UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission file number: 001-31216

McAfee, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code:

(408) 988-3832

      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 þ          No o

      Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).     Yes þ          No o

      As of July 29, 2005, 165,398,030 shares of the registrant’s common stock, $0.01 par value, were outstanding.

MCAFEE, INC.

FORM 10-Q

June 30, 2005

CONTENTS

MCAFEE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of our condensed consolidated financial statements.

MCAFEE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND

COMPREHENSIVE INCOME

The accompanying notes are an integral part of our condensed consolidated financial statements.

MCAFEE, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of our condensed consolidated financial statements.

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

      We and our wholly owned subsidiaries are a leading supplier of computer security solutions designed to prevent intrusions on networks and protect computer systems from the next generation of blended attacks and threats. We offer two families of products, McAfee System Protection Solutions and McAfee Network Protection Solutions. Our computer security solutions are offered primarily to large enterprises, governments, small and medium-sized businesses and consumers. We operate our business in five geographic regions: North America; Europe, Middle East and Africa (“EMEA”); Japan; Asia-Pacific, excluding Japan; and Latin America.

      In January 2004, we sold our Magic Solutions product line (“Magic”), and in July 2004, we sold our Sniffer product line (“Sniffer”).

      In October 2004, we acquired Foundstone, Inc. (“Foundstone”), a provider of risk assessment and vulnerability services and products.

      In April 2005, we sold our McAfee Labs assets.

      In June 2005, we acquired Wireless Security Corporation, a provider of home and small business wireless network security products.

      The accompanying condensed consolidated financial statements include our accounts as of June 30, 2005 and December 31, 2004 and for the three and six months ended June 30, 2005 and June 30, 2004. All significant intercompany accounts and transactions have been eliminated in consolidation. These condensed consolidated financial statements have been prepared by us, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. The December 31, 2004 Consolidated Balance Sheet was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. However, we believe that all disclosures are adequate to make the information presented not misleading. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto, included in our Annual Report on Form 10-K/ A for the fiscal year ended December 31, 2004.

      In the opinion of our management, all adjustments (which include normal recurring adjustments, except as disclosed herein) necessary to fairly present our financial position as of June 30, 2005, results of operations for the three and six months ended June 30, 2005 and June 30, 2004 and cash flows for the six months ended June 30, 2005 and June 30, 2004 have been included. The results of operations for the three and six months ended June 30, 2005 are not necessarily indicative of the results to be expected for the full fiscal year or for any future periods.

      Approximately $5.0 million and approximately $8.7 million were reclassified from cost of product net revenue to cost of services and support net revenue in the three and six months ended June 30, 2004, respectively, to be consistent with current-period presentation. This reclassification did not have an impact to total cost of net revenue. Certain other immaterial prior-period amounts have been reclassified to conform to current-period presentation.

      As permitted by Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and as amended by SFAS No. 148, “Accounting for

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

Stock-Based Compensation — Transition and Disclosure,” (“SFAS 148”), we account for employee stock-based compensation in accordance with Accounting Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” (“APB 25”), and related interpretations. Under APB 25, if the exercise price of an employee’s stock options equals or exceeds the market price of the underlying stock on the date of grant, no compensation expense is recognized. Stock-based compensation is based on the excess of the market price on the grant date over the exercise price and is recognized ratably over the vesting period. Stock-based compensation related to non-employees is based on the excess of the fair value price on the grant date over the exercise price and is recognized ratably over the vesting period in accordance with SFAS 123.

      In calculating the estimated fair value of the stock options granted in the period and for our employee stock purchase plan (“ESPP”), we utilized the Black-Scholes option-pricing model with the following weighted-average assumptions:

      During the three months ended June 30, 2005 and 2004, respectively, we did not have any ESPP grants.

      The following table illustrates the effect on net income and net income per share if we had applied the fair value recognition provision of SFAS 123 to all of our stock-based compensation plans:

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The impact on pro forma income per share and net income in the table above may not be indicative of the effect in future periods as options vest over several years and we continue to grant stock options to employees.

      In December 2004, the FASB issued SFAS No. 123R, “Share Based Payment” (“SFAS 123R”) which requires the measurement of all share-based payments to employees, including grants of employee stock options, using a fair-value-based method and the recording of such expense in the consolidated statements of income. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107). SAB 107 expresses views of the SEC staff regarding the interaction between SFAS 123R and certain SEC rules. In April 2005, the SEC extended the effective date for SFAS 123R to fiscal years beginning after June 15, 2005. Therefore, we are required to adopt SFAS 123R in the first quarter of fiscal year 2006. The pro forma disclosures previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. See “Pro forma Stock-based Compensation Disclosure” above for the pro forma net income and net income per share amounts, in the three and six months ended June 30, 2005 and June 30, 2004, respectively, as if we had used a fair-value-based method similar to the methods required under SFAS 123R to measure compensation expense for employee stock incentive awards. Although we have not yet determined whether the adoption of SFAS 123R will result in amounts that are similar to the current pro forma disclosures under SFAS 123, we are evaluating the requirements under SFAS 123R and expect the adoption to have a significant adverse impact on our consolidated results of operations.

