F-1/A 1 d218946df1a.htm AMENDMENT NO. 2 TO FORM F-1 AMENDMENT NO. 2 TO FORM F-1
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As filed with the Securities and Exchange Commission on January 27, 2012

Registration No. 333-178992

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Amendment No. 2

to

FORM F-1

REGISTRATION STATEMENT UNDER

THE SECURITIES ACT OF 1933

 

AVG Technologies N.V.

(Exact name of Registrant as specified in its charter)

Not Applicable

(Translation of Registrant’s name into English)

The Netherlands   7372   Not Applicable

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

Gatwickstraat 9-39

1043 GL Amsterdam

The Netherlands

+31-20-5226210

(Address, including zip code, and telephone number, including area code, of Registrant’s principal executive offices)

 

AVG Technologies USA, Inc.

1 Executive Drive, 3rd Floor

Chelmsford, MA 01824, USA

(978) 319-4460

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

Copies to:

Bruce Dallas, Esq.

John Meade, Esq.

Davis Polk & Wardwell LLP

1600 El Camino Real

Menlo Park, CA 94025

(650) 752-2000

 

Aaron Alter, Esq.

Tony Jeffries, Esq.

Steven Bernard, Esq.

Wilson Sonsini Goodrich & Rosati,

Professional Corporation

650 Page Mill Road

Palo Alto, CA 94304

(650) 493-9300

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after the effective date of this registration statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨

 

CALCULATION OF REGISTRATION FEE

 

Title of each class of securities to be registered   Amount to
be registered(1)
  Proposed maximum
aggregate offering
price per share
  Proposed maximum
aggregate offering
price(2)(3)
  Amount of
registration fee

Ordinary shares, nominal value €0.01 per share

  9,200,000   $18.00   $165,600,000.00   $18,977.76(4)

 

  (1)   Includes 1,200,000 shares that the underwriters have the option to purchase to cover over-allotments, if any.
  (2)   Estimated solely for the purpose of determining the amount of registration fee in accordance with Rule 457(a) under the Securities Act of 1933, as amended.
  (3)   Includes offering price of shares that the underwriters have the option to purchase to cover over-allotments, if any.
  (4)   Previously paid.

The Registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Commission, acting pursuant to such Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. Neither we nor the selling shareholders may sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and we and the selling shareholders are not soliciting an offer to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PROSPECTUS (Subject to Completion)

 

Issued January 27, 2012

 

8,000,000 Shares

 

LOGO

 

ORDINARY SHARES

 

 

 

AVG Technologies N.V. is offering 4,000,000 ordinary shares and the selling shareholders named in this prospectus are offering 4,000,000 ordinary shares. We will not receive any proceeds from the sale of the ordinary shares by the selling shareholders. This is our initial public offering and no public market exists for our ordinary shares. We anticipate that the initial public offering price will be between $16.00 and $18.00 per ordinary share.

 

 

 

We have applied for a listing of our ordinary shares on the New York Stock Exchange under the symbol “AVG.”

 

 

 

Investing in our ordinary shares involves risks. See “Risk Factors” beginning on page 13.

 

 

 

PRICE $                 A SHARE

 

 

 

     Price to Public      Underwriting
Discounts and
Commissions
     Proceeds
to us
     Proceeds
to Selling
Shareholders
 

Per Share

   $                    $                    $                    $                

Total

   $                    $                    $                    $                

 

The underwriters may also purchase up to 1,200,000 ordinary shares from certain of the selling shareholders within 30 days to cover over-allotments, if any. See “Underwriting.”

 

The U.S. Securities and Exchange Commission and state securities regulators have not approved or disapproved these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The underwriters expect to deliver the ordinary shares to purchasers on                     , 2012.

 

 

 

MORGAN STANLEY    J.P. MORGAN    GOLDMAN, SACHS & CO.

 

 

 

   ALLEN & COMPANY LLC   

 

 

 

COWEN AND COMPANY     JMP SECURITIES

 

                    , 2012.


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LOGO

Bringing peace of mind

to our connected world.

More than 106 million users

Over 185 countries

We Protect Us TM

AVG


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LOGO


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TABLE OF CONTENTS

 

     Page  

Our Business

     97   

Management

     118   

Related Party and Other Transactions

     130   

Principal and Selling Shareholders

     131   

Description of Share Capital

     134   

Shares Eligible for Future Sale

     154   

Material Tax Considerations

     155   

Underwriting

     164   

Legal Matters

     171   

Experts

     171   

Enforceability of Civil Liabilities

     171   

Where You Can Find More Information

     173   

Index to Consolidated Financial Statements

     F-1   
 

 

 

 

You should rely only on the information contained in this prospectus or in any free-writing prospectus we may authorize to be delivered or made available to you. We, the selling shareholders and the underwriters have not authorized anyone to provide you with additional or different information. We and the selling shareholders are offering to sell and seeking offers to buy ordinary shares only in jurisdictions where offers and sales are permitted. The information in this prospectus or a free-writing prospectus is accurate only as of its date, regardless of its time of delivery or of any sale of ordinary shares. Our business, financial condition, results of operations and prospects may have changed since that date.

 

Through and including                     , 2012 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

Unless otherwise indicated or the context otherwise requires, all references in this prospectus to “AVG” or the “Company,” “we,” “our,” “ours,” “us” or similar terms refer to AVG Technologies N.V. and its subsidiaries, or if before November 25, 2011, to our predecessor company and former wholly owned subsidiary AVG Technologies N.V. and its subsidiaries. See “Description of Share Capital—Historical Development of the Issuer, AVG Technologies N.V.” and “Description of Share Capital—Historical Development of Our Predecessor Company, AVG Technologies N.V.” AVG®, LinkScanner®, TuneUp and our logo are our key brands, and are variously registered in several jurisdictions. This prospectus contains references to these and others of our marks and those of other entities and these references may omit the ® or ™ symbols solely for convenience. Such references are not intended, however, to imply that we will not enforce our rights in any of our marks to the fullest extent permitted by law. All references to the “selling shareholders” refer to the selling shareholders as set forth in the section of this prospectus titled “Principal and Selling Shareholders.”

 

No action is being taken in any jurisdiction outside the United States to permit a public offering of our ordinary shares or possession or distribution of this prospectus in any such jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to those jurisdictions.

 

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PROSPECTUS SUMMARY

 

This summary highlights information contained elsewhere in this prospectus. This summary may not contain all the information that may be important to you and we urge you to read this entire prospectus carefully, including the “Risk Factors,” “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections and our consolidated financial statements and notes to those statements, included elsewhere in this prospectus, before deciding to invest in our ordinary shares.

 

OUR BUSINESS

 

Our Mission

 

Our mission is to simplify, optimize and secure the Internet experience, providing peace of mind to a connected world. Our powerful yet easy-to-use software and online services put users in control of their Internet experience. By choosing our solutions, users become part of a trusted global community that benefits from inherent network effects, mutual protection and support.

 

Our Business

 

We provide software and online services that deliver peace of mind to users by simplifying, optimizing and securing their Internet experiences. Our business model, based on delivering high-quality solutions in high volume and at no cost to our users, enables us to rapidly acquire new users. Through our large user community, we are able to better understand the needs of our users, become a trusted provider of peace-of-mind software solutions, and thereby intelligently monetize our user base through premium products and value-added online services. Our solutions, which today range from desktop, laptop and mobile security software to dynamic secure Internet search solutions, can be accessed and utilized with minimal effort and limited technical know-how from the user. In choosing our solutions, which can be downloaded from the Internet, users become part of a trusted global community that benefits from network effects such as the mutual protection and support of a large user base. Our sales and marketing activities benefit from word-of-mouth recommendations from our large user network to create a viral marketing effect, which is amplified by the speed and ease of use of our products and allows us to gain new customers at a low acquisition cost. This strategy has allowed us to grow our user base to approximately 106 million active users as of September 30, 2011.

 

We believe that our community of approximately 106 million active users is one of our most valuable assets. We establish a trusted relationship with our community through our solutions with the goal of driving greater user engagement. Community engagement provides important contributions to our product development initiatives, enables rapid response to online threats and assists in our customer support initiatives, enabling us to accurately deliver compelling products and online services that meet the evolving needs of our users. The contributions from our community lower our costs, enabling us to offer free and low-cost offerings that further build upon the value we can deliver. We believe further monetization of our user base through online services represents a significant market opportunity for us.

