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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, 1999
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 ___________________________________________________
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
Title of Each Class on Which Registered
------------------- -------------------
American Depositary Shares* The Nasdaq National Market
Common Stock** The Nasdaq National Market
* American Depositary Shares evidenced by American Depositary Receipts.
Each American Depositary Share represents 10 shares of Common Stock.
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** Par value 50 Japanese yen per share. Not for trading, but only in
connection with the listing of American Depositary Shares pursuant to
the requirements of The Nasdaq National Market.
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
(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.
<TABLE>
<CAPTION>
Outstanding as of
--------------------------------------------
December 31, 1999 December 30, 1999
Title of Class (Japan Time) (New York Time)
-------------- ------------ ---------------
<S> <C> <C>
Common Stock - 50 yen par value per share 64,842,900
American Depositary Shares, each representing 0.10 shares of
common stock 8,020,000
</TABLE>
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, 1999 or for
the year ended December 31, 1999 (fiscal 1999) unless the context otherwise
indicates.
The noon buying rate for yen in New York City as certified for customs
purposes by the Federal Reserve Bank of New York on May 17, 2000 was (Yen)109.53
= U.S.$1.
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Cautionary Statement Regarding Forward-Looking Statements
- - - - - - - - ----------------------------------------------------------
This Annual Report on Form 20-F contains forward-looking statements within
the meaning of Section 21E of the U.S. Securities Exchange Act of 1934, as
amended. These statements involve known and unknown risks, uncertainties and
other factors, which may cause our actual results, levels of activity,
performance, or achievements to differ materially from those implied by the
forward-looking statements. The forward-looking statements in this Annual Report
can be identified, in some instances, by the use of words such as "expects,"
"anticipates," "intends," "believes," and similar language. We cannot guarantee
future results, levels of activity, performance or achievements.
Potential risks and uncertainties which may cause our actual results to
differ materially from those implied by the forward-looking statements include,
but are not limited to:
. 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;
. 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.
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PART I
Item 1. Description of Business
-----------------------
Introduction
We develop, market and support anti-virus software and management
solutions for corporate computing systems and personal computers. Our products
deliver virus protection at each access point within the corporate network where
data files are exchanged.
Our products have recently won the following awards:
Publication Award
PC Professionnell In February 2000, German magazine
PC Professionnell awarded the Editor's Choice
distinction to ServerProtect, OfficeScan
Corporate Edition and Trend Virus Control System.
Windows NT Magazine ServerProtect won Windows NT Magazine's Editor's
Choice Award in its December 1999 issue.
InfoWorld October 1998 "Test Center Hot Pick" award for
Trend Virus Control System, ServerProtect and
OfficeScan Corporate Edition package. For
products or solutions deemed to offer stand-out
technology, among other criteria.
InfoWorld In February 1999 InfoWorld picked the same
software package as the anti-virus "Solution of
the Year" for 1998.
PC Magazine In April 1999 a package of Trend
Virus Control System, ServerProtect,
ScanMail and OfficeScan Corporate Edition
earned a "NeaTSuite/Editor's Choice" award
based upon performance tests comparing
anti-virus solutions. PC Magazine is
published by Ziff-Davis Inc., a subsidiary
of SOFTBANK.
Network Magazine In April 1999 Network Magazine picked
Trend Virus Control System as the anti-virus
"Product of the Year" for 1999.
Our products operate across a range of computer operating system platforms,
including Windows NT, Windows 2000, Windows 98, NetWare, Sun Solaris and several
versions of UNIX. Corporate and government end users of our anti-virus software
and management tools include Boeing, Bank of America, Hewlett-Packard, Chase
Manhattan Bank, Lucent Technologies, GTE, Coca-Cola, MCI WorldCom, ConAgra,
Microsoft, Siemens, Bayer, Deutsche Bank, Nestle, Nissan, the European
Parliament and the European Commission.
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.
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 diskettes is downloaded into a personal computer's memory. They
also spread as e-mail and application software files are transmitted
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among multiple users within a computer network or through 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.
The Evolution of Computer Viruses
Computer viruses were first identified in 1986. Until 1995, the most
prevalent type of viruses were "boot sector" viruses, which infect the portion
of a floppy disk that was used to start a personal computer and load the
operating system. These viruses spread to a user's hard disk when the computer
accesses the disk to load system files into memory. "Polymorphic" viruses, which
use complex encryption and change characteristics each time they copy themselves
into a new host program, also developed during this period.
By the mid-1990s, computer networks had become a critical tool for
information sharing within companies. Viruses followed this new communication
channel, and the primary infection target shifted from the personal computer to
the network server. With enhanced productivity from computer use came the risk
of more widespread damage: in a networked environment, a virus in a single
desktop computer can easily be transmitted through the server to other clients,
and infect the entire network.
A second-generation class of viruses called "macro viruses" followed the
development of the enterprise network. Like other viruses, macro viruses can
replicate only by attaching to other software programs. Macro viruses differ
from other viruses, however, in that they attach to macro-enabled data files
such as Word and Excel. Macro viruses are relatively easy to create because they
can be written in Basic or other relatively simple programming languages and, as
a result, comprise most of the growth in new viruses. The International Computer
Security Association published a virus prevalence survey in 1999 which stated
that macro viruses accounted for approximately two-thirds of all virus
infections among 300 North American companies surveyed. Like many of our
competitors, we are a member of the Association and in the past have been a
corporate sponsor of the Association's annual survey. We also participate in
anti-virus industry consortia organized by the Association. The Association has
provided certification testing of OfficeScan, ServerProtect, InterScan and other
of our products for us in 1999 for a fee of $22,000.
Most recently, the advent of the internet as a medium for communication and
commerce has increased the likelihood of infection by a third generation of
viruses carried by applets. Applets are small programs written in ActiveX and
Java. Programmers use ActiveX and Java applets in web pages to enable animation
and interactivity. Accessing a web page containing ActiveX or Java applets
automatically triggers the download and execution of these programs by the
desktop computer. Neither ActiveX nor Java requires a separate program to access
other computers on the internet because they can use the internet as a host. As
a result, malicious code in these languages can easily replicate and infect
computer systems and files. We believe that most companies do not yet have
security systems to detect and eliminate ActiveX and Java viruses.
Virus Detection Techniques
The traditional method of virus detection has been pattern-matching
scanning, which involves gathering suspicious code samples, conducting code
analysis, creating new virus signature files and distributing such files to
customers as updates to existing anti-virus software. This process can be
time-consuming and is generally recognized as ineffective against macro viruses
which can replicate and spread quickly through e-mail and the internet. To block
macro viruses more effectively, anti-virus software developers have created
rule-based scanning, which runs suspect code in an emulated computing
environment to confirm whether it is a virus.
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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. According to Dataquest,
an independent research organization, worldwide anti-virus revenues have grown
from approximately $375 million in 1996 to approximately $771 million in 1998,
and are expected to grow to approximately $1.16 billion in 2002. International
Data Corporation, another independent research organization, estimates that
worldwide anti-virus revenues have grown from approximately $686 million in 1997
to approximately $1.1 billion in 1998, and are expected to grow to approximately
$2.9 billion in 2002.
Until recently, sales of anti-virus software products consisted primarily
of sales of desktop programs. As viruses followed the shift by companies from
stand-alone desktop personal computers to client-server networks, anti-virus
software developers introduced new products to operate at the network server
level. Screening data at the server has the benefit of preventing viruses from
spreading to multiple personal computers through the exchange of files and e-
mail messages. In addition, the growth of the internet has resulted in increased
risk of virus infection for networks. In response, anti-virus software companies
have begun to develop solutions to protect against viruses entering the
corporate network from the internet.
While many businesses, particularly in the United States and Europe, have
responded to the computer virus threat by adopting network security policies and
adding anti-virus software to their networks, viruses continue to infect
enterprise networks worldwide. According to data compiled by the Information-
Technology Promotion Agency, a quasi-governmental organization affiliated with
the Japanese Ministry of International Trade and Industry, incidents of virus
infections in Japan have increased significantly, from 755 in 1996 to 3,645 in
1999. We cooperate with the Information-Technology Promotion Agency by providing
information regarding new types of viruses, product demonstrations and virus
protection seminars. In 1998, the Information-Technology Promotion Agency paid
us approximately (Y)9.0 million ($75,000) for virus analysis services. We
believe that, for publicity and other reasons, companies in Japan tend not to
report virus infections as readily as companies elsewhere and that the actual
number of incidents is even higher. The International Computer Security
Association's 1999 survey indicates that the 300 surveyed North American
companies experienced about 13 virus encounters per 1,000 machines per month
during the period from January 1996 to February 1999.
Our products have evolved with the development of the anti-virus
software market as a whole. Until recently, sales of anti-virus software
products consisted primarily of sales of our desktop programs, such as
PC-cillin/Virus Buster, which we introduced in Japan in 1991. To meet increased
demand for network-based products as companies shifted from stand-alone desktop
personal computers to client-server enterprise networks in the early 1990s, we
introduced LANprotect, our first server application, in 1993. To address the
increased risk of virus infection for enterprise networks resulting from
widespread use of the internet, we introduced InterScan VirusWall in 1997 to
provide real-time scanning at the internet gateway. The internet gateway is the
network server where data enters the network from the internet. In 1998 we
introduced Trend Virus Control System to enable network-wide anti-virus software
monitoring, updating and management from a central management console.
Challenges to Providing Comprehensive Anti-virus Protection
The evolution of computer viruses with the shift from stand-alone
personal computers to client-server enterprise networks and, most recently, the
emergence of the internet has created a number of challenges to businesses
seeking protection against viruses:
. Keeping Pace with the Rapid Evolution and Proliferation of New
Viruses. As computer technology has grown more sophisticated, the
number of viruses, as well as the type or "species" of viruses,
have grown rapidly. We estimate that the number of known viruses
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has increased from approximately 100 in 1990 to more than 25,000
in 1999. We believe that new viruses are appearing at the rate of
14 or 15 per day. Moreover, there are now at least five "species"
of viruses, each exploiting a different aspect of computer
technology: boot sector viruses, file viruses, macro viruses,
script viruses and malicious ActiveX and Java programs. Our virus
prevalence estimates are based on our experience in developing
and maintaining our products. We keep a record of each virus
which our software has detected and removed, and maintain
computer files of virus samples. The above estimates are based on
the number and types of viruses that we have detected and removed
on an annual basis from 1990 to 1999.
. Protecting Against Infections at Multiple Levels. New
technologies have not only spurred growth in the number and types
of viruses, they have also created multiple entry points for
viruses. Transmission of viruses is no longer confined to
downloading a file off a floppy disk onto a desktop personal
computer. Viruses can now be transmitted at the server level,
through files transmitted from a local area network server to
client, and the internet gateway level, through e-mail or Java
applets embedded in web pages. Traditional approaches which focus
on protecting only at the desktop level have become inadequate in
today's networked environment.
. Difficulty in Providing Enterprise-Wide Protection Against
Rapidly Evolving Virus Technology. The pervasiveness of computing
technology in today's business enterprises creates enormous
challenges for deploying and updating comprehensive anti-virus
protection. No matter how advanced the basic underlying anti-
virus program, protection for a computer system consisting of
multiple servers and hundreds or even thousands of client
computers is inadequate unless there is an efficient means to
administer it. Traditional approaches which rely on monitoring by
information technology staff are costly and inefficient.
Strategy
We seek to develop and deliver the most effective anti-virus and security
software in the market. Our strategy to attain this goal includes:
Implement Internet Service Business Model. We believe the internet presents
an important opportunity to address customers' network security needs by
offering products and services delivered through the internet. Our Trend Virus
Control System software and eDoctor service already use the internet to update,
monitor and manage anti-virus software throughout the enterprise network. We
plan to offer services for a fee over the internet indirectly through systems
integrators and internet and telecom service providers. We are also expanding
our business model to include additional security-oriented solutions such as our
InterScan eManager e-mail management product and our InterScan WebManager
internet access management product. We will seek to offer additional internet-
related applications which can manage network capacity, control access to
designated websites and provide security for electronic commerce transactions.
We may also in the future seek to expand our business by acquiring companies
which offer competitive services delivered over the internet.
Expand International Market Presence through Strategic Partnerships. We are
focusing on increasing our share of the international anti-virus and network
security market, particularly in the U.S. and Europe. One of our strategies in
this area is to form alliances with major computer hardware manufacturers,
software developers and telecom providers. We believe these partnerships create
new sales channels for our products and strengthen the Trend Micro brand name in
key markets. To this end, we have entered into agreements with Check Point,
Compaq, Hewlett-Packard, IBM/Lotus, Lucent Technologies, Microsoft, Oracle and
other companies. These agreements provide for cooperative
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marketing activities such as the vendors' referral of customers to our products
and reference to our products in their product literature and websites. Our
agreements with these vendors also typically provide for co-development and
licensing arrangements so that our products and the vendors' products operate
smoothly when used together. We plan to seek relationships with other providers
of complementary products such as server vendors and network management software
developers.
Enhance Trend Micro's Technology. Our multinational team of 251 research
and development anti-virus engineers has enabled us to focus on providing
innovative anti-virus products and services to customers. We intend to continue
to improve our existing products and to develop new products and services, such
as our InterScan AppletTrap software for detecting unknown ActiveX and Java
malicious code.
Consolidate Leading Market Position in Japan. We believe we are the leading
supplier of anti-virus software products to corporate users in Japan. Sales of
anti-virus software to Japanese corporate end users typically occur through
distributors and systems integrators. To consolidate our market position in
Japan, we are seeking additional distributors, and to expand distribution
through our existing distributor and systems integrator partners. We plan to
continue our focus on the Japanese corporate market, where we believe that some
companies do not yet use anti-virus software to protect their networks.
Maintain Strong Customer Support Network. To support our international
customer base and to provide real-time service response, we have established a
network of virus analysis centers staffed with our multinational team of 132
computer virus engineers, which includes employees in the United States, Taiwan,
Japan and the Philippines. Our service centers allow customers to send virus
infected files via e-mail for detection and cleaning. We intend to further
foster customer allegiance by working together with our systems integrators,
value-added resellers and strategic partners to provide high levels of service
and support.
The Trend Micro Enterprise Solution
Trend Micro offers a suite of integrated anti-virus software and anti-virus
management solutions designed to provide comprehensive, cost-effective
protection at each level of the enterprise network -- from the internet gateway
to the desktop personal computer. Our anti-virus solutions provide the following
benefits:
. Advanced Protection Against New Viruses. The core of our anti-
virus solutions is our proprietary pattern matching, rules-based
and emulation detection technologies which can identify and
remove most known viruses, including boot sector, polymorphic,
macro and applet based viruses. Our Cheetah scanning engine,
which incorporates our MacroTrap virus detection technology,
rapidly detects known and some unknown macro viruses. In
addition, we continuously collect data on new viruses and offer
solutions which allow:
. important virus events to be recorded in a
comprehensive system log;
. weekly anti-virus software updates to help protect
against emerging viruses; and
. monthly anti-virus "health check" status reports.
. Multi-level Anti-virus Protection. Our products operate at
multiple levels in the enterprise network:
. first, at the gateway level, before data enters the
network server;
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. second, at the network server, where infected files can
be detected before being transmitted to client
computers; and
. finally, at the client computer itself.
We believe that protection at the gateway level is of particular
importance due to the increasingly widespread use of the internet. Our
InterScan product, with its real-time scanning technology, provides
virus protection at the network server where data enters the network
from the internet.
. Web-based, Enterprise-Wide Anti-virus Updating, Monitoring and
Management. Our Trend Virus Control System technology allows anti-
virus deployment, updating and monitoring to be performed via the
internet and across the enterprise network.
We offer products, described more fully below, in the following categories:
. enterprise-wide management;
. internet gateway virus protection;
. server level virus protection;
. desktop level virus protection;
. internet-based service solutions; and
. integrated small business solutions.
Enterprise-Wide Management
Trend Virus Control System is a management tool that allows the network
administrator to monitor, update and manage anti-virus programs on the network
from a single point, regardless of the programs' physical location or platform.
Once installed on a Windows NT server, the Trend Virus Control System registers
every anti-virus product detected on the network and delivers network-wide virus
reports and alerts to the central management console. Using technology that can
automatically update and reconfigure software from a remote location, the Trend
Virus Control System installs, configures and automatically delivers virus
pattern updates to our InterScan VirusWall, ScanMail, ServerProtect and
OfficeScan Corporate Edition anti-virus products. When used in conjunction with
our eDoctor software, the Trend Virus Control System enables network-wide
updating and management of anti-virus software by a service partner, such as a
systems integrator, through the internet. The Trend Virus Control System and
eDoctor give our product suite an important competitive advantage in Japan,
where enterprises tend to rely on remotely based systems integrators to provide
continuing anti-virus support. The Trend Virus Control System supports both
Microsoft Internet Explorer and Netscape/AOL Navigator browsers.
Internet Gateway Virus Protection
InterScan VirusWall provides real-time scanning at the network server where
data enters the network from the internet. InterScan VirusWall blocks viruses
hidden in simple mail transfer protocol, file transfer protocol and hypertext
transfer protocol internet traffic. Network administrators can set InterScan
VirusWall to respond to virus infection incidents in any or all of the following
ways:
. alerting the system administrator;
. isolating the infected file for later cleaning or later action;
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. deleting the infected file; or
. permitting the user to download the file under controlled
conditions.
Check Point Software Technologies Ltd. in August 1998 certified that
the Sun Microsystems Solaris version of InterScan VirusWall can operate
compatibly on Check Point's FireWall-1 internet gateway server. InterScan
VirusWall was named as Network Computing magazine's "Editor's Choice" for anti-
virus solutions in April 1999 and received a similar award from the British
magazine Network Week in April 1999.
In 1999, we offered free downloading and 30-day use of InterScan
VirusWall to prevent the Melissa virus, which struck networks worldwide in late
March 1999, from infecting or damaging users' networks.
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
patent-pending technology to instruct the destination client personal computer
regarding acceptable behavior and shuts down applets exhibiting malicious
behavior, such as trying to access unauthorized directories, without affecting
network or client personal computer performance. Finally, unknown applets which
have exhibited malicious behavior on a client personal computer are placed on a
list to be automatically excluded at the server where data enters the network
from the internet if such applets attempt to re-enter the network in the future.
InterScan AppletTrap can be used in conjunction with either Netscape/AOL
Navigator or Microsoft Internet Explorer.
ScanMail acts at the e-mail and groupware server level to combat computer
viruses where they currently most often appear: in document files shared via e-
mail and groupware, which is software that facilitates work among personal
computers users at different remote locations. When it detects a virus, ScanMail
sends a customizable alert message to the administrator, sender and recipient
without delaying the original message. Infected files are cleaned automatically
and sent on to the intended recipients.
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Using ScanMail's ActiveX program controls, the network administrator can send
files containing unknown viruses to Trend eDoctor Lab for analysis and
disinfection. ScanMail products are available for Lotus Notes, Microsoft
Exchange, Lotus cc:Mail, Microsoft Mail and OpenMail. ScanMail for Lotus Notes
received the Gold Editors' Choice Security Award, recognizing innovative Lotus-
based products, from Lotus Notes and Domino Adviser Magazine in May 1998.
ScanMail for Microsoft Exchange was named as the "best buy" e-mail anti-virus
solution in the January 2000 issue of SC Magazine.
Server Level Virus Protection
ServerProtect offers anti-virus protection at the file and application
server level for organizations using Windows NT or Novell NetWare to manage
their local area networks. ServerProtect scans and disinfects remote servers,
sends infection notices, installs anti-virus programs on client personal
computers and automatically generates a virus report log. ServerProtect allows
administrators of local area networks to securely install and manage virus
protection on multiple servers and domains from a single console, which can be
remotely located.
Desktop Level Virus Protection
OfficeScan Corporate Edition is the desktop-based anti-virus component of
our corporate solution. While active at the desktop level, Office Scan Corporate
Edition is centrally controlled and can be installed, managed and upgraded using
the Trend Virus Control System, or deployed through an intranet web page,
Windows NT remote server, Microsoft System Management Server or login script.
Centralized administration ensures that all users have the most up-to-date
software and virus descriptions, limits client modifications to the software,
and ensures that reports of virus activity reach the system administrator.
PC-cillin, which is marketed in Japan as Virus Buster, is our anti-virus
product for the home personal computer and workstation. PC-cillin removes
viruses without interrupting programs then running on the user's personal
computer or workstation, when infections occur. PC-cillin includes an easy-to-
use graphic user interface, and is available in Windows NT Workstation, Windows
98, Windows 95 and Windows 2000 Professional versions. Virus Buster was the only
product among six personal computer anti-virus products surveyed to receive a
"four-star" rating from the Japanese magazine PC Computing in September 1998. PC
Computing is published by SOFTBANK. The latest version of PC-cillin enables
users to prevent access to designated web page addresses. The latest version of
Virus Buster released in Japan also includes a one-year warranty providing for a
refund of the product's purchase price if, under conditions set forth in the
product package, new viruses infect and cause damage to a user's files or
programs. Trend Micro is insured against liabilities, subject to certain
limitations and exclusions, arising from this warranty service.
Trend ChipAway Virus provides hardware-level protection to stop boot-sector
viruses from infecting the computer during the period before the operating
system and traditional anti-virus software load. This product works by encoding
virus protection in the basic input/output system, read-only memory chips used
to start the computer before its operating system software loads.
Internet-Based Support Services
eDoctor is an anti-virus service to which purchasers of the Trend Virus
Control System can subscribe for a monthly per-user fee. Qualified providers of
first-line support, typically systems integrators and internet service
providers, acting as "Premium Security Partners," use the management
capabilities of Trend Virus Control System to install virus protection software
on the customer's network, to resolve virus incidents and to continually
diagnose and maintain virus protection systems remotely over the internet.
eDoctor includes around-the-clock access to Trend Micro engineers who work with
the Premium Security Partner and the customer in real-time to resolve virus
incidents as they occur. Premium Security Partners will receive a significant
portion of the monthly fee and are expected
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to play a key role in marketing the service. The role of the Premium Security
Partner is particularly important in Japan, where enterprise users typically
look to systems integrators to manage their networks and to provide virus
solutions. eDoctor was introduced in Japan, the U.S. and Taiwan in December
1998. In September 1999, we also announced the establishment of the eDoctor
Global Network, a worldwide internet anti-virus service initiative which builds
malicious code protection directly into the internet infrastructure. The eDoctor
Global Network enables customers to obtain virus protection as a value-added
service from telecom companies, internet service providers and other managed
service providers. Service providers who are part of the eDoctor Global Network
include SECOM, JoS, UniSVR, Otsuka Shokai, PSINet, Internet Security Systems, U
S West, MCI's UUNet division, Sprint and Compaq Services.
Trend eDoctor Lab is a web-based virus analysis service available generally
to corporate end users to send virus-infected files via e-mail to one of Trend
Micro's internationally located virus analysis centers for detection and
cleaning. Files containing unusual or unknown viruses are automatically routed
to the Trend Micro virus expert on duty.
HouseCall is online scanning software which allows personal computer users
to have virus infections detected and removed over the web. Upon detecting a
virus, HouseCall lists its name and the infected file. If the virus cannot be
removed, HouseCall gives the user the opportunity to delete the file. The
service is accessible to all internet users from our website. HouseCall
demonstrates Trend Micro's anti-virus expertise and serves as a useful tool to
introduce potential customers to Trend Micro's family of products.
Integrated Small Business Solution
OfficeScan SBS is designed for the Microsoft Small Business Server.
OfficeScan SBS combines file server protection, e-mail and groupware server
protection for Microsoft Exchange, and desktop-based protection in a single
package. It provides centralized installation, administration and reporting for
networks of up to 25 workstations. OfficeScan SBS was recommended as an
"excellent choice" by Computer Reseller News, a newsletter published for
computer resellers, in May 1998.
Technology
We believe that our innovative anti-virus technologies are an important
competitive advantage. Key technologies used in Trend Micro products include the
following:
Cheetah is the core of our anti-virus technology and our newest scanning
engine. Cheetah, which is incorporated in all of Trend Micro's anti-virus
products, detects most known viruses, including boot-sector, polymorphic, macro
and applet-based viruses as well as some unknown viruses. When a virus is
detected, Cheetah alerts system users based upon instructions selected by a
network administrator and either blocks the virus-infected file from being
forwarded or cleans and quarantines it, with notice to the user, mail recipient
and/or network administrator. Cheetah also incorporates the following scanning
technologies and features:
. Trend Micro's proprietary SoftMice simulator, which traces,
decrypts and extracts polymorphic viruses;
. Trend Micro's DeepScan technology, which tracks a program's
execution through multiple-layered files and locates viruses
buried in the file body;
. Wildcard virus scanning capability to detect variant viruses;
. Scanning capability for 19 types of compressed files and decoding
capability for MIME, BinHex, Base64 and UUEncoded files; and
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. A specific scanning module for detecting known malicious Java code.
MacroTrap is an advanced virus detection technology incorporated into the
Cheetah scanning engine. Unlike simple pattern matching detection technologies
which identify viruses by their unique software codes, MacroTrap uses rule-based
scanning to detect known macro viruses and mutated versions of macro viruses by
executing the code in a virtual environment that emulates the actual system
environment in which the code will be run. Executed code that does not match the
software code of any known virus but nonetheless violates predetermined rules of
"good behavior" is then identified as suspect and "trapped." This method is
particularly well suited for macro viruses because such viruses are very easily
created and therefore more varied. Because it uses the same technology upon
which Word and Excel files are based, MacroTrap extracts only the affected
portion of each word processing or spreadsheet file it scans. This minimizes
scanning time and the processing burden on the central processing unit.
AppletTrap, our newest technology, detects known and unknown malicious
ActiveX controls and Java applets with minimal impact on internet traffic
performance. AppletTrap uses pattern-matching to block known malicious ActiveX
controls and Java applets before they enter the network. AppletTrap's patent-
pending technology also enables client personal computers to terminate unknown
ActiveX controls or Java applets that are behaving in an abnormal manner before
they can damage the computers' hard drive or spread elsewhere in the network.
InterScan: Server Pipeline is our patented technology which enables
scanning of data which has been transmitted through the internet, and also the
review of the content of e-mail files. The scanning and detection functions are
performed at the server level, enabling viruses to be detected and eliminated
before they spread to client personal computers via e-mail or file exchange. The
InterScan technology forms the basis of Trend Micro's 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 Trend Micro's first implementation of the Cascade Update technology.
Research and Product Development
Trend Micro's research and product development activities focus on the
development of new anti-virus and security software, enhancements to existing
products and integration of products to enable monitoring, updating and
management via the internet. We conduct research and development at our Tokyo
headquarters and our U.S. and Taiwan subsidiaries and have a research staff of
147 engineers. Complementing our internal development efforts, we are members of
industry-level initiatives such as the Association of Anti-virus Asia
Researchers group launched in Hong Kong in September 1998. Our engineers'
participation in this group gives us additional access to information regarding
newly discovered viruses.
Research and development expenditures, consisting primarily of software
development costs and research and development staff salaries and benefits,
increased from (Yen)557.0 million in 1997 to (Yen)960.2 million ($8.5 million)
in 1998 and (Yen)994.3 million ($9.7 million) in 1999.
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
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package software sales through distributors. As a result, we are substantially
dependent on these third parties. Our agreements with distributors are generally
nonexclusive, do not have minimum purchase requirements and may be terminated by
either party without cause. Our current marketing efforts are targeted primarily
at large to mid-size corporations, and to a lesser extent, small businesses and
individual end users. We work with systems integrators and value-added
resellers, through which most of our sales are made, to increase the brand
recognition and visibility of our products in the network security market. We
also promote sales of our products as a suite so that corporate end users can
benefit from comprehensive anti-virus protection throughout their enterprise
networks. As part of these efforts, we also disseminate product and industry
information through our website. In addition, we advertise in trade publications
and exhibit our products at trade shows worldwide, including World PC Expo,
Windows World Expo Japan, Comdex Japan in Japan, Comdex, InfoSec, NetWorld and
Interop, Internet World, ISPCON, and the RSA Conference in the United States,
CeBit in Germany and the Network and Windows NT shows in Britain.