      In December 2004, the FASB issued Staff Position (“FSP”) 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creations Act of 2004 (“AJCA”) (“FSP 109-2”).” The AJCA introduces a limited time 85% dividends received deduction on the repatriation of certain foreign earnings to a United States taxpayer (repatriation provision), provided certain criteria are met. FSP 109-2 provides accounting and disclosure guidance for the repatriation provision. Although FSP 109-2 is effective immediately, we do not expect to be able to complete our evaluation of the repatriation provision until after Congress or the Treasury Department provides additional clarifying language on key elements of the provision. We expect to complete our evaluation of the effects of the repatriation provision by the end of fiscal 2005. The range of possible amounts that we are considering for repatriation under this provision is between $0 and $500 million. While we estimate that the related potential range of additional income tax is between $0 and $30 million, this estimation is subject to change following technical correction legislation that we believe is forthcoming from Congress. The amount of additional income tax would be reduced by the part of the eligible dividend that is attributable to foreign earnings on which a deferred tax liability had been previously accrued.

      In June 2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 143-1, “Accounting for Electronic Equipment Waste Obligations”, that provides guidance on how commercial users and producers of electronic equipment should recognize and measure asset retirement obligations associated with the European Directive 2002/96/ EC on Waste Electrical and Electronic Equipment. The guidance applies to the later of our fiscal quarter ended June 30, 2005 or the date of the adoption of the law by the applicable European Union (EU) member country. The adoption of SFAS 143-1 in the current quarter did not have a material effect on our financial statements. Due to the fact that several major EU-member countries have not yet enacted country-specific laws, we cannot estimate the effect of applying this guidance in future periods,

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

however, we do not believe SFAS 143-1 will have a material effect on our consolidated financial position, results of operations or cash flows.

      In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”), a replacement of APB Opinion No. 20, “Accounting Changes”, and SFAS Statement 3, “Reporting Accounting Changes in Interim Financial Statements”. SFAS 154 changes the requirements for the accounting for and reporting of a change in accounting principle. Previously, most voluntary changes in accounting principles required recognition via a cumulative effect adjustment within net income of the period of the change. SFAS 154 requires retrospective application to prior periods’ financial statements, unless it is impracticable to determine either the period-specific effects or the cumulative effect of the change. SFAS 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005; however, the Statement does not change the transition provisions of any existing accounting pronouncements. We do not believe the adoption of SFAS 154 will have a material effect on our consolidated financial position, results of operations or cash flows.

      In March 2004, the FASB issued Emerging Issues Task Force Issue No. 03-1 (“EITF 03-1”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” which provided new guidance for assessing impairment losses on investments. Additionally, EITF 03-1 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF 03-1; however the disclosure requirements remain effective for annual periods ending after June 15, 2004. We do not believe that the adoption of EITF 03-01 will have a material impact on our financial position, results of operations or cash flows, however, we will evaluate the impact of EITF 03-1 once final guidance is issued.

      We recorded stock-based compensation charges (benefits) of $2.4 million and $0.4 million, before taxes, in the three months ended June 30, 2005 and 2004, respectively, and ($0.9) million and $2.7 million, before taxes, in the six months ended June 30, 2005 and 2004, respectively. These charges (benefits) are comprised of the following (in thousands):

      Exchange of McAfee.com options. On September 13, 2002, we acquired the minority interest in McAfee.com that we previously did not own. McAfee.com option holders received options for 0.675 of a share of our common stock plus $8.00 in cash, $11.85 after applying the option exchange ratio, which is paid to the option holder upon exercise of the option and without interest. McAfee.com options to purchase 4.1 million

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

shares were converted into options to purchase 2.8 million shares of our common stock. The assumed options are subject to variable accounting treatment, which means that a compensation charge was measured initially at the date of the closing of the acquisition and is remeasured each reporting period based on our common stock fair market value at the end of each report period.

      The initial charge was based on the excess of the closing price of our common stock over the exercise price of the options plus the $11.85 per share payable in cash. This compensation charge has been and will be remeasured using the same methodology until the earlier of the date of exercise, forfeiture or cancellation without replacement. This compensation charge is recorded as an expense over the remaining vesting period of the options using the accelerated method of amortization under FASB Interpretation No. 28, “Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans.” Charges related to unvested options are recorded as deferred stock-based compensation in stockholders equity in the consolidated balance sheet and recognized as expense as the options vest.

      During the three months ended June 30, 2005 and 2004, we recorded a charge of approximately $1.2 million and $0.3 million, respectively, related to exchanged options subject to variable accounting. During the six months ended June 30, 2005 and 2004, we recorded a benefit of approximately $0.8 million and a charge of approximately $2.2 million, respectively, related to exchanged options subject to variable accounting. This stock-based compensation was based on our closing stock price of $26.18 on June 30, 2005 and $18.13 on June 30, 2004. The benefit in the six months ended June 30, 2005 was due to a decline in our stock price from $28.93 at December 31, 2004 to $26.18 as of June 30, 2005, and the charge in the three months ended June 30, 2005 was due to an increase in our stock price from $22.56 on March 31, 2005 to $26.18 on June 30, 2005. As of June 30, 2005, we had approximately 0.3 million outstanding options subject to variable accounting. Further fluctuations in the stock price may result in significant additional stock-based compensation charges or benefits in future periods.