 

Our product portfolio targets the consumer and small business markets and includes Internet security, PC performance optimization, online backup, mobile security, identity protection and family safety software. While a significant majority of our active users have been users of our free products and online services, we also offer products with premium functionality and enhanced customer support when customers purchase an annual or multi-year subscription. As of September 30, 2011, we had approximately 15 million subscription users. In addition, our online services, accessed primarily through our browser toolbar, provide dynamic secure search capabilities through agreements with leading Internet search providers. We have been successful in growing our product portfolio over time through internal development and select acquisitions. For instance, in 2011, we launched AVG Mobilation for Android-based mobile phones, AVG LiveKive, a cloud-based storage, sync and

 

 

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share solution and MultiMi, an innovative solution to streamline the various ways our users engage in online communication. In addition, we acquired TuneUp Software GmbH, or TuneUp, a leading provider of PC optimization software, in August 2011 to improve our existing optimization offering.

 

We distribute our products primarily online, which allows us to generate high-margin revenue from direct distribution of our premium products and search agreements with third-party search providers. We also have a global network of resellers and distributors, including CNET, Ingram Micro and Wal-Mart. In 2010 and for the nine months ended September 30, 2011, 69.4% and 74.2%, respectively, of our revenue was generated online, with the remainder generated through resellers and distributors. AVG Antivirus Free Edition has been downloaded more times than any other software on CNET’s Download.com website.

 

Our revenue has grown from $113.8 million in 2008 to $217.2 million in 2010, representing a compound annual growth rate, or CAGR, of 38.1%. During this same period, our adjusted net income grew from $33.1 million to $67.2 million, representing a CAGR of 42.5%, and our free cash flow grew from $60.3 million to $76.2 million, representing a CAGR of 12.4%. For the nine months ended September 30, 2011, we generated revenue of $198.1 million, adjusted net income of $104.8 million and free cash flow of $66.2 million. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Metrics” below for discussions of adjusted net income and free cash flow as measures outside generally accepted accounting principles in the United States, or U.S. GAAP, and reconciliations of these measures to net income and net cash provided by operating activities, respectively. Other than the initial start-up capital provided by our founder, we have not raised equity financing for our operations. Our net cash provided by operations has been sufficient to fund our growth to date. As of September 30, 2011, our total shareholders’ deficit was $321.0 million, or $130.9 million as adjusted to give effect to conversion of our preferred shares upon the closing of this offering, with the shareholders’ deficit being principally a result of the aggregate of $557.5 million in dividends and distributions in excess of capital paid since January 1, 2008.

 

Our Opportunity

 

The Internet has transformed how information is created, accessed and shared. New platforms for finding information, communicating and collaborating have emerged. These platforms, including Internet search engines, social networks and cloud computing, have fundamentally changed the way people communicate, obtain information and engage with each other, in addition to increasing the time users spend online. Consumers and businesses today rely on the Internet as an integral component of their daily lives. However, the accelerating growth in online activity has attracted the attention of hackers and other nefarious groups, fueling online security attacks that are increasingly severe, frequent and sophisticated. Today’s online threats are increasingly driven by criminal enterprises targeting personal and corporate information to drive monetary gain.

 

Furthermore, while users have continued to embrace the Internet and its expanding utility, they are encountering a significantly more complex Internet experience. The growth of Internet services has increased user concern about the level of trust they place in their online engagements. The Internet has continued to see a massive increase in the amount of data available and the diversity of online destinations, creating challenges for users who are trying to better use information and resources to improve their lives. In addition, users who were previously connected online with just their desktop computers are now connecting, often up to 24 hours a day, through their smartphones, tablet devices and other Internet-enabled devices. As a result, users must now manage their data across a wide array of connected devices.

 

Users today must also navigate through an ever-increasing number of browsers, plug-ins, websites and desktop, laptop and mobile applications, often leading to frustrating user experiences. In turn, software vendors have released a profusion of applications and other Internet services, requiring users to sift through even more options. It is becoming increasingly difficult for users to identify the trusted solutions they need to simplify, optimize and secure their Internet experiences.

 

 

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Our Business Model

 

We believe our business model affords us a significant competitive advantage. We employ a business model that leverages our large and engaged user base, low-cost Internet-based distribution and cost-effective research and development. Benefiting from viral marketing, user-generated product feedback and community support, we continuously improve product quality and user experience and add new users at a low cost of acquisition. This, in turn, improves our monetization potential and allows for incremental investment in product innovation and marketing for future growth. These business model characteristics drive scalable growth, robust operating margins and strong cash flow generation.

 

Key components of our business model are:

 

   

Large and growing user base driving tangible benefits. The size and growth of our user base and the amount of information generated by our users increase the value of our offerings and drive tangible business results. We seek to drive greater user engagement with our solutions by delivering peace of mind and, over the long term, building a relationship based on trust. We believe this is critical to building a user base that can be monetized effectively. As our users are actively engaging with each other, they provide a first level of community support as well as real-time product feedback that contributes to product innovation, as reflected in our slogan, “We Protect Us.”

 

   

Easy-to-use, high-quality free and premium products that enable the business model. Our business model is built on high-quality products that can be deployed or accessed with minimal effort, while providing a compelling and robust user experience. We focus on developing products that spread virally, are highly sticky and ultimately drive increased user engagement with our platform. We provide no- or low-cost solutions to facilitate rapid user adoption. We then seek to up-sell or cross-sell premium products to our user base.

 

   

Monetization and expansion of our user base through value-added free online services. Since March 2008, we have deployed our dynamic secure search solution to our online community as part of a value-added service enabling secure search of the Internet. While our dynamic secure search is free to our users, we generate revenue through agreements with search providers, such as Google, to which we direct search queries to generate search results.

 

   

Cost-effective marketing and low customer acquisition cost. Our business benefits from cost-effective marketing and online distribution channels. By leveraging our large user base and high customer satisfaction, we are able to achieve powerful viral marketing at low cost. We also distribute through resellers and distributors, which we refer to as our reseller network. The end-sellers of our solutions in this reseller network vary from large retail stores, such as Wal-Mart, to small individual retailers, both online and offline. This reseller network forms a part of our brand marketing strategy and generates the majority of our small business sales. We believe that our presence among retailers contributes significantly to consumer awareness of our brand. In 2010 and for the nine months ended September 30, 2011, we generated 30.6% and 25.8%, respectively, of our revenue through our reseller network.

 

   

Proven track record of execution, monetization and innovation. As one of the largest software vendors employing a free-to-pay model, we have a proven track record of execution over two decades. Whether through organic development or technology acquisitions, we continue to add products and online services that simplify, optimize and secure our users’ Internet experience.

 

 

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Our Growth Strategy

 

The key elements of our strategy are:

 

   

Increase monetization by leveraging our existing large user base. We intend to leverage our user base of approximately 106 million active users to further monetize our platform. As part of our strategy, we plan to sell compelling premium products and services to our current user base and provide additional platform monetization solutions beyond dynamic secure search. As an example of our monetization, our revenue per active user increased from $1.53 for the twelve months ended December 31, 2008 to $2.21 for the twelve months ended December 31, 2010, and from $1.63 for the nine months ended September 30, 2010 to $1.94 for the nine months ended September 30, 2011. Over these periods, the main driver of increased revenue per active user has been successful implementation of our platform monetization strategy, including the launch and user adoption of our dynamic secure search solution. In the nine months ended September 30, 2011, we have added products including TuneUp, MultiMi and AVG LiveKive, expanding our platform beyond internet security and creating opportunities to up-sell or cross-sell a variety of other products and online services to our user base.

 

   

Drive greater user engagement and targeted product development. We are focused on driving user engagement, and, through a compelling suite of solutions, engendering trust in our brand. We intend to increase user engagement, which we define as the amount of time our users are using and interacting with our products, primarily by innovating compelling solutions that become an increasingly fundamental part of a user’s daily life on the Internet. By increasing user engagement, and leveraging the anonymous user and traffic data we receive through our solutions to deliver highly relevant products and online services, we believe that we can enhance our platform monetization potential.