Japan
We sell our products in Japan to both corporate and individual end users
primarily through systems integrators and distributors, and conduct a limited
amount of direct sales to end users, including online sales through a reseller's
website. Historically, most of our revenues have been derived from sales in
Japan. We expect that sales in Japan will continue to represent a significant
percentage of our revenues in the future.
Distribution Through Systems Integrators and Distributors. Virtually all of
our sales to Japanese corporate end users are made through systems integrators,
with remaining sales coming mostly from direct sales to major corporate
customers. In Japan, systems integrators play a much larger role in delivering
management information services than in the United States, providing primary
computer support services such as installation, systems integration, upgrades
and maintenance.
Historically, a significant percentage of our net sales have been sales to
SOFTBANK. For example, sales to SOFTBANK totaled approximately (Yen)2.4 billion
($21.1 million) or 24% of net sales in 1998 and (Yen)2.5 billion ($24.0 million)
or 18% of net sales in 1999. The majority of these sales in 1998 took place
through Vaccine Bank, a cooperative marketing program which we maintained with
SOFTBANK from 1997 to early 1999. The majority of sales to SOFTBANK in 1999
consisted of SOFTBANK's sales of our products to systems integrators.
Relationship with SOFTBANK. In December 1996, Trend Micro and SOFTBANK
entered into two agreements for an investment by SOFTBANK in Trend Micro and the
distribution by SOFTBANK of our products in Japan. The distribution agreement
was an oral agreement granting SOFTBANK the non-exclusive right to distribute
all of our anti-virus software products in Japan. Individual sales under this
agreement were effected on a purchase-order basis. In June 1998, we and SOFTBANK
entered into a written distribution agreement giving SOFTBANK a non-exclusive
right to distribute our InterScan product suite in Japan at volume-based
discount rates. Under a December 1998 memorandum to the 1996 oral agreement,
SOFTBANK included Trend Virus Control System and ServerProtect for Windows NT in
a number of computing products distributed by SOFTBANK. On January 1, 1999, we
entered into a written agreement with SOFTBANK superseding the 1996 agreement
and granting SOFTBANK the non-exclusive right to distribute in Japan all of our
products other than the InterScan products, which continue to be covered by the
1998 written agreement. Individual sales under the January 1999 master
distribution agreement were effected on a purchase-order basis. The January 1999
master distribution agreement provided for percentage rebate payments to
SOFTBANK based on the volume of sales of covered products.
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
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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 Trend Micro relating to
distribution of Trend Micro's products. We make rebate payments to SOFTBANK
based on SOFTBANK's achievement of sales targets agreed upon between SOFTBANK
and us.
Service Provider and Other Relationships. In December 1998, we entered into
an alliance with SECOM, a home security service provider. We certify SECOM to
provide eDoctor and other anti-virus software to update, monitor and maintain
SECOM customers' computer networks. We plan to certify additional service
providers to offer 24-hour service and support to customers. We have developed
with Hitachi Corporation a solution that allows users of Hitachi's JP1 network
management software to click on a command icon in Hitachi's JP1 product to
access our Trend Virus Control System product. We have developed a similar
solution in cooperation with Fujitsu that allows users of SystemWalker,
Fujitsu's network of operating and management software, to use Trend Virus
Control System. In September 1999, we agreed to license InterScan VirusWall
technology to PSINet K.K., a Japan internet service provider, enabling PSINet to
provide virus scanning services to its corporate customers as part of its
comprehensive security services. In March 2000, Otsuka Shokai began offering to
its ".-mail" hosting service customers a virus detection and removal service
developed jointly with Trend Micro. We also plan to pursue alliances with other
internet service providers, which we believe are becoming increasingly important
in the Japanese market.
Recent Developments. In October 1999, we agreed with NTT Data, Hitachi,
Cisco Systems Japan and S&T Consulting to form NTT Data Security Corporation, a
joint venture which is designed to provide comprehensive network security
services. Each of the five partners has expertise in a different area of network
security, and we are contributing our antivirus and internet security expertise
to the venture. The joint venture began its commercial operations in January
2000.
In February 2000, we acquired a majority ownership interest in Nihon
Unisoft Corporation, a Japanese Unix software solution provider in the
networking communications and internet domain. We made this acquisition through
ipTrend Incorporated, a wholly-owned subsidiary that we established in January
2000. As a result of the acquisition, ipTrend and Nihon Unisoft intend to
jointly promote development of their internet-focused technology. The parties
began offering Linux components and communication protocols to major internet
service providers, information-technology vendors and communication companies in
April 2000.
United States
Our U.S. sales strategy has evolved with the development of the anti-virus
software market as a whole, moving from a focus on packaged software sales for
the personal computer to our current focus on corporate protection. Initially,
we distributed and sold mainly packaged anti-virus software for the personal
computer in the U.S. through a republisher. As a market has developed for
selling products to corporate customers with multiple users, we have shifted our
strategy to building relationships with value-added resellers and distributors
who sell to corporate customers, and to cooperating with major hardware and
software manufacturers. Our current focus in the U.S. is developing these
strategic partnerships in the server, security, groupware and router areas to
take advantage of our product strengths and partners' marketing channels and, in
the process, to increase brand awareness of our products. As of March 2000, we
had 30 employees dedicated to strategic partner and distributor relationships
and 5 employees focusing on direct sales efforts in the U.S. Our direct sales
efforts in the U.S. focus on sales to Fortune 1000 companies and government
accounts.
Strategic Partnerships. We have entered into agreements with Check Point,
Compaq, Hewlett-Packard, IBM/Lotus, Lucent Technologies, Microsoft, Oracle,
Sprint, UUNET Technologies and US West which include cooperative marketing
activities such as these vendors' referral of customers to our products and
reference to our products in their product literature and websites. Our
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agreements with these vendors also typically provide for co-development and
licensing arrangements so that our and the vendors' products operate smoothly
when used together. Under one relationship with Microsoft, InterScan WebProtect
is available to users of Microsoft Proxy through a web link. We have also
licensed Microsoft to include ScanMail in Microsoft's Resource Kits and have
developed a compatible version of OfficeScan for the Microsoft Small Business
Server. Check Point has certified InterScan VirusWall for Solaris and Window NT
to be compatible with Check Point's Firewall-1 enterprise security solution.
Under one agreement with Compaq, our anti-virus products are described as a
compatible enterprise anti-virus solution in Compaq Active Answers, an online
information service for marketing and buying enterprise computing solutions.
We have licensed Compaq to provide technology found in ScanMail for
Microsoft Exchange to Compaq customers who outsource this e-mail anti-virus
protection function to Compaq. Under an agreement with Hewlett-Packard, we
provide virus protection products to Hewlett-Packard's global CoVision internet
solutions program. Hewlett-Packard has also certified Trend Virus Control System
for use in conjunction with Hewlett-Packard's OpenView Node Manager, and has
agreed to resell our products and services through Hewlett-Packard's North
American Local Products Organization. This arrangement gives us access to
leading resellers of Hewlett-Packard products and allows our products and
services to be included as part of an integrated Hewlett-Packard solution. Trend
Micro is also a "Lotus Premium Business Partner" which allows us to integrate
our anti-virus solutions more closely with Lotus Notes/Domino and cc:Mail. In
December 1998, we released ScanMail for Lotus Domino for the IBM AS/400
platform. Under our April 1999 agreement with Lucent Technologies, Lucent will
promote InterScan VirusWall as a compatible anti-virus solution for use in
conjunction with Lucent's VPN Gateway and Managed Firewall network access
control system, and will facilitate marketing of our products. We have also
licensed Sprint to provide its customers with InterScan VirusWall scanning
capability at the internet gateway. A similar arrangement with US West allows US
West to use InterScan VirusWall to automatically scan its customers' incoming
and outgoing internet e-mail attachments for viruses. We have also licensed
UUNET Technologies, the internet services division of MCI WorldCom, to provide
virus scanning services using ScanMail technology to UUNET's Lotus Notes hosted
customers.
Distributors and Value-Added Resellers. Our principal distributors and
value-added resellers in the U.S. are Software House International, Softmart,
Vanstar, Interwork Technology, Ingram Micro, Midwest Systems, ASAP Software
Express and Tech Data. Value-added resellers 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 50 resellers currently participate in our reseller channel
program, including Secure IT, Netrex, Osage Systems and ASAP Software Express.
We also provide such services and support to targeted corporate customers
directly.
Other Distribution Channels. We are also pursuing sales growth through
other distribution channels including alliances with internet service providers
and other providers of internet-related services. Under an agreement with
Infonet Services Corporation, a global internet service provider, we receive a
percentage royalty based on sales of our e-mail and internet traffic virus
protection scanning services to Infonet customers. In addition, InterScan
VirusWall has been added to the virus scanning services offered by Pilot Network
Services, a provider of secure internet services to corporations. We also
distribute our Virus Buster product under the name "PC-cillin" directly to end
users who download it from our website.
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Other Parts of the World
Outside of Japan and the United States, we sell our products mostly to
corporate end users through distributors, resellers and value-added resellers,
with some direct sales to corporate end users and retail customers. A majority
of these sales in Asia were to corporate end users through systems integrators
and distributors. We have formed alliances with internet service providers in
Australia, Hong Kong and Taiwan to provide internet-based services such as e-
mail security. Trend Micro currently plans to explore additional partnerships
with internet service providers worldwide.
The majority of our European revenues are from sales of site licenses to
corporate users. Our principal systems integrators and distributors in Europe
are C2000, MME and Peapod Distribution.
As of April 2000, we had 13 employees dedicated to our "brand-name"
partnership, reseller, value-added reseller and distributor relationships in
Europe and 9 employees focusing on direct sales efforts.
Potential customers accessing our website who wish to purchase products are
referred to a list of resellers, based on the country where the customer is
located. We are continuing to recruit other network security-oriented systems
integrators and value-added resellers in Europe and Asia to target a broader
range of prospective corporate customers. Our partnerships with global major
hardware and software vendors also enhance our marketing efforts in Europe and
Asia as well as in the U.S.
Operations
In Japan, we outsource assembly, packaging and shipping of all of our anti-
virus software products to value-added resellers. Our Taiwanese subsidiary and,
in some cases, third party service providers assemble, package and ship products
to be sold in the United States, Europe and Asia other than Japan. Products are
generally shipped within seven days of receipt of an order and, accordingly,
there is minimum order backlog at any time.
Competition
The markets for our products are highly competitive and changing rapidly,
and we expect competition to increase in the near term. We believe that the
principal competitive factors affecting the anti-virus software market are:
. performance, including the number and type of viruses which can be
detected and effectiveness in detecting and cleaning virus-infected
files;
. product features;
. ease of use;
. brand recognition;
. customer service and technical support;
. company reputation; and
. price.
Our primary competitors in the anti-virus software market are Network
Associates, vendor of the McAfee VirusScan and Dr. Solomon's Toolkit product
lines, and Symantec Corporation, vendor of Norton brand anti-virus products.
Other competitors include Computer Associates International, Inc., Data Fellows
Ltd., which distributes anti-virus software in Japan through Yamada Corporation,
Sophos Plc, Finjan Software Ltd. and Security-7 Ltd. While we believe that our
commitment to technological innovation and integrated product suites represents
a competitive advantage over Network Associates and Symantec, these companies
have generally greater name recognition, broader product lines, access to larger
customer bases and greater financial, distribution and other resources.
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Network Associates and Symantec have been allocating significant resources
to the Japanese anti-virus software market in recent years. In 1997, Symantec
released a Windows 95 compatible Japanese version of its virus protection
software in Japan, and Network Associates acquired a Japanese virus protection
software maker, Jade K.K. In the U.S., we believe that Network Associates and
Symantec have allocated greater resources than we have to the development of
their anti-virus businesses and have significantly larger customer bases.
With the introduction of InterScan eManager in October 1998, we entered
the market for non-virus security products. Our primary competitors in this
market are Integralis Technology Ltd. and Worldtalk Communications Corp. We
expect to encounter competition from larger, more established companies as we
begin to offer other non-virus security products.
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:
<TABLE>
<CAPTION>
Name Status Registration Registration Applicant/Patentee
---- ------ ------------------
Date Number
---- ------
<S> <C> <C> <C> <C>
MacroAgent pre-boot Patented 8/22/1995 5,444,850 Trend Micro Incorporated (USA)
authentication
Network and Workstation Access Patented 10/21/1997 5,680,547 Trend Micro Incorporated (Taiwan)
pre-boot
Apparatus and method for e-mail Patented 3/30/1999 5,889,943 Trend Micro Incorporated (Taiwan)
virus detection and elimination
InterScan: Server pipeline Patented 4/22/1999 5,623,600 Trend Micro Incorporated (USA)
System apparatus and method for Patented 9/14/1999 5,951,698 Trend Micro Incorporated (Taiwan)
macro virus detection and
removal
Event-triggered iterative virus Patented 9/28/1999 5,960,170 Trend Micro Incorporated (Taiwan)
detection
Computer network malicious code Patented 11/9/1999 5,983,348 Trend Micro Incorporated (USA)
scanner
</TABLE>
The duration of these patents is 17 years from the date of registration. We plan
to transfer the ownership of these patents to Trend Micro.
We do not typically enter into signed license agreements with our
corporate, government and institutional customers who license products directly
from us. We include an electronic version of a "shrinkwrap" license in all of
our electronically distributed software and a printed license in the box for our
packaged products in order to protect our copyrights in those products. The
enforceability of these
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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.
Employees
As of March 2000, we had 851 employees, of whom 593 are located in Asia,
146 are located in the United States, 75 are located in Europe and 37 are
located in other regions. None of our employees is represented by a labor union
and we have not experienced a work stoppage. We believe that our employee
relations are good.
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RISK FACTORS
You should consider carefully the risks described below and the other
information in this Annual Report before investing in the shares or the ADSs.
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.
Major software and hardware vendors may incorporate anti-virus protection in
their product offerings, which could render our products obsolete or
unmarketable
Major vendors of operating system software, other software such as firewall
or e-mail software or computer hardware may decide to enhance or bundle their
products with other products to include anti-virus functions. These companies
may offer anti-virus protection as a standard feature in their products, at
minimal or no additional cost to customers. This could render our products
obsolete or unmarketable, particularly if anti-virus products offered by these
vendors were comparable to our products. In addition, even if these vendors'
anti-virus products offered fewer functions than our products, or were less
effective in detecting and cleaning virus-infected files, customers could still
choose them over our products due to lower cost.
Because we generate substantially all of our revenue from a single product line,
we are vulnerable to decreased demand for such products
Unlike software companies with diversified product lines, substantially
all of our net sales come from licensing and selling anti-virus software
products. Although we have begun to offer more comprehensive network and
internet security and management software and services, 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 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)1.4 billion or 19% of our net sales
in 1997, approximately (Yen)2.4 billion or 24% of our net sales in 1998 and
(Yen)2.5 billion ($24.0 million) or 18% of our net sales in 1999. In addition,
SOFTBANK has close relationships with many systems integrators through which we
sell our anti-virus software to corporate end users in Japan.
At the time of our initial public offering in Japan in August 1998,
SOFTBANK was our largest shareholder. Since that time, SOFTBANK has reduced its
holding of our shares. This process culminated in March 2000, when SOFTBANK sold
all of its remaining shares of our common stock and thus ceased to be a Trend
Micro shareholder. We do not believe that our business relationship with
SOFTBANK will suffer as a result of SOFTBANK's sale of its Trend Micro shares,
but we cannot be sure that it will not.
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Because of our dependence on SOFTBANK, the price of our shares and ADSs could
fall as a result of adverse events affecting SOFTBANK, even if the events do not
relate directly to us
Because of our dependence on SOFTBANK, the price of our shares and ADSs
could fall as a result of adverse events affecting SOFTBANK that do not affect
us directly, such as a deterioration in SOFTBANK's business. Also, public market
analysts and investors might view SOFTBANK's sale of all of its Trend Micro
shares in March 2000 as a withdrawal of SOFTBANK's support for us. As a result,
the price of our shares and the ADSs could also fall.
Our net sales in Japan could decline as a result of our revised corporate
licensing policy in Japan
Starting in April 1999, we revised our corporate licensing policy in Japan.
Under our revised policy, SOFTBANK may have less incentive to sell our products
because discounts on sales to SOFTBANK have been reduced. To date, the new
licensing policy has not hurt our business relationship with SOFTBANK or with
other distributors, or resulted in a decrease in net sales. However, we cannot
be sure that our revised corporate licensing policy will not hurt our business
in the future. If SOFTBANK's or other distributors' purchases of our products
were to decrease significantly because of the revised policy, our net sales
would likely decline.
Because rapid technological change regularly occurs in the anti-virus software
market, our products may become obsolete
The anti-virus software market is characterized by:
. rapid technological change;
. the proliferation of new and changing computer viruses;
. frequent product introductions and updates; and
. changing customer needs.
These characteristics of our market create significant risks and
uncertainties for our business success. For example, our competitors might
introduce anti-virus products that are technologically superior to our products.
Additionally, new software operating system, network system or anti-virus
software industry standards could emerge. Emerging trends in these systems and
standards currently include applications distributed over the internet and the
use of a web browser to access client-server systems. Our existing products
might be incompatible with some or all of such standards. Our business,
financial condition and results of operations could materially suffer unless we
are able to respond quickly and effectively to these developments.
Because our competitors are more established than we are in the U.S. and
European markets, we may not be able to increase our market share in such
markets
We believe that our share of the anti-virus software market in the U.S. and
Europe is small relative to the market shares of our principal competitors,
despite the growth of our sales in these markets in 1999. 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
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. significantly greater financial, technical, marketing and other
resources.
As a result, as compared to us, our competitors may be able to:
. better withstand downturns in the anti-virus software market and in the
computer software market in general;
. adapt more quickly to new or emerging technologies or changes in
customer requirements; and
. more effectively and profitably market, sell and support their
products.
We may suffer a loss of sales and market share in our core Japanese market if
our competitors achieve success in Japan
Two of our major competitors, Network Associates and Symantec Corporation,
have entered the Japanese anti-virus software market and are allocating
significant resources to achieving success in this Japanese anti-virus software
market. Although these competitors currently have smaller shares of the Japanese
market than Trend Micro, Network Associates and Symantec 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. 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. We do not have significant
experience in this business area, and we have generated only limited revenues
from this business to date.
Because we may acquire companies to grow our business, future acquisitions may
reduce our earnings and result in increased costs in our business operations
In a rapidly changing industry, we occasionally review acquisition
opportunities. Accordingly, we may seek to expand our business through
acquisitions, including our internet service business. Unlike some of our major
competitors, we have limited experience in acquiring existing businesses. Future
acquisitions could result in numerous risks and uncertainties, including:
. Our inability to retain customers, suppliers and other important
business relationships of an acquired business;
. Difficulties in integrating an acquired company into Trend Micro,
including the acquired company's operations, personnel, products and
information systems;
. Diversion of our management's attention from other business concerns;
and
. Adverse effects on our results of operations from acquisition-related
charges and amortization of goodwill and purchased technology.
If we make such an acquisition using stock, our current shareholders'
ownership interests will be diluted. Any of these factors could materially hurt
our business, financial condition and results of operations.
22
<PAGE>
We must adapt to the rapidly changing business environment brought on by the
widespread use of the internet
We have been seeking to use the internet in many parts of our business,
including in the sale, distribution and support of our products. There are still
many uncertainties regarding many facets of the internet, including reliability,
security, access, tax, government regulation and cost. We also run the risk of
not adapting to the latest changes in the internet, which could harm our
business operations. If growth of the internet does not develop at the rapid
pace we expect, our business, financial condition and operating results could be
adversely affected.
If hackers gain unauthorized access to our systems, we could suffer disruptions
in our business and long-term damage to our reputation
As an anti-virus company that delivers virus protection products over the
internet, we may be more susceptible to problems caused by hackers than other
software companies. For example, if hackers were able to cause us to transmit
computer viruses or interrupt the delivery of our anti-virus software monitoring
and security services over the internet, we could suffer substantial disruptions
in our business and material damage to our reputation. This could result in a
significant loss of our customers and other important business relationships. We
could also incur costs for public relations efforts following attacks by
hackers. Hacker activities could also force us to incur substantial costs to fix
technical problems or result in hackers gaining access to our proprietary
information.
We must effectively manage our growth
Our business has grown rapidly. This growth has placed, and any future
growth would continue to place, a significant strain on our limited personnel,
management and other resources. Our ability to manage any future growth in our
business will require us to:
. attract, train, retain, motivate and manage new employees
successfully;
. effectively integrate new employees into our operations; and
. continue to improve our operational, financial, management and
information systems and controls.
If we continue to grow, our management systems currently in place may be
inadequate or we may not be able to effectively manage our growth. In
particular, we may be unable to:
. provide effective customer service;
. develop and deliver products in a timely manner;
. implement effective financial reporting and control systems;
. implement a new internet-based service business model; or
. exploit new market opportunities and effectively respond to
competitive pressures.
We sell our products through intermediaries who may not vigorously market our
products, have rights of return or may have difficulty in timely paying for
purchased products
We market substantially all of our products to end users through
intermediaries, including distributors, resellers and value-added resellers. Our
distributors sell other products that are complementary to, or compete with, our
products. While we encourage our distributors to focus on our products through
market and support programs, these distributors may give greater priority to
products of other suppliers, including competitors.
23
<PAGE>
We rely heavily on our management and technical personnel, who may not remain
with us in the future
We rely, and will continue to rely, on a number of key technical and
management employees, including our CEO, Steve Ming-Jang Chang. While we require
our employees to sign employment agreements, our employees are generally not
otherwise subject to noncompetition covenants. If any of our key employees
leave, our business, results of operations and financial condition could suffer.
Fluctuations in our interim financial results could cause the market price for
the shares and the ADSs to fall
We believe that our interim 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 semi-annual or other interim 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 interim financial results to fluctuate
include:
. Timing of sales of our products and services due to customers'
budgetary constraints, seasonal buying patterns and our
promotional activities;
. New product introductions by our competitors;
. Significant marketing campaigns, research and development
efforts, employee hirings, and other current expenditures by
Trend Micro to drive the growth of our business;
. Changes in customer needs for anti-virus software; and
. Changes in economic conditions in our major markets.
Because of the influence of our principal shareholders, our other shareholders
may be unable to influence our business
Our principal shareholders, including our executive officers and
directors, beneficially owned approximately 45.9% of our outstanding shares as
of March 31, 2000. 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.
Under the terms of SOFTBANK's prior investment in Trend Micro, in the
past we have held management meetings with SOFTBANK. A SOFTBANK executive is
also currently a member of our board of directors. As a result, although
SOFTBANK no longer owns Trend Micro shares after its sale of our stock in March
2000, SOFTBANK remains able to influence our management and affairs.
Because Japan is our largest market, weakness in the Japanese economy may hurt
our business performance
While our sales in the U.S. 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 50% of our net sales in
1997, approximately 49% in 1998 and approximately 43% in 1999. During 1998 and
1999, the Japanese economy contracted 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. We currently anticipate that
24
<PAGE>
the rate of growth in our net sales in Japan will continue to decline, partly
due to continued weakness in the Japanese economy.
Because we make a significant percentage of our net sales in Asia, we are more
vulnerable than our competitors to weaknesses in the economies of Asian
countries
Since the late summer of 1997, a number of Asian countries have
experienced economic, banking and currency difficulties that have led to
economic downturns in those countries. Among other things, the decline in value
of Asian currencies, together with difficulties in obtaining credit, has
significantly limited the purchasing power of our Asian customers. This has
resulted in lower net sales of our products in 1999 and 1998 than in 1997 in
Taiwan, Hong Kong, Korea, Malaysia and other Asian countries. Net sales of our
products in these countries was approximately (Y)2.0 billion or approximately
28% of our net sales in 1997, approximately (Y)1.9 billion ($17.2 million) or
approximately 20% of our net sales in 1998 and approximately (Y)1.8 billion or
approximately 13% of our net sales in 1999. When compared with our main
competitors, we believe we make a greater portion of our total sales in these
countries. We expect that continued economic weakness in Asia will continue to
hinder our growth.
Because we earn revenues denominated in a number of different currencies,
foreign exchange fluctuations could lower our results of operations
Our reporting currency is the Japanese yen and the functional currency
of each of our subsidiaries is the currency of the country in which the
subsidiary is domiciled. However, a significant portion of our revenues and
operating expenses is denominated in currencies other than the Japanese yen,
primarily the U.S. dollar and the New Taiwan Dollar. As a result, appreciation
or depreciation in the value of other currencies as compared to the Japanese yen
could result in material transaction or translation gains or losses which could
reduce our operating results. These negative effects on Trend Micro from
currency fluctuations could become more significant if we are successful in
increasing our sales in markets outside of Japan. We do not currently engage in
currency hedging activities.
Because our business depends significantly on intellectual property,
infringement of our intellectual property could hurt our business
Our success depends upon the development of proprietary software
technology. We rely on a combination of contractual rights and patent,
copyright, trademark and trade secret laws to establish and protect proprietary
rights in our software. If we are unable to establish and protect these rights,
our competitors may be able to use our intellectual property to compete against
us. This could limit our growth and hurt our business. At present, our U.S.
subsidiary holds three 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.
Our business could suffer if we do not prevail in our lawsuits with Network
Associates
Our U.S. subsidiary, Trend Micro, Inc., is currently involved in two
lawsuits with Network Associates. In May 1997, Trend U.S. sued Network
Associates in the U.S. Federal District Court for the Northern District of
California, alleging that some of Network Associates' products infringe Trend
U.S.'s patent relating to the technology used in our InterScan VirusWall
product, and seeking injunctive relief and unspecified money damages. Network
Associates has asserted counterclaims against us in this litigation. In April
2000, Network Associates filed suit against Trend U.S. in the U.S. Federal
District Court for the Northern District of Texas, alleging that Trend U.S.'s
anti-virus software
25
<PAGE>
packages, including the Trend Virus Control System, infringes a Network
Associates patent. Network Associates' complaint seeks injunctive relief and
unspecified money damages.
A ruling that is adverse to Trend U.S. in either of these lawsuits
could hurt our business, including by hindering our efforts to further develop
the U.S. market. Also, any ruling that requires Trend U.S. to pay damages or
refrain from taking specified actions, or finds that any of our patents are
invalid, could reduce our operating results or limit our ability to compete. We
are currently in negotiations with Network Associates to settle all outstanding
litigation between the parties. Although we expect to reach agreement with
Network Associates on terms that are acceptable to us, we cannot assure you that
we will be able to do so. We may also become involved in other litigation in the
future. If this happens, we might have to incur significant costs. This could
hurt our business and operating results, and cause the market price of the
shares and ADSs to fall.
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.
Our license agreements typically contain provisions, such as disclaimers of
warranty and limitations of liability, which seek to limit our exposure to these
types of claims. However, in some jurisdictions these provisions may not be
enforceable or statutory, public policy or other grounds. We currently do not
carry product liability insurance covering claims arising in the U.S. While we
have not been sued on product liability grounds to date, a successful product
liability or related claim brought against us could harm our business.
Our 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 Japanese over-the-counter market,
which is the principal market for the shares. The Japanese over-the-counter
market is not as large or as active as the Tokyo Stock Exchange or The Nasdaq
National Market and therefore may be less liquid and more volatile. 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 Japanese over-the-counter market on August 17,
1998, our stock price has fluctuated between a low of (Y)1,393 and a high of
(Y)32,800. 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 $4.667 and a
high of $31.875. The closing price on the Japanese over-the-counter market for
our stock on May 18, 2000 was (Y)12,800, and the closing price on The Nasdaq
National Market for our ADSs on May 17, 2000 was $13.125 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 Japanese over-the-counter market 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.