      Repriced options. On April 22, 1999, we offered to substantially all of our employees, excluding executive officers, the right to cancel certain outstanding stock options and receive new options with an exercise price of $11.063, the then current fair value of the stock. Options to purchase a total of 9.5 million shares were cancelled and the same number of new options were granted. These new options vested at the same rate that they would have vested under previous option plans and are subject to variable accounting. Accordingly, we have and will continue to remeasure compensation cost for these repriced options until these options are exercised, cancelled or forfeited without replacement. The first valuation period began July 1, 2000.

      The amount of stock-based compensation recorded was and will be based on any excess of the closing stock price at the end of the reporting period or date of exercise, forfeiture or cancellation without replacement, if earlier, over the fair value of our common stock on July 1, 2000, which was $20.375. As these options are fully vested, the charge is recorded to earnings immediately. Depending upon movements in the market value of our common stock, this variable accounting treatment can result in additional stock-based compensation charges or benefits in future periods until the options are exercised, forfeited or cancelled.

      During the three months ended June 30, 2005, we recorded a charge of approximately $0.9 million, and did not record any charges or benefits in the three months ended June 30, 2004. During the six months ended June 30, 2005, we recorded a benefit of $0.8 million and did not record any charges or benefits in the six months ended June 30, 2004. The stock-based compensation for these options was based on closing stock prices as of June 30, 2005 and 2004 of $26.18 and $18.13, respectively. The benefit in the six months ended June 30, 2005 was due to a decline in our stock price from $28.93 at December 31, 2004 to $26.18 as of June 30, 2005, and the charge in the three months ended June 30, 2005 was due to an increase in our stock price from $22.56 on March 31, 2005 to $26.18 on June 30, 2005. There was no charge or benefit in the three months and six months ended March 31, 2004 as our closing stock price from December 31, 2003 to June 30,

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

2004 was below $20.375. As of June 30, 2005, there were approximately 0.2 million options which were outstanding and subject to variable plan accounting.

      New and existing employees and executives. In January 2005, our board of directors granted 75,000 shares of restricted stock, which vests through December 31, 2007, to our chief financial officer. The price of the underlying shares is $0.01 per share. We recorded expense of approximately $0.2 million in the three months ended June 30, 2005 and $0.4 million in the six months ended June 30, 2005 related to the stock-based compensation associated with the chief financial officer’s restricted stock grant.

      In connection with the acquisition of Foundstone in October 2004, we assumed stock options to Foundstone employees which are subject to vesting provisions as the employees provide service to us. We recognized approximately $0.1 million in the three months ended June 30, 2005, and $0.3 million in the six months ended June 30, 2005. An additional $0.7 million will be recognized through 2008, which is subject to reduction based on employees terminating prior to the full vesting of their options.

      In January 2002, our board of directors approved a grant of 50,000 shares of restricted stock, which vested through January 2005, to our chief executive officer. The price of the underlying shares is $0.01 per share. During the three months ended June 30, 2005, we recorded no stock-based compensation related to the chief executive officer’s 2002 restricted stock grant compared to $0.1 million in the three months ended June 30 2004. During the six months ended June 30, 2005 and 2004, we recorded less than $0.1 million and approximately $0.2 million, respectively, related to stock-based compensation associated with the chief executive officer’s 2002 restricted stock grant.

      Former employees. In November and December 2003, we extended the vesting period of two employees and also extended the period after which vesting ends to exercise their options. As these employees options continued to vest after termination and their exercise period was extended an additional 90 days, we recorded a one time stock-based compensation charge of approximately $0.1 million during the six months ended June 30, 2004.

      Extended life of vested options held by terminated employees. During a significant portion of 2003, we suspended exercises of stock options until our required public company reports were filed with the SEC. The period during which stock options were suspended is known as the black-out period. Due to the black-out period, we extended the exercisability of any options that would otherwise terminate during the black-out period for a period of time equal to a specified period after termination of the black-out period. Accordingly, we recorded a stock-based compensation charge on the date the options should have terminated based on the intrinsic value of the option on the modification date and the option price. During the six months ended June 30, 2004, we recorded a stock-based compensation charge of approximately $0.1 million.

      In June 2005, we acquired 100% of the outstanding shares of Wireless Security Corporation, a provider of home and small business wireless network security products, for approximately $20.0 million in cash and $0.3 million of direct expenses, totaling $20.3 million. We acquired Wireless Security Corporation to continue to develop their patent-pending technology and to integrate the technology into our small business managed VirusScan solution. The results of operations of Wireless Security Corporation have been included in our results of operations since the date of acquisition.

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Our management determined the preliminary purchase price allocation based on estimates of the fair values of the tangible and intangible assets acquired and liabilities assumed. These estimates were arrived at utilizing recognized valuation techniques and the assistance of valuation consultants. The following is a summary of the assets acquired and liabilities assumed in the acquisition of Wireless Security Corporation as adjusted during the current period for resolution of ongoing purchase price valuation procedures:

      We recorded approximately $4.0 million for in-process research and development, which was fully expensed upon purchase because technological feasibility had not been achieved and there was no alternative use for the projects under development. The in-process research and development included the development of the consumer wireless security product that we plan to introduce in the third quarter of 2005. In addition, the in-process research and development included existing wireless security offers that we plan to integrate in our small business managed solution. At the date of acquisition, we estimated that 60% of the development effort had been completed and that the remaining 40% of the development would take approximately three months to complete and would cost approximately $0.6 million. The intangible assets, other than goodwill, are being amortized over their useful lives of 2.0 to 3.5 years or a weighted average period of 3.2 years. As part of the acquisition, we did not assume any outstanding stock options or warrants. A performance and retention plan, which provides for payment of up to $1.8 million, was established at the close of the acquisition. At June 30, 2005, approximately $0.1 million had been accrued and no amounts had been paid related to this performance plan. The results of operations for Wireless Security Corporation prior to the acquisition would not have a material impact on our results of operations.