 

   

Broaden our portfolio of solutions. We have built a strong reputation and brand name in the technology industry and, most importantly, with consumers and small businesses, for continuous product innovation and technological advances. Our objective is to continue to enhance and broaden our product portfolio to address our users’ evolving needs, ultimately driving greater user base growth, enhancing product stickiness and increasing revenue from user adoption through diversification beyond our security solutions. Our acquisition of TuneUp in August 2011 to improve our PC optimization software solution is a recent example of our pursuit of this strategy.

 

   

Grow and retain our user base. We are one of the largest active user communities on the Internet and we seek to continue to grow our user base. We focus on developing solutions that serve as low-cost user acquisition vehicles, such as our current security software. For example, in the third quarter of 2011, we released a standalone AVG Toolbar that can be installed without our security solutions. This standalone toolbar is being distributed through select distribution partners, allowing us to grow our user base and drive the volume of search through our platform without the need to use security software to drive customer acquisition. We also intend to pursue additional customer acquisition strategies. We believe our online free solutions enable viral marketing, which leverages the inherent network effects of our business model. Finally, we intend to increase our investment in sales and marketing to further build brand awareness.

 

   

Continue to expand capabilities for mobile markets. The proliferation of mobile devices has created a diverse computing environment for users. We intend to provide products and services that deliver functionality currently available for our desktop and laptop users to mobile devices, particularly smartphones and tablets. In March 2011, we launched AVG Mobilation to address the security needs of users of the Android platform. To date, our solutions are one of the two most popular security products for the Android platform.

 

   

Increase our presence in the small business market. We intend to increase our presence in the small business market. We expect to continue to develop our offerings by adding features and functionalities tailored towards this customer segment, such as security delivered through a software-as-a-service model.

 

 

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Risks Associated With Our Business

 

Our business is subject to numerous risks and uncertainties of which you should be aware before making an investment decision. These risks are discussed more fully in the section titled “Risk Factors,” and include but are not limited to the following:

 

   

Our business model is evolving and we may be unable to monetize our active user base sufficiently to increase or maintain our profitability.

 

   

We must maintain our relationships with our existing users and attract new users if we are to continue to expand and improve the quality of our user base, which we may be unable to do.

 

   

Our search-traffic program is crucial to our effort to monetize more of our active user base and this program is vulnerable to technological change and reliance on one major search provider.

 

   

If we are unable to maintain and enhance our brand, our business and operating results may be harmed.

 

   

We are subject to fluctuations in demand for our products and online services as a result of numerous factors, most of which are beyond our control.

 

   

Any failure or perceived failure to anticipate, prepare for and respond promptly to technological developments and the changing nature of online security threats could harm our competitive position and business prospects.

 

   

If our upgrades and new products and online services, whether acquired or internally developed, fail to achieve widespread market acceptance, our competitive position and business prospects will be harmed.

 

   

A significant percentage of our total revenue comes from purchases of subscriptions to our premium products, which must by their terms be renewed by our users to remain in force.

 

   

We operate in highly competitive markets and many of our competitors have significantly greater resources than we do.

 

   

Our failure to adequately protect our users’ personal information could have a material adverse effect on our business.

 

   

Our future revenue depends on our ability to continue to market to new users, which we may not be able to accomplish on a cost-effective basis or at all.

 

   

Accurately measuring the number and retention of our active and subscription users is difficult and our failure to accurately measure the number and retention of these users at any time will compromise our ability to monitor our key performance indicators, which in turn could adversely affect our ability to manage our business.

 

Recent Developments

 

The following financial data regarding our revenue for the quarter ended December 31, 2011 is preliminary, based upon our estimates and subject to completion of our financial closing procedures. This data has been prepared by and is the responsibility of management. This summary is not a comprehensive statement of our financial results for this quarter and our actual results may differ from these estimates due to the completion of our financial closing procedures and related adjustments and other developments that may arise between now and the time the financial results for this period are finalized.

 

Revenue for the quarter ended December 31, 2011 is expected to be between $70.0 million and $73.0 million, which would represent an increase of between 21.9% and 27.1% from revenue of $57.4 million for the quarter ended December 31, 2010. We have provided a range for the preliminary results for revenue because our

 

 

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financial closing procedures for the quarter ended December 31, 2011 are not yet complete and, as a result, we expect that our final results upon completion of our closing procedures will vary from our preliminary estimates within the ranges as described above. We are not able to provide a comparable estimated range for other financial results for the quarter ended December 31, 2011 as we have not yet determined certain line items used to calculate such results beyond those used to calculate revenues.

 

Primarily due to the effect of acquisition accounting rules in connection with our acquisition of TuneUp, as well as an increase in sales and marketing expense, an increase in general and administrative expense associated with our ongoing preparations to become a public company, and the effect of other acquisition activity during the quarter ended December 31, 2011, we expect that for the quarter ended December 31, 2011, our net income will be at or below break-even, and our adjusted net income will be near break-even before giving effect to the potentially favorable accounting impact of TuneUp’s results falling below contractually agreed earn-out targets and certain tax-related charges associated with the fiscal consolidation of AVG Holding Coöperatief U.A. and AVG Technologies N.V. in November 2011. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Metrics” for a discussion of adjusted net income as a measure outside U.S. GAAP; “Unaudited Pro Forma Combined Financial Information” for a description of factors that affect our ability to recognize TuneUp deferred revenue at historical levels; and “Our Business—Research and Development—Key acquisitions” and “Our Business—Marketing and Sales—Marketing and sales acquisitions” for further detail on our acquisitions during the quarter ended December 31, 2011.

 

CORPORATE INFORMATION

 

We are a public company with limited liability (naamloze vennootschap) incorporated under the laws of the Netherlands. Our articles of association will be amended and restated entirely on or prior to the closing of this offering; references to our articles of association in this prospectus are to the articles of association as so amended and restated. We are registered with the Trade Register of the Chamber of Commerce of Amsterdam under number 52197204 and have an official seat in Amsterdam, the Netherlands. Our registered office address is at Gatwickstraat 9-39, 1043 GL Amsterdam, the Netherlands, with telephone number +31 (0)20 522 6210. Our principal executive offices are located at that address and at Karla Engliše 3219/4, 150 00 Praha 5, Czech Republic, with telephone number +42 (0)72 569 5114. Our principal website address is www.avg.com. The information contained in our website or that can be accessed through our website neither constitutes a part of this prospectus nor is incorporated by reference herein.

 

 

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THE OFFERING

 

Issuer

  

AVG Technologies N.V.

Ordinary shares offered by us

  

4,000,000 ordinary shares.

Ordinary shares offered by the selling shareholders

  

4,000,000 ordinary shares.

Over-allotment option

   Certain of the selling shareholders have granted the underwriters the right to purchase up to an additional 1,200,000 ordinary shares within 30 days of the date of this prospectus to cover over-allotments, if any, in connection with this offering.

Ordinary shares to be outstanding after this offering

  

54,382,591 ordinary shares.

Listing

   We have applied to list our ordinary shares on the New York Stock Exchange, or NYSE, under the symbol “AVG.”

Use of proceeds

   We estimate that the net proceeds to us from this offering will be approximately $53.7 million, based on an assumed initial public offering price of $17.00 per share, the midpoint of the price range set forth on the front cover of the prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us. We intend to use the proceeds of this offering for general corporate purposes, which may include future acquisitions. See “Use of Proceeds.
   We will not receive any of the net proceeds from the sale of ordinary shares by the selling shareholders.

Dividend policy

   All ordinary shares carry full dividend rights if and when declared from the date the holder acquires such ordinary shares. We currently intend to retain future earnings, if any, to finance the growth and development of our business and to provide additional liquidity. In addition, our term loan facility restricts the payment of dividends to holders of our ordinary shares. As a result, we currently have no intention to pay dividends apart from payment of accrued and unpaid dividends on our Class D preferred shares in connection with the automatic conversion of such preferred shares into ordinary shares upon the closing of this offering. The amount of such accrued dividends will be equal to (1) approximately $1.8 million, which would have been the amount of accrued dividends if the closing had occurred on December 31, 2011, plus (2) approximately $20,000 per day for the period from December 31, 2011 to the date of the closing. See “Dividend Policy” and “Description of Share Capital.