26
<PAGE>
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.
Sales of additional shares to the public may cause the price of the shares and
ADSs to fall
The sale of a substantial amount of shares in our global offering of
shares in the form of shares and American Depositary Shares in July 1999
increased significantly the number of shares held by the public. This may cause
the price of the shares and the ADSs to fluctuate more than the price of the
shares has in the past, and may also cause the price of the shares and ADSs to
decline. In addition, if our shareholders sell substantial amounts of shares or
ADSs in the public market, the market price of the shares and the ADSs could
fall. Such sales also might make it more difficult for us to sell equity or
equity-related securities in the future at a time and price that we deem
appropriate. At April 30, 2000, we had 65,096,142 shares issued and outstanding,
assuming no exercise of outstanding warrants. All of these shares are freely
tradable in our primary trading market, the Japanese over-the-counter market.
Certain of our shares are also traded in the United States in the form of ADSs
in compliance with the holding period, volume, and manner of sale restrictions
under Rule 144 under the Securities Act of 1933. It is also possible that we may
issue additional shares in connection with our financing activities, acquisition
activities or otherwise. Any shares that we issue will also be freely tradable
in the Japanese over-the-counter market, and, depending on the circumstances of
their issuance, may also be freely tradable in the U.S. public market.
The rights of small shareholders are limited under the Japanese unit share
system
Our articles of incorporation provide that 500 shares constitute one
"unit." The Japanese Commercial Code restricts the rights of shares that do not
constitute whole units. Holders of shares constituting less than one unit do not
have the right to vote, to institute derivative actions or to examine our books
and records. Each ADS offered in the offering represents the right to receive
one-tenth of one share. A holder who owns less than 5,000 ADSs will indirectly
own less than a whole unit. Under the deposit agreement governing the rights of
ADS holders, in order to withdraw any shares, an ADS holder must surrender ADRs
evidencing 5,000 ADSs or a multiple of 5,000 ADSs. Each ADR will bear a legend
to that effect. Under the unit share system, holders of less than a unit have
the right to require us to purchase their shares. Holders of ADSs that represent
other than multiples of whole units cannot withdraw the underlying shares
representing less than one unit. They will therefore be unable, as a practical
matter, to
. exercise the right to require us to purchase the underlying
shares, or
. receive cash settlement in lieu of withdrawal.
As result, as a holder of ADSs, you will not be able to access the
Japanese markets through the withdrawal mechanism to sell shares in lots of less
than one unit. The unit share system does not affect the transferability of
ADSs, which may be transferred in any lot size.
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
27
<PAGE>
to bring a derivative action, examine the accounting books and records of the
company or exercise appraisal rights through the depositary.
Rights of shareholders under Japanese law may be more limited than under the law
of other jurisdictions
Our articles of incorporation, our board of directors' regulations and
the Japanese Commercial Code govern our corporate affairs. Legal principles
relating to such matters as the validity of corporate procedures, directors' and
officers' fiduciary duties and shareholders' rights may be different from those
that would apply if we were a non-Japanese company. For example, under the
Commercial Code, only holders of 3% or more of the issued and outstanding shares
are entitled to examine our accounting books and records. Shareholders' rights
under Japanese law may not be as extensive as shareholders' rights under the law
of other countries. You may have more difficulty in asserting your rights as a
shareholder than you would as a shareholder of a corporation organized in
another jurisdiction. In addition, Japanese courts may not be willing to enforce
liabilities against us in actions brought in Japan which are based upon the
securities laws of the United States or any U.S. state.
Item 2. Description of Property
-----------------------
Our headquarters are located in Tokyo, Japan, where we lease 1,537
square meters of office space under a lease which expires in March 2002. We also
lease an aggregate of approximately 210 square meters of office space in Osaka
and Fukuoka.
We lease approximately 20,000 square feet of office space in
Cupertino, California under a lease which expires in July 2002. We lease office
space for our regional sales, research and development and sales office in
Taiwan and for our customer service center in the Philippines. We also lease
small sales offices in Korea, China, Hong Kong, Malaysia, Australia, Germany,
Italy, France, the United Kingdom, Mexico, Brazil and Argentina.
Item 3. Legal Proceedings
-----------------
In May 1997, Trend Micro Incorporated, our U.S. subsidiary, sued
Network Associates, formerly McAfee Associates, Inc., and Symantec in the U.S.
Federal District Court for the Northern District of California alleging that
some of their products infringe a U.S. registered patent held by Trend U.S.
relating to a system and method for detecting computer viruses in a network
environment and seeking injunctive relief and unspecified money damages. The
products which incorporate the patented technology are InterScan VirusWall,
InterScan eManager, InterScan WebProtect, InterScan AppletTrap, ScanMail and
other of our products which we sell for inclusion in our customers' products.
Trend U.S. settled its claims against Symantec in April 1998 by entering into a
patent cross-license arrangement which included an agreement to exchange samples
of viruses. In June 1997, Network Associates denied infringement, alleging that
Trend U.S.'s patent is invalid, and filed counterclaims against Trend U.S.
alleging unfair competition, false advertising, trade libel and interference
with prospective economic advantage. These counterclaims are based primarily on
Network Associates' allegations that Trend Micro made false claims about Network
Associates products in its advertising and on its website. In April 2000,
Network Associates filed suit against Trend U.S. in the U.S. Federal District
Court for the Northern District of Texas, alleging that Trend U.S.'s anti-virus
software packages, including the Trend Virus Control System, infringes a Network
Associates patent which was issued on February 22, 2000. Trend Micro believes
that the final disposition of these matters will not have a material adverse
effect on Trend Micro's business or results of operation.
28
<PAGE>
We are currently in negotiations with Network Associates to settle all
outstanding litigation between the parties. Although we expect to reach
agreement with Network Associates on terms that are acceptable to us, we cannot
assure you that we will be able to do so.
Item 4. Control of Registrant
---------------------
(a) Trend Micro is not, directly or indirectly, owned or controlled by
other corporations or by the Japanese government or any foreign
government.
(b) The following table shows information known to us regarding the
beneficial ownership of our common stock as of March 31, 2000, by (1)
each person known by us to own more than 10% of the outstanding shares,
(2) STG Incentive Company L.L.C. and (3) all directors and executive
officers as a group. As of March 31, 2000, there were 65,068,900 shares
outstanding. To our knowledge, except as otherwise stated, each entity
named in the table below has sole voting and investment power over the
shares shown opposite the entity's name.
<TABLE>
<CAPTION>
Shares of common stock
beneficially Number of shares Shares of common stock
owned prior to offered beneficially owned after
offering in this offering offering
-------------------------- ------------------ --------------------------
Name Number Percentage Number Number Percentage
---- ------ ---------- ------ ------ -----------
<S> <C> <C> <C> <C> <C>
Trueway Company Limited (1)............... 12,759,000 19.6 -- 12,759,000 19.6
P.O. Box 3151, Roadtown,
Tortola, British Virgin Islands
MLPFS Custody Account No. 2 (2) 6,776,000 10.4 6,776,000 10.4
South Tower, World Financial Center
New York, NY 10080-0801 U.S.A.
Gainway Enterprises Limited (3)........... 6,597,000 10.1 -- 6,597,000 10.1
P.O. Box 3151, Roadtown,
Tortola, British Virgin Islands
STG Incentive Company L.L.C. ............. 810,000 (4) 1.2 810,000 -- 1.2
c/o The Corporation Trust Center
1209 Orange Street
Wilmington, Delaware 19801 U.S.A.
All directors and executive officers as a
group (10 persons)....................... 4,266,000 (5) 6.6 -- 4,266,000 6.6
</TABLE>
- - - - - - - - ---------------------
(1) All of the shares of Trueway are beneficially owned by Yeh Min Yuen.
None of Trend Micro's directors or executive officers have voting or
investment power over the shares beneficially owned by Mr. Yeh.
Trueway's share total reflects 157,000 shares transferred by Trueway to
STG Incentive Company L.L.C. in July 1999 in connection with the U.S.
program of the 1999 incentive plan.
(2) The shares held by the MLPFS Custody Account No. 2 include 1,353,000
shares beneficially owned by Eva Chiang. The shares held by the MLPFS
Custody Account No. 2 include shares beneficially owned by family
members of Eva Chiang and her husband. Steve Chang and Eva Chiang
disclaim beneficial ownership of the shares beneficially owned by these
family members.
(3) All of the shares of Gainway are beneficially owned by Liao
Hsueh-Hsuan. None of Trend Micro's directors or executive officers have
voting or investment power over the shares beneficially owned by Mr.
Liao. Gainway's share total reflects 243,000 shares transferred by
Gainway to STG Incentive Company L.L.C. in July 1999 in connection with
the U.S. program.
(4) STG Incentive Company L.L.C.'s pre-offering share total reflects
810,000 shares transferred to STG Incentive Company L.L.C. by Trueway,
Gainway and Mr. Chang in July 1999 in connection with the U.S. program
of our 1999 incentive plan.
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<PAGE>
(5) The share total includes 1,353,000 shares held by the MLPFS Custody
Account No. 2 that are beneficially owned by Eva Chiang. The share
total excludes 96,000 shares transferred by Steve Jang-Ming Chang to
STG Incentive Company L.L.C. in July 1999 in connection with the U.S.
program. For additional information regarding ownership of warrants,
see "Management--Incentive Plans."
(c) As far as is known to the Company, there is no arrangement, the
operation of which may at a subsequent date result in a change in
control of Trend Micro.
Item 5. Nature of Trading Market
------------------------
Japanese Over-The-Counter Market
Our shares have been traded since August 18, 1998 on the Japanese
over-the-counter market, 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, taking into account the one-into-three stock split effected on
September 30, 1999.
<TABLE>
<CAPTION>
Yen Price Per Share
--------------------
High Low
----- -----
<S> <C> <C>
1998 Third quarter (August 18 to September 30, 1998)........... Yen 2,833 Yen 1,867
Fourth quarter............................................ 2,583 1,393
1999 First quarter............................................. 5,100 2,367
Second quarter............................................. 7,333 3,800
Third quarter.............................................. 10,833 3,177
Fourth quarter............................................. 25,800 14,000
2000 First quarter............................................. 32,800 16,900
Second quarter (through May 18, 2000)..................... 19,100 9,500
</TABLE>
On May 18, 2000, the closing sale price of the shares on the Japanese
over-the-counter market was Yen 12,800 per share.
U.S. Market
Certain of our shares have been traded on The Nasdaq National Market
since July 8, 1999 in the form of American Depositary Shares under the symbol
"TMIC." The following table shows, for the periods indicated, the high and low
closing per-ADS sale price of the ADSs and the average daily trading volume of
the ADSs, taking into account the one-into-three stock split effected on
September 30, 1999.
Dollar Price Per ADS
---------------------
High Low
------ ------
1999 Third quarter (from July 8, 1999)............. $13.125 $ 4.667
Fourth quarter................................ 24.500 13.500
2000 First quarter................................. 31.875 16.500
Second quarter (through May 17, 2000)......... 17.188 10.375
30
<PAGE>
On May 17, 2000, the closing sale price of the ADSs on The Nasdaq
National Market was $13.125 per ADS.
Overview of the Japanese Over-The-Counter Market
On the Japanese over-the-counter market, member securities firms trade
registered stocks primarily through JASDAQ Market Services, Inc., which acts as
a matching and settlement agent for the Japan Securities Dealers Association.
Member securities firms receive bid and offer quotations, trading volumes,
selling prices and other trading information through a computerized system. As
of March 31, 2000, the stock of 872 companies was registered on the Japanese
over-the-counter market. As of March 31, 2000, the Japanese over-the-counter
market had an aggregate market capitalization of approximately (Y)30.7 trillion.
Item 6. Exchange Controls and Other Limitations Affecting Security Holders
------------------------------------------------------------------
(a) Japanese Foreign Exchange Regulations
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.
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<PAGE>
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 (Y)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 the shares of Trend Micro
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
become a beneficial owner 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 Minister of Finance within
five business days a report concerning such shareholdings.
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.
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(b) Description of Common Stock
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 April 30, 2000 is 250,000,000
shares, of which 65,096,142 shares with par value of (Y)50 per share were issued
and outstanding. Under the Commercial Code, shares must be registered and are
transferable by delivery of share certificates. In order to assert shareholders'
rights against us, a shareholder must have its name and address registered on
our register of shareholders, in accordance with our share handling regulations.
The registered beneficial holder of deposited shares underlying the ADSs is the
depositary for the ADSs. Accordingly, holders of ADSs will not be able to assert
shareholders' rights.
A holder of shares may choose, at its discretion, to participate in the
central clearing system for share certificates under the Law Concerning Central
Clearing of Share Certificates and Other Securities of Japan. Participating
shareholders must deposit certificates representing all of the shares to be
included in this clearing system with Japan Securities Depository Center. If a
holder is not a participating institution in the Securities Center, it must
participate through a participating institution, such as a securities company or
bank having a clearing account with the Securities Center. All shares deposited
with the center will be registered in the name of the center on our register of
shareholders. Each participating shareholder will in turn be registered on our
register of beneficial shareholders and be treated in the same way as
shareholders registered on our register of shareholders. For the purpose of
transferring deposited shares, delivery of share certificates is not required.
Entry of the share transfer in the books maintained by the Securities Center for
participating institutions, or in the book maintained by a participating
institution for its customers, has the same effect as delivery of share
certificates. The Securities Center system is intended to reduce paperwork
required in connection with transfers of shares. Beneficial owners may at any
time withdraw their shares from deposit and receive share certificates.
Dividends
Under our articles, our financial accounts will be closed on December
31 of each year and dividends, if any, will be paid to shareholders of record at
December 31. In addition to year-end dividends, the board of directors may by
resolution declare an interim cash dividend to shareholders of record as of June
30 of each year. Under the Commercial Code, however, we cannot declare or pay
dividends unless specified financial criteria are met based on the amount of our
stated capital and legal reserves. For information as to Japanese taxes on
dividends, see "Tax Considerations--Japanese Taxation."
Japanese Unit Share System
In accordance with the requirements of the Commercial Code, our
articles of incorporation provide that 500 shares constitute one "unit."
Transferability of Shares Representing Less Than One Unit. Under the
Commercial Code and the Deposit Agreement, holders of ADSs will be able to
surrender ADSs and withdraw the underlying shares from deposit only in whole
unit lots of one unit or larger. A holder who owns ADRs evidencing less than
5,000 ADSs will indirectly own less than a whole unit. Such a holder will not be
able to dispose of its shares in lots of less than one unit and will not have
access to the Japanese market through
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surrender of their ADSs and withdrawal and sale in Japan of the underlying
shares. The Japanese unit share system does not affect the transferability of
ADSs, which may be transferred in lots of any size.
Right of a Holder of Shares Representing Less Than One Unit to Require
Trend Micro to Purchase Such Shares. A holder of shares representing less than
one unit may at any time require Trend Micro to purchase such shares. Such
shares will be purchased at their last reported sale price on the Japanese over-
the-counter market on the day a request pertaining to such purchase is delivered
to our transfer agent or, if no sales take place on that day, the price at which
the next sale of shares is effected in the Japanese over-the-counter market,
less applicable brokerage commissions. However, because holders of ADSs
representing less than one unit are not able to withdraw the underlying shares
from deposit, such holders will not be able to exercise this right as a
practical matter.
Other Rights of a Holder of Shares Representing Less Than One Unit. A
holder of shares representing less than one unit has the following rights:
. to receive dividends (including interim dividends);
. to receive shares and/or cash by way of a stock split, upon
consolidation or subdivision of shares or upon a capital decrease
or merger;
. to be allotted rights to subscribe for new shares and other
securities when such rights are granted to shareholders;
. to participate in any distribution of surplus assets upon the
liquidation of Trend Micro; and
. to require us to issue replacement certificates for lost, stolen
or destroyed share certificates.
A shareholder who owns shares representing less than one unit will not
be able to exercise any other rights, including voting rights, the right to
institute derivative actions and the right to examine our accounting books and
records.
Voting Rights of a Holder of Shares Representing Less Than One Unit. A
holder of shares representing less than one unit cannot exercise any voting
rights pertaining to such shares. In calculating the quorum for various voting
purposes, the aggregate number of shares representing less than one unit will be
excluded from the number of outstanding shares. A holder of shares representing
one or more whole units will have one vote for each share held, except as stated
in "--Voting Rights" below.
Consolidation by Operation of Law of Shares Constituting One Unit into
One Share. The Japanese unit share system was intended to be an interim measure
to encourage companies to issue shares denominated in larger amounts. The
Commercial Code provides that, on a date to be specified by separate
legislation, shares comprising one unit will be consolidated into one share. We
do not currently know when a bill specifying such date will be submitted to the
Japanese Diet. The Japanese Diet is the highest legislative body within the
Japanese governmental system and performs a function analogous to that of the
U.S. Congress. When this consolidation happens, a holder of a fractional share,
equal to one-hundredth of one share or any integral multiple of one-hundredth
which results from the consolidation, will be registered as the holder of the
fraction in our register of fractional shares. A holder of any fraction
representing less than one-hundredth of one share will be entitled to only
limited rights, such as the right to receive a cash payment or a distribution of
shares by way of a stock split. The registered holders of fractional shares may
request that we issue share certificates, but such fractional shares will not
have voting rights. In addition, unless the Articles are amended to provide
otherwise, the rights of the fractional shareholders will be limited and will
not include, for example, the right to receive dividends.
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Ordinary General Meeting of Shareholders
We normally hold our ordinary general meeting of shareholders in March
of each year in Tokyo, Japan. In addition, we may hold an extraordinary general
meeting of shareholders whenever necessary by giving at least two weeks' advance
notice. Under the Commercial Code, notice of any shareholders' meeting must be
given to each shareholder having voting rights or, in the case of a non-resident
shareholder, to his resident proxy or mailing address in Japan in accordance
with our share handling regulations, at least two weeks prior to the date of the
meeting.
Any shareholder or group of shareholders holding at least 300 units of
shares, or 1% of the total outstanding shares, for a continuous period of six
months or longer may propose a matter for consideration at a shareholders
meeting by submitting a written request to the board of directors at least six
weeks before such meeting.
Voting Rights
A shareholder is generally entitled to one vote per share except in
those instances described in this paragraph and under "--Japanese Unit Share
System" above. In general, under the Commercial Code, a resolution can be
adopted at an ordinary meeting of shareholders by a majority of the shares
having voting rights represented at the meeting. The Commercial Code and our
articles of incorporation require a quorum for the election of directors and
statutory auditors of not less than one-third of the total number of outstanding
shares having voting rights. Our shareholders are not entitled to cumulative
voting in the election of directors. A corporate shareholder whose outstanding
shares are in turn more than one-quarter directly or indirectly owned by Trend
Micro does not have voting rights. Shareholders may exercise their voting rights
through proxies, provided that such proxies are also shareholders who have
voting rights.
The Commercial Code provides that a quorum of the majority of
outstanding shares with voting rights must be present at a shareholders' meeting
to approve any material corporate actions such as:
. amendment of the articles of incorporation;
. the removal of a director or statutory auditor;
. a dissolution, merger or consolidation; and
. the transfer of the whole or an important part of our business.
At least two-thirds of the shares having voting rights represented at the
meeting must approve such actions.
The voting rights of holders of ADSs are exercised by the depositary
based on instructions from such holders. An agent of the depositary is the
record holder of the underlying shares.
Subscription Rights
Holders of shares have no preemptive rights under our articles of
incorporation. Under the Commercial Code, the board of directors may, however,
determine that shareholders be given subscription rights in connection with a
particular issue of new shares. In this case, such rights must be given on
uniform terms to all shareholders as of a specified record date by at least two
weeks' prior public notice to shareholders of the record date. Public or
individual notice must be given to each of these shareholders at least two weeks
prior to the date of expiration of the subscription rights.
Rights to subscribe for new shares may be transferable or
nontransferable as determined by the board of directors. If subscription rights
are not transferable, a purported transfer by a shareholder who is not resident
in Japan will be enforceable against Trend Micro and third parties only with our
prior written consent.
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Liquidation Rights
Upon a liquidation of Trend Micro, the assets remaining after payment
of all debts, liquidation expenses and taxes will be distributed among the
shareholders in proportion to the number of shares they own.
Liability to Further Calls or Assessments
All of our currently outstanding shares, including shares represented
by the ADSs, are fully paid and nonassessable.
Transfer Agent
The Toyo Trust and Banking Company, Limited is the transfer agent for
the Common Stock. Toyo Trust's office is located at 4-3, Marunouchi 1-chome,
Chiyoda-ku, Tokyo, 100-0005 Japan. Toyo Trust maintains our register of
shareholders and records transfers of record ownership upon presentation of
share certificates.
Repurchase by Trend Micro of Shares
In addition to repurchases of shares constituting less than one unit,
our articles of incorporation permit us to repurchase up to 4.8 million of our
shares.
Item 7. Taxation
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The following is a general discussion of material Japanese and United
States federal income tax consequences of the ownership of shares or ADSs by
U.S. holders, as defined below. The summary is not a complete analysis or
description of all potential tax consequences to U.S. holders. It does not
address all tax considerations that may be relevant to all categories of
potential purchasers, such as
. U.S. holders who are broker-dealers or who own, directly or
indirectly, 10% or more of the outstanding shares;
. U.S. holders holding the shares or ADSs as a hedge or as part of
a hedging, straddle or conversion transaction; and
. Some U.S. holders including:
. insurance companies;
. tax-exempt organizations;
. financial institutions;
. persons paying alternative minimum tax; and
. persons having a functional currency other than the
U.S. dollar.
These persons may need to comply with special rules not discussed
below.
The summary deals only with holders who hold the shares or ADSs as
capital assets. In addition, this summary is based on the representations of the
depositary and the assumption that each obligation in the deposit agreement
between Trend Micro, The Bank of New York as depositary, registered holders of
outstanding ADSs and the owners of a beneficial interest in ADSs, and any
related agreement, will be performed in accordance with its terms.
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The following summary is based on:
. the Japan - U.S. tax treaty;
. current Japanese tax law;
. the current United States Internal Revenue Code; and
. current interpretations of these laws by Japanese and United
States taxation authorities and courts.
The treaty, the laws, or administrative or judicial interpretation of
the treaty or the laws may change, and the changes may have retroactive effect.
This discussion does not consider the effect of any state, local or
national tax laws other than U.S. federal income tax or Japanese tax laws that
may be applicable to a purchaser of shares or ADSs. We urge you to consult your
tax advisors regarding the United States federal, state and local and the
Japanese and other tax consequences of owning and disposing of shares and ADSs.
As used in this section of the prospectus, the term "U.S. holder"
means a beneficial owner of shares or ADSs that is:
. a citizen or resident of the United States for U.S. federal
income tax purposes;
. a corporation or other entity created or organized under the laws
of the United States or any political subdivision of the United
States;
. an estate, the income of which is includable in gross income for
United States federal income tax purposes regardless of its
source;
. a trust, if a court within the United States is able to exercise
primary jurisdiction over the administration of the trust and one
or more U.S. persons has the authority to control all substantial
decisions of the trust; or
. a trust that has a valid election in effect under U.S. treasury
regulations to be treated as a United States person.
In general, and taking into account the earlier assumptions, for
United States federal income and Japanese tax purposes, owners of ADRs
evidencing ADSs will be treated as the owners of the shares represented by such
ADSs, and no United States federal income tax or Japanese tax will be payable on
exchanges of shares for ADSs, and ADSs for shares.
Japanese Taxation
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. However, if Trend Micro
transfers a part of its retained earnings or legal reserve to stated capital,
whether in connection with stock splits or otherwise, the transfer will be
treated as a dividend payment for Japanese tax purposes, even though no payment
is distributed to shareholders. In such case, Japanese income tax will be
payable.
Under the Japan-U.S. tax 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
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"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 Japan-U.S. tax 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 Japan - U.S. tax treaty. The application must be filed on or
before the day before the dividend is paid. If you hold ADSs, two application
forms must be filed through the depositary, one form before the dividend payment
and the other within eight months after Trend Micro's fiscal year in which the
dividend is paid. To claim the reduced rate, you will need to file proof of:
. taxpayer status;
. residence; and
. beneficial ownership.
The depositary may also require you to provide other information. If
you do not submit an application for reduced withholding before a dividend is
paid, you may file a claim for refund of the excess tax with the Japanese tax
authorities.
You will not have to pay any Japanese tax on a sale of Trend Micro
shares or ADSs. If you make a gift of Trend Micro shares or die holding Trend
Micro shares, a person who receives the shares as a gift or inherits the shares
may have to pay Japanese gift or inheritance tax.
United States Federal Income Taxation
U.S. Federal Tax Consequences of Options
The following summarizes only the U.S. federal income tax consequences
of the options granted under the U.S. program of the 1999 incentive plan. State
and local tax consequences may differ.
The grant of a nonqualified stock option under the U.S. program of the
1999 incentive plan will not result in any federal income tax consequences to
the optionee, to Trend Micro or to Trend U.S. Upon exercise of a nonqualified
stock option, the optionee is subject to income taxes at the rate applicable to
ordinary compensation income on the difference between the option price and the
fair
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market value of the shares on the date of exercise. This income is subject to
withholding for federal and state income and employment tax purposes, and Trend
U.S. may withhold such amounts from other compensation of the optionee, or may
require the optionee to pay to Trend U.S. an amount sufficient to satisfy the
withholding obligation. Trend U.S. is entitled to an income tax deduction in the
amount of the income recognized by the optionee.
Any gain or loss on the optionee's subsequent disposition of the shares
will be taxable as short-term or long-term capital gain or loss, depending on
whether the shares are held for more than one year following exercise. The
maximum marginal rate at which long-term capital gains are taxed is 20%. Trend
U.S. does not receive an income tax deduction for any such gain recognized by
the shareholder.
Taxation of Dividends Distributed on the Shares or ADSs
Distributions on Trend Micro shares or ADSs, including the amount of any
Japanese tax withheld from the distribution, will be taxable at ordinary income
rates as a dividend to a U.S. holder if paid out of Trend Micro's current or
accumulated earnings and profits as determined under U.S. tax principles.
Dividends will be foreign source income for U.S. tax purposes, and will not be
eligible for the dividends-received deduction. Dividends paid on shares will be
taxable when received by the U.S. holder. Dividends paid on ADSs will be taxable
when received by the depositary.
The amount of any distribution of property other than cash will be the fair
market value of the property on the distribution date.
The amount of any cash distribution paid in Japanese yen will equal the
U.S. dollar value of the Japanese yen at the spot yen/dollar rate on the date of
receipt by the U.S. holder, in the case of shares, or the depositary, in the
case of the ADSs. This is the case regardless of whether a U.S. holder converts
the payments into U.S. dollars. If the Japanese yen received as a dividend is
not converted into U.S. dollars on the date of receipt, a U.S. holder will have
a basis in the Japanese yen equal to its U.S. dollar value on the date of
receipt. Gain or loss, if any, recognized by a U.S. holder on the sale or other
disposition of Japanese yen will be U.S. source ordinary income or loss.
Distributions in excess of Trend Micro's current or accumulated earnings
and profits will be treated first as a non-taxable return of capital which will
reduce the U.S. holder's tax basis in the shares or ADSs. As a result of the
reduction in tax basis, the U.S. holder will realize an increased gain or
reduced loss for tax purposes on a subsequent disposition of the shares or ADSs.