      In October 2004, we acquired 100% of the outstanding shares of Foundstone, Inc., a provider of risk assessment and vulnerability services and products, for $82.5 million in cash and $3.1 million of direct expenses, totaling $85.6 million. Total consideration paid for the acquisition was $90.4 million including $4.8 million for the fair value of vested stock options assumed in the acquisition. We acquired Foundstone to enhance our network protection product line and to deliver enhanced risk classification of prioritized assets, automated shielding and risk remediation using intrusion prevention technology, and automated enforcement and compliance. The results of operations of Foundstone have been included in our results of operations since the date of acquisition.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Under the transaction, we recorded approximately $27.0 million for developed technology, $1.0 million for acquired product rights, including revenue related order backlog and contracts, $0.6 million for trade names/trademarks and non-compete arrangements, $59.4 million for goodwill (none of which is deductible for tax purposes), $2.6 million for net deferred tax liabilities and $4.9 million of tangible assets, net of liabilities. The intangible assets acquired in the acquisition, excluding goodwill, are being amortized over their estimated useful lives of two to 6.5 years or a weighted average period of 6.4 years. We accrued $0.3 million in severance costs for employees terminated at the time of the acquisition. As of June 30, 2005, we have paid all severance costs related to the acquisition.

      As part of the Foundstone acquisition, we assumed a portion of outstanding vested and unvested Foundstone stock options. The intrinsic value of the stock options will be recognized by us through 2008 as employment services are provided. In the three and six months ended June 30, 2005, we expensed $0.1 million and $0.3 million, respectively, related to the Foundstone stock options. At June 30, 2005, unearned compensation to be recognized by us in future periods as services are provided was $0.7 million.

      We cancelled the Foundstone stock options we did not assume, such options being held by four executives, in exchange for a cash payment equal to the intrinsic value of the cancelled stock options based on the purchase price per share. Forty percent of this amount was placed into escrow accounts for the four executives (Key Employee Escrow), along with 40% of the proceeds for the purchase of shares from the four executives. The four executives also received retention bonus payments, which were placed into Key Employee Escrow accounts. The Key Employee Escrow amounts are subject to vesting provisions from the date of acquisition through October 1, 2007. We recorded the $5.6 million paid into Key Employee Escrow as prepaid compensation, which is being recognized as compensation expense over the vesting period. In January 2005, the vesting schedule was amended such that a greater portion of the escrow amount vests within one year of the close of the transaction. In the three and six months ended June 30, 2005, we recorded approximately $0.7 million and $1.8 million, respectively, in expense for escrow amounts vesting in the period.

      Our management determined the preliminary purchase price allocation based on estimates of the fair values of the tangible and intangible assets acquired and liabilities assumed. These estimates were arrived at utilizing recognized valuation techniques and the assistance of valuation consultants. The following is a summary of the assets acquired and liabilities assumed in the acquisition of Foundstone as adjusted during the current period for resolution of ongoing purchase price valuation procedures:

MCAFEE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      The following unaudited pro forma financial information presents our combined results with Foundstone, Inc., as if both acquisitions had occurred at the beginning of 2004 (in thousands, except per share amounts):

      The above unaudited pro forma financial information includes adjustments for interest income on cash disbursed for the acquisitions, amortization of identifiable intangible assets and adjustments for expenses incurred in conjunction with the acquisitions.

      In May 2003, we acquired 100% of the outstanding shares of IntruVert Networks, Inc., (“IntruVert”) a provider of network-based intrusion prevention solutions designed to proactively detect and stop system and network security attacks before they occur, for $98.1 million in cash and $5.2 million of direct expenses, totaling $103.3 million. We acquired IntruVert to enhance our intrusion detection product line, improve our position in the emerging intrusion prevention marketplace, embed the acquired technologies in our current product offering, and sell IntruVert products to our existing customer base.