Risk factors

   See “Risk Factors” and the other information included in this prospectus for a discussion of factors you should consider before deciding to invest in our ordinary shares.

 

 

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The total number of ordinary shares that will be outstanding immediately after this offering is calculated based on 48,000,000 ordinary shares outstanding as of September 30, 2011 and:

 

   

includes 2,382,591 ordinary shares issuable upon the exercise of certain options outstanding as of September 30, 2011, at a weighted-average exercise price of $0.13 per share, which are held by certain of the selling shareholders and are expected to be exercised at the closing of this offering, 650,000 of which are being sold in the offering for the purpose of payment of the exercise price of these options and certain potential associated tax liabilities (see “Principal and Selling Shareholders”);

 

   

excludes 1,710,029 ordinary shares issuable upon the exercise of options outstanding as of September 30, 2011, at a weighted-average exercise price of $15.68 per share, which are not expected to be exercised at the closing of this offering;

 

   

excludes 554,638 ordinary shares issuable upon the exercise of options that have been granted since September 30, 2011, at a weighted average exercise price of $23.37, which are not expected to be exercised at the closing of this offering;

 

   

excludes 806,760 ordinary shares issuable to the sellers of TuneUp immediately upon the closing of this offering, assuming an initial public offering price of $17.00 per share, the midpoint of the price range set forth on the front cover of this prospectus, and a euro/U.S. dollar exchange rate of $1.27 per euro, which shares will remain in escrow following this offering subject to satisfaction of certain vesting criteria, including continuing employment by TuneUp of the sellers of TuneUp;

 

   

excludes 1,366,351 ordinary shares issuable upon the exercise of options expected to be granted immediately following the pricing of this offering to certain members of our management and supervisory boards, certain members of senior management and certain other employees at an exercise price equal to the initial public offering price; and

 

   

excludes 2,146,339 additional ordinary shares reserved for issuance under our amended and restated option plan.

 

Unless otherwise indicated, all information contained in this prospectus assumes:

 

   

no exercise of the option granted to the underwriters by certain of the selling shareholders to purchase up to 1,200,000 additional ordinary shares to cover over-allotments, if any, in connection with this offering;

 

   

an initial public offering price of $17.00 per share, the midpoint of the price range set forth on the front cover of this prospectus; and

 

   

the automatic conversion upon the closing of this offering of all classes of our outstanding shares into the same number of ordinary shares, with all special rights associated with the existing classes of shares ceasing to be applicable, such conversion referred to as the Share Conversion, and the payment in cash of accrued and unpaid dividends on our Class D preferred shares in connection with such conversion. See “Description of Share Capital—Share Capital—Share Conversion.

 

 

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SUMMARY HISTORICAL CONSOLIDATED FINANCIAL AND OTHER DATA

 

We have derived the following consolidated statement of comprehensive income data for 2008, 2009 and 2010 from our audited consolidated financial statements included elsewhere in this prospectus. The financial data for the nine months ended September 30, 2010 and 2011 have been derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus, which have been prepared on a basis consistent with our annual audited consolidated financial statements. You should read the consolidated financial data and other operating metrics set forth below in conjunction with our consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our reporting currency is the U.S. dollar. Our historical results are not necessarily indicative of our results to be expected in any future period. We have prepared our financial statements in this prospectus in accordance with U.S. GAAP.

 

    Year ended December 31,     Nine months ended
September 30,
 
    2008     2009     2010     2010     2011  
    (in thousands, except for share data and per share data)  
                      (unaudited)  

Statement of Comprehensive Income Data and Other Operating Metrics:

         

Revenue:

         

Subscription

  $ 104,762      $ 151,365      $ 166,904      $ 125,417      $ 130,071   

Platform-derived

    9,079        30,603        50,314        34,373        68,022   

Total revenue

    113,841        181,968        217,218        159,790        198,093   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cost of revenue:(1)

         

Subscription

    24,458        30,112        26,686        19,736        17,287   

Platform-derived

           1,308        2,293        1,801        6,517   

Total cost of revenue

    24,458        31,420        28,979        21,537        23,804   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    89,383        150,548        188,239        138,253        174,289   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:(1)

         

Sales and marketing

    26,963        45,988        58,562        39,007        53,904   

Research and development

    13,725        19,533        23,364        16,730        24,478   

General and administrative

    18,997        24,404        40,683        29,371        35,984   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    59,685        89,925        122,609        85,108        114,366   

Operating Income

    29,698        60,623        65,630        53,145        59,923   

Other income (expense), net

    1,313        (1,600     1,722        1,377        (12,278
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes and loss from investment in equity affiliate

    31,011        59,023        67,352        54,522        47,645   

Benefit (Provision) for income taxes

    (1,643     (6,538     (9,394     (6,748     52,212   

Loss from investment in equity affiliate

                  (46            (180
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net Income

    29,368        52,485        57,912        47,774        99,677   

Preferred share dividends

           (1,802     (7,210     (5,407     (5,406

Distributed and undistributed earnings to preferred shares

                  (12,676     (10,592     (27,513
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to ordinary shareholders

  $ 29,368      $ 50,683      $ 38,026      $ 31,775      $ 66,758   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per ordinary share—basic(2)

  $ 0.65      $ 1.19      $ 1.06      $ 0.88      $ 1.85   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per ordinary share—diluted(2)

  $ 0.62      $ 1.09      $ 0.99      $ 0.82      $ 1.72   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average ordinary shares outstanding—basic(2)

    45,000,000        42,750,000        36,000,000        36,000,000        36,000,000   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

 

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    Year ended December 31,     Nine months ended
September 30,
 
    2008     2009     2010     2010     2011  
    (in thousands, except for share data and per share data)  
                      (unaudited)  

Weighted-average ordinary shares outstanding—diluted(2)

    47,423,334        48,155,490        38,585,664        38,519,783        38,837,773   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared per ordinary share(3)

  $ 0.44      $ 3.28      $ 0.83      $ 0.83      $ 4.53   

Cash dividends declared per preferred share

  $      $      $ 1.43      $ 1.28      $ 4.98   

Pro forma earnings per share (unaudited)(4)

         

Basic

      $ 0.79        $ 1.39   
     

 

 

     

 

 

 

Diluted

      $ 0.75        $ 1.31   
     

 

 

     

 

 

 

Weighted-average number of ordinary shares used in pro forma computation (unaudited)

         

Basic

        48,000,000          48,000,000   
     

 

 

     

 

 

 

Diluted

        50,585,664          50,837,773   
     

 

 

     

 

 

 

Other operating metrics:

         

Adjusted net income(5) (unaudited)

  $ 33,084      $ 62,796      $ 67,192      $ 54,380      $ 104,836   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

  $ 64,282      $ 79,483      $ 87,911      $ 61,843      $ 62,716   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

  $ (3,318   $ (19,157   $ (15,340   $ (9,296   $ (46,552
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities

  $ (21,522   $ (71,702   $ (54,367   $ (51,993   $ (6,963
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow(6) (unaudited)

  $ 60,299      $ 72,680      $ 76,196      $ 56,526      $ 66,244   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1)   We have recognized employee share-based compensation in the consolidated statements of comprehensive income as follows:

 

     Year ended December 31,      Nine months ended
September 30,
 
     2008      2009      2010      2010      2011  
     (in thousands)  
                          (unaudited)  

Cost of revenue

   $ 85       $ 178       $ 61       $ 46       $ 17   

Sales and marketing

     604         2,520         2,049         1,323         614   

Research and development

     514         1,108         1,008         608         1,019   

General and administrative

     1,006         4,483         3,655         2,871         1,362   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total share-based compensation expense

   $ 2,209       $ 8,289       $ 6,773       $ 4,848       $ 3,012   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

  (2)   The shares issued in March 2009, which had the effect of a 10 for 1 share split, are considered as outstanding for purposes of calculating earnings per ordinary share and weighted-average ordinary shares outstanding in 2008, as this issuance of shares was in substance a recapitalization of our share capital.
  (3)   The shares issued in March 2009, which had the effect of a 10 for 1 share split, are considered as outstanding for purposes of calculating cash dividends declared per ordinary share in 2008, as this issuance of shares was in substance a recapitalization of our share capital.
  (4)   The pro forma presentation reflects the automatic conversion upon the closing of this offering of all classes of our outstanding shares into the same number of ordinary shares.

