country in which the
subsidiary is domiciled. However, a significant portion of our revenues and
operating expenses is denominated in currencies other than the Japanese yen,
primarily the U.S. dollar, EURO and the New Taiwan Dollar. As a result,
appreciation or depreciation in the value of other currencies as compared to the
Japanese yen could result in material transaction or translation gains or losses
which could reduce our operating results. These negative effects 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 we 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
-9-
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 experienced intermittent power
shortages in 2000, sharp increases in the cost of energy and even interruptions
of service to some business customers. If power shortages continue to be a
problem our business may be materially adversely affected. Additionally, we may
experience natural disasters that could interrupt our business.
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.
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 48.6% of our outstanding shares as
of May 31, 2002. These shareholders, if they act together, would be able to
significantly influence all matters requiring approval by our shareholders,
including the election of directors and the approval of mergers or other
business combination transactions. Our principal shareholders may have strategic
or other interests that conflict with the interests of our other shareholders.
As a result, the concentration in our shareholdings may have the effect of
delaying or preventing a change in control of Trend Micro, which could result in
the loss of a significant financial gain to our shareholders.
OUR STOCK PRICE IS VOLATILE, AND INVESTORS BUYING THE SHARES OR ADSS MAY NOT BE
ABLE TO RESELL THEM AT OR ABOVE THEIR PURCHASE PRICE.
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)1,670 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 $14.50 and a high of $159.38. The closing price
on the Tokyo Stock Exchange for our stock on May 31, 2002 was (Yen)3,680, and
the closing price on The Nasdaq National Market for our ADSs on May 31, 2002 was
$29.35 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. Each ADS offered in the offering represents the right to
receive one share. A holder who owns less than 500 ADSs will indirectly own less
than a whole unit. Under the deposit agreement governing the rights of ADS
holders, in order to withdraw any shares, an ADS holder must surrender ADRs
evidencing 500 ADSs or a multiple of 500 ADSs. Each ADR will bear a legend to
that effect. Under the unit share system, holders of less than a unit have the
right to require us to purchase their shares. Holders of ADSs that represent
other than multiples of whole units cannot withdraw the underlying shares
representing less than one unit. They will therefore be unable, as a practical
matter, to
. exercise the right to require us to purchase the underlying
shares, or
-10-
. 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.
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
Japanese Commercial Code, only holders of 3% or more of the issued and
outstanding shares are entitled to examine our accounting books and records.
Shareholders' rights under Japanese law may not be as extensive as shareholders'
rights under the 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 international
subsidiaries.
We are a leader in network anti-virus 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 does not constitute part of this annual
report.
-11-
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, President of Operations, North America and Senior Vice President, c/o
Trend-Micro, Inc., 10101 N. DeAnza Blvd., Cupertino, California 95014.
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 1998. We listed
American Depositary Shares on The Nasdaq National Market in July 1999 in
connection with a global offering of 12,750,000 shares in the form of shares and
ADRs. In August 2000 we listed on the first section of Tokyo Stock Exchange.
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 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 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.
-12-
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 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, states that in 2000,
worldwide revenue for anti-virus software reached $1.4 billion, representing a
25% growth over 1999 revenue, and estimates that this market will increase at a
15% compound annual growth rate and reach $2.8 billion by 2005. International
Data Corporation estimates that worldwide revenue for the anti-virus software
market will increase at a 17% compound annual growth rate from 1999 to 2004,
reaching $2.7 billon.
In 2001, the International Computer Security Association published a
virus prevalence survey which gathered responses from 300 qualified respondents
who worked for companies and government agencies with more than 500 PCs, two or
more LANs, and at least two remote connections to the site. The group of 300
organizations had 1,182,634 virus encounters on 666,327 machines during the 20
months of the survey period from January 2000 through August 2001. This
translates to 113 encounters per 1,000 machines per month over the entire survey
period.
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. In 2001
we introduced GateLock, a broadband security appliance.
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 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 VSAPI
scanning engine, which incorporates our MacroTrap virus detection technology,
rapidly detects known and some unknown macro viruses. VSAPI is the core of our
anti-virus technology and is explained in greater detail below. 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:
-13-
. weekly anti-virus software updates to help protect against
emerging viruses; and
. monthly anti-virus "health check" status reports.
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. Furthermore, 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
The principal product in our enterprise-wide management line is called
Trend Virus Control System. 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.
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
-14-
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;
. 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.
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 computer 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 to TrendLabs 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.
In 2001, Trend Micro began providing free PDA device resident virus
protection on Palm, EPOC and Pocket PC operating systems to protect users from
wireless.
-15-
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 for Network Appliance(TM) filers
provides a comprehensive anti-virus solution for Network Appliance filers.
Managed through an intuitive management console, the software provides
centralized virus scanning, pattern updates, event reporting, and anti-virus
configuration. Virus scanning takes place in separate scan servers running
Windows 2000/NT. ServerProtect for EMC Celerra(TM) brings the power of Trend
Micro's centralized virus protection to the Celerra line of server devices which
connect and move data to enterprise-level data storage systems. 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 XP Home and
Professional, Windows NT Workstation 4.0 SP6 or above, Windows Me, Windows 98 or
98 SE, Windows 95 OSR2, and Windows 2000, Professional SP1 or above.
PC-cillin 2002 includes a Personal Firewall for secure internet
computing. PC-cillin 2002 scans for viruses in new emails, including viruses
that might, for example, hide in the "Personal Folders" within Microsoft Outlook
that allow users to store emails locally on their computer. With adjustable
security levels, a trusted site list, and port blocking capabilities,
PC-cillin's Personal Firewall gives users the control to keep their computer
safe from malicious programs and internet intruders. The Personal Firewall is
ideal for computers using always-on broadband connections (DSL, cable modem) or
for computers that are often online. But computers that only connect to the
internet for short periods of time are still vulnerable to hacker attacks and
need protection. PC-cillin 2002 includes Trend Micro's PC-cillin for Wireless to
provide portable, easy-to-use anti-virus security for your Personal Digital
Assistants, to protect important information they have on them, and to secure
PCs during synchronization.
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.
Broadband Security Product
DSL gateways, cable modems, and other "always-on" broadband connections
provide immediate, high-speed access to the internet. However, along with their
speed and convenience, broadband connections also bring new threats and
increased danger to online security. Without adequate precautions, they leave an
open channel to the PC that is plainly visible to anyone on the internet. Due to
their "always-on" characteristic, viruses and hackers can easily access
unprotected computers to damage or steal personal data. Code Red and Nimda,
recent examples of hybrid threats which combine the functions of viruses and
hacker tools, were able to spread so rapidly in part because they were aided by
host computers infected through open broadband connections.
-16-
GateLock is a broadband security appliance for home and small office
and home office users. It combines a range of security solutions, including a
hardware-based firewall and high-performance virus scanning, embedded in a
single plug-and-play unit. GateLock aims to solve on-line security problems by
creating a strong defense line at the point where the user's computer links up
with the internet, stopping hackers and viruses before they enter the computer
and reach the user's data. It scans and deals with email and attachments that
might contain viruses, hides user IP addresses, and blocks unauthorized
intrusions. It provides a record of all viruses and unauthorized entry attempts
that it detects. Moreover, GateLock also functions as a DHCP server that allows
multiple computers on a small network to share a single, secure broadband
connection.
Internet-Based Support Services
The role of our Premium Security Partners is particularly important in
Japan, where enterprise users typically look to systems integrators to manage
their networks and to provide virus solutions. A Premium Security Partner is a
systems integrator with whom we have entered into an agreement to provide the
Premium Security Partner with a bundle of services, which we call our eDoctor
services, which enable the Premium Security Partner to provide those services to
its own customers. eDoctor, which was introduced in Japan in 1998, includes
services such as administrating anti-virus products in customers' networks,
monitoring virus infection and sending network-wide reports.
TrendLabs 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.
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.
Technology
We believe that our innovative anti-virus technologies are an important
competitive advantage. Key technologies used in our products include the
following:
VSAPI is the core of our anti-virus technology and our newest scanning
engine. VSAPI, 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, VSAPI 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. VSAPI 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;
-17-
. A specific scanning module for detecting known malicious Java
code;
. our Script Trap technology, which scans for scripting viruses
based on how viruses "behave" rather than the design of the virus
code; and
. our Trend System Cleaner, which is designed to completely
clean computer systems of Trojans and the unwanted, lingering
items they leave behind.
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.
Server Pipeline is our patented technology which enables scanning of
data which have been transmitted through the internet, and also reviews 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 in Japan,
Comdex, InfoSec, ISPCON, and the RSA Conference in the United States, CeBit in
Germany and the Network and Windows NT shows in Britain.
Some of our customers seek to get their anti-virus products from
service providers and not directly from anti-virus solution vendors, such as
Trend Micro. To meet this challenge, we are also making efforts to enter into
agreements with
-18-
service providers so that they offer our products to their customers, as
discussed in "---- Service Provider and Other Relationships".
Trend Micro has a global network of partnerships and strategic
alliances with some of the most respected names in the IT industry including:
Check Point, Cisco Systems, Compaq, Hewlett Packard, ISS, Lotus, Lucent
Technologies, GE Access and Network Appliance.
Japan
Overview. We sell our products in Japan to both corporate and
individual end users primarily through systems integrators and distributors, and
conduct a limited amount of direct sales to end users, including online sales
through a reseller's website. 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.
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.
Historically, a significant percentage of our net sales have been sales
to SOFTBANK. For example, sales to SOFTBANK totaled approximately (Yen) 2.5
billion or 18.0% of net sales in 1999, (Yen) 3.5 billion or 17.5% of net sales
in 2000 and (Yen) 7.4 billion ($55.7 million) or 23.5% of net sales in 2001. The
majority of sales to SOFTBANK in 1999, 2000 and 2001 consisted of SOFTBANK's
sales of our products to systems integrators.
Service Provider and Other Relationships. We contracted with Nifty,
NTT-Communications, Internet Initiative Japan, Cable & Wireless IDC and NTT-ME,
to license InterScan VirusWall technology to them which enables them to provide
virus scanning service to their subscribers. We entered into eDoctor agreements
with SECOM Trust net, Hitachi, Fujituu Business Systems, Otsuka Shokai which
allow them to provide anti-virus outsourcing service to their customers.
United States
Overview. 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.
Strategic Partnerships. We have entered into agreements with Check
Point, Compaq, Hewlett-Packard, IBM/Lotus, NetIQ Microsoft, Cisco, Netscreen,
EMC, Network Appliance, Citrix, Stonesoft, NetIQ, Rainfinity, Sun Microsystems
and SendMail. These agreements permit cooperative marketing activities such as
vendors' referral of customers to our products and reference to our products in
their product literature and websites. Our agreements
-19-
with these vendors also typically provide for co-development and licensing
arrangements so that our and the vendors' products operate smoothly when used
together.
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 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. We have similar agreements
with USi, Syntegra, USA.net, and other global Service Providers. We have
agreements with various hardware manufacturers to include our software with
their products. For example Ositis Software includes our scan engine in their
AVStripper appliance, and Sony includes PC-cillin on their laptops. 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, the Middle East and Africa
Overview. Trend Micro is represented throughout Europe, the Middle East
and Africa the region with offices in Germany, France, Italy, Spain, UK, Norway,
Sweden, Holland and Dubai. Our European Support Center, which is located in
Munich, Germany, offers real-time technical support and anti-virus expertise to
Trend Micro's channel partners throughout the whole of Europe.
Distributors. 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. Principal
distributors for Europe, Middle East and Africa region include: France; Logix
( France) Allasso (France) Risc (France) ComputerLinks (France) Cris Reseaux
(France) IDE PRO (France) InfoManage (Suisse), Germany; Entrada, Infinigate,
ICON Bristol, ComputerLinks (TechData Midrange, starting end of Q2), Italy ;
ITWAY, Esprinet, JSoft/Opengate, Computer Gross, Nordic Region; Network Consult
A/S (Denmark), Next AB (Sweden), Itegra AB (Sweden), Scribona AS (Norway),
Itegra (Norway), Securesoft Oy (Finland), Spain, ADD Distribuciones
Informaticas, AFINA Sistemas, Allasso, GTI, Netmaster (Portugal), UK; e92+,
Peapod, Sphinx cst, Unipalm.
-20-
World Online. In May, 2000 Trend Micro entered into an agreement with
World Online International, one of the leading internet communications
companies. Under our agreement, we provide World Online with the software to
enable it to deliver web-based anti-virus scanning services to its customers.
World Online is headquartered in the Netherlands. As of March 31st, 2000, World
Online had 2.2 million active subscribers. 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).
Other Parts of the World
Outside of Japan and the United States, we sell our products mostly to
corporate and individual end users worldwide, mostly 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, Australia and
South America were to corporate end users through systems integrators and
distributors.
Trend Micro is a leading enabler of managed virus protection services
to the global carrier and service provider marketplace. Based on the features
inherent to Trend Micro's products, and the global support service capacity,
global carries and service providers of nearly every prevalent service model and
industry categorization model, worldwide, have chosen Trend Micro as their
solution provider partner.
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 United States.
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.
LEGAL PROCEEDINGS
We are involved in normal claims and other legal proceedings in the
ordinary course of business, and are not involved in any litigation or other
legal proceedings which, if determined adversely to us, we believe would
individually or in the aggregate have a material adverse effect on us or our
operations.
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 as of May 31,
2002, each of which is significant except the final three.
-21-
EQUITY HELD BY
COUNTRY OF TREND-MICRO
NAME INCORPORATION DIRECTLY OR INDIRECTLY
Trend Micro Incorporated Taiwan 99%
Trend Micro Inc. USA 100%
Trend Korea Inc. Korea 99%
Trend Micro Italy S.r.l. Italy 100%
Trend Micro Deutschland Gmbh Germany 100%
Trend Micro Australia Pty. Ltd. Australia 100%
Trend Micro do Brasil Ltda. Brazil 99%
Trend Micro France France 99%
Trend Micro Hong Kong Limited Hong Kong 99%
Trend Micro (UK) Limited UK 100%
Trend Micro Latinoamerica S.A.de C.V. Mexico 100%
Trend Micro (Shanghai) Inc. China 100%
Trend Micro (NZ) Limited NZ 100%
ipTrend Incorporated* Taiwan 99%
Trend Micro Incorporated Sdn.Bhd* Malaysia 99%
_______________
* Currently in the process of being liquidated.
D. Property, Plants and Equipment.
Our headquarters are located in Tokyo, Japan, where we lease an
aggregate of 4,002 square meters of office space in two buildings under lease
contracts which expire in April 2003 and in April 2004 respectively. We also
lease an aggregate of approximately 487 square meters of office space in Osaka,
Fukuoka and Nagoya.
We lease approximately 37,490 square feet of office space in Cupertino,
California under a lease which expires in January 2006. 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, Norway, Sweden, Spain, Holland, Dubai, Singapore, India,
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 headings "Cautionary Statement Regarding Forward-Looking
Statements" and "Risk Factors" 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 post-contract customer
support 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 post-contract customer support
delivered over the initial license term. Maintenance and support generally
include 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 post-contract customer
support 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 United States
and elsewhere, depending on the country. For retail purchasers of PC-cillin/
Virus Buster, the license fee includes post-contract customer support for the
initial one-year
-22-
term only. In order to receive post-contract customer support services after the
initial term, these retail purchasers must pay a percentage, generally less than
one-half, of the original license fee.
We generally recognize revenues from product licenses when:
. persuasive evidence of an arrangement exists;
. the product has been shipped or electronically delivered;
. the fee is fixed and determinable; and
. collection of the resulting account receivable is reasonably
assured.
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 30% in 2000 and 2001.
Our net sales grew 56% from approximately (Yen)20.1 billion in 2000 to
approximately (Yen) 31.3 billion ($237.3 million) in 2001. Our net sales consist
primarily of sales by our operating entities in Japan, the United States, Taiwan
and Europe. Japan, the U.S., Taiwan and Europe accounted for approximately 39%,
27%, 6% and 22%, respectively, of our net sales in 2001, and approximately 33%,
31%, 10% and 21%, respectively, in 2000.
Net sales in Japan totaled approximately (Yen)6.6 billion and (Yen)12.1
billion ($91.8 million) in 2000 and 2001, respectively, representing
approximately 33% and 39% of our total net sales in these periods. The increase
in the percentage of our total net sales represented by our net sales in Japan
was primarily due to the fact that our net sales in Japan grew approximately 83%
compared to 2000. In absolute terms, net sales in Japan grew from 2000 to 2001,
primarily due to the introduction of a new version of our PC client products to
corporate and consumer users. Net sales in Japan grew approximately 13% from
1999 to 2000.
Our U.S. net sales grew from approximately (Yen)6.3 billion in 2000 to
approximately (Yen)8.6 billion ($65.0 million) in 2001, an increase of
approximately 37%. Net sales in the United States grew approximately 63% from
approximately (Yen)3.8 billion in 1999 to approximately (Yen)6.3 billion in
2000. These annual increases in our U.S. net sales resulted largely from higher
sales of internet-based products. Also, annual increase in our net sales
resulted from higher sales of our new version of PC client products in 2001.
Our Taiwan net sales decreased from approximately (Yen)1,918 million in
2000 to approximately (Yen)1,896 million ($14.4 million) in 2001, a decrease of
approximately 1%. Net sales increased from approximately (Yen)1,647 million in
1999 to approximately (Yen)1,918 million in 2000. As the continuing recession in
Asia adversely affected our net sales in Japan and other parts of Asia during
1999, 2000 and 2001, net sales in 2000 increased slightly compared with 1999 and
net sales in 2001 decreased compared with 2000.