      As part of the IntruVert acquisition, we cancelled all outstanding IntruVert restricted stock and outstanding stock options and agreed to make cash payments to former IntruVert employees contingent upon their continued employment with us based on the same vesting terms of their restricted stock or stock option agreements. The payments to former IntruVert employees are recorded as salary expense ratably over the vesting period since the employees are currently providing services to us. Payments under the restricted stock plan are paid monthly from an escrow account and will total approximately $3.0 million from the purchase date through the fourth quarter of 2006. For the restricted stock agreements, we recorded expense of approximately $0.1 million and $0.3 million in the three months ended June 30, 2005 and 2004, respectively. In the six months ended June 30, 2005 and 2004, we recorded expense of approximately $0.2 million and $0.7 million, respectively. Payments under the stock option plan are being paid monthly through our payroll, and will total approximately $4.1 million. For stock option agreements, we recorded expense of approximately $0.2 million and $0.3 million in the three months ended June 30, 2005 and 2004, respectively. In the six months ended June 30, 2005 and 2004, we recorded expense of approximately $0.4 million and $0.8 million, respectively, and will record an additional $1.5 million through the first quarter of 2007. Cash payments that were fully vested at the date of acquisition were included in the purchase price. If a former IntruVert employee ceases employment with us, unvested payment amounts will be returned to us.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      In April 2003, we acquired 100% of the outstanding shares of Entercept Security Technologies, Inc. (“Entercept”), a provider of host-based intrusion prevention solutions designed to proactively detect and stop system and network security attacks before they occur, for $121.9 million in cash and $3.9 million of direct expenses, totaling $125.8 million. We acquired Entercept to enhance our intrusion detection product line, achieve a leading position in the emerging intrusion prevention marketplace, embed the acquired technologies in our current product offering, and sell Entercept products to our existing customer base. At the acquisition date, we accrued $2.8 million for permanently vacated facilities. A summary of activity in the restructuring accrual related to Entercept during the six months ended June 30, 2005 is as follows (in thousands):

      In April 2005, we completed the sale of our McAfee Labs assets to SPARTA, Inc. (“SPARTA”) for $1.5 million and recognized a gain on the sale of $1.3 million for the three and six months ended June 30, 2005. The carrying value of McAfee Labs assets and liabilities, which were sold in this agreement, were not significant. The operations of McAfee Labs, which are not material to our consolidated results of operations, are included in income from operations.

      In the three months ended June 30, 2005, we had $0.2 million in revenue from McAfee Labs compared to $1.8 million in the three months ended June 30, 2004. Revenues related to McAfee Labs were approximately $1.9 million and $3.2 million in the six months ended June 30, 2005 and 2004, respectively.

      In July 2004, we completed our sale of our Sniffer product line to Network General Corporation for $213.8 million in cash, net of approximately $4.0 million in direct costs. We recorded a gain on sale of $197.4 million in 2004. Revenues related to Sniffer were approximately $38.4 million and $80.7 million, respectively, in the three and six months ended June 30, 2004.

      In conjunction with the sale of Sniffer, we entered into a transition services agreement with the Network General Corporation. Under this agreement, we provide certain transitional services, including initial order processing, use of facilities, transaction processing services and certain other back office functions. We are reimbursed for our costs plus a margin. Operating expenses under this agreement are included in general and administrative expenses, while reimbursements for such expenses are included in the caption “Reimbursement from transition services agreement” on the accompanying consolidated statements of income. We recorded less than $0.1 million and $0.4 million of reimbursements under the transition services agreement in the three and six months ended June 30, 2005.

      In January 2004, we completed our sale of our Magic Solutions product line to BMC Software for $47.1 million in cash. We recorded a gain of $46.5 million during the three months ended March 31, 2004. In conjunction with the Magic sale, we paid a $1.4 million bonus to an executive related to the transaction in the six months ended June 30, 2004. Revenues related to Magic were approximately $2.9 million in both the three and six months ended June 30, 2004.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      We account for goodwill and other intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets.” In lieu of amortization, we perform an impairment review of our goodwill on at least an annual basis.

      We perform our annual goodwill impairment review as of October 1 of our fiscal year. We completed our annual goodwill review as of October 1, 2004 and concluded that goodwill was not impaired. The fair value of the reporting units was estimated using the average of the expected present value of future cash flows and of the market multiple value. As a result of the sale of Sniffer and Magic in 2004, we tested goodwill, excluding Sniffer and Magic. These impairment tests were performed during the three months ended March 31, 2004 and September 30, 2004, respectively, and no impairment was identified. We will continue to test for impairment on an annual basis and on an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting units below their carrying amounts.

      Goodwill information is as follows (in thousands):

      The adjustment to goodwill in the six months ended June 30, 2005 related to the McAfee.com, Traxess and Foundstone acquisitions.

      The components of intangible assets are as follows (in thousands):

      The aggregate amortization expenses for the intangible assets listed above totaled $7.6 million and $6.8 million in the three months ended June 30, 2005 and 2004, respectively, and $15.0 million and $13.8 million in the six months ended June 30, 2005 and 2004, respectively.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Expected future intangible asset amortization expense as of June 30, 2005 is as follows (in thousands):

      During the six months ended June 30, 2005, we permanently vacated several leased facilities and recorded a $1.9 million accrual for estimated lease related costs associated with the permanently vacated facilities. The remaining costs associated with vacating the facilities are primarily comprised of the present value of remaining lease obligations, along with estimated costs associated with subleasing the vacated facility, net of estimated sublease rental income. We also recorded a restructuring charge of $0.2 million related to a reduction in headcount of approximately 14 employees.

      The following table summarizes our restructuring accrual established in 2005 and activity through June 30, 2005 (in thousands):

      As of June 30, 2005, $1.1 million of the restructuring accrual is due within 12 months and has been classified as current accrued liabilities, while the remaining balance of $0.2 million has been classified as other long term liabilities, and will be paid through July 2007.