 

 

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  (5)   Adjusted net income is defined as net income for the period, adding back share-based payments and acquisition-related intangible asset amortization expense less the consequent effect of taxes on such adjustments. For a reconciliation of adjusted net income to net income, the most comparable U.S. GAAP measure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-U.S. GAAP Measures—Adjusted net income.
  (6)   Free cash flow is defined as net cash provided by operating activities less capital expenditures (which we define as being made up of payments for property and equipment and intangible assets) less interest income (expense), net. For a reconciliation of free cash flow to net cash provided by operating activities, the most directly comparable U.S. GAAP financial measure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-U.S. GAAP Measures—Free cash flow.

 

     For the year
ended or as of
December 31,
     For the nine months
ended or as of
September 30,
 
         2008              2009              2010              2010              2011      
     (unaudited, users in millions)  

User metrics:

              

Active users(1)

     83         99         98         98         106   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Subscription users(2)

     10         10         12         12         15   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Revenue per average active user(3)

   $ 1.53       $ 2.00       $ 2.21       $ 1.63       $ 1.94   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

  (1)   Active users are those who (i) have downloaded and installed our free software on a PC or mobile device and have connected to our server twice in the preceding 30-day period or (ii) have a valid subscription license for our software. For further detail on our definition and counting of active users, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Metrics—Active and subscription users.
  (2)   Subscription users are a subset of active users who subscribe to one or more of our premium products. Payments from subscription users make up the substantial majority of subscription revenue. For further detail on our definition and counting of subscription users, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Metrics—Active and subscription users.
  (3)   The number of average active users is calculated as the simple average of active users at the beginning of a period and the end of a period.

 

The following table presents selected consolidated balance sheet data as of September 30, 2011:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect the conversion of all outstanding shares into 48,000,000 ordinary shares upon the closing of this offering, and the payment in cash of accrued and unpaid dividends on our Class D preferred shares in connection with such conversion (assuming a closing on September 30, 2011); and

 

   

on a pro forma, as adjusted basis to give effect to (i) such conversion and payment of associated dividends, (ii) the sale of ordinary shares by us in this offering (at an assumed initial public offering price of $17.00 per share, the midpoint of the range set forth on the cover page of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us) and the use of proceeds therefrom, (iii) 806,760 ordinary shares that are issuable to the sellers of TuneUp immediately upon the closing of this offering (assuming an initial public offering price of $17.00 per share, the midpoint of the price range set forth on the front cover of this prospectus, and a euro/U.S. dollar exchange rate of $1.27 per euro), which shares will remain in escrow following this offering subject to satisfaction of certain vesting criteria, including continuing employment by TuneUp of the sellers of TuneUp and (iv) our receipt of the proceeds from the exercise of options to purchase 2,382,591 ordinary shares, 650,000 of which will be sold in this offering.

 

 

 

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     As of September 30, 2011  
     Actual     Pro forma     Pro forma
as adjusted
 
     (in thousands)  
     (unaudited)  

Consolidated Balance Sheet Data:

      

Cash and cash equivalents

   $ 73,288      $ 71,486      $ 125,532   

Working capital (deficit)

     (80,305     (80,305     (26,248

Goodwill and other intangible assets, net

     97,680        97,680        97,680   

Total assets

     296,555        296,555        350,601   

Deferred revenue, current

     111,771        111,771        111,771   

Deferred revenue, less current portion

     28,396        28,396        28,396   

Long-term debt

     225,155        225,155        225,155   

Total liabilities

     425,627        425,627        425,616   

Class D preferred shares(1)

     191,954                 

Total shareholders’ deficit(1)

     (321,026     (130,874     (76,817

 

  (1)   In connection with the initial investment in us in October 2009 by TA AVG Participations Coöperatief U.A., or TA Coöperatief (which subsequently transferred such investment to TA AVG Luxembourg S.à r.l., or TA Sàrl), we amended our articles of association and converted 5,850,000 outstanding Class A ordinary shares and 3,150,000 outstanding Class B ordinary shares into an aggregate of 9,000,000 Class D preferred shares, which our shareholders then sold to TA Coöperatief. At the same time we also issued 3,000,000 Class D preferred shares to TA Coöperatief for $47.8 million, net of issuance costs. We recorded a distribution in excess of capital in shareholders’ equity (deficit) of $144.1 million in connection with the conversion of ordinary shares into 9,000,000 Class D preferred shares and the issuance of 3,000,000 Class D preferred shares to TA Coöperatief.

 

 

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RISK FACTORS

 

An investment in our ordinary shares involves a high degree of risk. You should carefully consider the risks and uncertainties described below and the other information in this prospectus before making an investment in our ordinary shares. Our business, financial condition or results of operations could be materially and adversely affected if any of these risks occurs, and as a result, the market price of our ordinary shares could decline and you could lose all or part of your investment.

 

This prospectus also contains forward-looking statements that involve risks and uncertainties. See “Special Note Regarding Forward-Looking Statements.” Our actual results could differ materially and adversely from those anticipated in these forward-looking statements as a result of certain factors.

 

Risks Relating to Our Business and Our Industry

 

Our business model is evolving and we may be unable to monetize our active user base sufficiently to increase or maintain our profitability.

 

Our business model has evolved in recent years toward seeking to monetize all of our active user base through a variety of means rather than drawing revenue primarily from users purchasing subscriptions to our premium products and online services. To expand our user base, we have added and plan to continue to add new products and online services to our product portfolio, broadening our focus beyond security solutions and increasing our support for mobile computing devices. The evolution of our business model is ongoing and may depart further from the subscription-based model we used for much of our operating history.

 

We may be unsuccessful in executing our new business model of adding compelling new products and online services and monetizing all of our active user base. Our primary means of monetizing our active user base has been our dynamic secure search solution under, until November 2010, our search agreement with Yahoo! and, since its implementation in November 2010, our search agreement with Google. These search agreements have provided us with a significant revenue stream. We have also generated revenue from the sale of threat-analysis data derived from online search activity. Our new products and online services, in addition to helping to expand our user base, have generated revenue more directly via the sale of backup recovery CDs, online backup space and extended download files for data recovery. If we cannot find additional methods of monetizing our active user base and additional products and online services that users find compelling, we will not be able to continue our recent growth and increase our revenue, margins and profitability. If our new methods of monetizing our active user base or our new products and online services cannot be sustained, our revenue, margins and profitability could recede toward those we had with our previous, subscription-based model.

 

We must maintain our relationships with our existing users and attract new users if we are to continue to expand and improve the quality of our user base, which we may be unable to do.

 

A significant portion of our users stop using our products in any given period because the cost of switching to the products and online services of competitors on existing hardware is minimal and because competitors’ products are often preinstalled on new hardware purchased by our users, among other reasons. For example, in the security software market, about 95% of new desktop computers have one of our competitors’ security products preinstalled. To continue to expand our user base, we must retain our existing users to the extent possible and continuously attract new users, both to replace the many users who exit our user base and to expand that base. Any failure to continue to expand our user base could have a material adverse effect on our business, operating results and financial condition.

 

In addition, our ability to monetize our active user base varies depending on many characteristics of those users, including level of engagement with our products, amount and nature of Internet and computing activities, geographic location and income level. If we are unable to retain and recruit users whose characteristics contribute

 

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to a user base with optimum potential for monetization, our business, operating results and financial condition could suffer materially. The significant turnover in our user base also limits our ability to predict our revenue and cash flows for future periods, making it more difficult for us to manage our business.

 

Our search-traffic program is crucial to our effort to monetize more of our active user base and this program is vulnerable to technological change, including the rise of mobile computing, and our reliance on one search provider.