Net sales in Europe grew approximately 66% from approximately (Yen)4.1
billion in 2000 to (Yen)6.9 billion ($52.0 million) in 2001. Net sales in Europe
grew approximately 126% from approximately (Yen)1.8 billion in 1999 to (Yen)4.1
billion in 2000. We achieved a high rate of growth in sales from 1999 to 2000
and from 2000 to 2001 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 United States, Taiwan and Europe
increased approximately 135% from approximately (Yen)483 million in 1999 to
approximately (Yen)1.1 billion in 2000, and from 2000 to 2001 increased
approximately 66% from approximately (Yen)1.1 billion to approximately (Yen)1.9
billion ($14.1 million). Due to the establishment of our Mexican subsidiary in
2000, net sales in 2000 greatly increased compared with 1999. We gained greater
name recognition in the Latin American market because of our Mexican subsidiary
and as a result of heightened use of anti-virus products by Latin America
corporate customers in these periods.
We made rebate payments to SOFTBANK of approximately (Yen)97.8 million
in 1999, approximately (Yen)71.5 million in 2000 and approximately (Yen)221.9
million ($1.7 million) in 2001. 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.
-23-
Our consolidated financial statements are denominated in Japanese yen.
All asset and liability accounts of our foreign subsidiaries are translated into
Japanese yen at the year-end rates of exchange. We translate all income and
expense accounts at rates of exchange that approximate those prevailing at the
time of the transactions and accumulate the resulting adjustments as a separate
component of shareholders' equity. We translate foreign currency-denominated
receivables and payables into Japanese yen at year-end rates of exchange and
recognize or expense the resulting translation gains or losses on a current
basis. Fluctuations in the exchange rate between the Japanese yen and other
currencies, principally the U.S. dollar, Euro and the New Taiwan Dollar, will
affect the translation of the financial results of our foreign subsidiaries into
Japanese yen for purposes of our consolidated financial results, and will also
affect the Japanese yen value of any amounts we receive from our subsidiaries.
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, June 2000, and March, June and
November, 2001, 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, and in March 2001, options were granted under an incentive stock option
plan which qualified under the Japanese Commercial Code and the Industrial
Revitalization Special Measures Law. 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 generally commenced vesting
one year after the grant date. The warrants granted in 2001 and the stock option
granted in 2001 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 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, 2001. Had such non-cash compensation
expense for our warrants and stock options in 1998, 1999, 2000 and 2001 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)1.7 billion in 1999, approximately
(Yen)2.8 billion in 2000 and approximately (Yen)3.7 billion ($27.9 million) in
2001 and net income per share would have been (Yen)13.36, or (Yen)12.99 on a
fully diluted basis, in 1999, (Yen)21.70, or (Yen)21.20 on a fully diluted
basis, in 2000 and (Yen)28.03 ($0.21) or (Yen)27.77 ($0.21) on a fully diluted
basis, in 2001. Those figures are significantly different than those determined
under Accounting Principles Board Opinion No.25. Those differences result mainly
from the current price of the shares and their expected volatility. The impact
of the pro forma value of the warrants 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 and (Yen)0.9
billion ($6.8 million) which were composed of (Yen)6 billion worth of unsecured
bonds issued in 1999 was redeemed in 2000 and in 2001, respectively. Also
(Yen)0.8 billion ($6.1 million) which was composed of (Yen)6 billion worth of
unsecured bonds issued in 1999 was repurchased in 2001. 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 issued (Yen)5 billion ($37.9 million) worth of unsecured bonds
due March 2004 with detachable warrants in connection with our 2001 incentive
plan in March 2001. The bonds bear interest at the annual rate of 1.75%. We
issued (Yen)1.5 billion ($11.4 million) worth of unsecured bonds due June 2004
with detachable warrants in connection with our 2001 incentive plan in June
2001. The bonds bear interest at the annual rate of 1.5%. We issued (Yen)6
billion ($45.5 million) worth of unsecured bonds due November 2004 with
detachable warrants in connection with our 2001 incentive plan in November 2001.
The bonds bear interest at the annual rate of 1.75%. (Yen)6 billion ($45.5
million) which was composed of (Yen)6 billion worth of unsecured bonds issued in
November, 2001 was repurchased in December, 2001. 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.
-24-
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000 AND 2001
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.
-25-
FOR THE YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------
2000 2000 2001 2001 2001
---------------- ------- ----------------- ------- --------
(in thousands, except percentages)
Net sales .................................... (Yen) 20,070,366 100.0% (Yen) 31,326,321 100.0% $237,321
Cost of sales ................................ 1,474,689 7.3 1,898,971 6.1 14,387
---------------- ------- ----------------- ------- --------
Gross profit ............................. 18,595,677 92.7 29,427,350 93.9 222,934
---------------- ------- ----------------- ------- --------
Operating expenses:
Selling .................................. 5,445,167 27.2 7,177,519 22.9 54,375
Research and development ................. 2,043,480 10.2 2,755,200 8.8 20,873
General and administrative ............... 5,303,661 26.4 9,725,458 31.0 73,678
Goodwill amortization .................... 276,286 1.4 - - -
Goodwill write-off ....................... - - 2,253,559 7.2 17,072
---------------- ------- ----------------- ------- --------
Total operating expenses ............. 13,068,594 65.2 21,911,736 69.9 165,998
---------------- ------- ----------------- ------- --------
Operating income ............................. 5,527,083 27.5 7,515,614 24.0 56,936
Other income (expense):
Interest income .......................... 241,133 1.2 393,254 1.3 2,979
Interest expense ......................... (220,960) (1.1) (296,625) (1.0) (2,247)
Gain on sales of marketable securities ... 119,650 0.6 19,975 0.1 151
Foreign exchange gain (loss), net ........ 283,305 1.4 585,671 1.9 4,437
Other income (expense), net .............. 941,500 4.7 (461,312) (1.5) (3,494)
---------------- ------- ----------------- ------- --------
Total other income ................... 1,364,628 6.8 240,963 0.8 1,826
Income before income taxes, minority
interest And equity in loss of affiliated
companies ................................. 6,891,711 34.3 7,756,577 24.8 58,762
Income taxes:
Current .................................. 4,701,426 23.4 4,214,459 13.5 31,928
Deferred ................................. (1,578,889) (7.9) (973,338) (3.1) (7,374)
---------------- ------- ----------------- ------- --------
3,122,537 15.5 3,241,121 10.4 24,554
---------------- ------- ----------------- ------- --------
Income before minority interest and
equity in losses of affiliated
companies ................................. 3,769,174 18.8 4,515,456 14.4 34,208
---------------- ------- ----------------- ------- --------
Minority interest in income of a
consolidated subsidiary ................... 6,845 0.1 - - -
---------------- ------- ----------------- ------- --------
Income from consolidated companies ........... 3,762,329 18.7 4,515,456 14.4 34,208
Equity in losses of affiliated companies ..... 87,672 0.4 129,544 0.4 981
---------------- ------- ----------------- ------- --------
Net income ................................... (Yen)3,674,657 18.3% (Yen)4,385,912 14.0% $ 33,227
---------------- ------- ----------------- ------- --------
NET SALES
Net sales increased 56.1% from (Yen)20.1 billion in 2000 to (Yen)31.3
billion ($237.3 million) in 2001. The increase was due to increased sales of
internet-based products such as InterScan VirusWall and ScanMail, which grew
from approximately (Yen)7.8 billion or 39% of our net sales in 2000 to
approximately (Yen)10.1 billion ($76.3 million) or 32% of our net sales in 2001.
Net sales of server-based products, primarily ServerProtect, increased from
approximately (Yen)2.5 billion or 13% of our net sales in 2000 to approximately
(Yen) 3.4 billion ($25.8 million) or 11% of our net sales in 2001, 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, increased from approximately
(Yen)4.0 billion of net sales in 2000 to approximately (Yen)11.3 billion ($85.5
million) of net sales in 2001. Net sales of anti-virus software for personal
computers, including retail package sales of PC-cillin/Virus Buster, increased
from approximately 20% of net sales in 2000 to approximately 36% of net sales in
2001. Within the personal computer product category, retail package sales of
personal computer software increased from approximately (Yen)0.9 billion in 2000
to approximately (Yen)5.5 billion ($41.6 million) in 2001,
-26-
due primarily to increased sales of our products in our Japanese market. We
released Virus Buster 2002 in November 2001. Site license sales of personal
computer software to corporate end users increased from approximately (Yen) 3.1
billion in 2000 to approximately (Yen) 5.8 billion ($43.9 million) in 2001.
Our net sales include a limited amount of sales of our products to
other companies for inclusion in their products. Sales of these products was
approximately (Yen) 0.4 billion in 2000 and a percentage of net sales was 2% in
2000. From 2001, these sales are allocated to internet-based products,
server-based products and anti-virus software for personal computers. Our net
sales also include revenues from post-contract customer support fees and
royalties. Sales, other than product sales, increased from approximately (Yen)
4.0 billion in 2000 to approximately (Yen) 5.4 billion ($41.1 million) in 2001.
The increase was due primarily to increased renewals of post-contract customer
support by corporate customers. In terms of a percentage of net sales, sales,
other than product sales, decreased from approximately 20% in 2000 to
approximately 17% in 2001. Net sales of products developed by ipTrend, which
totaled approximately (Yen) 1.4 billion and (Yen) 1.1 billion ($8.6 million) or
6% and 4% of net sales in each of 2000 and 2001, respectively.
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. Cost of sales increased 28.8 % from approximately (Yen) 1,474.7 million
in 2000 to approximately (Yen) 1,899.0 million ($14.4 million) in 2001. The
increase was primarily due to the increase in retail package sales for personal
computer software.
OPERATING EXPENSES
Operating expenses increased 67.7% from approximately (Yen) 13.1
billion in 2000 to approximately (Yen) 21.9 billion ($166.0 million) in 2001.
SELLING EXPENSES
Selling expenses consist primarily of advertising and selling
commissions. Selling expenses were approximately (Yen) 5.4 billion in 2000 and
approximately (Yen) 7.2 billion ($54.4 million) in 2001, an increase of 31.8%.
The increase was primarily due to increased personnel expenses resulting from an
increase in the number of employees from 404 in 2000 to 455 in 2001.
RESEARCH AND DEVELOPMENT EXPENSES
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 34.8% from
approximately (Yen) 2,043.5 million in 2000 to approximately (Yen) 2,755.2
million ($20.9 million) in 2001. Research and development personnel increased
from 365 at December 31, 2000 to 490 at December 31, 2001. 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 EXPENSES
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 83%
from approximately (Yen) 5.3 billion in 2000 to approximately (Yen) 9.7 billion
($73.6 million) in 2001, representing approximately 26% and 31% 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
-27-
existing employees. Employees engaged in activities other than research and
development increased from 398 at December 31, 2000 to 477 at December 31, 2001.
We expect general and administrative costs to increase in absolute terms in
future periods as we expand our operations.
GOODWILL AMORTIZATION AND GOODWILL WRITE-OFF
In February 2000, we acquired a controlling interest in ipTrend
Incorporated for the purpose of making inroads into UNIX-based operating
systems, and Internet platform technology, especially in Linux systems. ipTrend
effectively became a wholly-owned subsidiary upon acquisition of the remaining
minority interest in November 2000. The total purchase price was (Yen)2.8
billion and (Yen)2.5 billion was allocated to goodwill. However, based on a
revaluation of our strategy for ipTrend's business and ipTrend's performance, in
July 2001, we decided to curtail ipTrend's business, and ipTrend was liquidated
in December 2001 after transferring Trend Micro main business to IPSQUARE, an
unrelated third party, and its Security Appliance Server business to it in
August 2001. The assets of (Yen) 40 million ($0.3 million) and the liabilities
of (Yen) 29 million ($0.2 million) were transferred to or assumed by IPSQUARE at
their carrying amount without any gain or loss on the transaction. As a result
of the curtailment of ipTrend's business, we wrote off the unamortized goodwill
balance of (Yen)2.2 billion ($17.1 million). Goodwill amortization of (Yen)276
million and the write-off of (Yen)2.2 billion ($17.1 million) are included in
operating income for the year ended December 31, 2000 and 2001, respectively.
OTHER INCOME (EXPENSE)
We earned interest income of approximately (Yen) 241.1 million during
2000 and approximately (Yen) 393.3 million ($3.0 million) during 2001. Interest
income in 2001 is received mainly from our investment in bonds issued by
SOFTBANK and cash in bank.
We recognized a gain on sales of marketable securities of approximately
(Yen) 119.7 million and (Yen) 20.0 million in 2000 and 2001, respectively. The
gain primarily resulted from our sale in shares of common stock of March First,
a Nasdaq-listed U.S. technology company and Open Loop Inc, a Nasdaq Japan listed
Japan technology company in 2000 and 2001, respectively.
In 2000, we earned gain on settlement of litigation with Network
Associates of (Yen) 1 billion, net of related fees for lawyers of (Yen) 307
million in total.
INCOME TAXES
Our statutory tax rate was 42.1% in 2000 and 2001. Our effective tax
rate was 45.3% in 2000 and 41.8% in 2001. The difference between our statutory
and effective tax rates in 2000, resulted primarily from a change in valuation
allowance for deferred tax assets.
-28-
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999 AND 2000
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------
1999 1999 2000 2000
---------------- ------ ---------------- ------
(in thousands, except percentages)
Net sales ............................................... (Yen) 13,633,170 100.0% (Yen) 20,070,366 100.0%
Cost of sales ........................................... 481,574 3.5 1,474,689 7.3
---------------- ------ ---------------- ------
Gross profit ........................................ 13,151,596 96.5 18,595,677 92.7
---------------- ------ ---------------- ------
Operating expenses:
Selling ............................................. 3,453,296 25.3 5,445,167 27.2
Research and development ............................ 994,340 7.3 2,043,480 10.2
General and administrative .......................... 4,772,038 35.0 5,303,6612 6.4
Goodwill amortization ............................... - - 276,286 1.4
---------------- ------ ---------------- ------
Total operating expenses ......................... 9,219,674 67.6 13,068,594 65.2
---------------- ------ ---------------- ------
Operating income. ....................................... 3,931,922 28.9 5,527,083 27.5
Other income (expense):
Interest income ......................................... 148,487 1.1 241,133 1.2
Interest expense .................................... (66,526) (0.5) (220,960) (1.1)
Gain on sales of marketable securities .............. 280,532 2.1 119,650 0.6
Foreign exchange gain (loss), net ................... (174,921) (1.3) 283,305 1.4
Other income (expense), net ............................. (120,298) (1.0) 941,500 4.7
---------------- ------ ---------------- ------
Total other income .............................. 67,274 0.4 1,364,628 6.8
---------------- ------ ---------------- ------
Income before income taxes, minority interest and
equity in loss of affiliated companies .............. 3,999,196 29.3 6,891,711 34.3
--------- ---- --------- ----
Income taxes:
Current ............................................. 2,538,455 18.6 4,701,426 23.4
Deferred ............................................ (688,988) (5.1) (1,578,889) (7.9)
---------------- ------ ---------------- ------
1,849,467 13.5 3,122,537 15.5
---------------- ------ ---------------- ------
Income before minority interest and equity in losses
of affiliated companies ............................. 2,149,729 15.8 3,769,174 18.8
Minority interest in income of a consolidated
subsidiary .......................................... - - 6,845 0.1
Income from consolidated companies ...................... 2,149,729 15.8 3,762,329 18.7
Equity in losses of affiliated companies ................ 2,356 0.0 87,672 0.4
Net income .............................................. (Yen) 2,147,373 15.8% (Yen) 3,674,657 18.3%
---------------- ------ ---------------- ------
NET SALES
Net sales increased 47.2% from (Yen) 13.6 billion in 1999 to (Yen) 20.1
billion 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 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 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 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 in 2000, due primarily to increased sales of our products in
our Asian
-29-
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 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 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 post-contract
customer support fees and royalties. Sales, other than product sales, increased
from approximately (Yen) 1.4 billion in 1999 to approximately (Yen) 4.0 billion
in 2000. The increase was due primarily to increased renewals of post-contract
customer support by corporate customers. In terms of a percentage of net sales,
sales, other than product sales, increased from approximately 10% in 1999 to
approximately 20% in 2000.
Net sales of other products, which totaled approximately (Yen) 0.2
billion and (Yen) 1.4 billion or 2% and 6% of net sales in each of 1999 and
2000, respectively. The increase was primarily due to increased sales related
with ipTrend.
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. Cost of sales increased 206.2 % from approximately (Yen) 481.6 million
in 1999 to approximately (Yen) 1,474.7 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 41.7% from approximately (Yen) 9.2 billion
in 1999 to approximately (Yen) 13.1 billion in 2000.
SELLING EXPENSES
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 in 2000, an increase of 57.7%. 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 EXPENSES
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
in 2000. Research and development personnel 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.
GENERAL AND ADMINISTRATIVE EXPENSES
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
-30-
11% from approximately (Yen) 4.7 billion in 1999 to approximately (Yen) 5.3
billion in 2000, representing approximately 35% and 26% 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.
GOODWILL AMORTIZATION
In February 2000, we acquired a controlling interest in ipTrend.
ipTrend effectively became a wholly owned subsidiary in November 2000, when the
remaining minority interest was acquired. The total purchase price was (Yen)2.8
billion and (Yen)2.5 billion was allocated to goodwill. In 2000, (Yen) 276
million was booked as goodwill amortization.