      During 2004, we recorded several restructuring charges related to the reduction of employee headcount. In the first quarter of 2004, we recorded a restructuring charge of approximately $2.2 million related to the severance of approximately 160 employees, of which $0.7 million and $1.5 million was related to our North America and EMEA operating segments, respectively. The workforce size was reduced primarily due to our sale of Magic in January 2004. In the second quarter of 2004, we recorded a restructuring charge of approximately $1.6 million related to the severance of approximately 80 employees in our sales, technical support and general and administrative functions. Approximately $0.6 million of the restructuring charge was related to the EMEA operating segment and the remaining $1.0 million was related to the North America operating segment. In the third quarter of 2004, we recorded a restructuring charge related to ten employees which totaled approximately $0.9 million, all of which related to the North America operating segment. In the fourth quarter of 2004, we recorded a restructuring charge of $1.3 million related to 111 employees, of which $0.7 million, $0.2 million, $0.2 million and $0.2 million related to the Latin America, North America, EMEA

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and Asia-Pacific, excluding Japan, operating segments, respectively. All employees were terminated as of December 31, 2004. The reductions in the second, third and fourth quarters were part of the previously announced cost-savings measures being implemented by us.

      In September 2004, we announced the move of our European headquarters to Ireland, which was substantially completed by the end of March 2005. In the third and fourth quarters of 2004, we recorded restructuring charges of $0.2 million and $2.2 million, respectively, related to the severance of approximately 80 employees. During the six months ended June 30, 2005, we completed the move of our European headquarters to Ireland and vacated the remaining planned floors. We recorded an additional $1.5 million restructuring charge for estimated lease related costs associated with the permanently vacated facilities and a $1.4 million restructuring charge for severance costs. All of these restructuring charges were related to the EMEA operating segment.

      Also in September 2004, we permanently vacated an additional two floors in our Santa Clara headquarters building. We recorded a $7.8 million accrual for the estimated lease related costs associated with the permanently vacated facility, partially offset by a $1.3 million write-off of deferred rent liability. The remaining costs associated with vacating the facility are primarily comprised of the present value of remaining lease obligations, net of estimated sublease income along with estimated costs associated with subleasing the vacated facility. The remaining costs will generally be paid over the remaining lease term ending in 2013. We also recorded a non-cash charge of approximately $0.8 million related to disposals of certain leasehold improvements. The restructuring charge of $6.5 million and related cash outlay were based our management’s current estimates.

      In the fourth quarter of 2004, we permanently vacated several leased facilities and recorded a $2.2 million accrual for estimated lease related costs associated with the permanently vacated facilities. The remaining costs associated with vacating the facilities are primarily comprised of the present value of remaining lease obligations, along with estimated costs associated with subleasing the vacated facility.

      During 2004, we adjusted the restructuring accruals related to severance costs and lease termination costs recorded in 2004. We recorded a $0.3 million adjustment to reduce the EMEA severance accrual for amounts that were no longer necessary after paying out substantially all accrued amounts to the former employees. We also recorded a $0.2 million reduction in lease termination costs due to changes in estimates related to the sublease income to be received over the remaining lease term of our Santa Clara headquarters building.

      The following table summarizes our restructuring accruals established in 2004 and activity through June 30, 2005 (in thousands):

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      As of June 30, 2005, $2.2 million of the restructuring accrual is due within 12 months and has been classified as current accrued liabilities, while the remaining balance of $6.5 million has been classified as other long term liabilities, and will be paid through March 2013.

      In January 2003, as part of a restructuring effort to gain operational efficiencies, we consolidated operations formerly housed in three leased facilities in the Dallas, Texas area into our regional headquarters facility in Plano, Texas. The facility houses employees working in finance, information technology, and the customer support and telesales groups servicing the McAfee System Protection Solutions and McAfee Network Protection Solutions businesses. The remaining costs will generally be paid over the remaining lease term ending in 2013.

      In 2004, we adjusted the restructuring accrual related to lease termination costs previously recorded in 2003. The adjustments decreased the liability by approximately $0.6 million in 2004, due to changes in estimates related to the sublease income to be received over the remaining lease term.

      The following table summarizes our restructuring accrual established in 2003 and activity through June 30, 2005 (in thousands):

      As of June 30, 2005, $1.2 million of the restructuring accrual is due within 12 months and has been classified as current accrued liabilities, while the remaining balance of $10.8 million has been classified as other long term liabilities and will be paid through March 2013.

      Our estimate of the excess facilities charges recorded during 2005, 2004 and 2003 may vary significantly depending, in part, on factors which may be beyond our control, such as our success in negotiating with our lessor, the time periods required to locate and contract suitable subleases and the market rates at the time of such subleases. Adjustments to the facilities accrual will be made if actual lease exit costs or sublease income differ from amounts currently expected. The facility restructuring charges in 2005 were primarily allocated to the EMEA and Japan operating segments, and the facility restructuring charges in 2004 and 2003 were primarily allocated to the North America operating segment.

      We have a $17.0 million credit facility with a bank. The credit facility is available on an offering basis, meaning that transactions under the credit facility will be on such terms and conditions, including interest rate, maturity, representations, covenants and events of default, as mutually agreed between us and the bank at the time of each specific transaction. The credit facility is intended to be used for short-term credit requirements

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with terms of one year or less. The credit facility can be cancelled at any time. No balances were outstanding as of June 30, 2005 and December 31, 2004.