 

Our most successful program to monetize all of our active user base has been our dynamic secure search solution, including our browser toolbar, which gives our users a convenient way to access a search engine at any time and to be secure that the sites that are the results of the search will not infect or damage their computers. Search engine companies pay us for the search queries we steer to them via our dynamic secure search solution. If software companies that provide Internet browsers prevent the addition of our toolbar, either directly by limiting space for toolbars in the browser interface or indirectly by restricting access to software code, our ability to monetize all of our active user base will be adversely affected. The rise of mobile computing makes this risk more acute as most mobile devices have smaller screens than desktop and laptop computers and software developed for these devices may not as readily accommodate additional toolbars as software developed for desktop and laptop computers. We have not yet begun distributing our toolbar with software designed specifically for mobile devices but intend to do so in future, as mobile represents a small but expanding proportion of the total search market. In addition, we currently expect that revenue per active mobile user will be lower than revenue from traditional active users. As such, there can be no assurance that revenue from our dynamic secure search solution or other similar solutions we may develop will grow in line with our expectations, or that we will be able to maintain or expand our current and future platform-derived agreements or enter into additional agreements to generate platform-derived revenue. The failure of these markets to continue to grow would have an adverse effect on our results of operations.

 

For the majority of platform-derived revenue from our dynamic secure search, we have relied upon agreements with one search engine company at a time, previously Yahoo! and now Google, to generate revenue from our dynamic secure search solution. Our revenue generated by Yahoo! accounted for 21.6% of our total revenue in 2010. We began to generate revenue from Google sourced search in the fourth quarter of 2010 and our revenue from Google sourced search accounted for less than 10% of our revenue in 2010. Revenue generated by Yahoo! and Google sourced search accounted for less than 10% and more than 10%, respectively, of our revenue for the nine months ended September 30, 2011. Under our previous Yahoo! contract there was a transition period, ending in May 2011, during which users of our Yahoo! sourced search could continue to use Yahoo! sourced search through our toolbar, thereby still generating revenue under our Yahoo! contract, until they chose to switch to our Google sourced search. We have revenue concentration risk as we rely on our contractual arrangement with Google for a significant portion of our revenue and we cannot guarantee that the revenue generated from the Google sourced search agreement will continue. Furthermore, in most jurisdictions we may only use Google as our search service provider. Google pays us a percentage of any search revenue generated by Google whenever a user clicks on an ad (also called a sponsored link) served by Google and hosted on one of AVG’s search domains. Our users can click on such ads via the toolbar, default search, address bar search or the AVG search homepage. Any decline in the popularity of our products or Google’s search engine among users could result in a decrease in revenue under this agreement. Google can also unilaterally make changes to its policies and guidelines, which primarily concern the operations and technology of its search services. These changes could require us to modify or suspend certain of our activities relating to our toolbar, which could be costly for us to implement or lead to a reduction in the number of our toolbar users. We need Google’s permission to use the toolbar in a form other than that previously approved in connection with our initial contract with Google, which, if Google did not grant such permission, could adversely impact our ability to generate revenue by preventing us from using the toolbar as we otherwise could. In addition, Google may terminate this agreement if the advertisement revenue generated through our dynamic secure search solution falls below a certain amount for a period of three months and has other customary termination rights under the agreement, including upon a change of control. The agreement expires on September 30, 2012, and Google is under no

 

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obligation to renew this agreement. If, upon the termination or expiration of our agreement with Google, we fail to enter into a new agreement with Google or a similar search provider on substantially the same or more favorable terms, our revenue would significantly decrease.

 

If we are unable to maintain and enhance our brand, our business and operating results may be harmed.

 

We believe that maintaining and enhancing our brand identity is critical to our business. The successful promotion of our brand will depend largely upon our marketing and public relations efforts, the quality of our Internet security solutions and our ability to differentiate ourselves from our competitors. The promotion of our brand may require us to make substantial expenditures, which will likely increase as our market becomes more competitive and as we expand into new markets. If we are not successful at maintaining and enhancing our brand, our ability to attract new users would be adversely affected and we could lose users, third-party distributors and resellers.

 

Our business depends on our brand recognition and the failure to maintain or enhance our brand image could adversely affect our business and market position. In particular, we rely on our active users as primary drivers of our user-driven marketing strategy and any negative change to the perception of our brand among our active users could have a material adverse effect on our business.

 

In addition, independent industry analysts often provide reviews of our solutions, as well as those of our competitors. Perception of our products in the marketplace may be significantly influenced by these reviews. Our brand could be harmed if industry analysts provide negative reviews of our security software solutions or our company. Furthermore, we depend upon certain third-party distributors of our solutions and actions by those third parties could have a negative effect on our brand.

 

We are subject to fluctuations in demand for our products and online services as a result of numerous factors, most of which are beyond our control.

 

Demand for our products and online services fluctuates from period to period due to factors such as general economic conditions, competition, product obsolescence, technological change, shifts in buying patterns, financial and business conditions of our current and potential customers and levels of Internet usage. There are also particular factors driving demand for each of our specific products and online services. For instance, demand for our Internet security solutions among our targeted customer base of small businesses and consumers is driven by our small business customers’ need for protection of business-critical data, consumers’ need for protection of their own personal data, potential users’ awareness of Internet security threats (including cybercrime) generally, the perceived potential damage caused by information loss and other factors. Most of these factors are beyond our control. A change in the factors driving demand for our products and online services generally or for particular products and online services could adversely affect our revenue, cash flows, financial condition and results of operations.

 

Any failure or perceived failure to anticipate, prepare for and respond promptly to technological developments and the changing nature of online security threats could harm our competitive position and business prospects.

 

The needs of our customers and the threats they face evolve constantly. For example, in the endpoint security market, hackers and cybercriminals continuously develop and employ increasingly sophisticated techniques to penetrate systems and networks and access information. Although the market expects timely introduction of software solutions to respond to new threats, the development of these solutions can be challenging and time-consuming. We may experience delays in the introduction of new solutions, updates, enhancements and features. If we fail or are perceived to fail to respond to the rapidly changing needs of our users by developing and introducing on a timely basis Internet security solutions that effectively protect against new security threats, our competitive position, reputation and business prospects could be harmed.

 

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Similarly, the endpoint security market is dynamic, characterized by new technologies and access points to the Internet, which also require protection from hackers and cybercriminal attacks. Responding to the challenges posed by these new platforms and their corresponding new threats can be difficult and require significant reengineering of our software. We may therefore fail or be perceived to fail to provide solutions for these new technology platforms as threats to them arise, which could harm our competitive position, reputation and business prospects and would have an adverse effect on our business, financial condition and results of operations.

 

If our upgrades and new products and online services, whether acquired or internally developed, fail to achieve widespread market acceptance, our competitive position and business prospects will be harmed.

 

Our ability to attract new users and to maintain or increase revenue from existing users depends largely upon our ability to continue providing competitive new products and enhanced solutions that meet the changing needs of our target user base as these needs arise. We plan to continue to invest in acquisitions, research and development, marketing, promotion and sales of our products and online services, with new features, functionalities, enhancements and upgrades. Acquisition of new companies and products creates integration risk, while development of upgrades and new products and online services involves significant time, labor and expense and is subject to risks and challenges including management of the length of the development cycle, adaptation to evolving industry standards, entry into new markets, integration into our existing product line, regulatory compliance, evolution in sales methods and acquisition and maintenance of intellectual property rights. If we fail to launch these upgrades or new solutions on time, or they do not achieve widespread market acceptance, do not meet user expectations, do not operate in an efficient manner, otherwise create the perception of slow operating performance, or generate revenue that is not sufficient to recoup or justify the cost of development, our revenue, financial condition and results of operations may be adversely affected.

 

A significant percentage of our total revenue comes from purchases of subscriptions to our premium products, which must by their terms be renewed by our users to remain in force.

 

Historically, a significant majority of our active users have been users of our free products and online services. Our growth strategy is based in part on offering premium products on top of our core, free products. To the extent we are not able to convert these free users into subscription users, our ability to generate subscription revenue would be adversely affected.