OTHER INCOME (EXPENSE)
We earned interest income of approximately (Yen) 148.5 million during
1999 and approximately (Yen) 241.1 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. The gain primarily resulted from our sale in
shares of common stock of March First, a Nasdaq-listed U.S. technology company.
In 2000, we earned gain on settlement of litigation with Network
Associates of (Yen) 1 billion, net of related fees for lawyers of (Yen) 307
million 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 changes in valuation allowance
for deferred tax assets in 1999 and an amortization of goodwill in 2000.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
We believes the following critical accounting policies affect our more
significant judgments and estimates used in the preparation of our consolidated
financial statements:
. revenue recognition;
. Allowance for sales returns and allowance for doubtful accounts;
. accounting for income taxes;
. valuation of long-lived and intangible assets and goodwill;
REVENUE RECOGNITION
We derive our revenues primarily from (1) software product license, (2)
post-contract customer support which includes virus pattern updates, product
version updates, telephone and online technical support and free use of our
24-hour service centers, and (3) royalties. As described below, significant
management judgments and estimates must be made and used in connection with the
revenue recognized in any accounting period. Material differences may result in
the amount and timing of our revenue for any period if our management makes
different judgments or utilizes different estimates.
In accordance with the provisions of Statement of Position 97-2,
"Software Revenue Recognition," as amended by Statement of Position 98-9,
"Modification of SOP 97-2, Software Revenue Recognition, With Respect to Certain
Transactions", we recognize revenue from software product licenses when
persuasive evidence of an arrangement exists, the product has been delivered,
the fee is fixed and determinable, and collection of the resulting receivable is
reasonably assured. Delivery generally occurs when product is shipped or
electronically delivered. The portion of the license fee attributable to post-
contract customer support services 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.
-31-
At the time of the transaction, we assess whether the fee associated
with our revenue transactions is fixed and determinable and whether or not
collection is reasonably assured. We assess whether the fee is fixed and
determinable based on the payment terms associated with the transaction. If a
significant portion of a fee is due after our normal payment terms, which are 30
to 90 days from the invoice date, we account for the fee as not being fixed and
determinable. In these cases, we recognize revenue as the fees become due.
We assess collection based on a number of factors, including past
transaction history with the customer and the credit-worthiness of the customer.
We do not request collateral from our customers. If we determine that collection
of a fee is not reasonably assured, we defer the fee and recognize revenue at
the time collection becomes reasonably assured, which is generally upon receipt
of cash.
For all of our sales, we use either a binding purchase order or signed
license agreement as evidence of an arrangement. Sales through our distributors
are evidenced by a master agreement governing the relationship together with
binding purchase orders on a transaction by transaction basis.
We allocate revenue to post-contract customer support services based on
the fair value of the post-contract customer support services, which are
determined based on separate sales of renewals to customers.
ALLOWANCE FOR SALES RETURNS AND ALLOWANCE FOR DOUBTFUL ACCOUNTS
The preparation of financial statements requires our management to make
estimates and assumptions that affect the reported amount of assets and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the reported
period. Specifically, our management must make estimates of potential future
product returns related to current period product revenue. Management analyzes
historical returns, current economic trends, and changes in customer demand and
acceptance of our products when evaluating the adequacy of the sales returns.
Significant management judgments and estimates must be made and used in
connection with establishing the sales returns in any accounting period.
Material differences may result in the amount and timing of our revenue for any
period if management made different judgments or utilized different estimates.
The balance of allowance for sales returns was (Yen) 643,622 thousand
($4,876 thousand) as of December 31, 2001. Similarly, our management must make
estimates of the uncollectability of our accounts receivables. Management
specifically analyzes accounts receivable and analyzes historical bad debts,
customer concentrations, customer credit-worthiness, current economic trends and
changes in our customer payment terms when evaluating the adequacy of the
allowance for doubtful accounts. Our accounts receivable balance was (Yen)
11,430,383 thousand ($86,594 thousand), net of allowance for doubtful accounts
and sales returns of (Yen) 850,376 thousand ($6,442 thousand), as of
December 31, 2001.
ACCOUNTING FOR INCOME TAXES
As part of the process of preparing our consolidated financial
statements, we are required to estimate our income taxes in each of the
jurisdictions in which we operate. This process involves our estimating our
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items, such as deferred revenue, for tax
and accounting purposes. These differences result in deferred tax assets and
liabilities, which are included within our consolidated balance sheet. We must
then assess the likelihood that our deferred tax assets will be recovered from
future taxable income and to the extent we believe that recovery is not likely,
we must establish a valuation allowance. To the extent we establish a valuation
allowance or increase this allowance in a period, we must include an expense
within the tax provision in the statement of operations.
-32-
Significant management judgment is required in determining our
provision for income taxes, our deferred tax assets and liabilities and any
valuation allowance recorded against our net deferred tax assets. We have
recorded this valuation allowance of (Yen) 207,099 thousand ($1,569 thousand)
million as of December 31, 2001, due to uncertainties related to our ability to
utilize some of our deferred tax assets, primarily consisting of certain net
operating losses carried forward before they expire. The valuation allowance is
based on our estimates of taxable income by jurisdiction in which we operate and
the period over which our deferred tax assets will be recoverable. In the event
that actual results differ from these estimates or we adjust these estimates in
future periods we may need to establish an additional valuation allowance which
could materially impact our financial position and results of operations.
The net deferred tax asset as of December 31, 2001 was(Yen) 4,190,796
thousand($31,749 thousand), net of a valuation allowance of (Yen) 207,099
thousand ($1,569 thousand).
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS AND GOODWILL
We assess the impairment of identifiable intangibles, long-lived assets
and related goodwill whenever events or changes in circumstances indicate that
the carrying value may not be recoverable. Factors we consider important which
could trigger an impairment review include the following:
. significant underperformance relative to expected historical or
projected future operating results;
. significant changes in the manner of our use of the acquired assets
or the strategy for our overall business;
. significant negative industry or economic trends;
. significant decline in our stock price for a sustained period; and
. our market capitalization relative to net book value.
When we determine that the carrying value of intangibles, long-lived
assets and related goodwill may not be recoverable based upon the existence of
one or more of the above indicators of impairment, we measure any impairment
based on a projected discounted cash flow method using a discount rate
determined by our management to be commensurate with the risk inherent in our
current business model. Net intangible assets and long-lived assets amounted to
(Yen) 3,123,336 thousand ($23,662 thousand)as of December 31, 2001. We did not
have any goodwill balances as of December 31, 2001.
RECENT ACCOUNTING PRONOUNCEMENTS
Business combinations and goodwill and intangible assets
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("FAS") No.141 "Business
Combinations" which supersedes Accounting Principles Board Opinion ("APB") No.16
"Business Combinations" and FAS No.142, "Goodwill and Intangible Assets" which
supersedes APB No.17 "Intangible Assets." FAS No. 141 requires the use of the
purchase method of accounting for business combinations and prohibits the use of
the pooling of interests method which was previously permitted under APB No.16,
for business combinations initiated after June 30, 2001. FAS No.141 also refines
the definition of intangible assets acquired in a purchase business combination.
As a result, the purchase price allocation of future business combinations may
be different than the allocation that would have resulted under the old rules.
FAS No.142 eliminates the amortization of goodwill, requires annual
impairment testing of goodwill and introduces the concept of indefinite life
intangible assets. The new rules also prohibit the amortization of goodwill
associated with business combinations that close after June 30, 2001.
These new requirements will impact future period net income by an
amount adjusted for any differences between the old and new rules for defining
intangible assets on future business combinations. Although FAS No. 142 requires
to perform an initial transition impairment test in 2002, the Company did not
have any goodwill balances as of December 31, 2001.
Impairment or disposal of long-lived assets
In October 2001, the FASB issued FAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." FAS No. 144 addresses significant
issues relating to the implementation of FAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of,"
and develops a single accounting model, based on the framework established in
FAS No. 121 for long-lived assets to be disposed of by sale, whether such assets
are or are not deemed to be a business. SFAS No. 144 also modifies the
accounting and disclosure rules for discontinued operations. The standard was
adopted on January 1, 2002, and is not expected to have a material effect on the
Company's results of operations and financial position.
Accounting for asset retirement obligations
In August 2001, the FASB issued FAS No. 143, "Accounting for Assets
Retirement Obligations." SFAS No. 143 provides accounting and reporting guidance
for legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction or normal operation of a long-lived
asset. The standard is effective January 1, 2003. The Company is reviewing the
provisions of this standard. Its adoption is not expected to have a material
effect on the financial statements.
FAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections"
In April 2002, the FASB issued FAS No. 145, effective for the fiscal
years beginning or transactions occurring after May 15, 2002. This statement
rescinds certain authoritative pronouncements and amends, clarifies or describes
the applicability of others. The Company is now in the process of assessing the
impact that the statement will have on the Company's results of operations and
financial position.
B. Liquidity and Capital Resources.
At December 31, 2001, we had cash and cash equivalents and marketable
securities of approximately (Yen) 42.6 billion ($323.0 million), up from
approximately (Yen) 26.3 billion at December 31, 2000. The increase was
primarily due to operating activities and proceeds from our issuance of bonds.
Net cash provided by operating activities of approximately (Yen) 12.2
billion ($92.7 million) in 2001 and (Yen) 6.1 billion in 2000. The increase from
2000 to 2001 was primarily due to an increase of net income, an
-33-
increase in deferred revenue associated with increased net sales 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) 4.1
billion in 2000 and approximately (Yen) 2.9 billion ($22.1 million) in 2001. The
decrease from 2000 to 2001 was primarily due to a (Yen) 2.6 billion ($19.5
million) increase in proceeds from sales of marketable securities and no cash
payments for acquisition, net of cash acquired, which was occurred in 2000. This
decrease was partially offset by a (Yen) 2.5 billion ($18.9 million) increase in
payment for purchases of marketable securities and (Yen) 0.9 billion ($6.7
million) increase in payments for purchases of fixed assets.
Net cash provided by financing activities was approximately (Yen) 6.5
billion in 2000 and approximately (Yen) 5.8 billion ($43.8 million) in 2001. Net
cash provided by financing activities in 2000 and 2001 consisted primarily of
proceeds from our issuance of bonds in connection with our 2000 and 2001
warrants less payments for repurchasing treasury bonds in 2001.
During 2001, a significant portion of our cash inflows were generated
by our operations. Because our operating results may fluctuate significantly, as
a result of decrease in customer demand or decrease in the acceptance of our
future products, our ability to generate positive cash flow from operations may
be jeopardized.
In 2000, we issued (Yen) 5 billion worth of unsecured bonds in
connection with our 2000 incentive plan and in 2001, we issued (Yen) 12.5
billion ($94.7 million) worth of unsecured bonds in connection with our 2001
incentive plan. (Yen) 1.3 billion and (Yen) 0.9 billion ($6.8 million) which
were composed of (Yen) 6 billion worth of unsecured bonds issued in 1999 were
redeemed in 2000 and 2001 respectively. (Yen) 0.8 billion ($6.1 million) which
was composed of (Yen) 6 billion worth of unsecured bonds issued in 1999 and
(Yen) 6 billion ($45.5 million) which was composed of (Yen) 6 billion worth of
unsecured bonds issued in 2001 were repurchased in 2001. In order to reduce
interest costs, we repurchased some of the bonds in the market with an intention
to hold the treasury bonds until they can be extinguished legally. As the
repurchase transaction is deemed as redemption of the bonds in substance, the
treasury bonds are offset with the bonds on the face of consolidated balance
sheets [meaning unclear]. We used the proceeds of the bond issuance for working
capital and general corporate purposes.
Future payments due under debt and lease obligations as of December 31
(in thousands):
Non-cancelable Total in
Year ending December 31: long-term debt operating leases Total U.S. $
---------------- ----------------- --------------- --------
2002 ....................... (Yen) 3,000,000 (Yen) 976,558 (Yen) 3,976,558 $ 30,125
2003 ....................... 5,000,000 428,861 5,428,861 41,128
2004 ....................... 6,500,000 427,343 6,927,343 52,479
2005 ....................... - 425,795 425,795 3,226
2006 ....................... - 101,585 101,585 770
2007 and thereafter ........ - 9 9 0
---------------- ----------------- ---------------- --------
Total ...................... (Yen) 14,500,000 (Yen) 2,360,151 (Yen) 16,860,151 127,728
---------------- ----------------- ---------------- --------
We had no commercial commitments as of December 31, 2001.
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, 2001, no amounts were outstanding under these overdraft
agreements.
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
-34-
. 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. Insofar as
we are not able to satisfy our working capital and capital expenditure
requirements we may seek to raise additional equity or debt financing. However,
we cannot be sure that such funding will be available on commercially reasonable
terms, if at all.
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., Taiwan, Germany and China subsidiaries and have a
research staff of 571 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.
Research and development expenditures, consisting primarily of software
development costs and research and development staff salaries and benefits,
increased from (Yen) 994.3 million in 1999 to (Yen) 2043.5 million in 2000 and
(Yen) 2755.2 million ($20.9 million) in 2001.
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 EXPIRATION APPLICANT/
NAME STATUS DATE NUMBER DATE PATANTEE
------------------------------- ---------- ------------ ------------ ---------- ----------------------
Method and apparatus for Patented 8/22/1995 5,444,850 8/3/2013 Trend Micro Inc. (USA)
controlling network and
workstation access prior to
workstation boot
Virus detection and removal Patented 4/22/1997 5,623,600 9/25/2015 Trend Micro Inc. (USA)
apparatus for computer networks
Method and apparatus for Patented 10/21/1997 5,680,547 8/7/2015 Trend Micro
controlling network and Incorporated (Taiwan)
workstation access prior to
workstation boot
Apparatus and method for Patented 3/30/1999 5,889,943 3/28/2016 Trend Micro
electronic mail virus detection Incorporated (Taiwan)
and elimination
System, apparatus and method Patented 9/14/1999 5,951,698 10/1/2016 Trend Micro
for the detection and removal Incorporated (Taiwan)
of viruses in macros
Event triggered iterative virus Patented 9/28/1999 5,960,170 3/17/2017 Trend Micro
detection Incorporated (Taiwan)
Computer network malicious code Patented 11/9/1999 5,983,348 9/9/2017 Trend Micro Inc. (USA)
scanner
-35-
REGISTRATION REGISTRATION EXPIRATION APPLICANT/
NAME STATUS DATE NUMBER DATE PATANTEE
------------------------------- ---------- ------------ ------------ ---------- ----------------------
Controlled distribution of Patented 9/12/2000 6,119,165 11/16/2017 Trend Micro Inc. (USA)
application programs in a
computer network
Computer network malicious code Patented 8/7/2001 6,272,641 11/8/2019 Trend Micro Inc. (USA)
scanner method and apparatus
We plan to transfer the ownership of these patents to Trend Micro
(Japan).
We do not typically enter into signed license agreements with our
corporate, government and institutional customers who license products directly
from us. We include an electronic version of a "shrinkwrap" license in all of
our electronically distributed software and a printed license in the box for our
packaged products in order to protect our copyrights in those products. The
enforceability of these licenses generally is uncertain in the United States as
well as in foreign jurisdictions. In addition, the laws of some foreign
countries either do not protect proprietary rights or offer only limited
protection for those rights.
In addition, as is common in the software industry, third parties may sue
us for alleged infringement of their intellectual property rights. We may also
have to take legal action to defend our intellectual property from infringement.
We also generally enter into confidentiality agreements with our
employees, and limit access to and distribution of proprietary information.
D. Trend Information.
The information required by this Item is set forth in Item 5.A of this
annual report.
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 May 31, 2002.
Number of
Month in which Shares owned
Current as of
Name Age Position(s) Term Expires May 31, 2002
---------------------- ----- ------------------------------------------- -------------- ------------
Steve Ming-Jang Chang 47 Representative Director; President, Chief March, 2003 5,208,000
Executive Officer and Chairman of Officer
and Executive Vice President the Board
Mahendra Negi 42 Representative Director, Chief Financial March, 2003 0
Officer
Eva Yi-Fen Chiang 43 Director; Chief Technology Officer and March, 2003 2,816,000
Executive Vice President
Mike Conner 46 Director, President of Trend Micro North March, 2003 0
American Operations, Senior Vice President
Nick Dederer 51 Director, Chief Operating Officer and March, 2003 0
Executive Vice President
Edward Tian 38 Director March, 2003 0
Fumio Hasegawa 62 Statutory Auditor March, 2005 500
Sadatoshi Nakayama 50 Statutory Auditor March, 2005 0
Yasuo Kameoka 46 Statutory Auditor March, 2005 0
Kouji Fujita 40 Statutory Auditor March, 2005 0
-36-
Steve Ming-Jang Chang is the founder and Chief Executive Officer of Trend
Micro. Chang formed Trend Micro, in California, in 1988, with the goal of
developing anti-virus software for personal computers. Prior to launching Trend
Micro, Chang worked as an engineer at Hewlett Packard and later founded AsiaTek,
Inc., - a Taiwan-based UNIX software design company. Steve Chang received his
B.S. in Applied Mathematics from Fu-Jen Catholic University in Taiwan and his
M.S. in Computer Science from Lehigh University, Pennsylvania.
Mahendra Negi is the Chief Financial Officer of Trend Micro, and sits on
the Board of Directors. He joined Trend Micro in May 2000 from Merrill Lynch.
Negi started his career in the petroleum industry, and then moved to commercial
banking before joining Merrill Lynch. He holds a Ph.D. in Physics from Nagpur
University in India in addition to his Ph.D. in Management from the London
Business School.