Any distribution in excess of the U.S. holder's tax basis will be taxable as
capital gain. Since the capital gain realized will not be foreign source income
for U.S. tax purposes, a U.S. holder would not be able to use any Japanese
withholding tax on the distribution as a credit against the U.S. tax on the
capital gain. The Japanese withholding tax may be used as a credit against U.S.
tax due on other foreign source income in the appropriate category for foreign
tax credit purposes, or may be allowable as a deduction, as described in the
next paragraph.
A U.S. holder may elect to claim the Japanese tax withheld or paid on
dividends on the shares or ADSs either as a deduction or as a foreign tax credit
against the U.S. holder's U.S. federal income tax liability. In general, a U.S.
holder can use foreign tax credits only up to the amount of the U.S. holder's
foreign source income. Distributions on shares or ADSs that are taxable as
dividends will generally constitute foreign source ordinary income for purposes
of the U.S. foreign tax credit limitations. The overall limitation on foreign
taxes eligible for credit is calculated separately on specific classes of
income. For this purpose, dividends distributed by Trend Micro on the shares or
ADSs will generally constitute "passive income" or, in the case of certain U.S.
holders, "financial services income." Special rules apply to some individuals
whose foreign source income during the taxable year consists entirely of
"qualified passive income" and whose creditable foreign taxes paid or accrued
during the taxable year do not exceed $300 or $600 in the case of a joint
return. A U.S. holder may not be allowed a foreign tax credit for foreign taxes
withheld on dividends paid on shares or ADSs if:
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. the U.S. holder has held the shares or ADSs for less than a specified
minimum period during which the U.S. holder is not protected from risk
of loss;
. the U.S. holder is obligated to make payments related to the
dividends; or
. the U.S. holder holds the shares in arrangements in which the U.S.
holder's economic profit, after U.S. taxes, is insubstantial.
The rules governing the foreign tax credit are complex. You should consult
your tax advisors regarding the availability of the foreign tax credit under
your particular circumstances.
Japanese income tax will be imposed on a transfer by Trend Micro of
retained earnings or legal reserve to stated capital. Since such a transfer
generally is not a taxable event for U.S. tax purposes, the Japanese income tax
may be treated as imposed on "general limitation" income for U.S. foreign tax
credit purposes. This could affect a U.S. holder's ability to utilize the
credit. Such a transfer is not generally a taxable event for U.S. federal income
tax purposes. Consequently, under the applicable Treasury regulations, any
Japanese income taxes imposed in such case may be treated as imposed on "general
limitation" income, which may affect your ability to utilize the associated
credit.
Taxation of Disposition of Shares or ADSs
Upon a sale, exchange or other disposition of a share or an ADS, a U.S.
holder will recognize gain or loss for U.S. federal income tax purposes equal to
the difference between
. the U.S. dollar amount realized on the sale, exchange or other
disposition, or if the amount realized is denominated in yen, the U.S.
dollar equivalent determined by reference to the yen/dollar spot
exchange rate on the date of disposition; and
. the adjusted basis of the share or ADS.
Any such gain or loss will constitute capital gain or loss, and will
constitute long-term capital gain or loss if the holding period for the share or
ADS exceeds one year at the time of disposition. Individuals may be entitled to
reduced tax rates on long-term capital gains. The ability to deduct capital
losses may be limited. Any gain or loss recognized by a U.S. holder will
generally be treated as United States source gain or loss.
Foreign Personal Holding Company Status
A foreign corporation will be classified as a foreign personal holding
company if both of the following tests are satisfied:
. at any time during the taxable year, five or fewer individuals who are
United States citizens or residents own, or are deemed to own under
attribution rules, more than 50% of its stock, measured by voting
power or value; and
. at least 60% of its gross income, regardless of source, as
specifically adjusted, comes from certain passive sources.
After a corporation becomes a foreign personal holding company, the income
test percentage for each subsequent taxable year is reduced to 50%. Trend Micro
believes that it has not met the shareholder test at any time during its current
taxable year and that it will not meet the shareholder test immediately after
the offering. In addition, Trend Micro believes that it will not meet the income
test. Therefore, Trend Micro believes that it is currently not a foreign
personal holding company for U.S. federal income tax purposes.
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If Trend Micro were to be classified as a foreign personal holding company,
U.S. holders, including some indirect holders, would be required to include in
income, as a dividend, their pro rata share of Trend Micro's undistributed
foreign personal holding company income if they were holders:
. on the last day of Trend Micro's taxable year, or
. if earlier, the last day of Trend Micro's taxable year in which Trend
Micro satisfied the share ownership test.
The pro rata share would increase a U.S. holder's basis in the shares by a
corresponding amount. In addition, if Trend Micro became a foreign personal
holding company, U.S. holders who acquire shares or ADSs from decedents would be
denied the step-up of the income tax basis for such shares or ADSs to fair
market value at the date of death which would otherwise have been available.
Instead, the U.S. holders would have a tax basis equal to the lower of fair
market value or the decedent's basis. Trend Micro will notify U.S. holders if it
becomes aware that it is classified as a foreign personal holding company in any
taxable year.
Passive Foreign Investment Company Status
A foreign corporation will be a passive foreign investment company if,
after applying certain "look-through" rules, either:
. 75% or more of its gross income is "passive income," defined to
include dividends, interest and certain rents not derived in the
active conduct of a trade or business, among other items, or
. 50%, on average and generally by value, of its assets produce, or are
held for the production of, passive income.
The look-through rules provide in part that a foreign corporation that owns
at least 25% by value of another corporation will be treated as if it owned a
proportionate share of the other corporation's assets and earned a proportionate
share of its income.
Trend Micro believes that it currently is not a passive foreign investment
company for U.S. federal income tax purposes and does not anticipate that it
will become a passive foreign investment company in the future. This
determination is based on our current and anticipated sources of income and on
the current value of our tangible and intangible assets, including goodwill. We
have determined our goodwill, in part, on the value of our stock, and a change
in the value of our stock would affect this calculation. Trend Micro will notify
holders if it becomes a passive foreign investment company in any taxable year.
If Trend Micro were a passive foreign investment company for any taxable
year, the rules described above under "Taxation of Dividends Distributed on the
Shares or ADSs" and "Taxation of Disposition of Shares or ADSs" generally would
not apply. Instead, a U.S. holder of shares or ADSs would have to comply with
special tax rules on "excess distribution" in a taxable year with respect to the
shares or ADSs. For purposes of the passive foreign investment company rules, an
excess distribution includes:
. any gain realized on a disposition of the shares or ADSs; and
. any distribution which is greater than 125% of the average of the
distributions received by the U.S. holder in the three preceding
taxable years or, if shorter, the period the U.S. holder has held the
shares or ADSs.
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Under these rules:
. the excess distribution or gain would be allocated ratably over the
U.S. holder's holding period for the shares or ADSs;
. the amount allocated to the current taxable year, and any taxable year
prior to the first taxable year in which we are a passive foreign
investment company, would be taxed as ordinary income;
. the amount allocated to each of the other taxable years would be taxed
at the highest marginal rate in effect for the applicable class of
taxpayer for that year; and
. an interest charge for the deemed deferral benefit would be imposed on
the resulting tax attributable to each such other taxable year.
Any tax liability for amounts allocated to years prior to the year of the
excess distribution may not be offset by any net operating loss of the U.S.
holder. Any gains, but not losses, realized on the disposition of shares or ADSs
of a passive foreign investment company will be taxed as ordinary income, even
if the shares or ADSs are held as capital assets.
A U.S. holder of shares or ADSs in a passive foreign investment company may
avoid taxation under the rules for excess distributions described above by
making a "qualified electing fund" election to include in income the holder's
share of the company's income for a year, whether or not distributed. However, a
U.S. holder may make a qualified electing fund election only if the company
agrees to furnish the U.S. holder annually with certain tax information, and
Trend Micro does not presently intend to prepare or provide such information.
A U.S. holder of shares or ADSs in a passive foreign investment company may
limit application of the rules for excess distributions described above by
making a "deemed sale" election once a company ceases to be a passive foreign
investment company. If the U.S. holder makes the election, the U.S. holder will
be taxed under the excess distribution rules as if the holder had disposed of
the shares at the time of the election. A subsequent disposition of the shares
or ADSs and any distributions on the shares or ADSs after the deemed sale
election will not be subject to the excess distribution rules.
Alternatively, a U.S. holder of "marketable stock" in a passive foreign
investment company may make a mark-to-market election as an alternative to
taxation under the excess distribution rules. Under such election, the
shareholder will include in income each year an amount equal to the excess, if
any, of the fair market value of the passive foreign investment company stock as
of the close of the taxable year over the shareholder's adjusted basis in such
stock. The shareholder is allowed as an ordinary loss a deduction for the
excess, if any, of the adjusted basis of the passive foreign investment company
stock over its fair market value as of the close of the taxable year. However,
deductions are limited to net mark-to-market gains on the stock which the
shareholders included in income for prior taxable years. Amounts included in
income pursuant to a mark-to-market election, as well as gain on the actual sale
or other disposition of the passive foreign investment company stock, are
treated as ordinary income. Any loss realized on the sale or disposition of
passive foreign investment company stock which does not exceed net mark-to-
market gains previously included in income will be an ordinary loss. The tax
rules applicable to distributions by corporations which are not passive foreign
investment companies would apply to distributions by the passive foreign
investment company.
The mark-to-market election is available for stock or ADSs which are
regularly traded on The Nasdaq National Market. The ADSs are traded on The
Nasdaq National Market and, consequently, the mark-to-market election is
available to U.S. holders of ADSs if Trend Micro were to be or become a passive
foreign investment company.
42
<PAGE>
A U.S. holder who beneficially owns shares in a passive foreign
investment company must file an annual return with the U.S. Internal Revenue
Service on IRS Form 8621 that describes any distributions received on such
shares and any gain realized on the disposition of such shares.
Inheritance and Gift Tax
As discussed in "Tax Considerations--Japanese Taxation" Japanese gift
and inheritance taxes may be imposed on persons who receive Trend Micro stock as
a gift from a U.S. holder or on the death of a U.S. holder. You should consult
your own tax advisors regarding the effect of such taxes and the potential
application of the Estate and Gift Tax Treaty between the United States and
Japan.
Information Reporting and Backup Withholding
Information reporting to the Internal Revenue Service and backup
withholding at a rate of 31% may apply to distributions on shares or ADSs and to
proceeds from sales of shares or ADSs. Backup withholding will not apply to:
. a U.S. corporation or organization which is exempt from backup
withholding and, when required, provides evidence of its status;
and
. a U.S. holder who:
. provides a correct taxpayer identification number;
. certifies as to no loss of exemption from backup
withholding; and
. otherwise complies with the backup withholding rules.
Amounts withheld under the backup withholding rules may be credited against a
U.S. holder's tax liability, and a holder may obtain a refund of any excess
amounts withheld under the backup withholding rules by filing the appropriate
claim for refund with the Internal Revenue Service.
Item 8. Selected Financial Data
-----------------------
You should read the following selected consolidated financial
information together with the financial statements and notes to the statements,
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Summary of Significant Differences Between Generally Accepted
Accounting Principles in Japan and the United States" included elsewhere in this
Annual Report.
The consolidated income statement information for the fiscal years
ended December 31, 1997, 1998 and 1999, and the consolidated balance sheet
information as of December 31, 1998 and 1999, that are identified as being in
accordance with U.S. GAAP are derived from and should be read together with our
consolidated financial statements prepared in accordance with U.S. GAAP, which
have been audited by PricewaterhouseCoopers, independent accountants, and are
included elsewhere in this prospectus.
The consolidated balance sheet statement information as of December
31, 1997 that is identified as being in accordance with U.S. GAAP is derived
from our consolidated balance sheet prepared in accordance with U.S. GAAP, which
has been audited by PricewaterhouseCoopers, independent accountants, and is not
included in this prospectus. The consolidated income statement information for
the fiscal years ended December 31, 1995 and 1996, and the consolidated balance
sheet information as of December 31, 1995 and 1996, are derived from our
unaudited consolidated financial statements prepared in accordance with Japanese
GAAP and not included in this prospectus.
The consolidated income statement information for the years ended
December 31, 1997, 1998 and 1999, and the consolidated balance sheet information
as of December 31, 1997, 1998 and 1999, that are identified as being in
accordance with Japanese GAAP are derived from our consolidated financial
43
<PAGE>
statements prepared in accordance with Japanese GAAP, which have been audited by
PricewaterhouseCoopers, independent accountants, and are not included in this
prospectus.
Some of the information below is presented in accordance with Japanese
GAAP, which differs in important ways from U.S. GAAP. For a summary of
significant differences between Japanese GAAP and U.S. GAAP, see "Management's
Discussion and Analysis of Financial Condition and Results of Operations.
Accounting Differences between Japanese GAAP and U.S. GAAP" and "Summary of
Significant Differences between Generally Accepted Accounting Principles in
Japan and the United States." Historical results are not necessarily indicative
of future results of operations.
Prior to August 1996, Trend Micro was a Taiwanese company. In August 1996,
Trend Micro was reorganized in a series of transactions by which Trend Micro
became the parent corporation of Trend Taiwan and each of the international
subsidiaries then owned by Trend Taiwan.
<TABLE>
<CAPTION>
Year Ended December 31,
---------------------------------------------------------------------------------------
1995 1996 1997 1998 1999 1999
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(in millions of yen and thousands of dollars, except per share data)
Consolidated Income Statement
Information:
In accordance with Japanese GAAP
Net sales....................... (Yen)1,781 (Yen)4,318 (Yen)7,943 (Yen)10,217 (Yen)13,741 $134,505
---------- ---------- ---------- ----------- ----------- ----------
Operating income................ 553 927 2,349 2,427 4,254 41,641
---------- ---------- ---------- ----------- ----------- ----------
Income before income tax........ 530 974 2,432 2,379 4,464 43,696
Income taxes.................... (116) (346) (1,118) (1,325) (1,997) (19,548)
---------- ---------- ---------- ----------- ----------- ----------
Net income...................... 414 628 1,314 1,054 2,467 24,148
---------- ---------- ---------- ----------- ----------- ----------
Net income per share (basic).... (Yen)41.41 (Yen)11.63(1) (Yen)24.33(2) (Yen)18.50(3) (Yen)38.82 $0.38
========== ========== ========== =========== =========== ==========
Net income per share (diluted).. ---- ---- ---- (Yen)18.10 (Yen)37.73 $0.37
========== ========== ========== =========== =========== ==========
Cash dividends.................. (Yen)5.92(4) ---- ---- (Yen)3.33(5) 0.03
========== ========== ========== =========== =========== ==========
<CAPTION>
Year Ended December 31,
------------------------------------------------------------------------------------
1995 1996 1997 1998 1999 1999
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
(in millions of yen and thousands of dollars, except per share data)
In accordance with U.S. GAAP
Net sales..................................................... (Yen)7,398 (Yen)9,746 (Yen)13,633 $133,449
Cost of sales................................................. 734 560 481 4,714
----------- ---------- ---------- ---------
Gross profit............................................... 6,664 9,186 13,152 128,735
----------- ---------- ---------- ---------
Operating expenses:
Selling.................................................... 1,316 1,618 2,240 21,922
Research and development................................... 557 960 994 9,733
General and administrative................................. 2,755 4,995 5,986 58,592
----------- ---------- ---------- ---------
Total operating expenses............................... 4,628 7,573 9,220 90,247
----------- ---------- ---------- ---------
Operating income.............................................. 2,036 1,613 3,932 38,488
----------- ---------- ---------- ---------
Other income, net............................................. 82 85 67 658
----------- ---------- ---------- ---------
Income before income taxes.................................... 2,118 1,698 3,999 39,146
----------- ---------- ---------- ---------
Income taxes.................................................. 1,267 1,295 1,849 18,103
----------- ---------- ---------- ---------
Income before equity in losses of affiliated companies 403 2,150 21,043
========== ========== =========
Equity in losses of affiliated companies - 3 23
---------- ========== =========
Net income.................................................... (Yen)851 (Yen)403 (Yen)2,147 $21,020
=========== ========== ========= =========
Net income per share (basic).................................. (Yen)15.77 (6) (Yen)7.08 (6) (Yen)33.79 $0.33
=========== ========== ========== =========
Net income per share (diluted)................................ -- (Yen)6.92 (Yen)32.85 $0.32
=========== ========== ========== =========
Weighted average common shares outstanding (basic)............ 54,000,000 56,973,091 63,550,164
Weighted average common shares outstanding (diluted).......... -- 58,241,860 65,376,326
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
December 31,
-------------------------------------------------------------------------------
1995 1996 1997 1998 1999 1999
-------------------------------------------------------------------------------
(in millions of yen and thousands of dollars, except per share data)
<S> <C> <C> <C> <C> <C> <C>
Consolidated Balance Sheet Information:
In accordance with Japanese GAAP
Cash and cash equivalents (6)....... (Yen) -- (Yen) -- (Yen)1,444 (Yen)9,396 (Yen)15,649 $153,180
Total assets........................ 1,907 3,262 5,544 17,456 28,857 282,469
Total liabilities................... 963 1,689 2,657 3,215 10,381 101,615
Stockholders' equity................ (Yen)944 (Yen)1,573 (Yen)2,887 (Yen)14,241 (Yen)18,476 $180,854
In accordance with U.S. GAAP
Cash and cash equivalents.......................................... (Yen)1,144 (Yen)9,396 (Yen)15,649 $153,180
Total assets....................................................... 5,435 17,716 28,781 281,729
Total liabilities.................................................. 3,190 4,143 11,471 112,289
Shareholders' equity............................................... (Yen)2,245 (Yen)13,573 (Yen)17,310 $169,440
</TABLE>
- - - - - - - - -------------------------------
(1) As adjusted to reflect 54,000,000 shares outstanding as of December 31,
1996 as permitted under U.S. GAAP. As a result of the reorganization,
shares outstanding decreased from 10,000,000 shares at December 31, 1995 to
6,000 shares at December 31, 1996. Net income per share based upon 6,000
shares outstanding at December 31, 1996 was (Yen)104,664.
(2) As adjusted to reflect 54,000,000 shares outstanding as of December 31,
1997 as permitted under U.S. GAAP. Shares outstanding increased from 6,000
shares on December 31, 1996 to 18,000 shares in a one-into-three stock
split effected on September 1, 1997. Net income per share based on 18,000
shares outstanding at December 31, 1997 was (Yen)72,979.
(3) Shares outstanding increased from 18,000 shares on December 31, 1997 to
62,506,800 shares on December 31, 1998 due to the following events:
. an increase to 1,800,000 shares on January 1, 1998 in connection
with a lowering of the par value of our shares,
. a one-into-ten stock split effected on May 7, 1998,
. issuance of 2,500,000 shares on August 18, 1998 in connection
with our initial public offering in Japan,
. issuance of 335,600 shares upon exercise of warrants issued under
the 1997 and 1998 incentive plans, and
. a one-into-three stock split effected on September 30, 1999.
(4) Dividend amounts in New Taiwan dollars have been translated into Japanese
yen at the Bank of Tokyo-Mitsubishi TTM rate on September 11, 1995 of
NT$1.00 : (Yen)3.6127.
(5) Reflects an extraordinary dividend of (Yen)208.3 million paid in March 1999
to commemorate the listing of our shares on the Japanese over-the-counter
market.
(6) As adjusted to reflect the changes in outstanding shares described in note
3, as permitted under U.S. GAAP.
(7) Consolidated data under Japanese GAAP for cash and cash equivalents for the
years 1995-1996 is not available.
Item 9. Management's Discussion and Analysis of Financial Condition and
---------------------------------------------------------------
Results of Operations
---------------------
You should read the following discussion together with the financial
statements and notes included in this Annual Report. Additionally, the following
discussion includes forward-looking statements about our business and future
performance. You should read these forward-looking statements together with the
description of the uncertainties and risks associated with these statements
contained under the heading "Cautionary Statement Regarding Forward-Looking
Statements" in this Annual Report.
Overview
Trend Micro develops, markets and supports anti-virus software and
management solutions for corporate computer systems and desktop personal
computers. Our net sales consist primarily of license and license renewal fees,
as well as limited sales of our products to other companies for inclusion in
their products. Site license fees for corporate end users consist of a fee for
the license itself and fees for maintenance and support delivered over the
initial license term. Maintenance and support generally includes virus pattern
updates, product version updates, telephone and online technical support and
free use of our 24-hour service centers. Upon expiration of the initial term,
corporate end users can renew the license annually by paying a fee generally
equal to one-half of the initial license fee in Japan and 20%-50% of the initial
license fee in the U.S. and elsewhere,
45
<PAGE>
depending on the country. For retail purchasers of PC-cillin/Virus Buster, the
license fee includes maintenance and support for the initial one-year term only.
In order to receive maintenance and support services after the initial term,
these retail purchasers must pay a percentage, generally less than one-half, of
the original license fee.
We generally recognize revenues from product licenses when:
. the product has been shipped or electronically delivered;
. no significant vendor obligations remain; and
. collection of the resulting account receivable is probable.
In general, we record sales revenues attributable to maintenance and
support as deferred revenue and recognize such revenues ratably over the license
term. The percentage of the license fee which is deferred varies depending on
the location of the Trend Micro entity making the sale, as well as the product
sold. The weighted average percentage of license fees which were deferred was
approximately 25% in both 1998 and 1999. In 1999, we began to receive support
fees from systems integrators who subscribe to our eDoctor services. See note 1
to the financial statements.
Our net sales grew 40% from approximately (Yen)9.7 billion in 1998 to
approximately (Yen)13.6 billion ($133.4 million) in 1999. Our net sales consist
primarily of sales by our operating entities in Japan, the U.S., Taiwan and
Europe. Japan, the U.S., Taiwan and Europe accounted for approximately 43%, 28%,
12% and 13%, respectively, of our net sales in 1999, and approximately 49%, 19%,
18% and 8%, respectively, in 1998.
Net sales in Japan totaled approximately (Yen)4.8 billion and (Yen)5.8
billion ($57.2 million) in 1998 and 1999, respectively, representing
approximately 49% and 43% of our total net sales in these periods. The decrease
in the percentage of our total net sales represented by our net sales in Japan
was primarily the result of increased U.S. net sales in 1999. In absolute terms,
net sales in Japan grew approximately 22% from 1998 to 1999, primarily due to
increased sales of our internet-based products to corporate users. Net sales in
Japan grew approximately 30% from 1997 to 1998. Our rate of sales growth in
Japan in 1998 and 1999 was significantly lower than in 1997, when our net sales
in Japan grew approximately 84% over 1996. Our lower sales growth in Japan in
1998 and 1999 resulted primarily from the fact that by the end of 1997 we had
already established a large base of corporate end users due to rapid growth in
1997, and consequently added new corporate customers at a slower rate in 1998
and 1999. More generally, Japanese corporations' demand for anti-virus solutions
has lagged demand elsewhere, particularly in the U.S.
Our U.S. net sales grew from approximately (Yen)1.9 billion in 1998 to
approximately (Yen)3.8 billion ($37.5 million) in 1999, an increase of
approximately 105%. Net sales in the U.S. grew approximately 76% from
approximately (Yen)1.1 billion in 1997 to approximately (Yen)1.9 billion in
1998. These annual increases in our U.S. net sales resulted largely from higher
sales of internet-based products as well as our server-based products such as
ServerProtect, primarily as a result of increased internet and server use by new
corporate end users.
The continuing recession in Asia adversely affected our net sales in Japan
and other parts of Asia during 1998 and 1999. This was especially true in
Taiwan, where net sales decreased from approximately (Yen)1.8 billion in each of
1997 and 1998, to approximately (Yen)1.6 billion ($16.1 million) in 1999.
Net sales in Europe grew approximately 124% from approximately (Yen)813
million in 1998 to (Yen)1.8 billion ($17.9 million) in 1999. Net sales in Europe
grew approximately 90% from approximately (Yen)428 million in 1997 to (Yen)813
million in 1998. The growth in net sales from 1997 to 1998 resulted
46
<PAGE>
largely from increased sales following the establishment of our European
subsidiaries during 1997. We achieved an increased rate of growth in sales from
1998 to 1999 as we gained greater name recognition in the European market and as
a result of heightened use of anti-virus products by European corporate
customers.
Net sales outside of Japan, the U.S., Taiwan and Europe increased
approximately 17% from approximately (Yen)379 million in 1997 to approximately
(Yen)445 million in 1998, and from 1998 to 1999 increased approximately 9% from
approximately (Yen)445 million to approximately (Yen)483 million ($4.7 million).
These increases were primarily due to higher corporate sales in Europe.
Until April 1999, we offered three types of licenses to Japanese corporate
customers:
. a two-year "executive license" for corporate customers who purchased
our products through Vaccine Bank, a cooperative marketing program
which we established with SOFTBANK in 1997;
. a one-year site license for Virus Buster; and
. a one-year site license for our server package for corporate customers
who purchased our products through systems integrators.
Holders of executive licenses have been eligible for license fee discounts
through SOFTBANK. Effective as of April 1, 1999, we adopted a uniform one-year
site license policy for all new Japanese corporate end users, effectively
combining the three licenses described above. We adopted this license policy to
realize a more stable revenue stream based entirely on annual license fees,
rather than a combination of bi-annual and annual license fees. In addition, we
increasingly work directly with systems integrators to provide support and
service to corporate end users. As a result, we are placing less emphasis on
other distribution channels in Japan. Under our new licensing policy, volume
discounts are available for corporate end users with a large number of personal
computers. Discounts on sales to SOFTBANK have been reduced. As in the past, end
users may license our products directly from us or through SOFTBANK, or other
distributors or systems integrators. Existing executive licenses will remain in
effect through their initial term and are renewable for a two-year renewal term
at discounted rates stated in the original license. After the first renewal, our
standard renewal terms described above will apply. In markets other than Japan
and Taiwan, we generally offer one-year corporate site licenses, with volume
discounts for large corporate customers.
We made rebate payments to SOFTBANK of approximately (Yen)5.4 million in
1997, approximately (Yen)22.6 million in 1998 and approximately (Yen)97.8
million ($1.0 million) in 1999. The rebate amounts were based on SOFTBANK's
achievement of sales targets agreed upon between SOFTBANK and us. We record
rebate payments as deductions of sales revenue on an accrual basis.
Our consolidated financial statements are denominated in Japanese yen. All
asset and liability accounts of our foreign subsidiaries are translated into
Japanese yen at the year-end rates of exchange. We translate all income and
expense accounts at rates of exchange that approximate those prevailing at the
time of the transactions and accumulate the resulting adjustments as a separate
component of shareholders' equity. We translate foreign currency-denominated
receivables and payables into Japanese yen at year-end rates of exchange and
recognize or expense the resulting translation gains or losses on a current
basis. Fluctuations in the exchange rate between the Japanese yen and other
currencies, principally the U.S. dollar and the New Taiwan Dollar, will affect
the translation of the financial results of our foreign subsidiaries into
Japanese yen for purposes of our consolidated financial results, and will also
affect the Japanese yen value of any amounts we receive from our subsidiaries.
In the past we have recorded a majority of our expenses, and recognized a
substantial majority of our net sales, in Japanese yen.
47
<PAGE>
In October 1997, April and June 1998 and July 1999, we granted warrants to
attract and retain key employees. Also, in July 1999, options were granted under
the U.S. program of our 1999 incentive plan. The warrants granted in 1997
generally commenced vesting 30 days after our initial public offering, which we
completed in August 1998. 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 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)397.5
million for the year ended December 31, 1998 and approximately (Yen)379.8
million ($3.7 million) for the year ended December 31, 1999 with respect to the
1998 warrants. This expense accounts for the difference between the exercise
prices of the 1998 warrants and the deemed fair market value as of the warrants'
grant date of the shares issuable upon exercise of the warrants. The 1998
warrants are expected to continue to vest through December 31, 2000.