 

We generally provide our premium Internet security solutions pursuant to one-year and two-year subscriptions, after which the relevant product or services either cease to operate or are no longer updated with the latest online threat information (rendering the product increasingly less useful as new threats emerge). In 2010, subscription revenue accounted for 76.8% of our total revenue, and in the nine months ended September 30, 2011, subscription revenue accounted for 65.7% of our total revenue. While we offer subscription users the option to renew their subscriptions, a significant portion of our subscription users choose not to do so. We have taken steps to increase our renewal rates by, for example, adding an auto-renew option on our premium products and online services, but there can be no assurance that these efforts will be successful in increasing our renewal rates. Approximately 18% of users purchasing a license online in 2010 and 30.9% of those purchasing a license online in the nine months ended September 30, 2011 opted for auto-renewal. The European Union is developing a new EU Consumer Rights Directive, however, that is scheduled to come into effect in 2013 that will restrict the use of auto-renewals if the directive is enacted in its current form. We may consequently be forced to reduce or eliminate our use of auto-renewals with subscription users in the European Union once these rules go into effect. Proposals to restrict auto-renewals are also under consideration in the United States. To the extent that we must reduce or eliminate use of auto-renewals in these or other markets, our renewal rates may fall, potentially reducing the number of our subscription users. As a consequence, the growth of our subscription revenue depends significantly on attracting new subscription users, and this dependence could increase due to regulations concerning auto-renewal that are outside of our control. Any failure to maintain or improve the renewal rates of our subscription users or to attract new subscription users could have a material adverse effect on our results of operations.

 

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Furthermore, our ability to measure the conversion of free users into subscription users is limited as there are multiple upgrade paths to our premium products and online services, not all of which we are currently able to track or track accurately. If we are unable to effectively track changes in conversion rates, regardless of the reason for such changes, we may be unable to react to changing market dynamics, and this may negatively affect our growth and revenue. Uncertainty about the renewal rates of our subscription users also limits visibility with respect to future subscription revenue.

 

We operate in highly competitive markets and many of our competitors have significantly greater resources than we do.

 

The markets for the software solutions we offer are highly competitive and subject to rapid technological changes as customers’ needs and the threats they face evolve. We expect competition to increase in the future and we may not be able to compete successfully against current or potential competitors. In particular, some of our competitors may make acquisitions or enter into agreements or other strategic relationships to offer more comprehensive products and/or services, and new competitors may enter the market through acquisitions, agreements or strategic or other such relationships.

 

We and other vendors compete on price and functionality at different price points. Additional competition may cause increased pricing pressure, which could reduce our revenue per user. For example, in the endpoint security software market, while we have historically been able to reduce pricing pressure on our premium solutions and limit the decline in revenue per subscription user by releasing regular product enhancements, there can be no assurance that pricing pressure will not adversely affect our subscription revenue, which would have a material adverse effect on our business and results of operations. Similarly, across our markets, our competitors may offer free products perceived to be superior to our offerings, causing our free and/or subscription users to switch and shrinking our monetizeable user base.

 

Our main competitors fall into the following categories:

 

   

vendors with “freemium” pricing like our own, such as Avast!, Avira, PC Tools (which was acquired by Symantec), Carbonite and Dropbox;

 

   

traditional vendors such as McAfee (which was acquired by Intel Corporation), Symantec and Trend Micro (which primarily provide software solutions, including security software, for large enterprises) and Eset, Kaspersky Labs, Panda Software, Sophos, Rising, Kingsoft, Check Point and F-Secure (which offer more customized and segment-focused products);

 

   

vendors offering tune-up products, such as UniBlue; and

 

   

large corporations offering a wide variety of products, only a few of which compete with ours, such as Microsoft, Google, which recently introduced free security software solutions, Apple, which offers cloud-based data protection, Qihoo, Tencent and Facebook.

 

Many of these competitors have significantly greater brand name recognition and financial resources to devote to the development, promotion and sale of their products and/or services than we do. For example, Microsoft entered the endpoint security market through the introduction of Microsoft Security Essentials, a free Internet security product that has captured a significant share of the free endpoint security market. Similarly, Google, our primary provider for our search revenue stream, recently entered the security space by adding a malware alarm to its search engine results display and it may increase its security offerings in future. Further, smaller and/or more regionally focused vendors may be able to adapt more quickly to new or emerging technologies and changes in customer demand as recently evidenced by the rapid growth of Internet companies like Qihoo and Tencent.

 

Software vendors have begun to employ a “cloud-based” or software-as-a-service business model in which vendors host applications for use by customers over the Internet. This model may disrupt existing models like the

 

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model we employ for most of our products and online services, based on software downloaded from the Internet that resides on a user’s hard drive. Our competitors, including new cloud-based entrants or larger competitors with greater resources to shift to a new model, may have success with cloud-based provision of software, decreasing the demand for those of our products based on another model.

 

In the future, we may face competition from both emerging and established companies operating in our sector and in other areas of the IT business that may develop or acquire security software that they may offer as part of their broader product or service offerings and/or for free. Original equipment manufacturers, or OEMs, or operating system vendors may seek to include pre-installed, fully functional Internet security solutions with their core product offering. For example, Intel acquired McAfee, one of our leading competitors, and has indicated its intention to integrate McAfee’s security solutions into its hardware products, which may adversely affect sales of our aftermarket and/or standalone security solutions. Intel is one of the world’s largest semiconductor chip manufacturers and its investment division has been a shareholder in AVG since 2005. Intel’s shares are held through one of its indirect subsidiaries, Intel Capital (Cayman) Corporation, or Intel Capital, and it will hold 11.9% of the issued share capital in AVG following the completion of this offering, assuming no exercise of the overallotment option. Intel Capital and AVG agreed on measures to address competitive concerns arising from Intel’s announcement of its intention to acquire McAfee, the subsequent completion of that acquisition and its continued minority ownership of AVG. These include measures designed to prevent Intel Capital from accessing certain commercially sensitive information about AVG and suspending Intel Capital’s right to appoint a member of or have an observer on our supervisory board. Upon completion of this offering, Intel will have no ongoing special rights and will therefore only receive information about us at the same time and in the same fashion as our other public shareholders. Accordingly, the measures agreed by Intel Capital and AVG will terminate on completion of this offering. In addition, other competitors may leverage their greater resources to develop relationships with OEMs or operating system vendors, thereby diminishing demand for our products and adversely affecting our ability to acquire and retain customers.

 

Our failure to adequately protect our users’ personal information could have a material adverse effect on our business.

 

A wide variety of provincial, state, national and international laws and regulations apply to the collection, use, retention, protection, disclosure, transfer and other processing of personal data. These data protection and privacy-related laws and regulations are evolving and may result in ever-increasing regulatory and public scrutiny and escalating levels of enforcement and sanctions. Failure to comply with applicable laws and regulations, or to protect such data, could result in enforcement action, including fines, imprisonment of company officials and public censure, claims for damages by customers and other affected individuals, damage to reputation and loss of goodwill (both in relation to existing customers and prospective customers), any of which could have a material adverse effect on our operations, financial performance and prospects. Evolving and changing definitions of personal data and personal information, both within the European Union and elsewhere, especially relating to classification of IP addresses, machine identification, location data and other information, may limit or inhibit our ability to operate or expand our business, including limiting strategic partnerships that may involve the sharing of data. Even the perception of privacy concerns, whether or not valid, may harm our reputation and inhibit adoption of our solutions by current and future customers.

 

We are subject to privacy laws, which have become increasingly stringent.

 

We collect and process personal data (including email addresses, IP addresses, customer satisfaction data, physical names and addresses, customer service issues and website visits) as part of our business and part of our strategy for future growth involves greater interaction with our customer base. In addition, a majority of our online customers purchase our services online with a credit card. As a result, we must comply with strict data protection and privacy laws in the European Union, the United States and certain other jurisdictions where we operate, as well as data protection and documentation standards adopted by credit card issuers. Those laws and standards regulate and restrict our ability to collect and use personal information relating to customers and potential customers.

 

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There have been significant developments in the laws and regulations concerning data protection and privacy, including in relation to the use of “cookies” and the solicitation, collection, processing or other use of personal data, including data relating to consumers. Furthermore, the proposed U.S. Do Not Track law would allow users to opt out of online monitoring and would thereby block even monitoring conducted with benign intent, such as monitoring to increase the efficacy of security software. Additionally, efforts in the United States to propose a “privacy bill of rights” could lead to legislation that would require us to adopt additional security measures or prevent us from retaining or using certain data. Such regulation could affect our ability to execute our strategy of building additional commercial partnerships, as the sharing of customer data needed to derive value from those partnerships may be prohibited by regulation. Any present or future laws which restrict the collection and use of personal data could have a material adverse effect on our business.

