Are viruses really so bad?

The Internet application service provider for online security reported a strong quarter last week, as consumers flocked to the company's site, seeking to protect themselves from a trio of viruses. For its third quarter ended Sept. 30, McAfee.com doubled Wall Street estimates with a pro forma profit of 6 cents a share. The company is also one of the few profitable dot-coms around--no small feat considering the Sept. 11 terrorist attacks, a weak economy and malaise in the tech sector.

Despite all those worries, consumers are still buying antivirus software. McAfee.com targets consumers while its parent, Network Associates, which also reported a strong quarter, focuses on corporate network security. Network Associates took a part--about 17 percent--of McAfee.com public in December 1999.

McAfee.com's strong quarter had analysts gushing. Morgan Stanley's Chuck Phillips called McAfee.com a "fly in the buttermilk" and cheered the company's results. McAfee "was in the right place at the right time with a good product," Phillips said. "McAfee remains one of the few Internet business models that has worked and that has non-Internet stuff like profits and cash flow."

Analysts were also upbeat because McAfee.com boosted its subscription revenue. The company makes money from licensing its software and from subscriptions and advertising.

CNET News.com recently spoke with CEO Srivats Sampath, who anticipates that McAfee.com can become a "profit-generating machine" in the next two to three years.

Q: McAfee.com had some pretty impressive subscriber growth. Is that what fueled your quarter?
A: We have an entirely deferred revenue model, so for every subscriber that pays us today we recognize that revenue over the period of the subscription, which is usually one to two years. In our case, the subscribers are always a leading indicator of future business.

This quarter was phenomenal. We signed up 200,000 unique subscribers and sold over 300,000 subscriptions to those subscribers because we have multiple services, and customers buy more than one.

From an installed-base standpoint, we have 1.2 million unique subscribers, and we have sold to that 1.2 million base 1.4 million subscriptions. Today we're the largest Internet security service on the Internet.

What pushed the subscribers? Was it Nimda? Fears about terrorism?
I don't think it had anything to do with terrorism and the Sept. 11 tragedy. From a standpoint of what really delivered on the paid subscribers, I think it was the traffic we had on the Web site, and we had three really good viruses. We had the SirCam virus, the Code Red virus and the Nimda virus, which all contributed to the subscriber base. We acquire subscribers at a healthy clip on normal days, but on virus days it goes up a couple notches.

What's your average number of subscribers for one day?
We don't disclose that information, but we did have 100,000 unique subscribers last quarter. Our highest to date has been 175,000 per quarter.

So basically the three viruses helped you double your subscribers.
Yes.

In your press release and conference call there was a lot of talk of premium services. What is the success rate there? What are the chances of a subscriber getting an additional service?
We penetrated our base to slightly less than 20 percent. There's a lot more we can do. It has to go up. We're learning, and we're a bunch of technologists learning to sell subscriptions to consumers, the "soho" (small-office, home-office) market, and the small to medium-sized business market. There are two axes we can grow on. One is to get more customers, which is always great. The other is to sell more services to our existing subscribers. Our goal in the next year or so is to have every subscriber buy 1.5 services from us.

How do you plan on getting people to buy more services?
One is to convey the value proposition to them. People realize they need managed antivirus software, and now we have to educate them on personal firewall services and managed privacy services. How do you protect your services? How do you protect your identity from getting stolen? Things like that. There's a whole slew of services we're planning on in the next two to four quarters. All of it revolves around four categories: antivirus, anti-hacker, anti-abuse, and anti-theft, or how do I prevent my data from being stolen.

Antivirus is already huge. Out of those other categories what do you see as the next big worry for consumers?
I think the firewall is going to be important as people go more and more broadband. The always-on component of broadband makes it extremely vulnerable. When I installed DSL on my system, I was probed and pinged 93 times in an hour and a half. Even for me it was pretty unnerving. There are people trying to see my shares. What people don't realize is that beyond your Internet connection and PC, there's a pretty wild world out there.

What kind of growth outlook do you have?
For the next quarter, we are taking up our earnings estimate by a penny and reiterated guidance for next year, saying revenue will be $80 million to $90 million and earnings of 18 cents and 24 cents a share.

Who is your major competition?
Because we're a Web service, we haven't seen anyone in this space yet, as far as being directly competitive with our technology and delivery model. Having said that, from a pure solutions standpoint, the only other competitor is Symantec.

What's the division of your customer base in terms of consumers and small-office, home-office users?
Today, we are almost 95 percent consumer. We started our small to medium-sized (business) initiatives in the second quarter of this year. In (the second quarter) we acquired 1,000 small businesses. Last quarter, we acquired another 1,200 to 1,300 businesses. Over the next year we will see a tremendous amount of traffic in this (small-office, home-office) space. A year from now we expect soho to contribute 20 percent to 25 percent of our revenue. Today, most of it is consumer.

Let's talk about your relationship with Network Associates. Network Associates did an initial public offering for McAfee.com, and now you're doing well. Is there any benefit anymore to having two separate companies?
There's a lot of benefit. One, it gives us tremendous focus. Second is we don't hit their P&L (profit and loss) statement. In the early days, when we were making tremendous losses, it didn't make sense to be put under Network Associates. Now that we are profitable, the same holds true. They consolidate us anyway for reporting purposes. We're like an independent subsidiary that just happens to have currency that is liquid.

It has its benefits. The benefits are we are very focused, and when you are a public company you are committed to running a good business and creating shareholder value. What we have proven is that we have come from nowhere to being a $60 million to $70 million company in three years. It's a case study of how you can take an under-appreciated value in a company and totally spin it out.

Is there any chance that McAfee.com and Network Associates will compete?
We always have that risk, and we have had quite a few instances where we both have hit the customer at the same time. These are all people we've worked with in the past, so either (Network Associates) will pick up the phone and say, "We'll pick up the deal," or we'll call and say, "We'll pick up the deal." It's a very healthy environment where we work together. The important thing here is we don't try to compete with each other for that same customer. There are bigger fish to fry.