Consequently, we expect to record additional non-cash compensation expense of
approximately (Yen)101.5 million in 2000. Had such non-cash compensation expense
for our 1998 warrants in 1998 and 1999 been determined based on the fair value
of such warrants at the grant dates, as prescribed by Statement of Financial
Accounting Standards No. 123, our pro forma net income would have been
approximately (Yen)147.6 million in 1998 and approximately (Yen)1.7 billion in
1999, and net income per share would have been (Yen)2.59, or (Yen)2.53 on a
fully diluted basis, in 1998 and (Yen)26.73, or (Yen)25.98 on a fully diluted
basis, in 1999. 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 14 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%. We have invested the proceeds of
the bonds in cash and other short-term investments. Since these investments are
likely to yield less interest income than the interest expense on the bonds, we
will incur a net interest expense with respect to the bonds.
Results of Operations
The following table sets forth the results of operations for Trend Micro in
absolute terms and as a percentage of net sales. Our historical operating
results are not necessarily indicative of the results for any future period.
<TABLE>
<CAPTION>
For the Year Ended December 31
------------------------------------------------------------------------
1998 1998 1999 1999 1999
------------------------------------------------------------------------
(in thousands, except percentages)
<S> <C> <C> <C> <C> <C>
Net sales.......................................... (Yen)9,745,664 100.0% (Yen)13,633,170 100.0% $133,449
Cost of sales...................................... 559,530 5.7 481,574 3.5 4,714
-------------- -------------- ----------------- ----------- ------------
Gross profit.................................. 9,186,134 94.3 13,151,596 96.5 128,735
-------------- -------------- ----------------- ----------- ------------
Operating expenses:
Selling....................................... 1,617,759 16.6 2,239,594 16.4 21,922
Research and development............... 960,156 9.9 994,340 7.3 9,733
General and administrative.................... 4,994,937 51.2 5,985,740 43.9 58,592
-------------- -------------- ----------------- ----------- ------------
Total operating expenses.................. 7,572,852 77.7 9,219,674 67.6 90,247
-------------- -------------- ----------------- ----------- ------------
Operating income 1,613,282 16.6 3,931,922 28.9 38,488
Other income (expense):
Interest income............................... 44,620 0.4 148,487 1.1 1,453
Interest expense.............................. (29,279) (0.3) (66,526) (0.5) (651)
</TABLE>
48
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C> <C>
Gain on sales of marketable securities........ 146,310 1.5 280,532 2.1 2,746
Foreign exchange gain (loss), net............. (70,934) (0.7) (174,921) (1.3) (1,712)
Other income (expense), net................... (6,133) (0.1) (120,298) (1.0) (1,178)
-------------- -------------- ------------- -------------- -----------
Total other income................. 84,584 0.8 67,274 0.4 658
-------------- -------------- ------------- -------------- -----------
Income before income taxes................... 1,697,866 17.4 3,999,196 29.3 39,146
-------------- -------------- ------------- -------------- -----------
Income taxes:
Current................................ 1,641,902 16.8 2,538,455 18.6 24,848
Deferred............................... (347,151) (3.5) (688,988) (5.1) (6,745)
-------------- -------------- ------------- -------------- -----------
1,294,751 13.3 1,849,467 13.5 18,103
-------------- -------------- ------------- -------------- -----------
Income before equity in losses of affiliated
companies 2,149,729 15.8 21,043
============== ============== ============= ============== ===========
Equity in losses of affiliated companies 2,356 - 23
============== ============== ============= ============== ===========
Net income.................................. (Yen)403,115 4.1% (Yen)2,147,373 15.8% $ 21,020
============== ============== ============= ============== ===========
</TABLE>
Comparison of the Years Ended December 31, 1998 and 1999
Net Sales
Net sales increased 40% from (Yen)9.7 billion in 1998 to (Yen)13.6 billion
($133.4 million) in 1999. The increase was primarily due to increased sales of
internet-based products such as InterScan VirusWall and ScanMail, which grew
from approximately (Yen)2.8 billion or 29% of our net sales in 1998 to
approximately (Yen)6.3 billion ($61.8 million) or 46% of our net sales in 1999.
Net sales of server-based products, primarily ServerProtect, increased from
approximately (Yen)1.0 billion or 10% of our net sales in 1998 to approximately
(Yen)1.5 billion ($14.7 million) or 11% of our net sales in 1999, reflecting
higher corporate demand for internet-based products.
Net sales of anti-virus software for personal computers, including retail
package sales of PC-cillin/Virus Buster, declined from approximately (Yen)3.7
billion or 38% of net sales in 1998 to approximately (Yen)3.5 billion ($34.3
million) or 26% of net sales in 1999, and no longer represent the largest
portion of our net sales. Within the personal computer product category, retail
package sales of personal computer software decreased from approximately
(Yen)1.6 billion in 1998 to approximately (Yen)0.7 billion ($7.2 million) in
1999, due primarily to decreased sales of our products in our Asian markets. We
released Virus Buster 2000 in September 1999. Site license sales of personal
computer software to corporate end users increased from approximately (Yen)2.1
billion in 1998 to approximately (Yen)2.8 billion ($27.1 million) in 1999.
Our net sales include a limited amount of sales of our products to other
companies for inclusion in their products. Sales of these products decreased
slightly from approximately (Yen)1.0 billion in 1998 to approximately (Yen)0.7
billion ($6.9 million) in 1999, and as a percentage of net sales decreased from
10% in 1998 to 5% in 1999. The decrease was due primarily to lower sales of our
Trend Chip-Away Virus product.
Our net sales also include revenues from product upgrade fees, maintenance
fees, royalties and service sales. Sales in these areas increased from
approximately (Yen)0.6 billion in 1998 to approximately (Yen)1.5 billion ($14.7
million) in 1999. The increase was due primarily to increased license renewals
by corporate customers and Virus Buster updates in September 1999. As a
percentage of net sales, sales in these areas increased from approximately 6% in
1998 to approximately 10% in 1999. Royalties totaled approximately (Yen)0.5
billion or 5% of net sales in 1998. No royalties were paid in 1999. The decrease
was due to termination in 1998 of license agreements for a third party to sell
PC-cillin under that party's brand name and for another third party to license
scan engine technology. The remainder of our net sales consists of sales of
other products, which totaled approximately (Yen)0.2 billion ($2.0 million) or
2% of net sales in each of 1998 and 1999.
49
<PAGE>
Cost of Sales
Cost of sales consists primarily of outbound shipping and handling
costs, costs of manuals and packaging, and amortization of software development
costs. Cost of sales decreased 14% from approximately (Yen)559.5 million in 1998
to approximately (Yen)481.6 million ($4.7 million) in 1999. The decrease was
primarily due to the decrease in retail package sales for personal computer
software, which has lowered costs by reducing the amount of packaging required
for our net sales.
Operating Expenses
Operating expenses increased 22% from approximately (Yen)7.6 billion in
1998 to approximately (Yen)9.2 billion ($90.2 million) in 1999.
Selling
Selling expenses consist primarily of advertising and selling
commissions. Selling expenses were approximately (Yen)1.6 billion in 1998 and
approximately (Yen)2.2 billion ($21.9 million) in 1999, an increase of 38%. The
increase was primarily a result of increased advertising expenditures in Japan
and the U.S.
Research and development
Research and development expenses consist primarily of payroll and
related expenses for software engineers who develop and update our anti-virus
software products. Research and development expenses increased 4% from
approximately (Yen)960.2 million in 1998 to approximately (Yen)994.3 million
($9.7 million) in 1999. Research and development personnel increased from 152 at
December 31, 1998 to 204 at December 31, 1999. Our research and development
expenses in 1999 grew at a slower rate than our 1999 net sales largely due to
our substantially increased research and development spending in 1998, the
benefits of which carried over into 1999. All costs relating to research and
development to establish the technological feasibility of our software products
are expensed as incurred. In our software development process, technological
feasibility is established upon completion of all significant testing for the
original English language version of the product. We produce local language
versions of our anti-virus software, such as Japanese and Chinese, from the
English language version by adding local language functions. Localization costs,
which include direct labor and overhead costs, are capitalized and amortized
over the estimated life of the product in accordance with Statement of Financial
Accounting Standards No. 86. We believe that we will need to continue to incur
costs to update current products and develop new products to remain competitive.
Accordingly, we expect our research and development expenses to increase
moderately in absolute terms in future periods.
General and administrative
General and administrative expenses consist primarily of payroll and
related expenses, customer service, accounting and administration and other
general corporate expenses. General and administrative expenses increased 20%
from approximately (Yen)5.0 billion in 1998 to approximately (Yen)6.0 billion
($58.6 million) in 1999, representing approximately 51% and 44% of net sales for
these years. The increase in general and administrative expenses was primarily
due to higher payroll costs due to new hires and existing employees. Employees
engaged in activities other than research and development increased from 382 at
December 31, 1998 to 494 at December 31, 1999. We expect general and
administrative costs to increase in absolute terms in future periods as we
expand our operations.
Other income (expense)
We earned interest income of approximately (Yen)44.6 million during
1998 and approximately (Yen)148.5 million ($1.4 million) during 1999. Interest
income in 1999 was primarily earned from the
50
<PAGE>
investment of approximately (Yen)10.2 billion ($89.8 million) in net proceeds
from our August 1998 Japanese initial public offering in Japanese money market
funds and other cash equivalents, and from interest received from our investment
in bonds issued by SOFTBANK.
In 1999 we recognized a gain on sales of marketable securities of
approximately (Yen)280.5 million ($2.7 million). The gain primarily resulted
from our sale in shares of common stock of USWeb/CKS, a Nasdaq-listed U.S.
technology company. At December 31, 1999, we held common stock of USWeb/CKS with
an unrealized gain of approximately (Yen)412.4 million ($4.0 million). In March
2000, pursuant to Whittman-Hart's acquisition of USWeb/CKS in a stock-for-stock
merger transaction, we received common shares of MarchFirst, the renamed
Whittman-Hart parent entity following the merger, in exchange for our remaining
holdings of USWeb/CKS common stock.
Income Taxes
Our statutory tax rate was 51.4% in 1998 and 47.7% in 1999. A change in
Japanese income tax regulations reduced our statutory rate to approximately
42.1% beginning on January 1, 2000. Our effective tax rate was 76.3% in 1998 and
46.2% in 1999. The difference between our statutory and effective tax rates in
1998 and 1999 resulted largely from changes in the valuation allowances relating
to tax-deferred assets held by our U.S. subsidiary, and non-tax deductible
expenses in the form of non-cash warrant compensation expense of approximately
(Yen)397.5 million in 1998 and approximately (Yen)379.8 million ($3.7 million)
in 1999.
Comparison of the Years Ended December 31, 1997 and 1998
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.
<TABLE>
<CAPTION>
-----------------------------------------------------------------------
1997 1997 1998 1998 1998
-----------------------------------------------------------------------
(in thousands, except percentages)
<S> <C> <C> <C> <C> <C>
Net sales..................................... (Yen)7,397,979 100.0% (Yen)9,745,664 100.0% $ 86,184
Cost of sales................................. 733,789 9.9 559,530 5.7 4,948
-------------- ------------ -------------- ----------- ------------
Gross profit............................. 6,664,190 90.1 9,186,134 94.3 81,236
-------------- ------------ -------------- ----------- ------------
Operating expenses:
Selling.................................. 1,315,492 17.8 1,617,759 16.6 14,306
Research and development............... 557,001 7.5 960,156 9.9 8,491
General and administrative............... 2,755,435 37.3 4,994,937 51.2 44,172
-------------- ------------ -------------- ----------- ------------
Total operating expenses............. 4,627,928 62.6 7,572,852 77.7 66,969
-------------- ------------ -------------- ----------- ------------
Operating income 2,036,262 27.5 1,613,282 16.6 14,267
Other income (expense):
Interest income.......................... 46,203 0.6 44,620 0.4 394
Interest expense......................... (34,984) (0.5) (29,279) (0.3) (259)
Gain on sales of marketable securities... - - 146,310 1.5 1,294
Foreign exchange gain (loss), net........ 66,907 0.9 (70,934) (0.7) (627)
Other income (expense), net.............. 3,508 0.1 (6,133) (0.1) (54)
-------------- ------------ -------------- ----------- ------------
Total other income................. 81,634 1.1 84,584 0.8 748
-------------- ------------ -------------- ----------- ------------
Income before income taxes................... 2,117,896 28.6 1,697,866 17.4 15,015
-------------- ------------ -------------- ----------- ------------
Income taxes:
Current................................ 1,337,364 18.1 1,641,902 16.8 14,520
Deferred............................... (70,919) (1.0) (347,151) (3.5) (3,070)
-------------- ------------ -------------- ----------- ------------
1,266,445 17.1 1,294,751 13.3 11,450
-------------- ------------ -------------- ----------- ------------
Net income.................................. (Yen) 851,451 11.5% (Yen) 403,115 4.1% $ 3,565
============== ============ ============== =========== ============
</TABLE>
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<PAGE>
Net Sales
Net sales increased 32% from approximately (Yen)7.4 billion for the
year ended December 31, 1997 to approximately (Yen)9.7 billion ($86.2 million)
for the year ended December 31, 1998. The increase was primarily due to
increased sales of internet-based products such as InterScan VirusWall and
ScanMail, which grew from approximately (Yen)1.5 billion or 20% of our net sales
in 1997 to approximately (Yen)2.8 billion ($24.8 million) or 29% in 1998. Net
sales of server-based products, primarily ServerProtect, increased in absolute
terms from approximately (Yen)0.8 billion in 1997 to approximately (Yen)1.0
billion ($8.7 million) in 1998 and decreased slightly as a percentage of net
sales from 11% in 1997 to 10% in 1998, reflecting higher corporate demand for
internet-based products.
Net sales of anti-virus software for personal computers, including
retail package sales of PC-cillin/Virus Buster, declined as a percentage of net
sales, but still represented the largest portion of our net sales in 1998,
totaling approximately (Yen)3.7 billion ($32.6 million), or 38% of net sales.
Sales of these products totaled approximately (Yen)3.2 billion or 43% of net
sales in 1997. Within the personal computer product category, retail package
sales of personal computer software decreased slightly from approximately
(Yen)1.8 billion in 1997 to approximately (Yen)1.6 billion ($13.9 million) in
1998, while site license sales of personal computer software to corporate end
users increased significantly from approximately (Yen)1.4 billion in 1997 to
approximately (Yen)2.1 billion ($18.7 million) in 1998. The increase was due
primarily to higher demand by corporate end users for our product suites which
typically include our personal computer software products.
Net sales of our products to other companies for inclusion in their
products increased in absolute terms from approximately (Yen)0.5 billion in 1997
to approximately (Yen)1.0 billion ($8.6 million) in 1998, and as a percentage of
net sales from 7% in 1997 to 10% in 1998. This increase was primarily due to
significant growth in net sales of our Trend ChipAway Virus product, which
increased from approximately (Yen)31.1 million in 1997 to approximately
(Yen)479.9 million ($4.2 million) in 1998.
Service sales increased in absolute terms from approximately (Yen)0.5
billion in 1997 to approximately (Yen)0.6 billion ($5.2 million) in 1998, but
decreased slightly in percentage terms from 7% of net sales in 1997 to 6% in
1998. Royalties totaled approximately (Yen)0.5 billion or 7% of net sales in
1997, and approximately (Yen)0.5 billion ($4.1 million) or 5% in 1998. The
decrease in percentage terms was due to termination in 1998 of license
agreements for a third party to sell PC-cillin under that party's brand name and
for a third party to license scan engine technology. Net sales of other products
decreased from approximately (Yen)0.4 billion or 5% of net sales in 1997 to
approximately (Yen)0.2 billion ($1.8 million) or 2% in 1998. The decrease was
primarily due to a suspension of sales of some products on a customized combined
basis.
Cost of Sales
Cost of sales decreased 24% from approximately (Yen)733.8 million for
the year ended December 31, 1997 to approximately (Yen)559.5 million ($4.9
million) for the year ended December 31, 1998. The decrease was primarily
attributable to cost savings from
. our delivery in 1998 to distribute our products only on CD-ROMs, and
. our delivery of computer virus signature updates via the internet.
Operating Expenses
Operating expenses increased 64% from approximately (Yen)4.6 billion
for the year ended December 31, 1997 to approximately (Yen)7.6 billion ($67.0
million) for the year ended December 31, 1998.
52
<PAGE>
Selling
Selling expenses were approximately (Yen)1.3 billion for the year ended
December 31, 1997 and approximately (Yen)1.6 billion ($14.3 million) for the
year ended December 31, 1998, an increase of 23%. The increase was primarily a
result of increased advertising expenditures in Japan and the U.S.
Research and development
Research and development expenses increased 72% from approximately
(Yen)557.0 million for the year ended December 31, 1997 to approximately
(Yen)960.2 million ($8.5 million) for the year ended December 31, 1998. The
increase was primarily attributable to hiring of additional software engineers
to support product development and quality assurance. Research and development
personnel increased from 116 at December 31, 1997 to 152 at December 31, 1998.
General and administrative
General and administrative expenses increased 81% from approximately
(Yen)2.8 billion for the year ended December 31, 1997 to approximately (Yen)5.0
billion ($44.2 million) for the year ended December 31, 1998, representing
approximately 37% and 51% of net sales for these years. The increase was
primarily due to higher payroll costs due to new hires and bonuses to existing
employees, as well as non-cash compensation expense of approximately (Yen)397.5
million ($3.5 million) relating to our employee stock incentive programs and
increased lease expenses. Employees engaged in activities other than research
and development increased from 239 at December 31, 1997 to 382 at December 31,
1998.
Other income (expense)
We earned interest income of approximately (Yen)46.2 million during
1997 and approximately (Yen)44.6 million ($0.4 million) during 1998. Interest
income in 1997 was primarily earned from investments in time deposits in Taiwan.
Interest income in 1998 was primarily earned from the investment of
approximately (Yen)10.2 billion ($89.8 million) in net proceeds from our August
1998 Japanese initial public offering in Japanese money market funds and other
cash equivalents. Interest income decreased slightly in 1998, despite an
increase in cash and cash equivalents, due to a change from time deposits in
Taiwan, which generally earn a higher rate of interest, to Japanese money market
funds and other cash equivalents.
For the year ended December 31, 1998, we recognized a gain on sales of
marketable securities of approximately (Yen)146.3 million ($1.3 million),
primarily in connection with our sale of common stock of USWeb/CKS. As of
December 31, 1999, we continued to hold USWeb/CKS common stock with an
unrealized gain of approximately (Yen)412.4 million ($4.0 million).
Income Taxes
Our statutory tax rate for each of the years ended December 31, 1997
and 1998 was 51.4%. A change in Japanese income tax regulations reduced this
rate to approximately 47.7% beginning on January 1, 1999. Our effective tax rate
was 59.8% for 1997 and 76.3% for 1998. The increase in the effective rate for
1998 was primarily due to increased taxes as a result of an increase in non-tax
deductible expenses in the form of non-cash warrant compensation expense of
approximately (Yen)397.5 million ($3.5 million). The increase was also
attributable to an approximately (Yen)174.3 million ($1.5 million) net increase
in the valuation allowance for tax-deferred assets held by our U.S. subsidiary.
Accounting Differences between Japanese GAAP and U.S. GAAP
We prepare financial statements in accordance with both Japanese GAAP
and U.S. GAAP. In this Annual Report we include five years of selected financial
information in accordance with Japanese GAAP, and two years of consolidated
financial statements, prepared in accordance with U.S. GAAP.
53
<PAGE>
The principal differences between Japanese GAAP and U.S. GAAP which affect our
net sales and net income are:
. Revenue Recognition: A portion of our net sales from product
licenses is attributable to post-contract support, such as product
updates, virus pattern updates and customer support. Under Japanese
GAAP, the portion of net sales attributable to these services is
recognized as income at the beginning of the license term. Under
U.S. GAAP, these service revenues are deferred and recognized
ratably over the license term.
. Warrant Compensation Expense: Under Japanese GAAP, the carrying
value of the 1998 warrants is recognized as compensation expense
when the warrants are distributed to employees. This carrying value
is equal to (Yen)2.85 per warrant, which was the amount we paid to
repurchase the warrants from SOFTBANK. Under U.S. GAAP, the non-
cash compensation charge associated with the 1998 warrants which we
have recorded in the amount of (Yen)397.5 million in 1998
and (Yen)379.8 million ($3.7 million) in 1999, and will record in
the amount of(Yen)101.5 million in 2000, is accrued as an expense.
This expense accounts for the difference between the exercise price
and the deemed fair market value of the shares underlying the 1998
warrants as of the grant date of the warrants.
. Bonuses to Directors and Employees of Certain Non-U.S.
Subsidiaries: We accrued (Yen)191 million ($1.7 million) in bonuses
to directors and employees of some of our non-U.S. subsidiaries in
1998. Under Japanese GAAP, these bonuses are accounted for as an
appropriation of retained earnings when approved by our
stockholders. Under U.S. GAAP, these bonuses are generally accrued
as expense.
Liquidity and Capital Resources
Prior to our initial public offering, we financed our operations
primarily through the private placement of common stock, bank lines of credit
and funds generated from operations. In August 1998, we completed our initial
public offering in Japan, in which we issued 2.5 million shares at a price of
(Yen)1,433 per share. Proceeds from the initial public offering were
approximately (Yen)10.2 billion ($89.8 million), net of offering costs.
At December 31, 1999, we had cash and cash equivalents and marketable
securities of approximately (Yen)16.2 billion ($159.3 million), up from
approximately (Yen)11.1 billion at December 31, 1998. The increase was primarily
due to operating activities and proceeds from our issuance of bonds.
Net cash used in operating activities was approximately (Yen)610.5
million in 1998 compared to net cash provided by operating activities of
approximately (Yen)1.5 billion ($14.5 million) in 1999. Cash used in operating
activities in 1998 was primarily the result of lower net income, an increase in
accounts receivable relating to net sales in the fourth quarter of 1998 and a
decrease in accrued income and other taxes related to payment of estimated
Japanese corporate income tax. This decrease was partially offset by
amortization of deferred compensation expense relating to the warrants issued in
1997 and 1998 and deferred revenue associated with increased net sales. The
decrease was also offset by an increase in other current liabilities related to
withholding taxes imposed upon dividends paid by our Taiwan subsidiary and upon
inter-company payments in connection with relocation of our corporate
headquarters to Japan. Cash provided by operating activities in 1999 was
primarily the result of higher net income, an increase in deferred revenue
associated with increased net sales and amortization of deferred compensation
expense relating to the warrants issued in 1997 and 1998. These increase were
primarily offset by an increase of accounts receivable relating to increased net
sales.
Net cash used in investing activities was approximately (Yen)1.5
billion in 1998 and approximately (Yen)2.7 billion ($26.0 million) in 1999. The
increase from 1998 to 1999 was primarily due to a (Yen)4.0 billion ($39.8
million) increase in payments for purchases of marketable securities and a
(Yen)1.0 billion
54
<PAGE>
($9.4 million) increase in payments for other investments. This increase was
partially offset by proceeds from sales of marketable securities of (Yen)2.4
billion ($23.4 million) and proceeds from maturates of marketable securities for
(Yen)1.1 billion ($10.8 million).
Net cash provided by financing activities was approximately (Yen)10.4
billion in 1998 and approximately (Yen)7.6 million ($74.2 million) in 1999. Net
cash provided by financing activities in 1998 consisted primarily of cash
received from the issuance of shares in our initial public offering. Net cash
provided by financing activities in 1999 consisted primarily of proceeds from
our issuance of bonds in connection with our 1999 warrants.
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 ($7.8
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, 1999, no amounts were outstanding under these
overdraft agreements.
During the year ended December 31, 1998, our Taiwan subsidiary entered
into three lines of credit. Under these lines of credit, an aggregate of
(Yen)1.3 billion ($11.1 million) was available. We cancelled these lines of
credit during 1999, and no amounts were outstanding on December 31, 1999.
In July 1999, we issued (Yen)6 billion worth of unsecured bonds in
connection with our 1999 incentive plan. We used the proceeds of the bond
issuance for working capital and general corporate purposes.
Our capital requirements depend on numerous factors, including
. market acceptance of our products,
. the resources we devote to developing, marketing, selling and
supporting our products, and
. the extent to which we are able to establish relationships with
strategic partners in the U.S., Europe and elsewhere.
We plan to devote additional capital resources to hire additional engineers and
other employees and expand our product development, support, and sales and
marketing organizations, to expand marketing programs, establish additional
facilities worldwide and for other general corporate activities. Additionally,
in the future we may make acquisitions and strategic investments in order to
grow our business. We believe that our current cash balance, cash flow from
operations and existing credit facilities will satisfy our working capital and
capital expenditure requirements for the next 12 months. However, we cannot be
sure that we will not require additional funding during the next twelve months
or in the future. If we do need additional funding during the next 12 months or
in the future, such funding may not be available on commercially reasonable
terms, if at all. Even if no such additional funds are required, we may seek
additional equity or debt financing.
Year 2000 Compliance
Many currently installed computer systems and software products are
coded to accept only two digit entries in the date code field. As a result, the
Year 2000 problem is that software that records only the last two digits of the
calendar year may not be able to distinguish whether "00" means 1900 or 2000.
This software will need to be upgraded to accept four digit entries to
distinguish between 21st century and 20th century dates and avoid software
failures or erroneous data results.
We have evaluated all of the internally-developed and third-party
software and hardware technology which we use for Year 2000 compliance. We use
multiple software systems in our
55
<PAGE>
operations. These systems include several financial, sales and customer support
software programs which have been developed by other companies and which are
material to our business. Based on our evaluation, we believe that these
programs are Year 2000 compliant, and, as of April 30, 2000, we have not
experienced any material Year 2000-related problems. The costs which we have
incurred in the course of our Year 2000 evaluation process have not been
material.
Although we have not experienced any material Year 2000 problems as of
April 30, 2000, there can be no assurance that such problems will not occur in
the future.
Item 9A. Market Risk Disclosure
As discussed in Note 18 to the consolidated financial statements, we
have a policy not to utilize any derivative financial instruments with
off-balance sheet risk. The financial instruments other than derivatives as of
December 31, 1999 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, except for the following:
. An investment in USWeb/CKS, which was formerly listed on The
Nasdaq National Market. This investment had a fair market value of
$4.6 million as at December 31, 1999. During the course of the
year ended December 31, 1999, the high, low and month-end average
trading prices for the investment were $51.69, $17.63 and $31.23.
The potential change in the fair market value of the investment,
assuming a 10% change in prices, would be a gain or loss of
approximately $460,000. USWeb/CKS has merged with Whittman-Hart in
March 2000. The shares of marchFIRST, the renamed Whittman-Hart
parent entity following the merger, now trade on The Nasdaq
National Market under the symbol MRCH.
Item 10. Directors and Officers of Registrant
The following table shows information regarding Trend Micro's directors
and executive officers as of April 30, 2000. Our directors serve on the board
for two year terms and statutory auditors serve for three year terms. Our
executive officers serve at the discretion of the board. The terms of Messrs.
Chang, Lai and Kitao and Ms. Chiang expire upon the completion of our ordinary
shareholders' meeting in 2001. The terms of Messrs. Nakanishi and Watanabe
expire upon the completion of our ordinary shareholders' meeting in 2002. The
terms of Messrs. Sano, Kajikawa and Kawashima expire upon completion of our
ordinary shareholders' meeting in 2002. The term of Mr. Hasegawa expires upon
completion of our ordinary shareholders' meeting in 2003.