      In July 2002, we entered into interest rate swap transactions (the “Transactions”) with two investment banks (the “Banks”) to hedge the interest rate risk of our outstanding 5.25% Convertible Subordinated Notes (“Notes”) due 2006. The Notes were issued in August 2001 with an aggregate principal amount of $345.0 million.

      The Transactions had a termination date of August 15, 2006, subject to certain early termination provisions if on or after August 20, 2004 and prior to August 15, 2006 the five-day average closing price of our common stock were to equal or exceed $22.59 per share. Depending on the timing of the early termination event, the Banks would be obligated to pay us an amount equal to the repurchase premium called for under the terms of the Notes.

      The Transactions qualified and were designated as a fair value hedge against movements in the fair value of the Notes due to changes in the benchmark interest rate. Under the fair value hedge model, the derivative is recognized at fair value on the balance sheet with an offsetting entry to the income statement. In addition, changes in fair value of the Notes due to changes in the benchmark interest rate are recognized as a basis adjustment to the carrying amount of the Notes with an offsetting entry to the income statement. The gain or loss from the change in fair value of the Transactions and the offsetting change in the fair value of the Notes are recognized as interest and other expense.

      The Notes were fully repaid in August 2004, and the Transactions were left intact and became a speculative investment, with gains and losses being recorded in the consolidated statement of income, until the Transactions terminated in October 2004 when our common stock price exceeded $22.59 for a five-day period.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      A reconciliation of the numerator and denominator of basic and diluted net income per share is provided as follows (in thousands, except per share amounts):

      We have concluded that we have one business and operate in one industry, developing, marketing, distributing and supporting computer security solutions for large enterprises, governments, small and medium-sized business and consumer users, as well as resellers and distributors. Our management measures profitability based on our five geographic regions: North America; Europe, Middle East and Africa (“EMEA”); Japan; Asia-Pacific, excluding Japan; and Latin America. The regions are evidence of the operating structure of our internal organization.

      We market and sell, through our geographic regions, anti-virus and security software, hardware and services. These products and services are marketed and sold worldwide primarily through resellers,

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distributors, systems integrators, retailers, original equipment manufacturers, Internet service providers and directly by us. In addition, we offer web sites, which provide suites of on-line products and services personalized for the user based on the users’ PC configuration, attached peripherals and resident software. We also offer managed security and availability applications to corporations and governments on the Internet.

      Following is a summary of our net revenue from external customers and operating income by geographic region (in thousands):

      Net revenue information on a product and service basis is as follows (in thousands):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

      Net revenue information on a product family basis is as follows (in thousands):

      From time to time, we have been subject to litigation including the pending litigation described below. Our current estimated range of liability related to some of the pending litigation below is based on claims for which our management can estimate the amount and range of loss. We have recorded the minimum estimated liability related to those claims, where there is a range of loss. Because of the uncertainties related to both the range of loss on the remaining pending litigation, our management is unable to make a reasonable estimate of the liability that could result from an unfavorable outcome. As additional information becomes available, we will assess our potential liability and revise our estimates. Pending or future litigation could be costly, could cause the diversion of our management’s attention and could upon resolution, have a material adverse effect on the business, results of operations, financial condition and cash flow.

      In addition, we are engaged in certain legal and administrative proceedings incidental to our normal business activities and believe that these matters will not have a material adverse effect on our financial position, results of operations or cash flows.

      In September 2003, we entered into a settlement agreement with the plaintiffs in the In re Network Associates, Inc. II Securities Litigation, which was originally filed in December 2000. Under the settlement agreement, we paid $70.0 million, which was recorded as litigation settlement in the consolidated statement of income for 2002. The settlement was approved by the court in February 2004, and the case was dismissed with prejudice to all parties and claims. In 2004, we received approximately $25.0 million from our insurance carriers related to this litigation, of which $19.1 million was received in the first quarter of 2004 and was recorded as litigation reimbursement in the consolidated statement of income. The remaining $5.9 million was received in the second quarter of 2004.

      Certain investment bank underwriters, our company, and certain of our directors and officers have been named in a putative class action for violation of the federal securities laws in the United States District Court for the Southern District of New York, captioned In re McAfee.com Corp. Initial Public Offering Securities Litigation, 01 Civ. 7034 (SAS). This is one of a number of cases challenging underwriting practices in the initial public offerings (“IPOs”) of more than 300 companies. These cases have been coordinated for pretrial proceedings as In re Initial Public Offering Securities Litigation, 21 MC 92 (SAS). Plaintiffs generally allege that certain underwriters engaged in undisclosed and improper underwriting activities, namely the receipt of excessive brokerage commissions and customer agreements regarding post-offering purchases of stock in exchange for allocations of IPO shares. Plaintiffs also allege that various investment bank securities analysts issued false and misleading analyst reports. The complaint against us claims that the purported improper underwriting activities were not disclosed in the registration statements for McAfee.com’s IPO and seeks

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unspecified damages on behalf of a purported class of persons who purchased our securities or sold put options during the time period from December 1, 1999 to December 6, 2000. On February 19, 2003 the Court issued an Opinion and Order dismissing certain of the claims against us with leave to amend. We accepted a settlement proposal on July 15, 2003 and we are awaiting Court approval. Under this settlement proposal, we may assign our claims against certain underwriters to the plaintiffs, and we would be dismissed from the lawsuit without paying any monetary damages.