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.
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 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 Vice President of Sales before
coming to Trend Micro. Mike Conner graduated from Western Illinois University
with a B.S. degree.
Nick Dederer is the Chief Operating Officer of Trend Micro, and sits on
the Board of Directors. He joined Trend Micro in 2000 as Corporate Vice
President, from Intel Corporation. Nick Dederer holds M.A. in Business
Administration, Finance emphasis from University of California Berkeley.
Dr. Edward Suning Tian is the CEO of China Netcom, a 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 in China 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.
Sadatoshi Nakayama graduated from Kyoto University's Department of
Science in 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.
Kouji Fujita graduated from Hitotsubasdhi University's Department of
Juristic Law in 1987. He was admitted to the Japanese Bar, joined Okuno &
Partners legal office in April 1989. He became one of our Statutory Auditors in
March 2002.
B. Compensation
For the fiscal year ended December 31, 2001, the aggregate compensation
of all directors and executive officers paid or accrued by Trend Micro was (Yen)
68.8 million ($521 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 and statutory auditors. We have an internal
formula to determine the amounts of severance payments to statutory auditors if
we were to make
-37-
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, 1999, 2000 and 2001 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 a director is two years, although they may serve any
number of consecutive terms. We do not have an audit or recommendation
committee, a 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 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. However, in May, 2002, the Japanese
Commercial Code was amended to require that statutory auditors serve for a
period of 4 years, except that the statutory auditors who were in office both at
May 1, 2002 and who remain so at the time of our ordinary shareholders' meeting
in 2002 will serve for a period of three years. We intend to propose to our
shareholders at our next shareholders' meeting that our Articles of
Incorporation be amended to reflect this change. Our executive officers serve at
the discretion of the Board of Directors. The terms of Messrs. Chang, Negi,
Conner, Dederer and Tian and Ms.Chiang expire upon the completion of our
ordinary shareholders' meeting in 2003. The terms of Messrs. Hasegawa, Nakayama,
Kameoka and Fujita expire upon completion of our ordinary shareholders' meeting
in 2005.
Pursuant to the home country practices exception granted to us by the
Nasdaq National Market, we are permitted to follow corporate governance
practices complying with relevant Japanese laws and Japanese stock exchange
rules, which are different from those followed by U.S. domestic companies under
Nasdaq's listing standards. Nasdaq rules and our current practices relating to
corporate governance have the following significant differences:
. Audit Committee. Nasdaq requires that a U.S. domestic company
registered with Nasdaq have an audit committee consisting of at least
three independent directors, and that the audit committee be charged
with the responsibility of selecting, monitoring and communicating
with the outside auditor of the company to ensure the outside
auditor's independence. Pursuant to the home country practices
exception, we do not have an audit committee with functions called for
by Nasdaq rules.
. Shareholder Approval Policy. Nasdaq requires that shareholder approval
be obtained prior to issuance by a U.S. domestic company registered
with Nasdaq of stock options or a purchase plan to officers or
directors except, among others, when the plan under which the amount
of securities issued does not exceeds 1% of number of shares of common
stock, or the voting power outstanding or 25,000 shares. Pursuant to
the home country practices exception, we only follow relevant Japanese
laws which, as discussed in "Voting Rights" under Item 10.B of this
annual report, generally require us to obtain shareholder approval if
stock options are to be issued with "specially favorable" conditions.
Nasdaq also requires that, with certain exceptions specified in its
rules, in connection with acquisition of stock or assets of another
company, shareholder approval be obtained prior to issuance of common
stock or securities convertible into or exercisable for common stock
(1) if any director, and officer or substantial shareholder has a 5%
interest, or all of them collectively have a 10% interest, in the
stock or assets and the issuance would increase the outstanding common
shares or voting power by more than 5%, and (2) if due to the issuance
the voting power of the common stock equals or exceeds 20% of the
voting power outstanding before the issuance or if the number of
shares of the common stock is equals or exceeds 20% of the number of
shares outstanding before the issuance. Pursuant to the home country
practices exception, we only follow relevant Japanese laws which, as
discussed in "Voting Rights" under Item 10.B of this
annual report, generally require us to obtain shareholder approval
with respect to the issuance of new shares at a "specially favorable"
price or issuance of bond with share acquisition right with "specially
favorable" terms or of acquisition right with "specially favorable"
terms to person other than shareholders.
The Listing and Hearing Review Council of the Nasdaq Stock Market recently
issued a series of recommendations to the Securities and Exchange Commission to
modify several disclosure and corporate governance requirements. Under the
current proposals, non-U.S. issuers such as Trend Micro would continue to be
able to follow home country practices with respect to corporate governance
requirements. If and when the proposed rules are finally adopted after the
Securities and Exchange Commission's approval, there would be additional
significant differences other than those discussed above between the Nasdaq
rules and our current practices relating to corporate governance.
The rights of ADR holders, including their rights relating to corporate
governance practices, are provided in the deposit agreement which is an exhibit
to this annual report.
D. Employees.
As of May, 2002, we had 1,685 employees, of whom 1,069 are located in
Asia, 304 are located in the United States, 238 are located in Europe and 74 are
located in other regions. And of the 1,685 employees, 223 were in administrative
positions, 571 were in sales and marketing positions, 574 were in research and
development positions and 317 were in technical support positions.
As of December 31, 2001, we had 1,422 employees, of whom 191 were in
administrative positions, 455 were in sales and marketing positions, 490 were in
research and development positions, 286 were in technical support positions.
As of December 31, 2000, we had 1,167 employees, of whom 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.
Our employees do not belong to any labor union. We believe that our
employee relations are good.
E. Share Ownership.
See Item 6.A for information on share ownership of our directors
and senior management.
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
-38-
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, 2002, warrants
to purchase a total of 8,533,200 shares have been exercised, warrants to
purchase a total of 748,800 shares have been retired, warrants to purchase a
total of 947,400 shares have been expired, and warrants to purchase a total of
424,200 shares remain issued and outstanding. From June 1 to June 7, 2002, 8,400
shares have been exercised, and on June 7, 2002, remained 415,800 shares have
been expired. 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.
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 1,602,000 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
-39-
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, 2002.
Options Total
Number of Shares Aggregate
Name Expiration Date Underlying Exercise Price
---- --------------- ---------------- --------------
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 7/12/2003 173,187 $3,915,600
Officers as a group (10 persons)
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 directors and 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, 2002 under
our 2000 incentive plan.
Total Number of Shares Aggregate
Name Expiration Date Underlying Warrants Exercise Price
---- --------------- ---------------------- --------------
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 45,858 359,985,300
Officers as a group (10 persons)
2001 Incentive Plan
Our Board of Directors has authorized three 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 Aggregate
Name Expiration Date Underlying Warrants Exercise Price
---- --------------- ---------------------- --------------
Mahendra Negi 3/12/2004 13,920 78,996,000
Nick Dederer 3/12/2004 18,325 103,994,375
Directors and Executive 3/12/2004 32,245 182,990,375
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
-40-
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
---- --------------- ----------------- --------------
Eva Yi - Fen Chiang 5/28/2004 9,722 55,998,720
Mike Conner 5/17/2004 8,000 46,080,000
Directors and Executives 5/17/2004 17,722 102,078,720
Officers as a group (10 persons) 5/28/2004
The third plan was authorized in November 2001. Warrants for a total of
2,316,602 shares were issued at an exercise price of (Yen) 2,590. The following
table shows information about the warrants granted to our directors and
executive officers under the third 2001 incentive plan.
Total Number of Shares Aggregate
Name Expiration Date Underlying Warrants Exercise Price
---- -------------- ---------------------- --------------
Steve Ming-Jang Chang 11/12/2004 62,548 161,999,320
Mahendra Negi 11/12/2004 50,579 130,999,610
Eva Yi-Fen Chiang 11/12/2004 45,559 117,997,810
Mike Conner 11/12/2004 37,451 96,998,090
Nick Dederer 11/12/2004 42,471 109,999,890
Edward Tian 11/12/2004 8,494 21,999,460
Directors and Executive 11/12/2004 247,102 639,994,180
Officers as a group (10 persons)
2002 Incentive Plan
We have adopted the Trend Micro Incorporated Incentive Plan. The plan was
authorized in April 2002. We have issued warrants for a total of 1,159,420
shares were issued at an exercise price of (Yen) 3,450. The following table
shows information about the warrants granted to our directors and executive
officers under the plan.
Total Number of Shares Aggregate
Name Expiration Date Underlying Warrants Exercise Price
---- -------------- ---------------------- --------------
Steve Ming-Jang Chang 4/11/2006 10,144 34,996,800
Mahendra Negi 4/11/2006 21,739 74,999,550
Eva Yi-Fen Chiang 4/11/2006 21,739 74,999,550
Mike Conner 4/11/2006 14,492 49,997,400
Nick Dederer 4/11/2006 21,739 74,999,550
Edward Tian 4/11/2006 2,898 9,998,100
Directors and Executive 4/11/2006 92,751 319,990,950
Officers as a group (10 persons)
The 2002 Incentive Plan will be approved at an Extraordinary General
Meeting we plan to call in September 2002.
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
-41-
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 May 31, 2002, 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 May 31, 2002 held of record
24,850,000 shares, or 18.7% of the total issued shares, is a corporation
controlled by Yeh Min Yuen. Another record shareholder, Gainway Enterprises
Limited, which as of May 31, 2002 held of record 12,511,000 shares, or 9.4% of
the total issued shares, is a corporation controlled by Liao Hsueh-Hsuan. These
two individuals' beneficial ownership of our common stock is disclosed in the
table below. The third shareholder of record, MLPFS Custody Account No. 2, which
as of May 31, 2002 held of record 12,628,500 shares, or 9.5% 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 May 31, 2002, 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.
(3) We are aware of the filing by Merrill Lynch Investment Managers
Limited that, as of March 31, 2002, it and its affiliates together
owned, beneficially and jointly, 9.5% of the issued shares of our
common stock, as calculated pursuant to the Securities and Exchange
Law of Japan. Subsequently, Merrill Lynch Investment Managers
Limited made another filing, which reported that, as of May 31,
2002, it and its affiliates owned, beneficially and jointly, 5.2%
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 May 31, 2002, 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 ................................. 24,850,000 18.7%
Liao Hsueh-Hsuan ............................. 12,511,000 9.4%
As of December 31, 2001, there were 60 record shareholders of Trend Micro
with addresses in the United States, and those U.S. holders held 10,441,123
shares of our common stock including 1,204,500 held through our ADSs.
To the extent known to us, we are not directly or indirectly owned or
controlled by another corporation, by the Japanese or any other government or by
any other natural or legal persons severally or jointly.
-42-
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 and (Yen) 900
million ($6.8 million) were redeemed in June and September, 2001. To reduce
interest costs, (Yen) 800 million ($6.1 million) were repurchased in September,
2001. The purpose of the repurchase is to hold the treasury bonds until they can
be retired legally and it is same as the redemption substantially. Thus, bonds
and treasury bonds are disclosed in net amount in the balance sheet.
At the time we entered into these transactions, members of our management
were members of SOFTBANK's management and remained so until March 2001.
Investment in SoftTrend Capital. In December 1999, Trend Micro invested
(Yen) 12.5 million in SoftTrend Capital Corporation. As of April 30, 2000, Trend
Micro is a 20% shareholder of SoftTrend Capital. SoftTrend Capital is indirectly
owned by SOFTBANK.
-43-
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
Tokyo Stock Exchange
2000
Third quarter (from August 17) ......... 9,005 6,805
Fourth quarter ......................... 8,100 4,135
2001 .............................................. 6,375 1,670
First quarter .......................... 6,375 3,165
Second quarter ......................... 6,290 4,500
Third quarter .......................... 4,470 1,670
Fourth quarter ......................... 3,380 2,045
2002
First quarter .......................... 3,670 2,935
Second quarter ......................... 3,890 3,180
Calendar Year 2002
January ................................ 3,310 2,935
February ............................... 3,180 2,945
-44-
Yen Price Per Share
------------------------
High Low
------ -----
March .................................... 3,670 3,100
April .................................... 3,560 3,290
May ...................................... 3,700 3,340
June ..................................... 3,890 3,180
On June 28, 2002, the closing sale price of our shares on the Tokyo Stock
Exchange was 3,350 (Yen) 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, retroactively taking into account the
one-into-three stock split effected on September 30, 1999, the one-into-two
stock split effected on March 31, 2001, and the ten-into-one ADR ratio change
which take effect on July 2, 2001.
Dollar Price Per ADS
------------------------
High Low
------- ------
1999 ................................................ $121.25 $23.33
Third quarter ............................ 65.63 23.33
Fourth quarter ........................... 121.25 66.88
2000 ................................................ 159.38 32.50
First quarter ............................ 159.38 82.50
Second quarter ........................... 85.94 50.00
Third quarter ............................ 86.95 59.38
Fourth quarter ........................... 74.38 32.50
2001 ................................................ 59.38 14.50
First quarter ............................ 59.38 28.75
Second quarter ........................... 51.50 37.40
Third quarter ............................ 34.50 14.50
Fourth quarter ........................... 27.05 17.50
2002
First quarter ............................ 27.95 21.75
Second quarter ........................... 30.90 24.65
Calendar Year 2002
January .................................. 24.95 22.31
February ................................. 23.56 21.75
March .................................... 28.60 23.50
April .................................... 27.40 24.65
May ...................................... 29.35 26.21
June ..................................... 30.90 26.91
On June 28, 2002, the closing sale price of the ADSs on The Nasdaq
National Market was $27.44 per ADS.
-45-
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.
General
Our authorized share capital as of May 31, 2002 is 250,000,000 shares,
of which 132,317,000 (taking into account the one-to-two stock split in
March 31, 2001) shares are issued and 132,292,585 shares are outstanding as of
the same date. Under the Japanese Commercial Code, shares must be registered and
are transferable by delivery of share certificates. In order to assert
shareholders' rights against us, a shareholder must have its name and address
registered on our register of shareholders, in accordance with our share
handling regulations. The registered beneficial holder of deposited shares
underlying the ADSs is the depositary for the ADSs. Accordingly, holders of ADSs
will not be able to assert shareholders' rights.
A holder of shares may choose, at its discretion, to participate in the
central clearing system for share certificates under the Law Concerning Central
Clearing of Share Certificates and Other Securities of Japan. Participating
shareholders must deposit certificates representing all of the shares to be
included in this clearing system with Japan Securities Depository Center. If a
holder is not a participating institution in the Securities Center, it must
participate through a participating institution, such as a securities company or
bank having a clearing account with the Securities Center. All shares deposited
with the center will be registered in the name of the Securities Center on our
register of shareholders. Each participating shareholder will in turn be
registered on our register of beneficial shareholders and be treated in the same
way as shareholders registered on our register of shareholders. For the purpose
of transferring deposited shares, delivery of share certificates is not
required. Entry of the share transfer in the books maintained by the Securities
Center for participating institutions, or in the book maintained by a
participating institution for its customers, has the same effect as delivery of
share certificates. The Securities Center system is intended to reduce paperwork
required in connection with transfers of shares. Beneficial owners may at any
time withdraw their shares from deposit and receive share certificates.
Dividends
Under our Articles of Incorporation, our financial accounts will be
closed on December 31 of each year and dividends, if any, will be paid to
shareholders of record at December 31. In addition to year-end dividends, the
Board of Directors may by resolution declare an interim cash dividend to
shareholders of record as of June 30 or each year. Under the Japanese Commercial
Code, however, we cannot declare or pay dividends unless specified financial
criteria are met based on the amount of our stated capital and legal reserves.
Japanese Unit Share System
In accordance with the requirements of the Japanese Commercial Code, our
Articles of Incorporation provide that 500 shares constitute one "unit." The
number of shares constituting a unit is not permitted to exceed 1,000 shares or
one-two-hundredth (1/200) of the number of all issued shares. The unit share
system does not affect the transferability of ADSs, which may be transferred in
lots of any size.
Transferability of Shares Representing Less Than One Unit. Under the
Japanese Commercial Code and the Deposit Agreement, holders of ADSs will be able
to surrender ADSs and withdraw the underlying shares from deposit only in whole
unit lots of one unit or larger. A holder who owns ADRs evidencing less than 500
ADSs will indirectly own less than a whole unit. Such a holder will not be able
to dispose of its shares in lots of less than one unit and will not have access
to the Japanese market through surrender of their ADSs and withdrawal and sale
in Japan of the
-46-
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 First Section
of the Tokyo Stock Exchange on the day a request pertaining to such purchase is
delivered to our transfer agent or, if no sales take place on that day, the
price at which the next sale of shares is effected on the First Section of the
Tokyo Stock Exchange, less applicable brokerage commissions. However, because
holders of ADSs representing less than one unit are not able to withdraw the
underlying shares from deposit, such holders will not be able to exercise this
right as a practical matter.
Other Rights of Holder of Shares Representing Less Than One Unit. Under
our Articles of Incorporation, a holder of shares representing less than one
unit has all the rights that a holder of shares representing a full unit of
shares; except for the rights:
. to require us to issue share certificates;
. to require us to issue replacement certificates for lost, stolen or
destroyed share certificates; and
. to vote.
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 unit held.
General Meeting of Shareholders
We normally hold our ordinary general meeting of shareholders in March
of each year in Tokyo, Japan. In addition, we may hold an extraordinary general
meeting of shareholders whenever necessary by giving at least two weeks' advance
notice. Under the Japanese Commercial Code, notice of any shareholders' meeting
must be given to each shareholder having voting rights or, in the case of a
non-resident shareholder, to his resident proxy or mailing address in Japan in
accordance with our share handling regulations, at least two weeks prior to the
date of the meeting.