56
<PAGE>
<TABLE>
<CAPTION>
Name Age Position(s)
- - - - - - - - ---- --- -----------
<S> <C> <C>
Steve Ming-Jang Chang 45 Representative Director; President, Chief Executive Officer and
Chairman of the Board
Andrew Kwok-To Lai 43 Director; Chief Operating Officer and Executive Vice President
Eva Yi-Fen Chiang 41 Director; Chief Technology Officer and Executive Vice
President
Hiroyuki Nakanishi 42 Director; Chief Financial Officer
Toshihiro Watanabe 38 Director
Yoshitaka Kitao 49 Director
Fumio Hasegawa 60 Statutory Auditor
Mitsuo Sano 43 Statutory Auditor
Akira Kajikawa 41 Statutory Auditor
Katsuya Kawashima 37 Statutory Auditor
</TABLE>
Eva Yi-Fen Chiang, Director, Chief Technology Officer and Executive
Vice President of Trend Micro, is Steve Ming-Jang Chang's sister-in-law.
Item 11. Remuneration of Directors and Officers
--------------------------------------
For the fiscal year ended December 31, 1999, the aggregate
compensation of all directors and executive officers paid or accrued by Trend
Micro was (Yen)72.9 million ($713,270).
Under the Japanese Commercial Code and local practice, we may make
severance payments to a retired director or statutory auditor with shareholder
approval, if our management proposes such payments based on a resolution of our
board of directors. However, we do not intend to make such a proposal for
directors. We have an internal formula to determine the amounts of severance
payments to directors and statutory auditors if we were to make such a proposal
for statutory auditors. We have not recorded any liabilities relating to
severance payments to directors and statutory auditors as of December 31, 1997,
1998 and 1999 because we have no liabilities to directors, and related
liabilities to statutory auditors were insignificant.
Item 12. Options to Purchase Securities from Registrant or Subsidiaries
--------------------------------------------------------------
1997 Incentive Plan and 1998 Incentive Plans
Our 1997 incentive plan and 1998 incentive plans provide for the grant
of warrants to purchase shares to employees and directors. All directors and
employees of Trend Micro and its subsidiaries, other than directors or employees
residing in California and holding more than 10% of the outstanding shares, were
eligible to participate in the incentive plans.
All of the warrants authorized under the incentive plans, representing
an aggregate of 5,326,800 shares, have been issued. As of April 30, 2000,
warrants to purchase a total of 3,549,300 shares have been exercised, warrants
to purchase a total of 374,400 shares have been retired, and warrants to
purchase a total of 1,403,100 shares remain issued and outstanding. All warrants
issued to date under the incentive plans were issued with an exercise price of
(Yen)285 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,
57
<PAGE>
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 937,500 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 810,000 shares from STG Incentive
Company L.L.C.
The exercise price per share for the warrants and the options issued
under the 1999 incentive plan is the fair market value of the shares on the date
on which the exercise price was determined. We have issued the warrants in the
form of unsecured bonds with detachable warrants. Immediately following issuance
of the bonds, we repurchased the warrants and issued some of the warrants to our
Japanese employees and sold the remaining warrants to our subsidiaries for
issuance to employees outside of Japan and the United States. The terms of the
warrants issued under our 1999 incentive plan are substantially identical to
those of the warrants issued under the 1997 and 1998 incentive plans.
Trend U.S. determines the allocation of and vesting for options.
Options are granted by STG Incentive Company L.L.C. at the direction of Trend
U.S. Each option gives the option holder the right to purchase one unit of 500
shares during the four-year period from the date of grant. The options will not
be transferable other than by inheritance or under a domestic relations order by
a court. Upon exercise of an option, the option holder will deposit the
underlying shares into the ADS facility and receive ADSs. The custodian will
return shares underlying options which have not been exercised as of the end of
the option term to STG Incentive Company L.L.C. for distribution to Trueway,
Gainway and Mr. Chang.
58
<PAGE>
Warrant and Option Grants to Directors and Executive Officers
The following table shows information about the warrants and options
granted to the directors and executive officers of Trend Micro which are
outstanding as of April 30, 2000.
<TABLE>
<CAPTION>
Expiration Total Number of Shares
---------- ----------------------
Name Date Underlying Aggregate Exercise Price (1)
- - - - - - - - ---- ---- ----------- ------------------------
Warrants/Options
----------------
<S> <C> <C> <C>
Andrew Kwok-To Lai 7/12/2003 51,000 $2,559,690
Eva Yi-Fen Chiang 7/12/2003 51,000 $2,559,690
Yoshitaka Kitao 7/22/2002 53,125 (Yen)340,000,000
Hiroyuki Nakanishi 7/22/2002 53,125 (Yen)340,000,000
Toshihiro Watanabe 7/22/2002 8,593 (Yen)54,995,200
Directors and 7/22/2002 -
Executive Officers as a 7/12/2003 216,843 $5,119,380 (Yen)734,995,200
group (10 persons)
</TABLE>
(1) Yen figures represent aggregate yen-denominated exercise prices for
warrants, and dollar figures represent aggregate dollar-denominated
exercise prices for options.
Item 13. Interest of Management in Certain Transactions
----------------------------------------------
Transactions with SOFTBANK
In December 1996, we concluded a series of agreements with SOFTBANK
involving an investment by SOFTBANK in Trend Micro and the distribution by
SOFTBANK of our products in Japan.
Stock Purchase. In December 1996, SOFTBANK purchased 18,900,000 shares
from Steve Chang, Eva Chiang and several of their family members for
approximately (Yen)555 per share, or an aggregate of (Yen)3.5 billion. At the
time of the investment, the purchased shares represented 35% of our outstanding
shares. In accordance with a price adjustment provision in the purchase
agreement, SOFTBANK paid an additional (Yen)5 billion ($44.2 million) upon our
Japanese initial public offering in August 1998. SOFTBANK sold 3,000,000 shares
to an unaffiliated third party in September 1998, 12,750,000 shares in a global
offering of our shares in July 1999, and the remaining 3,150,000 shares in March
2000. Until the purchase agreement was amended in June 1998 to delete a
provision providing for such meetings, senior representatives from the two
companies occasionally held management meetings to discuss operational and
management issues relating to our business. The purchase agreement is no longer
in effect. In addition, Mr. Yoshitaka Kitao and Mr. Hiroyuki Nakanishi, who are
members of our board of directors, are a SOFTBANK executive and a former
SOFTBANK employee, respectively. Also, three of our statutory auditors, Mr.
Akira Kajikawa, Mr. Katsuya Kawashima and Mr. Mitsuo Sano, are current or former
employees of SOFTBANK.
Distribution. We have an important distribution agreement with
SOFTBANK, our largest distributor in Japan as discussed under "Business--Sales
and Marketing--Japan."
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
59
<PAGE>
were made on April 18 and October 18 of each year. The remaining 1,000,000 units
have a maturity date of October 18, 2000, and bear interest at the rate of 2.65%
per annum. Semi-annual interest payments under these bonds are also made on
April 18 and October 18 of each year. 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 1997 and 1998 incentive plans, we issued unsecured bonds
with detachable warrants to SOFTBANK in the following amounts: on October 17,
1997, (Yen)908.5 million; 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. These bonds remain outstanding. 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%.
Investment in SoftTrend Capital. In December 1999, Trend Micro
invested (Yen)12.5 million (approximately $122,000) 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, and acts as manager
for the SOFTBANK Internet Fund. Yoshitaka Kitao, who serves on the board of
directors of both Trend Micro and SOFTBANK, is president and chief executive
officer of SoftTrend Capital. Steve Ming-Jang Chang, Trend Micro's president and
chief executive officer, also became a board member of SoftTrend Capital upon
Trend Micro's investment in SoftTrend Capital. The SOFTBANK Internet Fund is a
venture capital fund established in July 1999 for the purpose of making
investments in internet-related companies. In December 1999, Trend Micro also
made an investment of (Yen)960 million (approximately $9.4 million) in the
SOFTBANK Internet Fund.
Acquisition of Shares of USWeb. In May 1997, Trend Micro purchased
common stock, and warrants to purchase common stock, of USWeb/CKS in a private
placement for a total purchase price of $1.3 million. We sold 60,000 of these
shares in September 1999 and 25,000 shares in December 1999. Aggregate proceeds
from the sales of these shares were approximately $3.2 million. USWeb/CKS has
subsequently merged with Whittman-Hart. In March 2000 we received shares of the
merged entity, renamed marchFIRST, in exchange for the 104,170 shares of
USWeb/CKS common stock that we then owned. SOFTVEN No. 2 Investment Enterprise
Partnership, a venture capital fund which is managed by a wholly-owned
subsidiary of SOFTBANK, is a former shareholder of USWeb/CKS.
PART II
Item 14. Description of Securities to be Registered
------------------------------------------
Not applicable
60
<PAGE>
PART III
Item 15. Defaults upon Senior Securities
-------------------------------
None
Item 16. Changes in Securities and Changes in Security for Registered
------------------------------------------------------------
Securities
----------
None
PART IV
Item 17. Financial Statements
--------------------
Not applicable
Item 18. Financial Statements
--------------------
See Financial Statements.
Summary of Significant Differences Between Generally Accepted Accounting
Principles in Japan and the United States
We have prepared our consolidated financial statements in conformity
with U.S. GAAP. However, other financial information in this Annual Report has
been prepared in conformity with Japanese GAAP, which differs from U.S. GAAP in
material respects. This summary highlights some significant differences between
Japanese GAAP and U.S. GAAP applicable to Trend Micro and our consolidated
subsidiaries. However, this summary is not exhaustive. In addition, regulatory
bodies that promulgate Japanese GAAP and U.S. GAAP have significant projects
ongoing that could affect companies such as Trend Micro in the future. We have
not attempted to identify below future differences between Japanese GAAP and
U.S. GAAP as the result of prescribed changes in accounting standards.
1. Statement of cash flows
Under Japanese GAAP, a consolidated statement of cash flows was not
required as part of Trend Micro's basic financial statements for the 1998 fiscal
year. Such statement was required as part of Trend Micro's basic financial
statements for the 1999 fiscal year.
Under U.S. GAAP, a statement of cash flows is required as part of the
basic financial statements, and cash and cash equivalents include highly liquid
investments that generally have original maturities at the time of purchase of
three months or less.
2. Post-contract support revenues
Under Japanese GAAP, we recognize revenues related to post-contract
support agreements upon the commencement of the agreement. Trend Micro's renewed
software license agreements are considered post-contract support agreements.
Under U.S. GAAP, post-contract support revenues are deferred and recognized over
the period of the agreements.
61
<PAGE>
3. Valuation of inventories
Under Japanese GAAP, inventories can be stated at the lower of cost or
market.
U.S. GAAP requires all inventories to be valued at the lower of cost
or market.
4. Valuation of securities
Under Japanese GAAP, investments in marketable securities are stated
at the lower of cost or market, and non-marketable securities can be stated at
cost. However, when significant impairment of value has been deemed permanent,
cost is appropriately reduced.
Under U.S. GAAP, investments in debt securities and equity securities
that have readily determinable fair values, except for investments accounted for
using the equity method, are to be classified in three categories and accounted
for as follows:
(a) Debt securities that the enterprise has the positive intent and
ability to hold to maturity are classified as held-to-maturity securities and
reported at amortized cost. Unrealized holdings gains and losses are not
reported in the financial statements until realized or until a decline in fair
value below cost is deemed to be other than temporary.
(b) Debt and marketable equity securities that are acquired and held
principally for the purpose of selling them in the near term are classified as
trading securities and reported at fair value, with unrealized gains and losses
included in earnings.
(c) Debt and equity securities not classified as either held-to-
maturity securities or trading securities are classified as available-for-sale
securities and reported at fair value, with unrealized gains and losses excluded
from earnings and reported in a separate component of shareholders' equity.
5. Accounting for income taxes
Under Japanese GAAP, income taxes are principally provided for based
on taxable income for the period, determined in accordance with applicable tax
laws. For fiscal years beginning on or after April 1, 1999, deferred tax
accounting must be applied in consolidated financial statements. Trend Micro has
applied deferred tax accounting in its consolidated financial statements since
the 1996 fiscal year.
U.S. GAAP requires that deferred income taxes be recognized for
temporary differences between the tax basis of the assets or liabilities and the
reported amount in the financial statements and for tax loss carry-forwards
which are permitted to be carried forward to offset taxable income over the next
five years under the Japanese Income Tax Law. A valuation allowance is provided
for the deferred tax assets if it is more likely than not that these assets will
not be realized.
6. Translation of Foreign Currency Financial Statements
Under Japanese GAAP, financial statements of overseas subsidiaries,
affiliated companies and branches are translated into Japanese yen at the
exchange rates prevailing at the end of the fiscal year of each entity, except
for the shareholders' equity accounts, which are translated at historical rates.
Income and expenses are translated at average rates of exchange prevailing
during the year. Resulting gains and losses are deferred and presented as an
asset or liability on the balance sheet.
62
<PAGE>
Under U.S. GAAP, assets and liabilities of overseas entities are
translated into Japanese yen at the respective fiscal year-end exchange rates.
Income and expenses are translated at average rates of exchange prevailing
during the year. Resulting gains and losses are excluded from income and
included in a separate component of shareholders' equity.
7. Accrued compensated absences
Under Japanese GAAP, accrued compensated absences are normally not
recognized for future absences due to the fact that such accruals do not meet
the conditions for tax deductible provisions. The Company does not recognize
such accrued compensated absences.
U.S. GAAP requires that accrued compensated absences be recognized as
earned by employees.
8. Accounting for Employee Retirement and Severance Benefits
Under Japanese GAAP, an accrual is established for unfunded retirement
allowances in the amount payable if all employees voluntarily terminated their
employment at the balance sheet date. For pension plans, pension expense is
generally provided based on actuarial determinations and is charged to income
when paid.
U.S. GAAP requires pension costs to be actuarially computed and
charged to expense as stipulated by Statement of Financial Accounting Standards
No. 87, "Employers' Accounting for Pensions."
9. Bonuses to Directors and Statutory Auditors
Under Japanese GAAP, bonuses to directors and statutory auditors are
accounted for as an appropriation of retained earnings when approved by the
stockholders.
Under U.S. GAAP, such bonuses are generally accrued as an expense.
10. Warrant Compensation Expense
Under Japanese GAAP, the carrying value of the warrants is recognized
as compensation expense when the warrants are subsequently distributed to
employees. The carrying value is equal to the purchase price paid by the company
to repurchase the warrants following issuance of bonds with detachable warrants
as required by Japanese law. No compensation expense is recognized based on the
difference between the warrant exercise price and the fair value of the
company's stock on the date of grant.
Under U.S. GAAP, the difference between the fair value of the
underlying stock as of the "measurement date," which, in general, is either the
grant date or the date on which both the number of shares to which the employee
is entitled and the exercise price are known, and the warrant exercise price is
recognized as compensation expense and charged against income over the warrant
vesting period.
Item 19. Financial Statements and Exhibits
---------------------------------
(a) Financial Statements
Our Consolidated Financial Statements are filed with this Annual Report
beginning on page F-1.
63
<PAGE>
(b) Exhibits
<TABLE>
<CAPTION>
Exhibit Sequentially
Number Document Numbered Page
========= ======================================================================== =============
<S> <C> <C>
1.1* Articles of Incorporation of Trend Micro
2.1*+ Basic Agreement on Continual Sale and Purchase of Goods dated October 1,
1999, between Trend Micro Incorporated and SOFTBANK COMMERCE CORP., and
related agreements
2.2* Agreements relating to Acquisition of Nihon Unisoft Corporation
3.1* Subsidiaries of the Registrant
</TABLE>
- - - - - - - - ------------------------------
* Incorporated by reference to the corresponding exhibit to the Company's
Amendment No. 2 to the Form F-1 Registration Statement (File No. 333-10586)
filed on May 22, 2000.
+ Confidential treatment being requested for a portion of these documents.
64
<PAGE>
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/ Chang Ming-Jang
-----------------------------------------
Name: Chang Ming-Jang
Title: Representative Director;
President, Chief Executive Officer
and Chairman of the Board
(Principal Executive Officer)
Date: May 24, 2000
65
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
<S> <C>
Report of independent accountants............................................................................... F-2
Consolidated balance sheets at December 31, 1998 and 1999....................................................... F-3
Consolidated statements of income for the years ended December 31, 1997, 1998 and 1999.......................... F-5
Consolidated statements of comprehensive income for the years ended December 31, 1997, 1998 and 1999............ F-6
Consolidated statements of shareholders' equity for the years ended December 31, 1997, 1998 and 1999............ F-7
Consolidated statements of cash flows for the years ended December 31, 1997, 1998 and 1999...................... F-9
Notes to consolidated financial statements...................................................................... F-11
Financial statement schedule for the years ended December 31, 1997, 1998 and 1999:
Schedule II - Valuation and qualifying accounts................................................................. F-36
</TABLE>
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 the registrant not
consolidated and of 50% or less owned persons accounted for by the equity method
have been omitted because the registrant's proportionate share of the income
from continuing operations before income taxes, and 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
<PAGE>
Report of Independent Accountants
---------------------------------
To the Shareholders and Board of Directors of
Trend Micro Kabushiki Kaisha
("Trend Micro Incorporated"):
In our opinion, the consolidated financial statements and financial statement
schedule listed in the accompanying index present fairly, in all material
respects, the financial position of Trend Micro Incorporated and its
consolidated subsidiaries at December 31, 1998 and 1999, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999, in conformity with accounting principles generally
accepted in the United States of America. These financial statements are the
responsibility of the company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with auditing standards generally
accepted in the United States of America which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PricewaterhouseCoopers
PricewaterhouseCoopers
Tokyo, Japan
April 25, 2000
F-2
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
----------------------------------- ----------------
December 31
----------------------------------- December 31,
1998 1999 1999
--------------- --------------- ----------------
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. (Yen) 9,396,477 (Yen)15,648,881 $ 153,180
Marketable securities..................................... 1,738,204 624,328 6,111
Notes and accounts receivable, trade...................... 4,474,510 6,057,172 59,291
Allowance for doubtful accounts and sales returns......... (338,881) (382,973) (3,749)
Inventories............................................... 60,059 64,036 627
Deferred income taxes..................................... 394,922 922,061 9,026
Prepaid expenses and other current assets................. 449,271 771,577 7,553
--------------- --------------- ----------------
Total current assets............................ 16,174,562 23,705,082 232,039
--------------- --------------- ----------------
Investments and other assets:
Securities investments.................................... 97,650 3,078,406 30,133
Investment in and advances to affiliate company........... - 70,144 687
Intangibles............................................... 438,366 440,252 4,309
Deferred income taxes..................................... 129,465 276,609 2,708
Other..................................................... 380,253 461,125 4,514
--------------- --------------- ----------------
1,045,734 4,326,536 42,351
--------------- --------------- ----------------
Property and equipment:
Office furniture and equipment............................ 637,442 998,126 9,770
Other properties.......................................... 128,747 222,094 2,174
--------------- -------------- ----------------
766,189 1,220,220 11,944
Less: Accumulated depreciation............................ (270,775) (470,435) (4,605)
--------------- -------------- ----------------
495,414 749,785 7,339
--------------- --------------- ----------------
(Yen)17,715,710 (Yen)28,781,403 $ 281,729
=============== =============== ================
</TABLE>
The accompanying notes are an integral part of these statements.
F-3
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
Thousands of U.S.
Thousands of yen dollars
---------------------------------- -----------------
December 31
---------------------------------- December 31,
1998 1999 1999
--------------- ---------------- -----------------
<S> <C> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term borrowings............................................... (Yen) 71,720 (Yen) - $ -
Notes payable, trade................................................ 116,951 137,803 1,349
Accounts payable, trade............................................. 296,438 578,332 5,661
Accounts payable, other............................................. 347,762 633,806 6,204
Withholding income taxes............................................ 441,903 119,791 1,173
Accrued expenses.................................................... 403,276 343,243 3,360
Accrued income and other taxes...................................... 847,254 981,899 9,611
Deferred revenue.................................................... 1,332,505 2,185,659 21,394
Other............................................................... 74,475 139,326 1,365
--------------- ---------------- -----------------
Total current liabilities................................... 3,932,284 5,119,859 50,117
--------------- ---------------- -----------------
Long-term liabilities:
Long term debt...................................................... - 6,000,000 58,731
Deferred revenue.................................................... 140,049 226,365 2,216
Accrued pension and severance costs................................. 70,797 125,246 1,226
--------------- ---------------- -----------------
210,846 6,351,611 62,173
--------------- ---------------- -----------------
Shareholders' equity:
Common stock
Authorized
- 1998 72,000,000 shares ((Yen)50 par value)
- 1999 83,000,000 shares ((Yen)50 par value)
Issued and outstanding
- 1998 62,506,800 shares.................................... 5,081,714
- 1999 64,842,900 shares.................................... 5,414,660 53,002
Additional paid-in capital......................................... 7,735,744 9,198,712 90,042
Legal reserve...................................................... 129,157 149,991 1,468
Deferred compensation.............................................. (481,331) (101,528) (994)
Retained earnings.................................................. 1,164,100 3,082,302 30,171
Accumulated other comprehensive income -
Net unrealized gain on debt and equity securities................ 234,598 215,922 2,114
Cumulative translation adjustments............................... (278,522) (632,988) (6,196)
--------------- ---------------- -----------------
(43,924) (417,066) (4,082)
--------------- ---------------- -----------------
Treasury stock, at cost (1998 - 5700 shares; 1999 - 875 shares).. (12,880) (17,138) (168)
--------------- ---------------- -----------------
13,572,580 17,309,933 169,439
--------------- ---------------- -----------------
Commitments and contingent liabilities.............................. - - -
--------------- ---------------- -----------------
Total liabilities and shareholders' equity............. (Yen)17,715,710 (Yen) 28,781,403 $ 281,729
=============== ================ =================
</TABLE>
The accompanying notes are an integral part of these statements.
F-4
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------------------------------------------- -----------------
For the year ended For the year
December 31 ended
------------------------------------------------------- December 31,
1997 1998 1999 1999
-------------- -------------- --------------- -----------------
<S> <C> <C> <C> <C>
Net sales.............................................. (Yen)7,397,979 (Yen)9,745,664 (Yen)13,633,170 $ 133,449
Cost of sales.......................................... 733,789 559,530 481,574 4,714
-------------- -------------- --------------- -----------------
Gross profit........................................ 6,664,190 9,186,134 13,151,596 128,735
-------------- -------------- --------------- -----------------
Operating expenses:
Selling............................................. 1,315,492 1,617,759 2,239,594 21,922
Research and development............................ 557,001 960,156 994,340 9,733
General and administrative.......................... 2,755,435 4,994,937 5,985,740 58,592
-------------- -------------- --------------- -----------------
4,627,928 7,572,852 9,219,674 90,247
-------------- -------------- --------------- -----------------
Operating income.................................... 2,036,262 1,613,282 3,931,922 38,488
-------------- -------------- --------------- -----------------
Other income (expenses):
Interest income..................................... 46,203 44,620 148,487 1,453
Interest expense.................................... (34,984 (29,279) (66,526) (651)
Gain on sales of marketable securities.............. - 146,310 280,532 2,746
Foreign exchange gain (loss), net................... 66,907 (70,934) (174,921) (1,712)
Other income (expense), net......................... 3,508 (6,133) (120,298) (1,178)
-------------- -------------- --------------- -----------------
81,634 84,584 67,274 658
-------------- -------------- --------------- -----------------
Income before income taxes............................. 2,117,896 1,697,866 3,999,196 39,146
-------------- -------------- --------------- -----------------
Income taxes:
Current............................................. 1,337,364 1,641,902 2,538,455 24,848
Deferred............................................ (70,919 (347,151) (688,988) (6,745)
-------------- -------------- --------------- -----------------
1,266,445 1,294,751 1,849,467 18,103
-------------- -------------- --------------- -----------------
Income before equity in losses of affiliated companies. 851,451 403,115 2,149,729 21,043
-------------- -------------- --------------- -----------------
Equity in losses of affiliated companies............... - - 2,356 23
Net income............................................. (Yen) 851,451 (Yen) 403,115 (Yen) 2,147,373 $ 21,020
</TABLE>
<TABLE>
<CAPTION>
Yen Yen Yen U.S. dollars
---------- --------- ---------- ------------
<S> <C> <C> <C> <C>
Per share data:
Net income - basic................................. (Yen)15.77 (Yen)7.08 (Yen)33.79 $0.33
- diluted............................... -- 6.92 32.85 0.32
Cash dividends...................................... -- -- 3.33 0.03
</TABLE>
The accompanying notes are an integral part of these statements.
F-5
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
--------------------------------------------------- --------------
For the year
For the year ended ended
December 31 December 31,
---------------------------------------------------
1997 1998 1999 1999
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net income............................................ (Yen) 851,451 (Yen) 403,115 (Yen)2,147,373 $ 21,020
-------------- -------------- -------------- --------------
Other comprehensive income (loss), net of tax:
Unrealized gain on debt and equity securities:
Unrealized holding gains arising during period.. 116,840 366,657 168,711 1,651
Less reclassification adjustment for
gains included in net income.................. -- (35,340) (204,017) (1,997)
-------------- -------------- -------------- --------------
116,840 331,317 (35,306) (346)
Foreign currency translation adjustments........... (33,384) (138,397) (354,466) (3,470)
-------------- -------------- -------------- --------------
Other comprehensive income, before tax................ 83,456 192,920 (389,772) (3,816)
Income tax expense related to items of other
comprehensive income............................... (59,467) (154,092) 16,630 163
-------------- -------------- -------------- --------------
Other comprehensive income, net of tax................ 23,989 38,828 (373,142) (3,653)
-------------- -------------- -------------- --------------
Comprehensive income.................................. (Yen) 875,440 (Yen) 441,943 (Yen)1,774,231 $ 17,367
============== ============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these statements.
F-6
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
--------------------------------------------------- --------------
For the year ended December 31 December 31,
---------------------------------------------------
1997 1998 1999 1999
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Common stock:
Balance at beginning of year............................ (Yen) 697,575 (Yen) 900,000 (Yen)5,081,714 $ 49,743
New share offering...................................... - 4,038,078 - -
Transfer of additional paid-in capital to common stock.. 202,425 - - -
Exercise of stock purchase warrants..................... - 143,636 332,946 3,259
-------------- -------------- -------------- --------------
Balance at end of year.................................. 900,000 5,081,714 5,414,660 53,002
-------------- -------------- -------------- --------------
Additional paid-in capital:
Balance at beginning of year............................ 667,575 465,150 7,735,744 75,722
New share offering...................................... - 6,175,578 - -
Deferred compensation related to stock warrants......... - 878,798 - -
-------------- -------------- -------------- --------------
Tax benefit from exercise of non-qualified stock
warrants............................................. - 70,048 1,048,435 10,263
Gain on sales of treasury stock, net of tax............. - - 76,187 746
Transfer of additional paid-in capital to common stock.. (202,425) - - -
Exercise of stock purchase warrants..................... - 146,170 338,346 3,311
-------------- -------------- -------------- --------------
Balance at end of year.................................. 465,150 7,735,744 9,198,712 90,042
-------------- -------------- -------------- --------------
Legal reserve:
Balance at beginning of year............................ - - 129,157 1,264
Transfers from retained earnings........................ - 129,157 20,834 204
-------------- -------------- -------------- --------------
Balance at end of year.................................. - 129,157 149,991 1,468
-------------- -------------- -------------- --------------
Deferred compensation:
Balance at beginning of year............................ - - (481,331) (4,712)
Deferred compensation related to stock warrants......... - (878,798) - -
Amortization of deferred compensation related
to stock warrants..................................... - 397,467 379,803 3,718
-------------- -------------- -------------- --------------
Balance at end of year.................................. - (481,331) (101,528) (994)
-------------- -------------- -------------- --------------
Retained earnings:
Balance at beginning of year............................ 111,359 962,810 1,164,100 11,395
Net income.............................................. 851,451 403,115 2,147,373 21,020
Stock issue costs, net of tax........................... - (56,907) - -
Transfers to legal reserve.............................. - (129,157) (20,834) (204)
Cash Dividends ......................................... - - (208,337) (2,040)
Loss on sales of treasury stock, net of tax............. - (15,761) - -
-------------- -------------- -------------- --------------
Balance at end of year.................................. (Yen) 962,810 (Yen)1,164,100 (Yen)3,082,302 $ 30,171
-------------- -------------- -------------- --------------
Net unrealized gain on debt and equity securities:
Balance at beginning of year............................ (Yen) - (Yen) 57,373 (Yen) 234,598 $ 2,297
Net change during the year.............................. 57,373 177,225 (18,676) (183)
-------------- -------------- -------------- --------------
Balance at end of year.................................. 57,373 234,598 215,922 2,114
-------------- -------------- -------------- --------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-7
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
<TABLE>
<S> <C> <C> <C> <C>
Cumulative translation adjustments:
Balance at beginning of year.......................... (106,741) (140,125) (278,522) (2,726)
Aggregate translation adjustments for the year........ (33,384) (138,397) (354,466) (3,470)
-------------- -------------- -------------- --------------
Balance at end of year................................ (140,125) (278,522) (632,988) (6,196)
-------------- -------------- -------------- --------------
Treasury stock, at cost:
Balance at beginning of year.......................... - - (12,880) (126)
Purchases of treasury stock........................... - (183,269) (1,260,011) (12,334)
Sales of treasury stock............................... - 170,389 1,255,753 12,292
-------------- -------------- -------------- --------------
Balance at end of year................................ - (12,880) (17,138) (168)
-------------- -------------- -------------- --------------
Total shareholders' equity...................... (Yen) 2,245,208 (Yen)13,572,580 (Yen)17,309,933 $ 169,439
============== ============== ============== ==============
</TABLE>
The accompanying notes are an integral part of these statements.