      On June 6, 2002, Paul Cozza filed a Complaint in the United States District Court, District of Massachusetts, alleging breach of contract, fraud and bad faith arising out of a dispute concerning the licensing of certain technology used in the Virex 6.1 product. The Complaint seeks treble damages, attorneys’ fees and costs for the alleged unauthorized sale of products Cozza claims contain or contained his technology from and after January 1, 2002, and an injunction against the alleged further use of Cozza’s technology. McAfee filed papers in opposition to the Complaint and asserted various defenses. A motion by McAfee to compel arbitration and a motion for partial summary judgment on liability (but not damages) issues relating to whether the contract claims extended beyond the Virex 6.1 product, have both been denied by the Court. In its order denying the McAfee motion for partial summary judgment, the Court also granted a motion for partial summary judgment filed by Cozza in which Cozza sought a declaration that the language of an agreement is unambiguous and enforceable against any McAfee product which might be proved to contain that same technology referenced in a 1993 License Agreement. No trial date has been set, and discovery continues in anticipation of a trial either at the end of the first quarter, or during the second quarter, of 2006.

      On March 22, 2002, the Securities and Exchange Commission notified us that it has commenced a “Formal Order of Private Investigation” into our accounting practices. The SEC investigation is continuing, and we continue to provide documents and information to the SEC.

      In November 2002, the FASB issued Interpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee or indemnification. FIN 45 also requires additional disclosure by a guarantor in its interim and annual consolidated financial statements about its obligations under certain guarantees and indemnifications. The following is a summary of the agreements that we have determined are within the scope of FIN 45 as of June 30, 2005:

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      If we believe a liability associated with any of the aforementioned indemnifications becomes probable and the amount of the liability is reasonably estimable or the maximum amount of a range of loss is reasonably estimable, then an appropriate liability will be established.

Forward-Looking Statements; Trademarks

      Some of the statements contained in this Report on Form 10-Q are forward-looking statements that involve risks and uncertainties. The statements contained in this Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including, without limitation, statements regarding our expectations, beliefs, intentions or strategies regarding the future. All forward-looking statements included in this Report on Form 10-Q are based on information available to us on the date hereof. These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results to differ materially from those implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “targets,” “goals,” “projects,” “continue,” or variations of such words, similar expressions, or the negative of these terms or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Therefore, actual results may differ materially and adversely from those expressed in any forward-looking statements. Neither we nor any other person can assume responsibility for the accuracy and completeness of forward-looking statements. Important factors that may cause actual results to differ from expectations include, but are not limited to, those discussed in “Risk Factors.” We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

      This report includes registered trademarks and trade names of McAfee and other corporations. Trademarks or trade names owned by McAfee and/or our affiliates include, but are not limited to: “McAfee, McAfee Security, IntruShield, Foundstone, Entercept, PrimeSupport, AVERT, SpamKiller and VirusScan.”

      The following discussion should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this report. The results shown herein are not necessarily indicative of the results to be expected for the full year or any future periods.

      We are a leading supplier of computer security solutions designed to prevent intrusions on networks and protect computer systems from a large variety of threats and attacks. We offer two families of products, McAfee System Protection Solutions and McAfee Network Protection Solutions. Our computer security solutions are offered primarily to large enterprises, governments, small and medium-sized businesses and consumer users. We operate our business in five geographic regions: North America; Europe, Middle East and Africa, (collectively referred to as “EMEA”); Japan; Asia-Pacific, excluding Japan, and Latin America. See Note 10 to our condensed consolidated financial statements for a description of revenues and operating income by geographic region.

      We derive our revenue and generate cash from customers from primarily two sources (i) services and support revenue, which includes software license maintenance, training, consulting and on-line subscription arrangements revenue and (ii) product revenue, which includes software license, hardware and royalty revenue. In the three months ended June 30, 2005 and 2004, our net revenue was $245.4 million and $225.7 million, respectively, and our net income was $41.7 million and $10.2 million, respectively. In the six months ended June 30, 2005 and 2004, our net revenue was $481.1 million and $444.8 million, respectively, and our net income was $77.7 million and $68.2 million, respectively. Net income in the six months ended June 30, 2004 was favorably impacted by a $46.5 million gain from the sale of our Magic product line in January 2004 and insurance reimbursements of approximately $25.0 million relating to our previously settled class action lawsuit. Our net revenue is impacted by corporate IT, government and consumer spending levels. In addition to total net revenue and net income, in evaluating our business, management considers, among many other factors, the following:

      During the three and six months ended June 30, 2005, 42% and 41% of our total net revenue, respectively, was generated outside of North America. North America and EMEA collectively accounting for

approximately 84% and 85% of our total net revenue in the three and six months ended June 30, 2005, respectively. During the three and six months ended June 30, 2004, 36% and 38% of our net revenue, respectively, was generated outside of North America, with North America and EMEA collectively accounting for approximately 89% and 87% of our total net revenue in the three and six months ended June 30, 2004, respectively.

      See Note 10 to our condensed consolidated financial statements for a description of revenues on a product and service basis and a product family basis.