Any shareholder or group of shareholders holding at least 300 voting
rights, or 1% of the total outstanding voting rights, for a continuous period of
six months or longer may propose a matter for consideration at a shareholders
meeting by submitting a written request to the Board of Directors at least six
weeks before such meeting.
Voting Rights
A shareholder is generally entitled to one vote per unit. In general,
under the Japanese Commercial Code, a resolution can be adopted at a general
meeting of shareholders by a majority of the voting rights represented at the
meeting. The Commercial Code and our articles of incorporation require a quorum
for the election of directors and statutory auditors of not less than one-third
of the total number of outstanding voting rights. Our shareholders are not
entitled to cumulative voting in the election of directors. A corporate
shareholder whose outstanding 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 Japanese Commercial Code provides that a quorum of the majority of
outstanding voting rights must be present at a shareholders' meeting to approve
any material corporate actions such as:
. amendment of the Articles of Incorporation;
-47-
. 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 bond with share acquisition right with "specially
favorable" terms or of share acquisition right with "specially
favorable" terms to persons other than shareholders.
At least two-thirds of the voting rights represented at the meeting
must approve such actions.
The voting rights of holders of ADSs are exercised by the depositary
based on instructions from such holders. An agent of the depositary is the
record holder of the underlying shares.
Subscription Rights
Holders of shares have no preemptive rights under our articles of
incorporation. Under the Japanese Commercial Code, the Board of Directors may,
however, determine that shareholders be given subscription rights in connection
with a particular issue of new shares. In this case, such rights must be given
on uniform terms to all shareholders as of a specified record date by at least
two weeks' prior public notice to shareholders of the record date. Public or
individual notice must be given to each of these shareholders at least two weeks
prior to the date of expiration of the subscription rights.
Rights to subscribe for new shares may be transferable or
nontransferable as determined by the Board of Directors. If subscription rights
are not transferable, a purported transfer by a shareholder who is not resident
in Japan will be enforceable against 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
UFJ Trust and Banking Co., Limited is the transfer agent for our 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
The Japanese Commercial Code, in principle, permit us to acquire, hold
or dispose of our shares. We may acquire our shares on the First Section of the
Tokyo Stock Exchange on which the shares are traded, through the Japanese stock
exchange, if any, on which such shares are listed, by way of tender offer
(pursuant to an ordinary resolution of an ordinary general meeting of
shareholders), from a specific party (pursuant to a special resolution of an
ordinary
-48-
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 Japanese Commercial Code, and generally,
may dispose of or cancel such shares by a resolution of the Board of Directors.
C. Material Contracts.
The information required by this item is set forth in Item 4.
D. Exchange Controls.
The Foreign Exchange and Foreign Trade Law of Japan and the cabinet
orders and ministerial ordinances issued under the law govern the acquisition
and holding of shares of equity securities of Japanese corporations, including
Trend Micro, by exchange non-residents and by foreign investors.
Exchange non-residents are individuals who are not resident in Japan
and corporations whose principal offices are located outside Japan. Generally,
branches and other offices of non-resident corporations located within Japan are
regarded as exchange residents of Japan and branches and other offices of
Japanese corporations located outside Japan are regarded as exchange
non-residents of Japan.
Foreign investors are defined to be:
. individuals not resident in Japan;
. corporations which are organized under the laws of foreign countries
or whose principal offices are located outside Japan;
. corporations not less than 50% of the shares of which are 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.
-49-
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 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
-50-
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 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.
-51-
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 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.
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
-52-
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 Depositary,
in the case of ADSs, receive the dividend, actually or constructively. The
dividend will not be eligible for the dividends-received deduction generally
allowed to U.S. corporations in respect of dividends received from other U.S.
corporations. The amount of the dividend distribution that you must include in
your income as a U.S. holder will be the U.S. dollar value of the Japanese yen
payments made, determined at the spot Japanese yen/U.S. dollar rate on the date
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.
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%. 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
-53-
H. Documents on Display.
We are subject to the informational requirements of the Securities
Exchange Act of 1934 and, in accordance therewith, we will file annual reports
on Form 20-F within six months of our fiscal year-end and other reports and
information on Form 6-K with the Securities and Exchange Commission. These
reports and other information can be inspected at the public reference room at
the Securities and Exchange Commission at 450 Fifth Street, N.W., Washington,
D.C. 20549. You can also obtain copies of such material by mail from the public
reference room of the Securities and Exchange Commission at prescribed fees. You
may obtain information on the operation of the Securities and Exchange public
reference room by calling the Securities and Exchange Commission in the United
States at 1-800-SEC-0330. The Securities and Exchange Commission also maintains
a web site at www.sec.gov that contains reports, proxy statements and other
information regarding registrants that file electronically with the Securities
and Exchange Commission. As a foreign private issuer, we are exempt from the
rules under the Securities Exchange Act of 1934 prescribing the furnishing and
content of proxy statements to shareholders.
I. Subsidiary Information.
Not applicable
Item 11. Quantitative and Qualitative Disclosures About Market Risk.
As discussed in Note 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,
2001 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
-54-
PART II
Item 13. Defaults, Dividend Arrearages and Delinquencies.
None
Item 14. Material Modifications to the Rights of Security Holders and Use of
Proceeds
None.
Item 15. [Reserved]
None
Item 16. [Reserved]
None
-55-
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.
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
8.1**** Subsidiaries of Trend Micro
* Incorporated by reference to the corresponding exhibit to Trend Micro's
Form S-8 Registration Statement (File No. 333-85934) filed on April 10,
2002.
** Incorporated by reference to the corresponding exhibit to Trend Micro's
annual report on Form 20-F (File No. 333-10486) filed on June 29, 2001.
*** 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.
**** 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.
+ Confidential treatment granted for a portion of these documents.
-56-
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/ Mahendra Negi
-----------------------------------
Name: Mahendra Negi
Title: Representative Director
Chief Financial Officer and
Executive Vice President
Date: July 1, 2002
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of independent accountants. ....................................................... F-2
Consolidated balance sheets at December 31, 2000 and 2001. ............................... F-3
Consolidated statements of income for the years
ended December 31, 1999, 2000 and 2001 ................................................... F-5
Consolidated statements of comprehensive income for the years
ended December 31, 1999, 2000 and 2001 ................................................... F-6
Consolidated statements of shareholders' equity for the years
ended December 31, 1999, 2000 and 2001 ................................................... F-7
Consolidated statements of cash flows for the years
ended December 31, 1999, 2000 and 2001 ................................................... F-9
Notes to consolidated financial statements ............................................... F-11
Financial statement schedule for the years
ended December 31, 1999, 2000 and 2001:
Schedule II - Valuation and qualifying accounts. ......................................... F-38
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 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, 2000 and
2001, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 2001, in conformity with accounting
principles generally accepted in the United States of America. In addition, in
our opinion, the financial statement schedule listed in the accompanying index
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
These financial statements and financial statement schedule are the
responsibility of the company's management; our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits. We conducted our audits of these statements in accordance with
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 our opinion.
/s/ PricewaterhouseCoopers
Tokyo, Japan
June 12, 2002
F-2
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
Thousands of
Thousands of yen U.S. dollars
---------------- ------------
December 31,
---------------------- December 31,
2000 2001 2001
---- ---- ----
ASSETS
Current assets:
Cash and cash equivalents ................................................ (Yen)24,435,503 (Yen)40,782,650 $ 308,959
Time deposits ............................................................ - 70,768 536
Marketable securities .................................................... 1,893,475 1,847,113 13,993
Notes and accounts receivable, trade - less
allowance for doubtful accounts and sales returns of (Yen) 646,566
and (Yen) 850,376 ($6,442) ............................................. 8,133,700 11,430,383 86,594
Inventories .............................................................. 318,188 238,881 1,810
Deferred income taxes .................................................... 2,687,913 3,218,595 24,383
Prepaid expenses and other current assets ................................ 607,142 786,997 5,962
--------------- --------------- -----------
Total current assets ........................................... 38,075,921 58,375,387 442,237
--------------- --------------- -----------
Investments and other assets:
Securities investments ................................................... 1,335,849 1,304,489 9,882
Investment in and advances to affiliate company .......................... 182,473 84,929 643
Goodwill and intangibles ................................................. 2,740,827 1,110,462 8,413
Deferred income taxes .................................................... 446,004 972,201 7,366
Other .................................................................... 570,742 868,377 6,579
--------------- --------------- -----------
5,275,895 4,340,458 32,883
--------------- --------------- -----------
Property and equipment:
Office furniture and equipment ........................................... 1,536,444 2,317,359 17,556
Other properties ......................................................... 443,102 1,003,901 7,605
--------------- --------------- -----------
1,979,546 3,321,260 25,161
Less: Accumulated depreciation .......................................... (756,898) (1,308,386) (9,912)
--------------- --------------- -----------
1,222,648 2,012,874 15,249
--------------- --------------- -----------
(Yen)44,574,464 64,728,719 $ 490,369
=============== =============== ===========
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,
2000 2001 2001
---- ---- ----
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ........................... (Yen) 57,200 (Yen) 3,000,000 $22,727
Notes payable, trade ........................................ 132,499 175,510 1,330
Accounts payable, trade ..................................... 796,782 1,206,486 9,140
Accounts payable, other ..................................... 517,247 1,806,527 13,686
Withholding income taxes .................................... 120,994 264,608 2,005
Accrued expenses ............................................ 615,850 1,529,358 11,586
Accrued income and other taxes .............................. 2,014,589 3,359,572 25,451
Deferred revenue ............................................ 5,043,425 9,342,597 70,777
Other ....................................................... 415,372 304,525 2,307
-------------- --------------- --------
Total current liabilities ........................ 9,713,958 20,989,183 159,009
-------------- --------------- --------
Long-term liabilities:
Long term debt .............................................. 9,799,900 11,500,000 87,121
Deferred revenue ............................................ 548,225 916,873 6,946
Accrued pension and severance costs ......................... 168,032 277,488 2,102
Other ....................................................... - 279,149 2,115
-------------- --------------- --------
10,516,157 12,973,510 98,284
-------------- --------------- --------
Shareholders' equity:
Common stock
Authorized
- 2000 250,000,000 shares ((Yen)50 par value)
- 2001 250,000,000 shares (no par value)
Issued
- 2000 131,120,842 shares ................................. 6,183,266
- 2001 132,052,284 shares 6,833,678 51,770
Additional paid-in capital .................................. 11,631,591 12,144,908 92,007
Legal reserve ............................................... 149,991 149,991 1,136
Retained earnings ........................................... 6,745,769 11,127,585 84,300
Accumulated other comprehensive income -
Net unrealized gain (loss) on debt and equity securities .. (168,277) (310,480) (2,352)
Cumulative translation adjustments ........................ (169,616) 848,873 6,431
-------------- --------------- --------
(337,893) 538,393 4,079
-------------- --------------- --------
Treasury stock, at cost (2000 - 5,262 shares; 2001
- 9,102 shares) ........................................... (28,375) (28,529) (216)
-------------- --------------- --------
24,344,349 30,766,026 233,076
-------------- --------------- --------
Commitments and contingent liabilities ........................ - - -
- - -
Total liabilities and shareholders' equity ....... (Yen)44,574,464 64,728,719 490,369
============== =============== ========
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
---------------- ------------
Years ended December 31, Year ended
----------------------------------------- December 31,
1999 2000 2001 2001
---- ---- ---- ----
Net sales ............................................. (Yen)13,633,170 (Yen)20,070,366 (Yen)31,326,321 $ 237,321
Cost of sales ......................................... 481,574 1,474,689 1,898,971 14,387
-------------- --------------- -------------- -------
Gross profit ....................................... 13,151,596 18,595,677 29,427,350 222,934
-------------- --------------- -------------- -------
Operating expenses:
Selling ............................................ 3,453,296 5,445,167 7,177,519 54,375
Research and development ........................... 994,340 2,043,480 2,755,200 20,873
General and administrative ......................... 4,772,038 5,303,661 9,725,458 73,678
Goodwill amortization .............................. - 276,286 - -
Goodwill write-off ................................. - - 2,253,559 17,072
-------------- --------------- ---------- -------
9,219,674 13,068,594 21,911,736 165,998
-------------- --------------- -------------- -------
Operating income ................................... 3,931,922 5,527,083 7,515,614 56,936
-------------- ---------------- -------------- -------
Other income (expenses):
Interest income .................................... 148,487 241,133 393,254 2,979
Interest expense ................................... (66,526) (220,960) (296,625) (2,247)
Gain on sales of marketable securities ............. 280,532 119,650 19,975 151
Foreign exchange gain (loss), net .................. (174,921) 283,305 585,671 4,437
Other income (expense), net ........................ (120,298) 941,500 (461,312) (3,494)
-------------- --------------- -------------- -------
67,274 1,364,628 240,963 1,826
-------------- --------------- -------------- -------
Income before income taxes, minority interest and
equity in loss of affiliated companies ............. 3,999,196 6,891,711 7,756,577 58,762
-------------- --------------- -------------- -------
Income taxes:
Current ............................................ 2,538,455 4,701,426 4,214,459 31,928
Deferred ........................................... (688,988) (1,578,889) (973,338) (7,374)
-------------- --------------- -------------- -------
1,849,467 3,122,537 3,241,121 24,554
-------------- --------------- -------------- -------
Income before minority interest and equity in
losses of affiliated companies ..................... 2,149,729 3,769,174 4,515,456 34,208
-------------- --------------- -------------- -------
Minority interest in income of a consolidated
subsidiary ......................................... - 6,845 - -
-------------- --------------- -------------- -------
Income from consolidated companies .................... 2,149,729 3,762,329 4,515,456 34,208
Equity in losses of affiliated companies .............. 2,356 87,672 129,544 981
-------------- --------------- -------------- -------
Net income ............................................ (Yen)2,147,373 (Yen)3,674,657 (Yen)4,385,912 $33,227
============== =============== ============= =======
Yen Yen Yen U.S. dollars
--- --- --- ------------
Per share data:
Net income - basic ................................ (Yen)16.90 (Yen)28.18 (Yen)33.33 $0.25
- diluted .............................. 16.42 27.53 33.02 0.25
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
---------------- -------
Years ended December 31, Year ended
-------------------------------------- December 31,
1999 2000 2001 2001
---- ---- ---- ----
Net income................................................... (Yen)2,147,373 (Yen)3,674,657 (Yen)4,385,912 $33,227
-------------- -------------- -------------- -------
Other comprehensive income (loss), net of tax:
Unrealized gain (loss) on debt and equity securities:
Unrealized holding gains (losses) arising
during period............................................ 168,711 (560,025) (194,274) (1,472)
Less reclassification adjustment for losses(gains)
included in net income................................... (204,017) (119,649) 61 1
-------------- -------------- -------------- -------
(35,306) (679,674) (194,213) (1,471)
Foreign currency translation adjustments.................... (354,466) 463,372 1,018,489 7,716
-------------- -------------- -------------- -------
Other comprehensive income, before tax....................... (389,772) (216,302) 824,276 6,245
Income tax expense related to items of other
comprehensive income........................................ 16,630 295,475 52,010 394
-------------- -------------- -------------- -------
Other comprehensive income, net of tax....................... (373,142) 79,173 876,286 6,639
-------------- -------------- -------------- -------
Comprehensive income......................................... (Yen)1,774,231 (Yen)3,753,830 (Yen)5,262,198 $39,866
============== ============== ============== =======
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
---------------- -------
Years ended December 31, Year ended
----------------------------------------- December 31,
1999 2000 2001 2001
---- ---- ---- ----
Common stock:
Balance at beginning of year .............................. (Yen)5,081,714 (Yen)5,414,660 (Yen)6,183,266 $46,842
Transfer of additional paid-in capital to common stock .... - - 170,900 1,295
Exercise of stock purchase warrants........................ 332,946 768,606 479,512 3,633
-------------- -------------- -------------- -------
Balance at end of year .................................... 5,414,660 6,183,266 6,833,678 51,770
-------------- -------------- --------- ------
Additional paid-in capital:
Balance at beginning of year .............................. 7,735,744 9,198,712 11,631,591 88,118
Tax benefit from exercise of non-qualified
stock warrants ........................................... 1,048,435 1,702,289 211,985 1,606
Transfer of additional paid-in capital to common stock .... - - (170,900) (1,295)
Gain (loss) on sales of treasury stock, net of tax ........ 76,187 (39,013) (7,766) (58)
Exercise of stock purchase warrants........................ 338,346 769,603 479,998 3,636
-------------- -------------- -------------- -------
Balance at end of year .................................... 9,198,712 11,631,591 12,144,908 92,007
-------------- -------------- -------------- -------
Legal reserve:
Balance at beginning of year .............................. 129,157 149,991 149,991 1,136
Transfers from retained earnings .......................... 20,834 - - -
-------------- - - -
Balance at end of year .................................... 149,991 149,991 149,991 1,136
-------------- -------------- -------------- -------