F-8
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
----------------------------------------------------- ----------------
For the year
For the year ended ended
December 31 December 31,
-----------------------------------------------------
1997 1998 1999 1999
---------------- ----------------- ------------------ ----------------
<S> <C> <C> <C> <C>
Cash flows from operating activities:
Net income............................................... (Yen) 851,451 (Yen) 403,115 (Yen) 2,147,373 $ 21,020
Adjustments to reconcile net income to net cash
provided by operating activities -
Amortization of deferred compensation related
to stock warrants...................................... - 397,467 379,803 3,718
Depreciation and amortization......................... 143,826 265,857 428,238 4,192
Pension and severance costs, less payments............ 17,546 41,541 58,579 573
Loss on disposal of fixed assets...................... 10,846 11,009 1,192 12
Deferred income taxes................................. (70,919) (347,151) (688,988) (6,745)
Gain on sales of marketable securities................ - (146,310) (280,532) (2,746)
Equity in losses of affiliated companies.............. - - 2,356 23
Changes in assets and liabilities:
Increase in deferred revenue........................ 679,951 760,031 1,123,053 10,993
Increase in accounts receivable,
net of allowances................................. (1,265,515) (2,066,603) (1,945,194) (19,040)
(Increase) decrease in inventories.................. 1,185 2,750 (541) (5)
Increase (decrease) in notes and
accounts payable trade............................ (41,977) 57,960 377,869 3,699
Increase (decrease) in accrued income and
other taxes....................................... 711,517 (326,889) 273,696 2,679
(Increase) decrease in other current assets......... 524,338 (13,613) (370,227) (3,624)
Increase (decrease) in other current liabilities.... 360,384 672,749 (42,540) (417)
(Increase) decrease in other assets................. (20,001) (249,949) 23,729 232
Other................................................. (20,855) (72,479) - -
------------- --------------- --------------- -------------
Net cash provided by (used in)
operating activities......................... 1,881,777 (610,515) 1,487,866 14,564
------------- --------------- --------------- -------------
Cash flows from investing activities:
Payments for purchases of fixed assets................... (322,796) (440,304) (620,218) (6,070)
Payments for acquisitions of software.................... (128,109) (190,464) (185,455) (1,815)
Proceeds from sales of marketable securities............. - 321,011 2,388,480 23,380
Proceeds from maturities of marketable securities........ - - 1,101,846 10,785
Payments for purchases of marketable securities and
security investments................................... (300,906) (1,200,826) (5,264,042) (51,528)
Investments in affiliated companies...................... - - (72,500) (710)
Other.................................................... (58,671) 59,850 92 1
------------- --------------- --------------- -------------
Net cash used in investing activities ......... ((Yen)810,482) ((Yen)1,450,733) ((Yen)2,651,797) $ (25,957)
------------- --------------- --------------- -------------
</TABLE>
The accompanying notes are an integral part of these statements.
F-9
<PAGE>
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
----------------------------------------------------- -----------------
For the year
For the year ended ended
December 31 December 31,
-----------------------------------------------------
1997 1998 1999 1999
------------------ ----------------- ---------------- -----------------
<S> <C> <C> <C> <C>
Cash flows from financing activities:
Issuance of common stock pursuant to
new share offering, net of issuance costs........... (Yen) - (Yen)10,156,171 (Yen) - $ -
Issuance of common stock pursuant to exercise of stock
warrants............................................ - 287,514 671,292 6,571
Tax benefit from exercise of non-qualified stock
warrants............................................ - 70,048 1,048,435 10,263
Proceeds from issuance of bonds....................... 908,523 609,615 6,000,000 58,731
Redemption of bonds................................... (908,523) (609,615) - -
Decrease in short-term borrowings..................... (366,786) (76,145) (70,600) (691)
Dividends paid........................................ - - (208,337) (2,040)
Other................................................. (514) (28,641) 141,415 1,385
-------------- ----------------- --------------- ------------
Net cash provided by (used in) financing activities...... (367,300) 10,408,947 7,582,205 74,219
-------------- ----------------- --------------- ------------
Effect of exchange rate changes on cash and cash
equivalents........................................... (45,979) (95,391) (165,870) (1,624)
-------------- ----------------- --------------- ------------
Net increase in cash and cash equivalents................ 658,016 8,252,308 6,252,404 61,202
Cash and cash equivalents at beginning of year........... 486,153 1,144,169 9,396,477 91,978
-------------- ----------------- --------------- ------------
Cash and cash equivalents at end of year................. (Yen)1,144,169 (Yen) 9,396,477 (Yen)15,648,881 $ 153,180
============== ================= =============== ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-10
<PAGE>
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 is developing such software in
Japan, Taiwan and the United States 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.
Significant accounting policies are as follows:
Basis of consolidation
The consolidated financial statements include the accounts of the
parent company and those of its majority-owned subsidiaries. All intercompany
transactions and accounts are eliminated on consolidation.
Investments in affiliated companies (20 to 50 percent-owned companies)
in which the ability to exercise significant influence exists are stated at cost
plus 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. Goodwill at December 31,
1997, 1998 and 1999 was not significant.
The accompanying notes are an integral part of these statements.
F-11
<PAGE>
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 those prevailing
at the time of the transactions. The resulting translation adjustments are
accumulated as a separate component of shareholders' equity.
Foreign currency denominated receivables and payables are translated
into Japanese yen at year-end rates of exchange and the resulting translation
gains or losses are taken into current income.
Revenue recognition
The Company recognizes revenue from product licenses upon delivery of
software when no significant vendor obligations remain and collection of the
receivable, net of allowances for doubtful accounts and sales returns, is
probable. The Company estimates and recognizes allowances for doubtful accounts
and sales returns at the time of the related sale is recognized and treats them
as revenue reductions. The portion of the license fee attributable to
post-contract support is deferred and recognized as revenue over the license
agreement term. Royalty revenues are recognized as earned unless collection of
the related receivables is not assured. When collection is not assured, revenues
are recognized as payments are received.
Cash and cash equivalents
Cash and cash equivalents include cash on hand, cash on deposit with
banks and all highly liquid investments, with original maturities of three
months or less, that are readily convertible to known amounts of cash and are so
near maturity that they present insignificant risk of changes in value because
of changes in interest rates.
Marketable securities
Marketable securities consist of debt and equity securities. Debt and
equity securities designated as available-for-sale are carried at fair value
with unrealized gains or losses included as a component of shareholders' equity,
net of applicable taxes. Debt securities designated as held-to-maturity are
carried at amortized cost. Individual securities classified as either
available-for-sale or held-to-maturity are reduced to net realizable value for
other than temporary declines in market value. Realized gains and losses, which
are determined on the average cost method, are reflected in income.
Inventories
Finished products and raw materials are valued at the lower of weighted
average cost or net realizable value.
Property and equipment
Property and equipment are stated at cost. Major renewals and
improvements are capitalized; minor replacements, maintenance and repairs are
charged to current operations. Depreciation of property and equipment is
computed on the declining-balance method for the parent company and on the
straight-line method for foreign subsidiaries at rates based on estimated useful
lives of the assets according to general class, type of construction and use.
Estimated useful lives range from 3 to 5 years for office furniture and
equipment, and from 4 to 24 for other properties.
The accompanying notes are an integral part of these statements.
F-12
<PAGE>
Long-lived assets
The Company evaluates long-lived assets and certain identifiable other
intangibles whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. When the sum of expected
future cash flows (undiscounted and without interest charges) is less than the
carrying amount of the asset, an impairment loss is recognized, based on fair
value of the asset. The fair value of the asset is determined using a discounted
cash flows analysis.
Intangibles
Intangibles, which mainly consist of software development costs and
purchased software rights, are amortized on a straight-line basis principally
over a three-year period for software development costs and a five-year period
for purchased software rights and other intangibles.
Research and development costs and software development cost
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 an original English language version software are
capitalized. The 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 three years.
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 of 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.
The accompanying notes are an integral part of these statements.
F-13
<PAGE>
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 split and free
distributions of common stock.
Free distribution of common stock
On occasion, the Company may make a free distribution of common stock
to its shareholders which is accounted for either by a transfer of the
applicable par value from additional paid-in capital to the common stock account
or with no entry if free shares are distributed from the portion of previously
issued shares accounted for as excess of par value in the common stock account.
Under the Japanese Commercial Code, a stock dividend which is paid out of
profits can be effected by an appropriation of retained earnings to the common
stock account by resolution of the general shareholders' meeting, followed by a
free distribution with respect to the amount as appropriated by resolution of
the Board of Directors.
Common stock issue costs
Common stock issue costs are directly charged to retained earnings, net
of tax, in the accompanying consolidated financial statements as the Japanese
Commercial Code prohibits charging such stock issue costs to capital accounts,
which is the prevailing practice in the United States of America.
Comprehensive income
Other comprehensive income refers to revenues, expenses, gains and
losses that under Generally Accepted Accounting Principles are included in
comprehensive income but are excluded from net income as these amounts are
recorded directly as adjustments to shareholders' equity. The Company's other
comprehensive income is primarily comprised of 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. Further, the markets for the Company's products are highly
competitive and rapidly changing. The Company could incur substantial operating
losses if it is unable to offer products which address technological and market
place change in the anti-virus software industry.
Other financial instruments that potentially subject the Company to
significant concentrations of credit risk consist principally of cash
equivalents, marketable securities and accounts receivable. The Company invests
primarily in money market funds and marketable securities and places its
investments with high quality financial institutions. The Company performs
ongoing credit evaluations of its customers' financial condition and maintains
an allowance for uncollectible accounts receivable, if any, based upon the
expected collectibility of accounts receivable.
The accompanying notes are an integral part of these statements.
F-14
<PAGE>
Recent pronouncements
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133 ("FAS 133"), Accounting for Derivative
Instruments and Hedging Activities. FAS 133, as amended, is effective for all
fiscal years beginning after June 15, 2000. FAS 133 requires that all derivative
instruments be recognized as either assets or liabilities on the balance sheet,
measured at fair value. Changes in the fair value of derivatives are recorded
each period in current earnings or other comprehensive income, depending on
whether a derivative qualifies as part of a hedge transaction and the type of
hedge transaction. The portion of a derivative transaction not qualifying as a
hedge will be recognized in earnings. The Company does not expect the adoption
of FAS 133 to have a material impact on the Company's financial position or
results of operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 ("SAB 101"), Revenue Recognition in Financial
Statements. SAB 101 provides guidance on applying generally accepted accounting
principles to revenue recognition issues in financial statements. The Company
will adopt SAB 101 as required in the fiscal year beginning January 1, 2000. The
Company does not expect the adoption of SAB 101 to have a material impact on the
Company's financial position or results of operations.
Reclassifications
Certain prior year amounts have been reclassified to conform to the
1999 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
31,1999 ((Yen)102.16 = U.S. $1) has been used for the purpose of presentation of
the U.S. dollar amounts in the accompanying consolidated financial statements.
The accompanying notes are an integral part of these statements.
F-15
<PAGE>
4. Reconciliation of the difference between basic and diluted net income per
share ("EPS")
Reconciliation of the differences between basic and diluted EPS for the years
ended December 31, 1997, 1998 and 1999, is as follows:
<TABLE>
<CAPTION>
Thousands Thousands
of yen of shares Yen
----------------- --------------- ---------------
Weighted-
Net average
income shares EPS
----------------- --------------- ---------------
<S> <C> <C> <C>
For the year ended December 31, 1997
- - - - - - - - ------------------------------------
Basic EPS:
Net income available to common stock holders...... (Yen)851,451 54,000 (Yen)15.77
------------ ------------ ------------
Effect of dilutive securities:
Shares issuable from assumed exercise of
stock warrants.................................. - -
------------ ------------
Diluted EPS:
Net income for computation........................ (Yen)851,451 54,000 (Yen)15.77
============ ============ =============
<CAPTION>
Thousands Thousands
of yen of shares Yen
----------------- --------------- ---------------
Weighted-
Net average
income shares EPS
----------------- --------------- ---------------
<S> <C> <C> <C>
For the year ended December 31, 1998
- - - - - - - - ------------------------------------
Basic EPS:
Net income available to common stock holders...... (Yen)403,115 56,970 (Yen) 7.08
------------- ------------- -------------
Effect of dilutive securities:
Shares issuable from assumed exercise of
stock warrants.................................. - 1,269
------------ ------------
Diluted EPS:
Net income for computation........................ (Yen)403,115 58,239 (Yen) 6.92
============ ============ =============
<CAPTION>
Thousands Thousands
of yen of shares Yen Dollars
----------------- --------------- --------------- ---------------
Weighted-
Net average
income shares EPS EPS
----------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C>
For the year ended December 31, 1999
- - - - - - - - ------------------------------------
Basic EPS:
Net income available to common stock holders...... (Yen)2,147,373 63,550 (Yen)33.79 $0.33
-------------- ------------ ----------- ---------
Effect of dilutive securities:
Shares issuable from assumed exercise of
stock warrants.................................. - 1,826
-------------- ------------
Diluted EPS:
Net income for computation........................ (Yen)2,147,373 65,376 (Yen)32.85 $0.32
============== ============ =========== =========
</TABLE>
The accompanying notes are an integral part of these statements.
F-16
<PAGE>
5. Cash and cash equivalents
Cash and cash equivalents as of December 31, 1998 and 1999 were comprised
of:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------------------------- -----------------
December 31 December 31,
-------------------------------------
1998 1999 1999
----------------- ------------------- -----------------
<S> <C> <C> <C>
Cash................................... (Yen)1,744,449 (Yen)4,308,566 $ 42,175
Time deposits.......................... 2,040,315 11,340,284 111,005
Money market funds..................... 5,611,713 31 0
-------------- --------------- --------
(Yen)9,396,477 (Yen)15,648,881 $153,180
============== =============== ========
</TABLE>
6. Supplemental cash flow information
Cash payments for income taxes were (Yen)594,331 thousand, (Yen)1,690,391
thousand and (Yen)2,247,816 thousand ($22,003 thousand) for the years ended
December 31, 1997, 1998 and 1999, respectively; in these respective periods,
interest payments were (Yen)48,544 thousand, (Yen)17,147 thousand and (Yen)2,417
thousand ($24 thousand).
The accompanying notes are an integral part of these statements.
F-17
<PAGE>
7. 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, 1998 and 1999, were as
follows:
<TABLE>
<CAPTION>
Thousands of yen
----------------------------------------------------------------------------
December 31, 1998
----------------------------------------------------------------------------
Gross unrealized
-------------------------------------
Cost Gains Losses Fair value
------------------ ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Available for sale:
Money market funds.......... (Yen) 5,611,713 (Yen) - (Yen) - (Yen) 5,611,713
Equity securities........... 186,870 450,508 - 637,378
Debt securities............. 1,200,826 - 2,350 1,198,476
------------------ ----------------- ----------------- -----------------
Total.................. (Yen) 6,999,409 (Yen) 450,508 (Yen) 2,350 (Yen) 7,447,567
================== ================= ================= =================
<CAPTION>
Thousands of yen
----------------------------------------------------------------------------
December 31, 1999
----------------------------------------------------------------------------
Gross unrealized
-------------------------------------
Cost Gains Losses Fair value
------------------ ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Available for sale:
Money market funds.......... (Yen) 31 (Yen) - (Yen) - (Yen) 31
Mutual funds................ 960,806 - - 960,806
Equity securities........... 529,076 412,392 - 941,468
Debt securities............. 1,800,000 460 - 1,800,460
------------------ ----------------- ----------------- -----------------
Total.................. (Yen) 3,289,913 (Yen) 412,852 (Yen) - (Yen) 3,702,765
================== ================= ================= =================
<CAPTION>
Thousands of U.S. dollars
---------------------------------------------------------------------------
December 31, 1999
----------------------------------------------------------------------------
Gross unrealized
-------------------------------------
Cost Gains Losses Fair value
------------------ ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Available for sale:
Money market funds.......... $ - $ - $ - $ --
Mutual funds................ 9,405 - - 9,405
Equity securities........... 5,180 4,036 - 9,216
Debt securities............. 17,619 5 - 17,624
------------------ ----------------- ----------------- -----------------
Total..................... $ 32,204 $ 4,041 $ - $ 36,245
================== ================= ================= =================
</TABLE>
Fair value of money market funds and mutual funds approximate cost due to
the short-term maturities of the investments.
The accompanying notes are an integral part of these statements.
F-18
<PAGE>
The cost and fair value of "available-for sale" debt securities by
contractual maturity at December 31, 1999, were as follows.:
<TABLE>
<CAPTION>
Thousands of yen Thousands of U.S. dollars
------------------------------------ -------------------------------------
Available-for sale Available-for sale
------------------------------------ -------------------------------------
Cost Fair value Cost Fair value
------------------ --------------- ------------------ -----------------
<S> <C> <C> <C> <C>
Due within one year......... (Yen) 100,000 (Yen) 100,460 $ 978 $ 983
Due after one year.......... 1,700,000 1,700,000 16,641 16,641
------------------ --------------- ----------------- -----------------
(Yen) 1,800,000 (Yen) 1,800,460 $ 17,619 $ 17,624
================== =============== ================= =================
</TABLE>
The net unrealized gain on "available-for-sale" securities included in the
separate component of shareholders' equity, net of applicable taxes, increased
by (Yen)57,373 thousand and (Yen)177,225 thousand during the years ended
December 31, 1997 and 1998, respectively, and decreased by (Yen)18,676 thousand
($183 thousand) in the year ended December 31, 1999.
Proceeds from sales of "available-for-sale" securities for the years ended
December 31, 1998 and 1999 were (Yen)321,011 thousand and (Yen)2,388,480
thousand ($23,380 thousand), respectively. There were no such sales transactions
for the year ended December 31,1997. Gross realized gains on sales of
"available-for-sale" securities for the year ended December 31, 1998 and 1999
were (Yen)146,310 thousand and (Yen)280,532 thousand ($2,746 thousand),
respectively.
During the year ended December 31, 1999, the Company purchased a long-term
investment security, issued by a nonpublic company in the ordinary course of
business. The carrying amount of the investment in the nonpublic company was
(Yen)417,600 thousand ($4,088 thousand) at December 31,1999. The corresponding
fair value at that date was not computed as such estimation was not readily
determinable.
8. Inventories
Inventories as at December 31, 1998 and 1999 were (Yen)60,059 thousand and
(Yen)64,036 thousand ($627 thousand), respectively, and mainly consisted of
finished products and manuals.
The accompanying notes are an integral part of these statements.
F-19
<PAGE>
9. 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, which were established in the year ended December 31, 1999.
Summarized financial information of the affiliated companies accounted for
using the equity method is shown below:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------ -----------------
December 31, December 31,
1999 1999
------------------ -----------------
<S> <C> <C>
Current assets.................................... (Yen) 1,778,451 $ 17,408
Non-current assets including property, plant
and equipment.................................. 967,329 9,469
------------------ -----------------
Total assets.................................. (Yen) 2,745,780 $ 26,877
================== =================
Current liabilities............................... (Yen) 2,395,058 $ 23,444
Shareholders' equity.............................. 350,722 3,433
------------------ -----------------
Total liabilities and shareholders' equity.... (Yen) 2,745,780 $ 26,877
================== =================
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------ -----------------
December 31, December 31,
1999 1999
------------------ -----------------
<S> <C> <C>
Sales............................................. (Yen) 553,500 $ 5,418
================== =================
Net loss.......................................... (Yen) 11,778 $ 115
================== =================
</TABLE>
A summary of transactions and balances with the affiliated companies
accounted for by using the equity method is presented below;
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------ -----------------
For the year For the year
ended ended
December 31, December 31,
1999 1999
------------------ -----------------
<S> <C> <C>
Purchase.......................................... (Yen) 960,806 $ 9,405
================== =================
</TABLE>
The accompanying notes are an integral part of these statements.
F-20
<PAGE>
<TABLE>
<CAPTION>
Thousands of Thousands of
yen U.S. dollars
------------------ ----------------
December 31, December 31,
1999 1999
------------------ ----------------
<S> <C> <C>
Other receivables........................................ (Yen) 4,731 $ 46
================== ================
</TABLE>
10. Intangibles
Intangibles comprise the following:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------------------------- ----------------
December 31 December 31,
-------------------------------------
1998 1999 1999
----------------- ----------------- ----------------
<S> <C> <C> <C>
Software development costs ............................ (Yen) 318,573 (Yen) 504,029 $ 4,934
Purchased software rights ............................. 144,093 144,093 1,410
Other ................................................. 133,472 137,331 1,344
----------------- ----------------- ----------------
596,138 785,453 7,688
Less - Accumulated amortization ...................... (157,772) (345,201) (3,379)
----------------- ----------------- ----------------
(Yen) 438,366 (Yen) 440,252 4,309
================= ================= ================
</TABLE>
11. Research and development costs and software development costs
Research and development costs incurred until 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)557,001 thousand,
(Yen)960,156 thousand and (Yen)994,340 thousand ($9,733 thousand) for the years
ended December 31, 1997, 1998 and 1999, respectively.
Software development costs relating to the local language related
functions, representing software development costs as shown in Note 10 above,
after netting the related accumulated amortization, are capitalized and
amortized to cost of sales as follows:
<TABLE>
<CAPTION>
Thousands of U.S.
Thousands of yen dollars
----------------------------------------- ----------------
Year ended
Year ended December 31 December 31,
------------------------------------------
1997 1998 1999 1999
-------------- ------------- ------------ ---------------
<S> <C> <C> <C> <C>
Software development costs, net of accumulated amortization:
Balance, beginning of year .............................. (Yen) 33,529 (Yen) 107,699 (Yen)250,734 $ 2,454
Additions, at cost ...................................... 94,580 190,464 185,455 1,815
Amortization for the year ............................... (20,410) (47,429) (131,292) (1,284)
------------- ------------- ------------ ----------
Balance, end of year..................................... (Yen) 107,699 (Yen) 250,734 (Yen)304,897 $ 2,985
============= ============= ============ ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-21
<PAGE>
12. Transactions with related parties
Stock Sale
In December 1996, SOFTBANK purchased 18,900,000 shares of common stock of
the Company from the Company's founders for approximately (Yen)185 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 sales/purchase agreement, SOFTBANK paid an
additional (Yen)5 billion upon the Company's Japanese initial public offering,
which occurred in August 1998. SOFTBANK sold 3,000,000 shares to an unaffiliated
third party in September 1998 and, through Softbank America, Inc., a wholly-
owned subsidiary of SOFTBANK, owned 15,900,000 shares, representing
approximately a 25% equity ownership interest in the Company as of December
31,1998.
In July, 1999, Softbank America, Inc. sold 12,750,000 shares to an
unaffiliated third party and currently owns 3,150,000 shares, representing
approximately a 4.9% equity ownership interest in the Company.
Distribution
Based on two distribution agreements between the Company and SOFTBANK,
SOFTBANK was granted a non-exclusive right to distribute all of the Company's
anti-virus software products in Japan. Individual sales of products to SOFTBANK
under the agreements have been effected on a purchase-order basis.
Account balances and transactions with SOFTBANK and its affiliated company
are as follows:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
-----------------------------------------
December 31 December 31,
-----------------------------------------
1998 1999 1999
---------------- ----------------- --------------
<S> <C> <C> <C>
Accounts receivable, trade.................... (Yen) 847,431 (Yen) 852,004 $ 8,340
Accounts payable, other....................... 38,338 18,943 185
Sales for the year............................ 2,386,654 2,453,538 24,017
Purchases for the year........................ 167,609 - -
</TABLE>
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)5,400
thousand, (Yen)22,600 thousand and (Yen)97,758 thousand ($957 thousand) for the
years ended December 31, 1997, 1998 and 1999, respectively. These rebate amounts
were determined based on SOFTBANK's achievement of sales targets in the
distribution agreements. The rebate payments were recorded as deductions of
sales revenue on an accrual basis.
13. Short-term borrowings and long-term debt
Short-term borrowings at December 31, 1998 consisted of commercial papers
of (Yen)71,720 thousand with interest rates ranging from 5.6% to 7.88% per
annum, for which time deposits of (Yen)71,720 thousand were pledged as
collateral. Such commercial papers have been repaid in the year ended December
31, 1999.
The accompanying notes are an integral part of these statements.
F-22
<PAGE>
At December 31, 1999, the Company had unused lines of credit amounting to
(Yen)800,000 thousand ($7,831 thousand) related 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 at December 31, 1999 consisted of unsecured bonds of
(Yen)6,000,000 thousand ($58,731 thousand) due 2002 with interest rate of 2.5%
per annum. issued in relation to the Company's 1999 incentive plan. On July 29,
1999, the Company issued (Yen)6,000,000 thousand ($58,731 thousand) with 6,000
detachable warrants. One warrant, which is exercisable from August 20, 1999,
entitles the holder to subscribe (Yen)1 million ($10 thousand) for shares of
common stock of the Company at (Yen)6,400 ($63) per share (subject to adjustment
in certain circumstances). Upon issuance of the bonds, the Company bought all of
these warrants and distributed such instruments at fair market value 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. At December
31, 1999, all warrants were outstanding and will expire on July 22, 2002.
14. Stock warrants
Based on the Company's 1997, 1998 and 1999 incentive plans, the Company
issued the following bonds with detachable warrants to SOFTBANK.
<TABLE>
<CAPTION>
<S> <C> <C> <C> <C>
1. Shareholders' meeting approval............. September 29, 1997 March 28, 1998 May 29, 1998 June 30, 1999
2. Date of bond issuance...................... October 17, 1997 April 15, 1998 June 15, 1998 July 29, 1999
3. Amount of each bond
(Thousands of yen)......................... (Yen)908,523 (Yen)412,965 (Yen)196,650 (Yen)6,000,000
4. The date on which the bonds................
were fully redeemed........................ October 17, 1997 April 15, 1998 June 15, 1998 -
5. The exercise price per
each warrant............................... (Yen)285 (Yen)285 (Yen)285 (Yen)6,400
6. Warrant exercise period.................... October 27, 1997 to April 27, 1998 June 25, 1998 to August 20, 1999
October 12, 2001 to April 5, 2002 June 7, 2002 to July 22, 2002
7. Number of the shares represented
by warrants................................ 3,187,800 1,449,000 690,000 937,500
8. Outstanding as of
December 31, 1998.......................... 2,319,000 1,029,300 597,300 -
9. Outstanding as of
December 31, 1999.......................... 727,200 514,800 406,800 937,500
</TABLE>
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
and separately as issuance of warrants to the directors and employees. The
issuance of the warrants to the directors and employees was accounted for under
APB 25.
The accompanying notes are an integral part of these statements.
F-23
<PAGE>
Warrant activity was as follows:
<TABLE>
<CAPTION>
Thousands of shares represented
by warrants
-----------------------------------
<S> <C>
Outstanding at December 31, 1996...................... 3,188
Granted............................................. -
Exercised........................................... -
Redeemed............................................ -
-----------
Outstanding at December 31, 1997...................... 3,188
Granted............................................ 2,139
Exercised.......................................... (1,007)
Redeemed........................................... (374)
-----------
Outstanding at December 31, 1998...................... 3,946
Granted............................................ 937
Exercised.......................................... (2,336)
Redeemed........................................... -
-----------
Outstanding at December 31, 1999..................... 2,547
===========
</TABLE>
Balances are as follows:
<TABLE>
<CAPTION>
Thousands of shares
-----------------------------------
December 31
-----------------------------------
1998 1999
------------------ ----------------
<S> <C> <C>
Authorized and outstanding............... 3,946 2,547
Exercisable.............................. 2,010 1,308
</TABLE>
For the above stock warrants granted on April 15, 1998 and June 15, 1998,
management calculated deferred compensation expense 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
and (Yen)379,803 thousand ($3,718 thousand) were amortized during fiscal 1998
and 1999, respectively. The grants of October 17, 1997 and July 29, 1999, with
respect to which the vesting period is generally 24 months, did not result in
deferred compensation.
The subsidiary in the United States introduced the U.S. program of the 1999
incentive plan in July 1999. Under the U.S. program, STG Incentive Company
L.L.C., a Delaware limited company organized for the program by three principal
shareholders of the Company, grants stock options to purchase shares of the
Company's common stock, which vest one year from the date of grant and which are
exercisable for the 3 years subsequent to the vesting date, to directors and
certain employees of the subsidiary in the United States. The grants of options
to the directors and employees were accounted for under APB 25. Option activity
under the U.S. program for the year ended December 31, 1999 was as follows:
The accompanying notes are an integral part of these statements.
F-24
<PAGE>
<TABLE>
<CAPTION>
Thousands of shares
represented by options
-----------------------------------
<S> <C>
Granted............................................ 810
Exercised.......................................... -
Redeemed........................................... -
-----------------
Outstanding at December 31, 1999...................... 810
=================
</TABLE>
The exercise price per share for the options granted was determined as
equivalent to the fair market value of the Company's shares at the time of the
grants. The weighted average exercise price per share for the option granted for
the year ended December 31, 1999 was (Yen)6,133 ($60.03). Consequently, the
grants of the option did not result in deferred compensation.
Certain pro forma disclosures
In October 1995, SFAS 123 established a fair value based method of
accounting for employee stock based compensation. Had compensation cost for the
Company's stock warrants and the stock options under 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:
<TABLE>
<CAPTION>
Year ended December 31
------------------------------------------------------------------------
1997 1998 1999 1999
------------------- ---------------- ----------------- -----------------
(in thousands, except per share data)
<S> <C> <C> <C> <C>
Net income:
As reported................ (Yen) 851,451 (Yen) 403,115 (Yen) 2,147,373 $ 21,020
Pro forma net income....... 851,451 147,610 1,698,432 16,552
Net income per share:
As reported -
Basic................... (Yen) 15.77 (Yen) 7.08 (Yen) 33.79 $ 0.33
Diluted................. -- 6.92 32.85 0.32
Pro forma net income -
Basic................. (Yen) 15.77 (Yen) 2.59 (Yen) 26.73 $ 0.26
Diluted................. -- 2.53 25.98 0.25
</TABLE>
The fair value of each warrant grant was estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants during the years ended December 31, 1997, 1998 and
1999; expected life of two years, volatility of 88.6% and dividend yield of 0.0%
for both periods of fiscal 1997 and 1998, expected life of three years,
volatility of 25.8% and dividend yield of 0.0% for 1999; and risk-free interest
rates ranging from 1.235% to 1.765% for options granted during the years ended
December 31, 1997 and 1998, respectively, and the rate of 0.75% for options
granted during the year ended December 31, 1999. The weighted average fair value
per share of options granted above during fiscal 1998 and 1999 were (Yen)557 and
(Yen)953 ($9.32), respectively.
The accompanying notes are an integral part of these statements.
F-25
<PAGE>
15. 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.
Information regarding the defined benefit pension plans for the Company and
its consolidated subsidiaries is shown below:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------------------------------------------ -----------------
December 31 December 31,
------------------------------------------------------
1997 1998 1999 1999
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Change in benefit obligation:
Benefit obligation at beginning of year............ (Yen) 21,990 (Yen) 38,230 (Yen) 130,173 $ 1,275
Service cost....................................... 14,228 48,190 62,451 611
Interest cost...................................... 582 2,659 4,978 49
Amendments......................................... - 27,309 -- --
Actuarial (gain)/loss.............................. 1,989 21,035 (16,136) (158)
Benefits paid...................................... (559) (7,250) (1,077) (11)
Foreign currency exchange impacts.................. - -- (6,205) (61)
------------- --------------- --------------- ------------
Projected benefit obligation at end of
year 38,230 130,173 174,184 1,705
------------- --------------- --------------- ------------
Change in plan assets:
Fair value of plan assets at beginning of year..... - -- (6,771) (66)
Actual return on plan assets....................... - (33) (678) (7)
Benefits paid...................................... - -- 1,077 11
Employer contribution.............................. - (6,738) (11,342) (111)
Foreign currency exchange impacts.................. - -- 4,651 45
------------- --------------- --------------- ------------
Fair value of plan assets at end of year... - (6,771) (13,063) (128)
------------- --------------- --------------- ------------
Funded status
Unrecognized prior service cost....................... - (26,361) (24,802) (242)
Unrecognized net actuarial loss....................... (1,989) (20,372) (6,313) (62)
Unrecognized net transition obligation................ (6,984) (5,872) (4,760) (47)
------------- --------------- --------------- ------------
Accrued benefit cost.................................. (Yen) 29,257 (Yen) 70,797 (Yen) 125,246 $ 1,226
============= =============== =============== ============
</TABLE>
The accompanying notes are an integral part of these statements.
F-26
<PAGE>
<TABLE>
<CAPTION>
Thousands of yen
------------------------------------------------------
December 31
------------------------------------------------------
1997 1998 1999
---------------- ----------------- -----------------
<S> <C> <C> <C>
Weighted-average assumptions as of December 31:
Discount rate.................................. 3.00% 4.60% 4.50%
Expected return on plan assets................. -- 7.00% 6.50%
Rate of compensation increase.................. 4.00% 4.00% 5.25%
</TABLE>
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------------------------------------------ -----------------
December 31 December 31,
------------------------------------------------------
1997 1998 1999 1999
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Components of net periodic benefit cost:
Service cost........................................ (Yen) 14,228 (Yen) 48,190 (Yen) 62,451 $ 611
Interest cost....................................... 582 2,659 4,978 49
Expected return on plan assets...................... - (162) (808) (8)
Amortization of unrecognized transition obligation.. 1,112 1,112 1,112 11
Amortization of prior service cost.................. - 948 1,130 11
Recognized actuarial loss........................... - -- 697 7
----------------- --------------- ----------------- -------------
Net periodic pension cost........................... (Yen) 15,922 (Yen) 52,747 (Yen) 69,560 $ 681
================= =============== ================= =============
</TABLE>
Effective from July 1, 1998, the parent company's U.S. subsidiary had 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 Internal Revenue Code.
Under the Japanese Commercial Code and local practice, the Company may make
severance payments to a retired director or statutory auditor with shareholder
approval, if the Company's management proposes such payments based on a
resolution of the board of directors. However, the Company has no intention to
make such a proposal. The Company does have an internal formula to determine the
amounts of severance payments to directors and statutory auditors if the Company
were to make such a proposal for statutory auditors. The Company has not
recorded any liabilities relating to severance payments to directors and
statutory auditors as of December 31, 1998 and 1999 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 and life insurance benefits to
retired employees, nor does it provide benefits to former or inactive employees
after employment but before retirement.
The accompanying notes are an integral part of these statements.
F-27
<PAGE>
16. Income taxes
Income before income taxes and provision for income taxes comprise the
following:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
-------------------------------------------------------------------------
Year ended
Year ended December 31 December 31,
--------------------------------------------------------
1997 1998 1999 1999
----------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C>
Income before income taxes:
Parent company.............................. (Yen) 1,062,335 (Yen) 934,475 (Yen) 2,541,761 $ 24,880
Foreign subsidiaries........................ 1,055,561 763,391 1,457,435 14,266
---------------- --------------- ---------------- -------------
(Yen) 2,117,896 (Yen) 1,697,866 (Yen) 3,999,196 $ 39,146
================ =============== ================ =============
Income taxes, current:
Parent company.............................. (Yen) 1,121,141 (Yen) 1,276,505 (Yen) 1,245,851 $ 12,195
Foreign subsidiaries........................ 216,223 365,397 1,292,604 12,653
---------------- --------------- ---------------- -------------
(Yen) 1,337,364 (Yen) 1,641,902 (Yen) 2,538,455 $ 24,848
================ =============== ================ =============
Income taxes, deferred:
Parent company.............................. (Yen) (69,256) (Yen) (360,324) (Yen) (34,536) $ (338)
Foreign subsidiaries........................ (1,663) 13,173 (654,452) (6,407)
---------------- --------------- ---------------- -------------
(Yen) (70,919) (Yen) (347,151) (Yen) (688,988) $ (6,745)
================ =============== ================ =============
</TABLE>
The Company is subject to a number of different income taxes which, in the
aggregate, indicate a statutory tax rate in Japan of approximately 51.4% for the
years ended December 31, 1997 and 1998, and approximately 47.7% for the year
ended December 31, 1999. 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 is to be reduced from approximately 51.4% to
47.7% effective from the Company's fiscal year beginning January 1, 1999 and
from approximately 47.7% to 42.1% effective from the Company's fiscal year
beginning January 1, 2000.
The accompanying notes are an integral part of these statements.
F-28
<PAGE>
Reconciliation of the differences between the statutory tax rate and the
effective income tax rate is as follows:
<TABLE>
<CAPTION>
December 31
-----------------------------------------------------
1997 1998 1999
--------------- ----------------- ----------------
<S> <C> <C> <C>
Statutory tax rate:............................................. 51.4% 51.4% 47.7%
Increase (reduction) in rate resulting from
Different tax rates applied to
foreign subsidiaries.................................... (6.7) (1.4) (3.5)
Effect of change in normal
statutory tax rate in Japan............................ - - 2.3
State income taxes, net of federal tax.................... - - (1.1)
Permanent difference...................................... 0.8 4.5 2.5
Amortization of deferred compensation
related to stock warrants............................... - 10.1 2.6
Current tax on undistributed earnings..................... 3.8 5.1 -
Change in deferred tax valuation allowance................ - 10.3 (4.9)
Tax effect on undistributed earnings in
a subsidiary............................................ 13.2 - -
Tax credit relating to research and development costs..... (3.8) (8.4) (1.4)
Operating loss of subsidiaries............................ 1.2 3.6 -
Other..................................................... (0.1) 1.1 2.0
--------- ----------- ----------
Effective income tax rate....................................... 59.8% 76.3% 46.2%
========= =========== ==========
</TABLE>
The significant components of deferred income tax assets and liabilities at
December 31, 1998 and 1999 were as follows:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
------------------------------------- -----------------
December 31 December 31,
-------------------------------------
1998 1999 1999
----------------- ----------------- -----------------
<S> <C> <C> <C>
Deferred tax assets:
Deferred revenue................................................ (Yen) 605,122 (Yen) 831,759 $ 8,142
Allowance for doubtful accounts and sales returns .............. 100,872 134,971 1,321
Accrued enterprise tax.......................................... 111,087 42,370 415
Accrued liabilities............................................. 69,073 76,150 745
Intercompany profit............................................. 79,398 52,932 518
Tax loss carry forward.......................................... 14,551 126,731 1,241
Other........................................................... 35,293 118,033 1,155
--------------- --------------- ---------------
Gross deferred tax assets.................................... 1,015,396 1,382,946 13,537
Less: Valuation allowance................................... (212,051) (10,465) (102)
--------------- --------------- ---------------
803,345 1,372,481 13,435
--------------- --------------- ---------------
Deferred tax liabilities
Unrealized gain on debt and equity securities................ (214,681) (173,811) (1,701)
Deferred compensation........................................ (56,693) - -
Other........................................................ (7,584) - -
--------------- --------------- ---------------
(278,958) (173,811) (1,701)
--------------- --------------- ---------------
Net deferred tax assets......................................... (Yen) 524,387 (Yen) 1,198,670 $ 11,734
=============== =============== ===============
</TABLE>
The accompanying notes are an integral part of these statements.
F-29
<PAGE>
Net deferred tax assets are included in the consolidated balance sheets as
follows:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
--------------------------------------- -----------------
December 31 December 31
---------------------------------------
1998 1999 1999
------------------- ------------------ -----------------
<S> <C> <C> <C>
Current assets-Deferred income taxes................... (Yen)394,922 (Yen) 922,061 $ 9,026
Other assets-Deferred income taxes..................... 129,465 276,609 2,708
------------------- ------------------ -----------------
Net deferred tax assets................................ (Yen)524,387 (Yen)1,198,670 $11,734
=================== ================== =================
</TABLE>
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, 1997, 1998 and 1999 were increase of
(Yen)9,048, (Yen)163,003 thousand and decrease of (Yen)201,586 thousand ($1,973
thousand), respectively.
Operating loss carryforwards for tax purposes of a consolidated subsidiary
at December 31, 1999 amounted to approximately (Yen)499,041 thousand ($4,885
thousand) and are available as an offset against future taxable income of the
subsidiary. These carryforwards expire at various dates up to December 31, 2004.
Realization is dependent on such 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 valuation allowance, will be realized. The amount of
such net deferred tax assets considered realizable, however, could be changed in
the near term if estimates of future taxable income during the carry forward
period are changed.
At December 31, 1999, no deferred income taxes have been provided on
undistributed earnings of foreign subsidiaries not expected to be remitted in
the foreseeable future totaling (Yen)1,060,648 thousand ($10,382 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, 1999 for such temporary differences amounted to (Yen)237,668
thousand ($2,326 thousand).
17. Shareholders' equity
Changes in the number of shares of common stock outstanding have resulted
from the following:
<TABLE>
<CAPTION>
For the year ended
December 31
-------------------------------------------------------
1997 1998 1999
----------------- ----------------- -------------------
Shares of common stock outstanding:
<S> <C> <C> <C>
Balance at beginning of year.................................... 54,000,000 54,000,000 62,506,800
New share offering.............................................. - 7,500,000 -
Exercise of stock purchase warrants............................. - 1,006,800 2,336,100
----------------- ----------------- ----------------
Balance at end of year.......................................... 54,000,000 62,506,800 64,842,900
================= ================= ================
</TABLE>
The accompanying notes are an integral part of these statements.
F-30
<PAGE>
Based upon the board of directors' resolution on July 8, 1997, the Company
made a free share distribution of 12,000 shares to the shareholders of record on
September 1, 1997. This free distribution was made in the form of a stock split
in the ratio of three-for-one, for which the transfer of the applicable par
value of (Yen)202,425 thousand was made from additional paid-in capital to the
common stock account in accordance with the Japanese Commercial Code.
On January 1, 1998, in order to reduce the par value of its common stock,
the former Trend Micro Incorporated merged into a dormant company, a
consolidated subsidiary named K.K. International Media ("Media") which then
changed its name to Trend Micro. At that time the par value of the Company's
common stock was reduced from (Yen)50,000 to (Yen)500 per share. The merger was
approved at the extraordinary shareholders' meeting on November 17, 1997, and
took effect as of January 1, 1998. As a result of the merger, common stock was
increased by (Yen)900,000 thousand, representing 1,800,000 shares at a par value
of (Yen)500. At the same time, 20,000 shares (par value (Yen)500) of Media which
were held by the Company were retired.
As approved at an ordinary meeting of shareholders on March 28, 1998, each
share of the Company's (Yen)500 par value common stock was split into 10 shares
of par value (Yen)50 common stock.
Also approved, an increase in the authorized number of shares from 7.2
million shares to 72 million shares.
As approved at an ordinary meeting of shareholders on March 23,1999, the
authorized number of shares were increased from 72 million shares to 83 million
shares.
Effective from August 18, 1998, the common stock of the Company was
registered for trading in the Japanese Over-the-Counter Market. Upon the
registration, 7,500,000 shares were issued based on the resolutions of the Board
of Directors on July 28, 1998. As a result, the common stock account and the
paid-in capital account of the Company increased by (Yen)4,038,078 thousand and
(Yen)6,175,578 thousand, respectively.
Upon exercise of stock warrants, 1,006,800 shares of common stock at an
exercise price of (Yen)285 per share were issued and the common stock account
and the additional paid-in capital account of the Company increased by
(Yen)143,636 thousand and (Yen)146,170 thousand, respectively, in the year ended
1998.
Upon exercise of stock warrants, 2,336,100 shares of common stock at an
exercise price of (Yen)285 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 ($3,259 thousand) and (Yen)338,346 thousand ($3,311
thousand), respectively, in the year ended 1999.
On August 19, 1999, the board of directors of the Company decided and
declared a stock split in the ratio of three-for-one for which the record date
was September 30, 1999. All per share data in the consolidated financial
statements have been adjusted to give effect to the stock split made on
September 30, 1999.
Under the Japanese Commercial Code, at least 50% of the issue price of new
shares, with a minimum of the par value of those shares, is required to be
designated as common stock. The portion which is to be designated as common
stock is determined by resolution of the Board of Directors. Proceeds in excess
of the amounts designated as common stock are credited to
The accompanying notes are an integral part of these statements.
F-31
<PAGE>
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 on the books of the Company prepared in
accordance with Japanese Commercial Code requirements. However, certain
adjustments, not recorded on the Company's books, are reflected in the financial
statements as described in Note 2.
The Japanese Commercial Code provides that an amount equal to at least 10%
of cash dividends and other distributions from retained earnings paid by the
parent company and its Japanese subsidiaries be appropriated as a legal reserve.
No further appropriation is required when the legal reserve equals 25% of stated
capital. The amounts of statutory retained earnings of the parent company
available for the payments of dividends to stockholders as of December 31, 1998
and 1999 were (Yen)2,052,378 thousand, (Yen)2,866,888 thousand ($28,063
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 legal
reserve until it reaches 100% of 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 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 ($2,040 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, 1997, 1998
and 1999, which in each case was a net debit balance, was (Yen)82,752 thousand,
(Yen)43,924 thousand and (Yen)417,066 thousand ($4,081 thousand), respectively.
18. Financial instruments
Other than marketable debt and equity securities, the Company's involvement
in financial assets and liabilities with market risk is limited to cash and cash
equivalents, notes and accounts receivable, short-term borrowings, notes and
accounts payable and long-term debt. The Company has a policy not to utilize any
derivative financial instruments with off-balance sheet risk.
At December 31, 1998 and 1999, the carrying amounts of the Company's
financial instruments approximated their fair values which were estimated based
on the discounted amounts of future cash flows.
The accompanying notes are an integral part of these statements.
F-32
<PAGE>
19. Advertising costs
Advertising costs are expensed as incurred. Advertising costs included in
selling, general and administrative expenses were (Yen)1,192,109 thousand,
(Yen)1,540,715 thousand and (Yen)2,164,630 thousand ($21,189 thousand) for the
years ended December 31, 1997, 1998 and 1999, respectively.
20. Leased assets
Rental expenses under operating leases for the years ended December 31,
1997, 1998 and 1999 were (Yen)122,571 thousand, (Yen)292,214 thousand and
(Yen)422,727 thousand ($4,138 thousand), respectively. The minimum rental
payments required under operating leases that have initial or remaining
noncancelable lease terms in excess of one year at December 31, 1999 are as
follows:
Thousands of
Year ending December 31: Millions of yen U.S. dollars
------------------ ----------------
2000.............................. (Yen)272,138 $2,664
2001.............................. 40,146 393
2002.............................. 22,687 222
2003.............................. 12,591 123
------------------ ----------------
Total minimum future lease payments. (Yen)347,562 $3,402
================== ================
21. Commitments and contingent liabilities
There were no significant commitments outstanding at December 31, 1999.
In May 1997, Trend Micro Incorporated (TMI), the parent company's U.S.
subsidiary, sued Network Associates (formerly McAfee Associates, Inc.) and
Symantec 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 seeking injunctive relief and unspecified money damages. TMI
settled its claims against Symantec in April 1998 by entering into a patent
cross-license arrangement, which included an agreement to exchange certain virus
samples. 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 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. The Company believes that the final disposition of these matters will not
have a material adverse effect on the Company's business, financial condition or
results of operations at this time.
TMI is currently in negotiations with Network Associates to settle all
outstanding litigation between the parties. The Company expects to reach
agreement with Network Associates on terms that are acceptable to the Company.
22. Segment information
The Company operates in the microcomputer software industry business
segment. Net revenue is attributed to countries based on location of the Company
and consolidated subsidiaries and long-lived assets for the years ended December
31, 1997, 1998 and 1999 are as follows:
The accompanying notes are an integral part of these statements.
F-33
<PAGE>
Geographic information -
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
---------------------------------------------------------- -----------------
Year ended
Year ended December 31 December 31,
----------------------------------------------------------
1997 1998 1999 1999
------------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C>
Net sales to external customers:
Japan.............................. (Yen) 3,698,835 (Yen) 4,811,608 (Yen) 5,847,188 $ 57,236
U.S.A.............................. 1,061,159 1,866,747 3,830,589 37,496
Taiwan............................. 1,830,838 1,808,742 1,646,550 16,117
Europe............................. 427,781 813,962 1,825,699 17,871
Other.............................. 379,366 444,605 483,144 4,729
---------------- --------------- --------------- -----------
Total......................... 7,397,979 (Yen) 9,745,664 (Yen) 13,633,170 $ 133,449
================ =============== =============== ===========
Long-lived assets:
Japan.............................. 334,255 (Yen) 884,543 (Yen) 1,002,116 $ 9,809
U.S.A.............................. 130,216 147,469 320,497 3,137
Taiwan............................. 209,499 204,672 248,637 2,434
Europe............................. 38,355 38,333 52,779 517
Other.............................. 31,506 39,016 27,133 265
---------------- --------------- --------------- -----------
Total......................... (Yen) 743,831 (Yen) 1,314,033 (Yen) 1,651,162 $ 16,162
================ =============== =============== ===========
</TABLE>
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:
<TABLE>
<CAPTION>
Thousands of
Thousands of yen U.S. dollars
---------------------------------------------------------- -----------------
Year ended
Year ended December 31 December 31,
----------------------------------------------------------
1997 1998 1999 1999
------------------- ------------------ ----------------- -----------------
<S> <C> <C> <C> <C>
Investments and other assets::
Intangibles.......................... (Yen) 260,759 (Yen) 438,366 (Yen) 440,252 $ 4,309
Other................................ 130,304 380,253 461,125 4,514
Property and equipment, less
accumulated depreciation............. 352,768 495,414 749,785 7,339
---------------- -------------- -------------- -----------
Tota1........................... (Yen) 743,831 (Yen)1,314,033 (Yen)1,651,162 $ 16,162
================ ============== ============== ===========
</TABLE>
Significant customers
SOFTBANK and its affiliates accounted for more than 10% of net sales to
external customers for the years ended December 31, 1997, 1998 and 1999. Net
sales to SOFTBANK and its affiliates for the years ended December 31, 1997, 1998
and 1999 were (Yen)1,383,730 thousand, (Yen)2,386,654 thousand and
(Yen)2,453,538 thousand ($24,017 thousand), respectively.
The accompanying notes are an integral part of these statements.
F-34
<PAGE>
23. Subsequent events
Establishment of ipTrend Incorporated, new subsidiary
On January 18, 2000, the Company established a new wholly-owned subsidiary in
Japan with an initial capital of (Yen)490,000 thousand ($4,796 thousand), named
ip Trend Incorporated (ipTrend). Subsequently, on February 24, 2000, the Company
increased its investment in ip Trend by (Yen)1,510,000 thousand ($14,781
thousand). The Company intends to extend its business to the area of UNIX and
Linux as an internet-based technology through ip Trend, which will manufacture
and sell computer software for internet-based technology and provides related
services.
Acquisition of the shares of Nihon Unisoft Incorporated
On February 29, 2000, the Company completed the acquisition of 1,600 shares
(66.7%) of outstanding shares of Nippon Unisoft through ipTrend Inc., a wholly-
owned subsidiary of the Company. Nippon Unisoft Incorporated, which has annual
sales of approximately (Yen)1,484 millions ($14,546 thousand), has been a
Japanese Unix software solution provider in the networking communications and
Internet domain since November 1, 1983. The purpose of the acquisition is to
develop the internet-based technology and to expand the sales of the products
and services used by that technology. The acquisition will be accounted for as a
purchase. As such, the excess of the purchase price over the fair value of the
acquired net assets, which approximates (Yen)239,567 thousand ($2,345 thousand),
will be recorded as goodwill of (Yen)1,360,433 thousand ($13,317).
Unaudited pro forma information related to this acquisition is not included as
the impact of this acquisition is not deemed to be material.
The accompanying notes are an integral part of these statements.
F-35
<PAGE>
SCHEDULE II
TREND MICRO INCORPORATED
AND CONSOLIDATED SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
<TABLE>
<CAPTION>
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
------------ -------------- -------------- --------------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
Allowance for doubtful
accounts and sales returns....... (Yen) 76,818 (Yen) 97,973 (Yen) 35,787 (Yen) (6,325) (Yen) 492 (Yen) 204,745
============ ============= ============ ============== ============ =============
Year ended December 31, 1998:
Allowance for doubtful
accounts and sales returns....... (Yen)204,745 (Yen) 192,922 (Yen) 22,227 (Yen) (52,657) (Yen)(28,356) (Yen) 338,881
============ ============= ============ ============== ============ =============
Year ended December 31, 1999:
Allowance for doubtful
accounts and sales returns....... (Yen)338,881 (Yen) 97,102 (Yen)145,099 (Yen) (151,716) (Yen)(46,393) (Yen) 382,973
============ ============= ============ ============== ============ =============
</TABLE>
Notes: 1. Amounts written off.
2. Translation adjustment.
<TABLE>
<CAPTION>
Thousands of yen
---------------------------------------------------------------------------------
Balance at
beginning of Balance at
period Additions Deductions Other end of period
---------------- ---------------- --------------- ------------ --------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
Valuation allowance
- Deferred tax assets............ (Yen) - (Yen) 49,048 (Yen) - (Yen) - (Yen) 49,048
============== =============== ============== ============ ==============
Year ended December 31, 1998:
Valuation allowance
- Deferred tax assets............ (Yen) 49,048 (Yen) 188,819 (Yen) - (Yen)(25,816) (Yen) 212,051
============== =============== ============== ============ ==============
Year ended December 31, 1999:
Valuation allowance
- Deferred tax assets............ (Yen) 212,051 (Yen) - (Yen) (198,599) (Yen) (2,987) (Yen) 10,465
============== =============== ============== ============ ==============
</TABLE>
The accompanying notes are an integral part of these statements.
F-36