Deferred compensation:
Balance at beginning of year .............................. (481,331) (101,528) - -
Amortization of deferred compensation related
to stock warrants ........................................ 379,803 101,528 - -
-------------- -------------- -------------- -------
Balance at end of year .................................... (101,528) - - -
-------------- -------------- -------------- -------
Retained earnings:
Balance at beginning of year .............................. 1,164,100 3,082,302 6,745,769 51,104
Net income ................................................ 2,147,373 3,674,657 4,385,912 33,227
Stock issue costs, net of tax.............................. - (11,190) (4,096) (31)
Transfers to legal reserve ................................ (20,834) - - -
Cash Dividends ............................................ (208,337) - - -
Balance at end of year .................................... 3,082,302 6 ,745,769 11,127,585 84,300
-------------- -------------- -------------- -------
Net unrealized gain (loss) on debt and equity securities:
Balance at beginning of year .............................. 234,598 215,922 (168,277) (1,275)
Net change during the year ................................ (18,676) (384,199) (142,203) (1,077)
-------------- -------------- -------------- -------
Balance at end of year .................................... 215,922 (168,277) (310,480) (2,352)
============== ============== ============== =======
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 ........ (278,522) (632,988) (169,616) (1,285)
Aggregate translation adjustments
for the year ........................ (354,466) 463,372 1,018,489 7,716
--------------- --------------- --------------- --------
Balance at end of year .............. (632,988) (169,616) 848,873 6,431
--------------- --------------- --------------- --------
Treasury stock, at cost:
Balance at beginning of year ........ (12,880) (17,138) (28,375) (214)
Purchases of treasury stock ......... (1,260,011) (1,573,609) (398,857) (3,022)
Sales of treasury stock ............. 1,255,753 1,562,372 398,703 3,020
--------------- --------------- --------------- --------
Balance at end of year .............. (17,138) (28,375) (28,529) (216)
--------------- --------------- --------------- --------
Total shareholders' equity ..... (Yen)17,309,933 (Yen)24,344,349 (Yen)30,766,026 $233,076
=============== =============== =============== ========
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
---------------- ------------
Years ended December 31,
----------------------------------------- Year ended
December 31,
1999 2000 2001 2001
---- ---- ---- ----
Cash flows from operating activities:
Net income ......................................... (Yen) 2,147,373 (Yen)3,674,657 (Yen)4,385,912 $33,227
Adjustments to reconcile net income to net cash
provided by operating activities -
Amortization of deferred compensation related to
stock warrants .................................. 379,803 101,528 - -
Depreciation and amortization .................... 428,238 1,014,281 3,604,342 27,306
Pension and severance costs, less payments ....... 58,579 40,361 103,576 785
Deferred income taxes ............................ (688,988) (1,578,889) (973,338) (7,374)
Gain on sales of marketable securities ........... (280,532) (119,650) (19,975) (151)
Equity in losses of affiliated companies ......... 2,356 87,672 129,544 981
Changes in assets and liabilities:
Increase in deferred revenue .................... 1,123,053 2,975,760 4,141,118 31,372
Increase in accounts receivable,
net of allowances ............................. (1,945,194) (1,849,641) (2,660,035) (20,152)
(Increase) decrease in inventories .............. (541) (234,841) 87,290 661
Increase in notes and
accounts payable trade ........................ 377,869 51,234 360,097 2,728
Increase in accrued income and other taxes ...... 273,696 1,141,049 1,336,964 10,129
(Increase) decrease in other current assets ..... (370,227) 425,223 (132,105) (1,001)
Increase (decrease) in accounts payable, other .. (42,540) (133,267) 832,287 6,305
Increase in other current liabilities ........... - 62,997 1,192,476 9,033
Decrease (increase) in other assets ............. 23,729 268,804 (526,330) (3,987)
Other .......................................... 1,192 158,555 378,408 2,867
----------- ----------- ----------- ----------
Net cash provided by
operating activities ....................... 1,487,866 6,085,833 12,240,231 92,729
----------- ----------- ----------- ----------
Cash flows from investing activities:
Payments for purchases of fixed assets ............. (620,218) (876,964) (1,760,235) (13,335)
Payments for acquisitions of software .............. (185,455) (488,577) (969,360) (7,344)
Proceeds from sales of marketable securities ....... 2,388,480 239,486 2,811,975 21,303
Proceeds from maturities of marketable securities .. 1,101,846 100,000 - -
Payments for purchases of marketable securities and
security investments .............................. (5,264,042) (407,012) (2,897,926) (21,954)
Acquisition, net of cash acquired .................. - (2,508,248) - -
Investments in affiliated companies ................ (72,500) (200,000) (32,000) (242)
Payments for time deposit .......................... - - (70,768) (536)
Other .............................................. 92 - - -
--------------- --------------- --------------- ----------
Net cash used in investing activities......... (Yen)(2,651,797) (Yen)(4,141,315) (Yen)(2,918,314) ($)(22,108)
--------------- --------------- --------------- ----------
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
---------------- ------------
Years ended December 31, Year ended
---------------------------------------- December 31,
1999 2000 2001 2001
---- ---- ---- ----
Cash flows from financing activities:
Issuance of common stock pursuant to exercise of stock
warrants .................................................. 671,292 1,527,019 955,414 7,238
Tax benefit from exercise of non-qualified stock warrants ... 1,048,435 1,702,289 211,985 1,606
Proceeds from issuance of bonds ............................. 6,000,000 5,000,000 12,500,000 94,697
Purchase of treasury bonds ................................. - - (6,812,000) (51,606)
Redemption of bonds ......................................... - (1,300,000) (900,000) (6,818)
Decrease in short-term borrowings ........................... - (226,000) - -
Decrease in long-term borrowings ............................ - (127,685) (157,100) (1,190)
Purchase of / proceeds from sales of treasury stock, net .... (70,600) (78,617) (13,556) (103)
Dividends paid .............................................. (208,337) - - -
Other ...................................................... 141,415 (1,426) (943) (7)
--------------- --------------- --------------- --------
Net cash provided by financing activities .................... 7,582,205 6,495,580 5,783,800 43,817
--------------- --------------- --------------- --------
Effect of exchange rate changes on cash and cash
equivalents ................................................. (165,870) 346,524 1,241,430 9,404
--------------- --------------- --------------- --------
Net increase in cash and cash equivalents .................... 6,252,404 8,786,622 16,347,147 123,842
Cash and cash equivalents at beginning of year ............... 9,396,477 15,648,881 24,435,503 185,117
--------------- --------------- --------------- --------
Cash and cash equivalents at end of year. .................... (Yen)15,648,881 (Yen)24,435,503 (Yen)40,782,650 $308,959
=============== =============== =============== ========
The accompanying notes are an integral part of these statements.
F-10
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Nature of operations
Trend Micro Incorporated (the "parent company") and its subsidiaries
(collectively "the Company") are primarily engaged in the development,
production and sale of anti-virus software and providing management solutions
for corporate computer systems. The Company develops its software in Japan,
Taiwan, the United States, Germany, UK and China, and its products are marketed
by sales subsidiaries throughout the world.
2. Summary of significant accounting policies
The parent company and its subsidiaries in Japan maintain their records and
prepare their financial statements in accordance with accounting principles
generally accepted in Japan, and its foreign subsidiaries maintain their records
and prepare their financial statements in conformity with accounting principles
generally accepted in the respective countries of their domicile. Certain
adjustments and reclassifications, including those relating to the tax effects
of temporary differences, valuation of debt and equity securities and revenue on
post-contract support, have been incorporated in the accompanying consolidated
financial statements to conform with accounting principles generally accepted in
the United States of America ("U.S. GAAP"). These adjustments were not recorded
in the statutory books of account.
The preparation of financial statements in conformity with U.S. GAAP requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
(1) Significant accounting policies:
Basis of consolidation
The consolidated financial statements include the accounts of the parent
company and those of its majority-owned subsidiaries. All intercompany
transactions and accounts are eliminated on consolidation.
Investments in affiliated companies (20 to 50 percent-owned companies) in
which the ability to exercise significant influence exists are stated at
cost plus the equity in undistributed earnings (losses). Net consolidated
income includes the company's equity in the current net earnings (losses)
of such companies, after elimination of unrealized intercompany profit.
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.
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.
F-11
Revenue recognition
The Company recognizes revenue from software product licenses when
persuasive evidence of an arrangement exists, the product has been
delivered, the fee is fixed and determinable, and collection of the
resulting receivable, net of allowances for doubtful accounts and sales
returns, is reasonably assured. Delivery generally occurs when product is
shipped or electronically delivered. 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
services which includes virus pattern updates, product version updates,
telephone and online technical support and free use of our 24-hour
service centers 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.
Pursuant to the Security and Exchange Commission's Staff Accounting
Bulletin ("SAB") No.101, "Revenue Recognition in Financial Statements",
the Company reviewed its accounting policies for the recognition of
revenue. SAB No. 101 was required to be implemented in fourth quarter
2000. SAB No.101 provides guidance on applying generally accepted
accounting principles to revenue recognition in financial statements. The
Company's historical policies for revenue recognition are consistent with
the views expressed within SAB 101.
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.
Inventories
Finished products and raw materials are valued at the lower of weighted
average cost or net realizable value. Work in process is stated at
accumulated production costs.
Property and equipment
Property and equipment are stated at cost. 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.
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.
F-12
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 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 did not employ any derivative financial
instruments.
However ipTrend which was acquired in 2000 had 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 in 2000,
ipTrend repaid the underlying hedged debt without settling the interest
rate swap and cap arrangements. In 2001, the parent company assumed an
interest rate swap and cap arrangements upon the liquidation of ipTrend in
December 2001. Those arrangements which did not qualify for hedge
accounting were marked to market.
On January 1, 2001, the Company adopted the Financial Accounting Standards
Board's Statement of Financial Accounting Standard ("FAS") No.133
"Accounting for Derivative Instruments and Hedging Activities," as amended
by FAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities." FAS No.133, as amended, establishes accounting and
reporting standards for derivative instruments. Specifically, FAS No.133
requires an entity to recognize all derivatives, including certain
derivative instruments embedded in other contracts, 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
shareholders' equity or net income depending on whether the derivative
instrument qualifies as a hedge for accounting purposes and, if so, the
nature of the hedging activity. The adoption of the new standard did not
have an effect on the Company's financial position and results of
operations.
F-13
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 made a free distribution of common stock to its
shareholders which was accounted for either by a transfer of the applicable
par value from additional paid-in capital to the common stock account or
with no entry if free shares were distributed from the portion of
previously issued shares accounted for as excess of par value in the common
stock account in accordance with the Japanese Commercial Code. However, as
a result of the amendments to the Japanese Commercial Code in 2001 where
the concept of par-value of shares was eliminated effective from October 1,
2001, a free distribution of common stock to its shareholders is accounted
for with no accounting entry. Under the Japanese Commercial Code, a stock
dividend which is paid out of profits can be effected by an appropriation
of retained earnings to the common stock account by resolution of the
general shareholders' meeting, followed by a free distribution with respect
to the amount as appropriated by resolution of the Board of Directors.
Common stock issue costs
Common stock issue costs are directly charged to retained earnings, net of
tax, in the accompanying consolidated financial statements as the Japanese
Commercial Code prohibits charging such stock issue costs to capital
accounts, which is the prevailing practice in the United States of America.
Comprehensive income
Other comprehensive income refers to revenues, expenses, gains and losses
that under 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 time deposits, money market funds and marketable
securities and places its investments with high quality financial
institutions. The Company performs ongoing credit evaluations of its
customers' financial condition and maintains an allowance for uncollectible
accounts receivable, if any, based upon the expected collectibility of
accounts receivable.
(2) Recent pronouncements:
Business combinations and goodwill and intangible assets -
In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("FAS") No.141 "Business
Combinations" which supersedes Accounting Principles Board Opinion ("APB")
No.16 "Business Combinations" and FAS No.142, "Goodwill and Intangible
Assets" which supersedes APB No.17 "Intangible Assets." FAS No. 141 requires
the use of the purchase method of accounting for business combinations and
prohibits the use of the pooling of interests method which was previously
permitted under APB No.16, for business combinations initiated after June
30, 2001. FAS No.141 also refines the definition of intangible assets
acquired in a purchase business combination. As a result, the purchase price
allocation of future business combinations may be different than the
allocation that would have resulted under the old rules.
FAS No.142 eliminates the amortization of goodwill, requires annual
impairment testing of goodwill and introduces the concept of indefinite life
intangible assets. The new rules also prohibit the amortization of goodwill
associated with business combinations that close after June 30, 2001.
F-14
These new requirements will impact future period net income by an amount
adjusted for any differences between the old and new rules for defining
intangible assets on future business combinations. Although FAS No. 142
requires to perform an initial transition impairment test in 2002, the
Company did not have any goodwill balances as of December 31, 2001.
Impairment or disposal of long-lived assets -
In October 2001, the FASB issued FAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." FAS No. 144 addresses
significant issues relating to the implementation of FAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and develops a single accounting model, based
on the framework established in FAS No. 121 for long-lived assets to be
disposed of by sale, whether such assets are or are not deemed to be a
business. SFAS No. 144 also modifies the accounting and disclosure rules
for discontinued operations. The standard was adopted on January 1, 2002,
and is not expected to have a material effect on the Company's results of
operations and financial position.
Accounting for asset retirement obligations -
In August 2001, the FASB issued FAS No. 143, "Accounting for Assets
Retirement Obligations." SFAS No. 143 provides accounting and reporting
guidance for legal obligations associated with the retirement of
long-lived assets that result from the acquisition, construction or
normal operation of a long-lived asset. The standard is effective January
1, 2003. The Company is reviewing the provisions of this standard. Its
adoption is not expected to have a material effect on the financial
statements.
FAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment
of FASB Statement No. 13, and Technical Corrections" -
In April 2002, the FASB issued FAS No. 145, effective for the fiscal
years beginning or transactions occurring after May 15, 2002. This
statement rescinds certain authoritative pronouncements and amends,
clarifies or describes the applicability of others. The Company is now in
the process of assessing the impact that the statement will have on the
Company's results of operations and financial position.
(3) Reclassifications
Certain prior year amounts have been reclassified to conform to the 2001
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, 2001 ((Yen)132.00
= U.S. $1) has been used for the purpose of presentation of the U.S. dollar
amounts in the accompanying consolidated financial statements.
4. Acquisition and divesture
In February 2000, the company acquired a controlling interest in ipTrend
Incorporated ("ipTrend") for the purpose of making inroads into UNIX-based
operating systems, and Internet platform technology, especially into Linux
systems. ipTrend effectively became a wholly owned subsidiary upon acquisition
of the remaining minority interest in November 2000.The total
purchase price was (Yen) 2,800,000 thousand and (Yen) 2,527,636 thousand was
allocated to goodwill. However, based on a revaluation of the Company's strategy
for ipTrend's business and the performance of ipTrend, the Company decided to
curtail ipTrend's business. ipTrend was liquidated in December 2001 after
transferring the main business of ipTrend to IPSQUARE, an unrelated third party,
and the Security Appliance Server business to the parent company in August 2001.
The assets of (Yen) 40, 000 thousand ($303 thousand) and the liabilities of
(Yen) 29,000 thousand ($220 thousand) were transferred to or assumed by IPSQUARE
at their carrying amount without any gain or loss on the transaction. As a
result of the curtailment of ipTrend's business, the Company wrote off the
unamortized goodwill balance of (Yen) 2,253,559 thousand ($17,072 thousand).
Goodwill amortization of (Yen) 276,286 thousand and the write-off of (Yen)
2,253,559 thousand ($17,072 thousand) are included in operating income for the
year ended December 31, 2000 and 2001, respectively.
F-15
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, 1999, 2000 and 2001, is as follows:
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
------ --------- ---
Weighted-
Net average
income shares 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
-------------- ------- ----------
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
============== ======= ==========
Thousands Thousands
of yen of shares Yen Dollars
------ --------- --- -------
Weighted-
Net average
income shares EPS EPS
------ ------ --- ---
For the year ended December 31, 2001
Basic EPS:
Net income available to common stock holders ......... (Yen)4,385,912 131,595 (Yen)33.33 $0.25
-------------- ------- ---------- -----
Effect of dilutive securities:
Shares issuable from assumed exercise of stock
warrants ............................................ - 1,237
-------------- -------
Diluted EPS:
Net income for computation............................ (Yen)4,385,912 132,832 (Yen)33.02 $0.25
============== ======= ========== =====
F-16
6. Cash and cash equivalents
Cash and cash equivalents as of December 31, 2000 and 2001 comprised:
Thousands of
Thousands of yen U.S. dollars
---------------- ------------
December 31,
------------------------ December 31,
2000 2001 2001
---- ---- ----
Cash................................................................. (Yen) 14,388,599 (Yen)23,985,112 $181,705
Time deposits with original maturities of three months or less ...... 10,046,873 16,797,538 127,254
Money market funds................................................... 31 - -
---------------- --------------- --------
(Yen) 24,435,503 (Yen)40,782,650 $308,959
================ =============== ========
7. Supplemental cash flow information
Cash payments for income taxes were (Yen) 2,247,816 thousand, (Yen) 1,827,638
thousand and (Yen) 2,817,748 thousand ($21,347 thousand) for the years ended
December 31, 1999, 2000 and 2001, respectively; in these respective periods,
interest payments were (Yen) 2,417 thousand, (Yen) 217,922 thousand and (Yen)
284,433 thousand ($ 2,155 thousand).
F-17
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, 2000 and 2001, were as
follows:
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 yen
----------------
December 31, 2001
----------------------------------------------------------------
Gross unrealized
----------------
Cost Gains Losses Fair value
---- ----- ------ ----------
Available for sale:
Mutual funds ............. (Yen) 960,806 (Yen) - (Yen)253,417 (Yen) 707,389
Equity securities ........ 951,830 - 254,537 697,293
Debt securities .......... 1,700,000 46,920 - 1,746,920
-------------- ----------- ------------ --------------
Total ................. (Yen)3,612,636 (Yen)46,920 (Yen)507,954 (Yen)3,151,602
============== =========== ============ ==============
Thousands of U.S. dollars
-------------------------
December 31, 2001
----------------------------------------------------------------
Gross unrealized
----------------
Cost Gains Losses Fair value
---- ----- ------ ----------
Available for sale:
Mutual funds ............. $ 7,279 $ - $ 1,920 $ 5,359
Equity securities ........ 7,211 - 1,928 5,283
Debt securities .......... 12,879 355 - 13,234
------- ---------- ------- -------
Total ................. $27,369 $ 355 $ 3,848 $23,876
======= ========== ======= =======
F-18
The "available-for sale" debt securities were issued by SOFTBANK, a related
party of the Company, and the maturity date of the securities is March 24, 2003.
The cost and fair value of the securities at December 31, 2001 were
(Yen)1,700,000 thousand ($12,879 thousand) and (Yen)1,746,920 thousand ($13,234
thousand), respectively.
The net unrealized gain on "available-for-sale" securities included in the
separate component of shareholders' equity, net of applicable taxes, decreased
by (Yen)18,676 thousand, (Yen)384,199 thousand and (Yen)142,203 thousand ($1,077
thousand) in the years ended December 31, 1999, 2000, and 2001 respectively.
Proceeds from sales of "available-for-sale" securities for the years ended
December 31, 1999, 2000 and 2001 were (Yen)2,388,480 thousand, (Yen)239,486
thousand and (Yen)2,811,975 thousand ($21,303 thousand), respectively.
Grossrealized gains on sales of "available-for-sale" securities for the year
ended December 31, 1999, 2000 and 2001 were (Yen)280,532 thousand, (Yen)119,650
thousand, and (Yen)19,975 thousand ($ 151 thousand) respectively.
9. Inventories
Inventories as at December 31, 2000 and 2001 consist of the following:
Thousands of
Thousands of yen U.S. dollars
---------------- ------------
December 31,
------------ December 31,
2000 2001 2001
---- ---- ----
Finished goods .......... (Yen)171,231 (Yen)172,143 $1,304
Raw materials ........... 146,957 20,698 157
Work in process ......... - 46,040 349
----------- ------------ ------
(Yen)318,188 (Yen)238,881 $1,810
=========== ============ ======
10. Investments in affiliated companies
The investees accounted for using the equity method are NTT Data Security
Corporation (20.0%) and SOFT TREND CAPITAL CORPORATION (20.0%) at December 31,
1999, NTT Data Security Corporation, SOFT TREND CAPITAL CORPORATION and JCN Co
Ltd. (24.4%) at December 31, 2000, and NTT Data Security Corporation, SOFT TREND
CAPITAL CORPORATION, JCN Co Ltd. and Net Star Inc.(40.0%) at December 31, 2001.
Summarized financial information of the affiliated companies accounted
for using the equity method is shown below:
F-19
Thousands of
U.S. dollars
Thousands of yen ------------
-------------------------------
December 31,
------------------------------- December 31,
2000 2001 2001
---- ---- ----
Current assets ........................... (Yen)2,081,103 (Yen)1,442,004 $10,924
Non-current assets including
property, plant and equipment .......... 1,129,182 913,928 6,924
-------------- ------------- -------
Total assets .......................... (Yen)3,210,285 (Yen)2,355,932 $17,848
============== ============== =======
Current liabilities ...................... (Yen)2,702,376 (Yen)2,234,428 $16,927
Long-term liabilities .................... - 5,539 42
Shareholders' equity ..................... 507,909 115,965 879
-------------- ------------- -------
Total liabilities and
shareholders' equity ................ (Yen)3,210,285 (Yen)2,355,932 $17,848
============== ============== =======
Thousands of
U.S. dollars
Thousands of yen ------------
------------------------------------------------ Year
Years ended December 31, ended
------------------------------------------------ December 31,
1999 2000 2001 2001
---- ---- ---- ----
Sales....................... (Yen) 553,500 (Yen)1,624,782 (Yen)1,740,142 $13,183
============== ============== ============== =======
Net loss.................... (Yen) 11,778 (Yen) 318,966 (Yen) 490,828 $ 3,718
============== ============== ============== =======
A summary of transactions and balances with the affiliated companies accounted
for using the equity method is presented below:
Thousands of
U.S. dollars
Thousands of yen ------------
------------------------------------------------ Year
Years ended December 31, ended
------------------------------------------------ December 31,
1999 2000 2001 2001
---- ---- ---- ----
Sales (Yen) - (Yen) 196,517 (Yen) 150,086 $-1,137
============== ============== ============== =======
Purchases (Yen) 960,806 (Yen) - (Yen) 138,390 $ 1,048
============== ============== ============== =======
Thousands of yen Thousands of
------------------------------- U.S. dollars
December 31, ------------
------------------------------- December 31,
2000 2001 2001
---- ---- ----
Notes and accounts receivable, trade...... (Yen) 182,347 (Yen) 20,923 $ 159
============== ============== =======
Other receivables......................... (Yen) - (Yen) - $ -
============== ============== =======
Accounts payable, trade................... (Yen) - (Yen) 4,519 $ 34
============== ============== =======
Accounts payable, Other................... (Yen) - (Yen) 134,085 $ 1,016
============== ============== =======
11. Goodwill and intangibles
Goodwill and Intangibles comprise the following:
F-20
Thousands of
Thousands of yen U.S. dollars
---------------- ------------
December 31,
---------------------- December 31,
2000 2001 2001
---- ---- ----
Goodwill ..................................... (Yen) 2,527,637 (Yen) - $ -
Software development costs. .................. 468,456 1,233,029 9,341
Purchased software rights .................... 144,093 - -
Other ........................................ 231,412 490,612 3,717
--------------- --------------- --------
3,371,598 1,723,641 13,058
Less - Accumulated amortization .............. (630,771) (613,179) (4,645)
--------------- --------------- --------
(Yen) 2,740,827 (Yen) 1,110,462 $ 8,413
=============== =============== ========
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) 994,340
thousand, (Yen) 2,043,480 thousand and (Yen) 2,755,200 thousand ($20,873
thousand) for the years ended December 31, 1999, 2000 and 2001, respectively.
Software development costs relating to the local language related functions
(representing software development costs as shown in Note 11 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
---------------- ------------
Years ended December 31, Year ended
----------------------------------------- December 31,
1999 2000 2001 2001
---- ---- ---- ----
Software development costs, net of
accumulated amortization:
Balance at beginning of year. ................. (Yen) 250,734 (Yen) 304,897 (Yen) 345,293 $ 2,616
Additions, at cost. ........................... 185,455 488,577 969,360 7,344
Amortization for the year ..................... (131,292) (448,181) (494,584) (3,747)
------------- ------------- ------------- -------
Balance at end of year ........................ (Yen) 304,897 (Yen) 345,293 (Yen) 820,069 $ 6,213
============= ============= ============= =======
F-21
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.
Since March 2000 when Softbank America, Inc. sold the remaining 6,300,000
shares, SOFTBANK and its affiliates have not not had equity ownership
interest in the Company.
Distribution
Based on the October 1999 distribution agreement between the Company and
SOFTBANK COMMERCE, an indirect wholly-owned subsidiary of SOFTBANK,
SOFTBANK COMMERCE 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 COMMERCE under the agreements have been effected on
a purchase-order basis. SOFTBANK COMMERCE has been the most significant
distributor of the Company and net sales to SOFTBANK COMMERCE represent
18.0%, 17.5% and 23.5% of total net sales to external customers for the
year ended December 31, 1999, 2000 and 2001, respectively.
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.
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:
F-22
Thousands of yen Thousands of
December 31, U.S. dollars
----------- ------------
December 31,
1999 2000 2001 2001
---- ---- ---- ----
Accounts receivable, trade .......................... (Yen) 852,004 (Yen) 1,072,768 (Yen)4,074,617 $30,868
Securities investments .............................. 1,800,460 1,711,050 1,746,920 13,234
Accounts payable, other ............................. 18,943 16,435 217,334 1,646
Net sales for the year .............................. 2,453,538 3,507,641 7,356,441 55,731
Purchases and expenses for the year ................. - 69,104 43,545 330
Interest income on security investments ............. 82,608 53,113 51,000 386
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)97,758 thousand,
(Yen)71,545 thousand and (Yen) 221,896 thousand ($1,681 thousand) for the years
ended December 31, 1999, 2000 and 2001, 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, 2001, 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,
2000 2001 2001
---- ---- ----
Bank loans:
Unsecured bank loan of a consolidated
subsidiary due 2001 with a weighted
average interest rate of 2.175% per
annum ............................................... (Yen) 57,200 (Yen) - $ -
Unsecured bank loan of a consolidated
subsidiary due 2003 with a weighted
average interest rate of 2.175% per
annum ............................................... 99,900 - -
Bonds:
Unsecured 2.5% bonds, due 2002 with
detachable warrants ................................. 4,700,000 3,800,000 28,788
Unsecured 2.1% bonds, due 2003 with
detachable warrants ................................. 5,000,000 5,000,000 37,879
Unsecured 1.75% bonds, due 2004 with
detachable warrants ................................. - 5,000,000 37,879
Unsecured 1.50% bonds, due 2004 with
detachable warrants ................................. - 1,500,000 11,363
Unsecured 1.75% bonds, due 2004 with
detachable warrants ................................. - 6,000,000 45,455
--------------- -------------- --------
9,857,100 21,300,000 161,364
Less - treasury bonds:
Unsecured 2.5% bonds, due 2002 with
detachable warrants ................................. - (800,000) (6,061)
Unsecured 1.75% bonds, due 2004 with
detachable warrants ................................. - (6,000,000) (45,455)
--------------- --------------- --------
9,857,100 14,500,000 109,848
Less - portion due within one year (57,200) (3,000,000) (22,727)
--------------- --------------- --------
(Yen) 9,799,900 (Yen)11,500,000 $ 87,121
=============== =============== ========
F-23
Based on the Company's incentive plans, the parent company issued unsecured
bonds with detachable warrants and bought all of the warrants at the same time
for the purpose of distributing such instruments to the directors and certain
employees of the parent company and its subsidiaries as a part of their
remuneration. The Japanese Commercial Code, restricts redemptions and
extinguishments of these bonds in case the amount of each outstanding bond is
less than the aggregate amount of exercise price of each outstanding warrant.
During the year ended December 31, 2001, inorder to to reduce interest costs,
the parent company repurchased a part of the bonds through market with an
intention to hold the treasury bonds until they can be extinguished legally.
However, as the repurchase transaction is deemed as redemption of the bonds in
substance, the treasury bonds are offset with the bonds on the face
ofconsolidated balance sheets. However, the purchase price of the treasury bonds
excess of the book value of the bonds at the time of transaction amounting to
(Yen)12,000 thousand ($ 91 thousand) are charged to income as other expenses for
the year ended December 31, 2001.
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
----------- ---------------- ---------
2002 (Yen)3,000,000 $22,727
2003 5,000,000 37,879
2004 6,500,000 49,242
2005 - -
2006 - -
F-24
15. Stock warrants
Based on the Company's 1997, 1998, 1999, 2000 and 2001 incentive plans, the
Company issued the following bonds with detachable warrants to SOFTBANK or the
public.
1. Shareholders' meeting /
board meeting approval ............ September 26, 1997 March 17, 1998 May 28, 1998 June 30, 1999 June 1, 2000
September 29, 1997 March 28, 1998 May 29, 1998 July 7, 1999 June 8, 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, 1999 ................. 1,454,400 1,029,600 813,600 1,875,000 -
10. Outstanding as of
December 31, 2000 ................. 940,200 682,200 597,000 1,439,494 636,942
11. Outstanding as of
December 31, 2001 ................. - 500,400 505,800 1,169,062 636,942
1. Shareholders' meeting /
board meeting approval ............ February 15, 2001 May 8, 2001 October 25, 2001
February 23, 2001 May 16, 2001 November 1, 2001
2. Date of bond issuance ............. March 19, 2001 June 4, 2001 November 19, 2001
3. Maturity date ..................... March 19, 2004 June 4, 2004 November 19, 2004
4. Amount of each bond
(Thousands of yen) ................ (Yen)5,000,000 (Yen)1,500,000 (Yen)6,000,000
5. Issued to ......................... Public Public Public
5. Date on which the bonds were
fully redeemed .................... - - -
6. Exercise price per
each warrant ...................... (Yen)5,675 (Yen)5,760 (Yen)2,590
7. Warrant exercise period ........... April 12, 2001 May 17, 2002 November 2, 2002
to March 12, to May 28, to November 12,
2004 2004 2004
8. Number of shares represented
by warrants ....................... 881,057 260,416 2,316,602
9. Outstanding as of
December 31, 1999 ................. - - -
10. Outstanding as of
December 31, 2000 ................. - - -
11. Outstanding as of
December 31, 2001 ................. 873,128 256,076 2,316,602
F-25
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, 1998 ................ 7,891
Granted ........................................ 1,875
Exercised ...................................... (4,672)
Redeemed ....................................... --
Cancelled ...................................... --
Outstanding at December 31, 1999 ................ 5,094
Granted ........................................ 637
Exercised ...................................... (1,435)
Redeemed ....................................... --
Cancelled ...................................... --
Outstanding at December 31, 2000 ................ 4,296
Granted ........................................ 3,458
Exercised ...................................... (898)
Redeemed ....................................... (552)
Cancelled ...................................... (12)
Outstanding at December 31, 2001 ................ 6,292
F-26
Balances are as follows:
Thousands of shares
-------------------
December 31
-----------
2000 2001
---- ----
Authorized and outstanding ..................... 4,296 6,292
Exercisable .................................... 2,958 2,356
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 was amortized during fiscal
1998, 1999 and 2000 respectively. The grants of October 17, 1997, July 29, 1999,
June 26, 2000, March 19, 2001, June 4, 2001 and November 19,2001 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 was as follows:
Thousands of shares
represented by options
Outstanding at December 31, 1999 ............................ 1,620
Granted .................................................. --
Exercised ................................................ (113)
Redeemed ................................................. --
Cancelled ................................................ --
Outstanding at December 31, 2000 ............................ 1,507
Granted .................................................. --
Exercised ................................................ (45)
Redeemed ................................................. --
Cancelled ................................................ --
Outstanding at December 31, 2001 ............................ 1,462
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, 2001 was (Yen)3,051. Consequently, the grants of the
option did not result in deferred compensation.
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 Company granted options to
purchase up to 724,500 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. Option
activity under this plan was as follows:
Thousands of shares
represented by options
Outstanding at December 31, 2000 ............................. --
Granted ................................................... 725
Exercised ................................................. --
Redeemed .................................................. --
Cancelled ................................................. (18)
Outstanding at December 31, 2001 ............................. 707
F-27
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.
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 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:
Years ended December 31,
--------------------------------------------------------
1999 2000 2001 2001
---- ---- ---- ----
(in thousands, except per share data)
Net income:
As reported ....................... (Yen) 2,147,373 (Yen) 3,674,657 (Yen) 4,385,912 $33,227
Pro forma net income .............. 1,698,432 2,829,475 3,688,118 27,941
Net income per share:
As reported -
Basic ........................... (Yen) 16.90 (Yen) 28.18 (Yen) 33.33 $ 0.25
Diluted ......................... 16.42 27.53 33.02 0.25
Pro forma net income -
Basic ........................... (Yen) 13.36 (Yen) 21.70 (Yen) 28.03 $ 0.21
Diluted ......................... 12.99 21.20 27.77 0.21
The fair values of each warrant grant, stock option under the Japanese
Commercial Code and the Industrial Revitalization Special measures Law and stock
options under the U.S. Program were 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, 1999, 2000 and
2001; 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; expected life of three years, volatility of 14.980% to
15.000% and dividend yield of 0.0% for 2001 and risk-free interest rates of
0.75% for options granted during the years ended December 31,1999, and the rate
of 0.741% for options granted during the year ended December 31, 2000, and the
rate ranging from 0.157% to 0.429% for options granted during the year ended
December 31, 2001. The weighted average fair value per share of options granted
above during fiscal 1999, 2000 and 2001 were (Yen)474, (Yen) 1,005 and (Yen) 277
to 624 ($2.10 to 4.73), 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.
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,
1999 2000 2001 2001
---- ---- ---- ----
Change in benefit obligation:
Benefit obligation at beginning of year ............. (Yen)130,173 (Yen)174,184 (Yen)251,696 $1,907
Service cost ........................................ 62,451 66,643 107,991 818
Interest cost ....................................... 4,978 6,659 10,856 82
Amendments .......................................... - - - -
Actuarial (gain)/loss ............................... (16,136) 9,259 17,962 136
Benefits paid ....................................... (1,077) (4,100) (3,401) (26)
Foreign currency exchange impact .................... (6,205) (949) 27,276 207
------------ ------------ ------------ ------
Projected benefit obligation at end of year...... 174,184 251,696 412,380 3,124
------------ ------------ ------------ ------
Change in plan assets:
Fair value of plan assets at beginning of year ...... (6,771) (13,063) (29,282) (222)
Actual return on plan assets ........................ (678) (1,304) (1,870) (14)
Benefits paid ....................................... 1,077 4,100 3,401 26
Employer contribution ............................... (11,342) (19,303) (22,741) (172)
Foreign currency exchange impact .................... 4,651 288 (7,352) (56)
------------ ------------ ------------ ------
Fair value of plan assets at end of year ........ (13,063) (29,282) (57,844) (438)
------------ ------------ ------------ ------
Funded status
Unrecognized prior service cost ...................... (24,802) (23,213) (23,999) (182)
Unrecognized net actuarial loss ...................... (6,313) (27,521) (50,514) (383)
Unrecognized net transition obligation ............... (4,760) (3,648) (2,535) (19)
------------ ------------ ------------ ------
Accrued benefit cost ................................. (Yen)125,246 (Yen)168,032 (Yen)277,488 $2,102
============ ============ ============ ======
Thousands of yen
--------------------
December 31,
---------------------------------
1999 2000 2001
---- ---- ----
Weighted-average assumptions as of December 31:
Discount rate ............................................................... 4.50% 4.20% 4.24%
Expected return on plan assets .............................................. 6.50% 6.50% 6.00%
Rate of compensation increase ............................................... 5.25% 5.02% 5.91%
Thousands of
Thousands of yen U.S. dollars
---------------- ------------
Years ended December 31,
---------------------------------------- Year ended
December 31,
1999 2000 2001 2001
---- ---- ---- ----
Components of net periodic benefit cost:
Service cost ........................................ (Yen)62,451 (Yen)66,643 (Yen)107,991 $818
Interest cost ....................................... 4,978 6,659 10,856 82
Expected return on plan assets ...................... (808) (1,419) (2,706) (20)
Amortization of unrecognized transition obligation .. 1,112 1,112 1,112 8
Amortization of prior service cost .................. 1,130 1,097 1,142 9
Recognized actuarial loss ........................... 697 (143) 2,421 18
----------- ----------- ------------ ----
Net periodic pension cost ............................ (Yen)69,560 (Yen)73,949 (Yen)120,816 $915
=========== =========== ============ ====
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
F-29
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 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, 2000 and 2001 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
---------------- ------------
Years ended December 31,
------------------------ Year ended
December 31,
1999 2000 2001 2001
---- ---- ---- ----
Income before income taxes:
Domestic ........................... (Yen)2,541,761 (Yen) 2,485,562 (Yen) 2,427,164 $ 18,388
Foreign subsidiaries ............... 1,457,435 4,406,149 5,329,413 40,374
-------------- --------------- --------------- --------
(Yen)3,999,196 (Yen) 6,891,711 (Yen) 7,756,577 $ 58,762
============== =============== =============== ========
Income taxes, current:
Domestic ........................... (Yen)1,245,851 (Yen) 2,156,067 (Yen) 3,485,946 $ 26,409
Foreign subsidiaries ............... 1,292,604 2,545,359 728,513 5,519
-------------- --------------- --------------- --------
(Yen)2,538,455 (Yen) 4,701,426 (Yen) 4,214,459 $ 31,928
============== =============== =============== ========
Income taxes, deferred:
Domestic ........................... (Yen) (34,536) (Yen) (963,777) (Yen)(1,451,989) $(11,000)
Foreign subsidiaries ............... (654,452) (615,112) 478,651 3,626
-------------- --------------- --------------- --------
(Yen) (688,988) (Yen)(1,578,889) (Yen) (973,338) $ (7,374)
============== =============== =============== ========
The Company is subject to a number of different income taxes which, in
aggregate, indicate a statutory tax rate in Japan of approximately 47.7% for the
year ended December 31, 1999 and approximately 42.1% for the years ended
December 31, 2000 and 2001. 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.
F-30
Reconciliation of the differences between the statutory tax rate and the
effective income tax rate is as follows:
Years ended December 31,
----------------------------
1999 2000 2001
---- ---- ----
Statutory tax rate: 47.7% 42.1% 42.1%
Increase (reduction) in rate resulting from -
Different tax rates applied to
foreign subsidiaries. .............................. (3.5) (3.6) (2.9)
Effect of change in normal
statutory tax rate in Japan. ....................... 2.3 - -
State income taxes, net of federal tax. .............. (1.1) 1.8 1.3
Permanent difference. ................................ 2.5 0.8 2.8
Amortization of deferred compensation
related to stock warrants .......................... 2.6 0.6 -
Change in deferred tax valuation allowance ........... (4.9) 1.5 1.1
Tax credit relating to research and
development costs .................................. (1.4) (0.5) (0.6)
Goodwill amortization ................................ - 1.7 -
Other ................................................ 2.0 0.9 (2.0)
Effective income tax rate ................................... 46.2% 45.3% 41.8%
The significant components of deferred income tax assets and liabilities at
December 31, 2000 and 2001 were as follows:
Thousands of
Thousands of yen U.S. dollars
---------------- ------------
December 31,
------------
December 31,
2000 2001 2001
---- ---- ----
Deferred tax assets:
Deferred revenue. ........................................ (Yen) 1,998,724 (Yen)2,396,462 $18,155
Allowance for doubtful accounts and sales returns ........ 280,568 322,948 2,447
Accrued enterprise tax. .................................. 112,694 212,773 1,612
Accrued liabilities ...................................... 107,626 449,633 3,406
Tax loss carry forward. .................................. 236,689 151,251 1,146
Unrealized loss on debt and equity securities ............ 103,075 166,203 1,259
Other .................................................... 415,823 714,397 5,412
--------------- -------------- -------
Gross deferred tax assets. ............................ 3,255,199 4,413,667 33,437
Less: Valuation allowance ............................. (116,630) (207,099) (1,569)
--------------- -------------- -------
3,138,569 4,206,568 31,868
--------------- -------------- -------
Deferred tax liabilities
Unrealized gain on debt and equity securities ............ (4,652) (15,772) (119)
--------------- -------------- -------
(4,652) (15,772) (119)
--------------- -------------- -------
Net deferred tax assets. .................................... (Yen) 3,133,917 (Yen)4,190,796 $31,749
=============== ============== =======
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
2000 2001 2001
---- ---- ----
Current assets-Deferred income taxes .............. (Yen)2,687,913 (Yen)3,218,595 $ 24,383
Other assets-Deferred income taxes ................ 446,004 972,201 7,366
--------------- -------------- --------
Net deferred tax assets. .......................... (Yen) 3,133,917 (Yen)4,190,796 $ 31,749
=============== ============== ========
F-31
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, 1999, 2000 and 2001 were a decrease of (Yen)
201,586 thousand, an increase of (Yen) 106,165 thousand and an increase of (Yen)
90,469 ($685 thousand), respectively.
Operating loss carryforwards for tax purposes of consolidated subsidiaries at
December 31, 2001 amounted to approximately (Yen)591,143 thousand ($4,478
thousand) and are available as an offset against future taxable income of the
subsidiary. These carryforwards expire at various dates up to December 31, 2006.
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, 2001, no deferred income taxes have been provided on
undistributed earnings of foreign subsidiaries not expected to be remitted in
the foreseeable future totaling (Yen)4,768,298 thousand ($36,123 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, 2001 for such undistributed earnings amounted to (Yen)998,299
thousand ($7,563 thousand).
18. Shareholders' equity
Changes in the number of shares of common stock issued have resulted from
the following:
Years ended
December 31,
----------------------------------
1999 2000 2001
---- ---- ----
Shares of common stock issued:
Balance at beginning of year ............... 125,013,600 129,685,800 131,120,842
Exercise of stock purchase warrants. ....... 4,672,200 1,435,042 931,442
----------- ----------- -----------
Balance at end of year ..................... 129,685,800 131,120,842 132,052,284
=========== =========== ===========
As approved at an ordinary meeting of shareholders on March 11, 1999, the
authorized number of shares of par value (Yen)50 common stock 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.
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 May 18,
2001. All share and per share data in the consolidated financial statements have
been adjusted to give effect to the stock splits made on September 30, 1999 and
May 18, 2001.
As a result of the amendments to the Japanese Commercial Code in 2001, the
concept of par value of shares has been eliminated effective from October 1,
2001.
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, 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 and (Yen) 769,603 thousand, respectively, in the year ended 2000.
F-32
Upon exercise of stock warrants, 661,200 shares of common stock at an exercise
price of (Yen)142.5 per share and 270,242 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)479,512
thousand ($3,633 thousand) and (Yen) 479,998 thousand ($3,636 thousand),
respectively, in the year ended 2001.
Prior to the amendments to the Japanese Commercial Code in 2001, at least 50% of
the issue price of new shares, with a minimum of the par value of those shares,
was required to be designated as common stock. However, as a result of the
amendments where the concept of par value of shares has been eliminated
effective from October 1, 2001, at least 50% of the issue price of new 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. Prior
to the amendments to the Japanese Commercial Code in 2001, no further
appropriation was required when the legal reserve equals 25% of the stated
capital. However, as a result of the amendments effective from October 1, 2001,
no further appropriation is required when the aggregated amount of the
additional paid-in-capital and 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, 2000
and 2001 were (Yen)4,853,408 thousand and (Yen)5,118,340 thousand ($38,775
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, 2000 and 2001
was a net debit balance of (Yen)337,893 thousand and a net credit balance of
(Yen)538,393 thousand ($4,079 thousand), respectively.
F-33
19. Financial instruments
(1) Derivative instruments
The Company has a policy not to utilize any derivative financial instruments
with off-balance sheet risk. In accordance with the policy, the parent company
and its subsidiaries did not employ any derivative financial instruments.
However, ipTrend which was acquired in 2000 had 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 in 2000, ipTrend repaid the underlying
hedged debt without settling the interest rate swap and cap arrangements. In
2001, the parent company assumed an interest rate swap and cap arrangements upon
the liquidation of ipTrend in December 2001. Those arrangements which did not
qualify for hedge accounting were marked to market with changes in value
recognized in other income or expense. 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
and the aggregate carrying amount of the arrangements and the related fair value
were a credit balance of (Yen)6,751 thousand.
At December 31, 2001, 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 and the aggregate carrying amount of the
arrangements and the related fair value were a credit balance of (Yen)9,710
thousand ($74 thousand). The fair value of interest rate swap arrangement and
the interest rate cap arrangement are estimated based on the discounted amounts
of future net cash flows.
(2) Fair value of financial instruments
Other than debt and equity securities, the fair value of which are disclosed in
Note 8, the Company's involvement in financial assets and liabilities with
market risk is limited to cash and cash equivalents, time deposits, notes and
accounts receivable, trade, notes and accounts payable, trade, and long-term
debt. The estimated fair value of cash and cash equivalents, time deposits,
notes and accounts receivable, trade, and notes and accounts payable, trade are
carried at amounts which approximate fair value. At December 31, 2001, the
carrying amount and the estimated fair value of long-term debt including the
current portion are (Yen) 14,500,000 thousand ($109,848 thousand) and (Yen)
14,572,418 thousand ($110,397 thousand), respectively. At December 31, 2000, the
carrying amount of long-term debt including the current portion of (Yen)
9,857,100 thousand approximated their fair values. The fair value of the
long-term debt, including the current portion, is estimated based on the
discounted amounts of future cash flows using the Company's current incremental
debt rates for similar liabilities.
20. Advertising costs
Advertising costs are expensed as incurred. Advertising costs included in
selling, general and administrative expenses were (Yen)2,164,630 thousand,
(Yen)2,004,749 thousand and (Yen)2,096,035 thousand ($15,879 thousand) for the
years ended December 31, 1999, 2000 and 2001, respectively.
F-34
21. Leased assets
Rental expenses under operating leases for the years ended December
31,1999, 2000 and 2001 were (Yen)422,727 thousand, (Yen)644,343 thousand and
(Yen)1,167,026 thousand ($8,841 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, 2001 are as
follows:
Thousands of
Year ending December 31: Thousands of yen U.S. dollars
---------------- ------------
2002 ........................................ (Yen)976,558 $ 7,398
2003 ........................................ 428,861 3,249
2004 ........................................ 427,343 3,237
2005 ........................................ 425,795 3,226
2006 ........................................ 101,585 770
2007 ........................................ 9 0
-------------- -------
Total minimum future lease payments ............ (Yen)2,360,151 $17,880
============== =======
22. Commitments and contingent liabilities
There were no significant commitments outstanding at December 31, 2001.
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 to the Company in consideration for its past patent
license from the Company. For the year ended December 31, 2000, the Company
recorded a gain on settlement of the litigation of (Yen)1,019,734thousand, net
of related fees for lawyers of (Yen)307,016 thousand in total, as "other
income".
At December 31, 2001, the Company and its subsidiaries had no significant
commitments outstanding, 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
business segments: the "Security software business" and the "Internet-related
products/service business". The internet-related products and services are
operated by ipTrend which was acquired by the Company during the year ended
December 31, 2000. However, business 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 and (Yen) 574,197 thousand ($ 4,350
thousand) for the year ended December 31, 2000 and 2001, respectively.
Net revenue, attributed to countries based on location of the Company and
consolidated subsidiaries, and long-lived assets for the years ended December
31, 1999, 2000 and 2001 are as follows:
F-35
Geographic information -
Thousands of
Thousands of yen U.S. dollars
---------------- ------------
Years ended December 31,
----------------------- Year ended
December 31,
1999 2000 2001 2001
---- ---- ---- ----
Net sales to external customers:
Japan ................................. (Yen)5,847,188 (Yen) 6,633,573 (Yen)12,114,972 $91,780
U.S.A ................................. 3,830,589 6,258,300 8,577,200 64,979
Taiwan ................................ 1,646,550 1,918,175 1,896,326 14,366
Europe ................................ 1,825,699 4,126,420 6,860,193 51,971
Other ................................. 483,144 1,133,898 1,877,630 14,225
--------------- --------------- --------------- --------
Total ............................ (Yen)13,633,170 (Yen)20,070,366 (Yen)31,326,321 $237,321
=============== =============== =============== ========
Long-lived assets:
Japan ................................. (Yen) 1,002,116 (Yen) 3,465,387 (Yen) 2,180,338 $16,518
U.S.A ................................. 320,497 402,324 649,814 4,923
Taiwan ................................ 248,637 515,829 667,167 5,054
Europe ................................ 52,779 109,517 390,849 2,961
Other ................................. 27,133 41,160 103,545 785
-------------- --------------- --------------- -------
Total ............................ (Yen)1,651,162 (Yen) 4,534,217 (Yen) 3,991,713 $30,241
============== =============== =============== =======
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
---------------- ------------
Years ended December 31, Year ended
--------------------------------------------- December 31,
1999 2000 2001 2001
---- ---- ---- ----
Investments and other assets:
Goodwill and intangibles .............. (Yen)440,252 (Yen)2,740,827 (Yen)1,110,462 $8,413
Other ................................. 461,125 570,742 868,377 6,579
Property and equipment, less
accumulated depreciation .............. 749,785 1,222,648 2,012,874 15,249
-------------- -------------- -------------- -------
Total ............................ (Yen)1,651,162 (Yen)4,534,217 (Yen)3,991,713 $30,241
============== ============== ============== =======
Significant customers
SOFTBANK COMMERCE, an indirect wholly-owned subsidiary of SOFTBANK
accounted for more than 10% of net sales to external customers for
the years ended December 31, 1999, 2000 and 2001. Net sales to
SOFTBANK and its affiliates for the years ended December 31, 1999,
2000 and 2001 were (Yen)2,453,538 thousand, (Yen)3,507,641 thousand
and (Yen)7,356,441 thousand ($55,731 thousand), respectively.
F-36
24. Subsequent events
Issuance of unsecured bonds with detachable warrants
As approved by the Company's Board of Directors on March 26 and April
2, 2002, the Company issued the following bonds with detachable
warrants to the public based on the Company's 2002 incentive plan.
1. Approval by the board of directors ............. March 26, 2002 and April 2, 2002
2. Date of bond issuance .......................... April 18, 2002
3. Maturity date .................................. April 18, 2006
4. Amount of each bond ............................ (Yen)4,000,000 thousand
($30,303 thousand)
5. Interest rate per annum ........................ 1.90%
6. Exercise price per each warrant ................ (Yen)3,450
7. Warrant exercise period ........................ April 3, 2003 to
April 11, 2006
8. Number of shares represented
by warrants .................................... 1,159,420
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.
F-37
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, 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
============= ============ ============= =============== ============== =============
Year ended December 31, 2001:
Allowance for doubtful
accounts and sales returns ..... (Yen) 646,566 (Yen)124,787 (Yen) 110,742 (Yen) (67,535) (Yen) 35,816 (Yen) 850,376
============= ============ ============= =============== ============== =============
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, 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
============= ============ ============== ============== ==============
Year ended December 31, 2001:
Valuation allowance
- Deferred tax assets ......... (Yen) 116,630 (Yen)165,049 (Yen) (74,580) (Yen) - (Yen) 207,099
============= ============ ============== ============== ==============
F-38
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 October
1, 1999, between Trend Micro Incorporated and SOFTBANK COMMERCE
CORP., and related agreements
8.1**** Subsidiaries of Trend Micro
* Incorporated by reference to the corresponding exhibit to Trend Micro's
Form S-8 Registration Statement (File No. 333-85934) filed on April 10,
2002.
** Incorporated by reference to the corresponding exhibit to Trend Micro's
annual report on Form 20-F (File No. 333-10486) filed on June 29, 2001.
*** 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.
**** 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.
+ Confidential treatment granted for a portion of these documents.
Certificate of English Translation
The registrant hereby represents that the following English translation is a
fair and accurate English translation of its Regulations of the Board of
Directors.
TREND MICRO INCORPORATED
/s/ Mahendra Negi
---------------------------
Mahendra Negi
Representative Director,
Chief Financial Officer and
Executive Vice President
Date: July 1, 2002