 

The requirements imposed by data protection laws and regulations can conflict with laws, and the demands of regulators and other governmental authorities, in foreign jurisdictions. For example, U.S. authorities can demand access to data that is accessible by our group companies that are located in the United States, pursuant to the USA PATRIOT Act. If any of that data includes personal data, it is possible that any such disclosure could cause us to breach data protection laws and regulations in one or more member states of the European Union.

 

Our data security defenses could be breached.

 

Notwithstanding our efforts to secure our IT, data security and other systems, we are exposed to the risk that this data could be wrongfully accessed or used, whether by employees, customers or other third parties, or otherwise lost or disclosed or processed in a manner that violates applicable data protection law and regulation. In certain jurisdictions where we operate, we are under an affirmative legal obligation to notify the appropriate government authorities or data subjects in circumstances where personal data may have been wrongly accessed or used, or otherwise lost or disclosed. Efforts to mitigate and comply with such laws, and even the perception of a data security breach, increase the risk that such incidents will lead to sanctions (including fines and other penalties), claims by data subjects and disclosure leading to public knowledge of the breach, potentially causing reputational damage to our business.

 

Regulation of the Internet and the lack of certainty regarding application of existing laws to the Internet could substantially harm our operating results and business.

 

We are subject to laws and regulations applicable to doing business on the Internet. It is often not clear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet as these laws have in some cases failed to keep pace with technological change. Recently enacted laws governing the Internet could also impact our business. For instance, existing and future regulations on taxing Internet use or restricting the exchange of information over the Internet could result in reduced growth or a decline in the use of the Internet and could diminish the viability of our services. In particular, the European Union has approved rules that will come into effect in 2013, and the United States is considering similar proposals, to restrict the use of automatic renewals, which may reduce the renewal rate of and subscription revenue for our premium products. Furthermore, it is possible that governments of one or more countries may censor, limit or block certain users’ access to our websites. Changing industry standards and industry self-regulation regarding the collection, use and disclosure of certain data may have similar effects. Any such adverse legal or regulatory developments could substantially harm our operating results and our business.

 

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We believe that we and our resellers have sold or provided our products to users in jurisdictions that are the subject of export controls and sanctions administered by the U.S. Commerce Department’s Bureau of Industry and Security and the U.S. Treasury Department’s Office of Foreign Assets Control. We believe that we may have inadvertently violated certain of these controls and sanctions in the past. We cannot currently assess the nature and extent of fines or other penalties, if any, that the Bureau of Industry and Security or other U.S. governmental agencies may impose against us or our employees for any such violations.

 

Sale of certain of our products into Cuba, Iran, North Korea, Sudan and Syria may be restricted or prohibited under U.S. export control laws and/or economic sanctions administered by the U.S. Commerce Department’s Bureau of Industry and Security, or BIS, and the U.S. Treasury Department’s Office of Foreign Assets Control, or OFAC. We have discovered that, from time to time, we have sold or provided free of charge through the Internet licenses to use our products to a small number of users (relative to our active and subscription user bases) in Cuba, Iran, North Korea, Sudan and Syria. In August 2011, we filed initial voluntary self-disclosures with OFAC and BIS relating to these transactions. We conducted an investigation to determine the scope of possible violations over the past five years of the export control laws and economic sanctions administered by BIS and OFAC. While we had and continue to have certain controls in place to prevent sale into, and have not actively marketed our products in, any of the jurisdictions that are the target of economic sanctions, we have determined that some sales took place to users in those jurisdictions resulting in revenue to us constituting less than one half of one percent of total paid license fee revenues over the past three years. We filed our supplemental report concerning the results of our investigation with OFAC and BIS in November 2011. In December 2011, we received a cautionary letter from OFAC indicating that it has closed its investigation without imposing any penalty and without a final agency determination on whether a violation has occurred. We cannot predict when BIS will complete its review and determination. We have implemented a remediation plan that includes having terminated access to licenses and blocked the transmission of updates and upgrades of our products to all users with a geographic internet protocol (GEOIP) address in Cuba, Iran, North Korea, Sudan or Syria. While there can be no assurance that future violations will not occur, the remedial measures we have implemented are designed to prevent future violations of regulations administered by OFAC and BIS. We will be required to spend a significant amount of time and monetary and managerial resources to address these issues, and we could experience a loss of users as a result of these issues. If we are found to be in violation of BIS regulations, we may face criminal and/or civil penalties and/or reputational harm, which could have a material adverse effect on our business and financial results.

 

Our future revenue depends on our ability to continue to market to new users, which we may not be able to accomplish on a cost-effective basis or at all.

 

We are dependent on the acquisition of new users, many of whom have not previously used products and online services such as those we provide. We rely and have relied on a variety of marketing methods to attract new users to our solutions, such as generating interest through our user base and social networking services to create a user-driven marketing effect, public relations campaigns around new product and service launches and Internet security threats and efforts to improve our positioning in response to online searches through search engine optimization, search engines and other online advertising. Our ability to attract new users depends on the perceived value of our products and online services versus that of the premium and free products and online services offered by our competitors. If our current marketing initiatives are not successful or become less effective, or if the cost of such initiatives were to significantly increase, we may not be able to attract new customers as efficiently and, as a result, our revenue and results of operations would be adversely affected.

 

We have historically relied heavily on user-driven marketing to attract new users to our solutions, although we expect to increase our spending on marketing in the future. If we are unable to maintain or increase the efficacy of our user-driven marketing strategy, or if our more costly marketing campaigns do not have the desired impact, we may be required to increase marketing expenses still further to compensate, which could have an

 

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adverse effect on our results of operations. We cannot assure you that we will be successful in maintaining or expanding our user base on a cost-effective basis or at all, and failure to do so would adversely affect our business, operating results and financial condition.

 

Our software solutions may contain undetected errors, defects or security vulnerabilities, which could cause harm to our reputation and adversely affect our business.

 

Our software is inherently complex and may contain material defects, errors or vulnerabilities that may cause it to fail to perform in accordance with user expectations. As may happen to any vendor of software, errors, failures and bugs may be found in some of our new offerings after initial distribution of those offerings, particularly given that end users may deploy our products in computing environments with operating systems, software and/or hardware different than those in which we test our products before release. For example, in 2008, one of our software updates erroneously deleted a required Windows system file, causing significant operating difficulties for some of our users. The costs incurred in analyzing, correcting or eliminating any material defects or errors in our software may be substantial. Furthermore, we may not be able to correct any defects or errors or address vulnerabilities promptly, or at all, causing significant harm to our reputation and competitive position.

 

Any defects, errors or vulnerabilities may cause interruptions to the availability of our software and result in lost or delayed market acceptance and sales, or may require us to issue refunds to our customers. Security products are critical to the businesses of many of our customers, which may make them more sensitive to defects in our products than to defects in other types of software. We could face claims for product liability, tort, breach of warranty or damages caused by faulty installation of, or defects in, our products. In the event of claims, provisions in our contracts relating to warranty disclaimers and liability limitations may be unenforceable. Defending a lawsuit, regardless of its merit, could be costly and divert management attention. Defects, errors and vulnerabilities may also lead to loss of existing or potential customers, to diversion of development resources, or to increasing our services, warranty, product replacement and product liability insurance costs, and may damage our reputation. Our product liability insurance coverage may be inadequate or future coverage may be unavailable on acceptable terms or at all.

 

We have experienced rapid growth in recent years and we may not be able to sustain the same rate of growth or maintain our operating or profit margins going forward.

 

Our revenue has grown significantly in recent years, increasing by 24.0% in the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010, by 19.4% in 2010 compared to 2009 and by 59.8% in 2009 compared to 2008. However, our operating income margins decreased by 9.0% in the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010, and by 9.3% in 2010 compared to 2009, partially counteracting the effects of revenue growth on our profitability. We operate in a dynamic and changing market and investors should not rely on our historical results as an indication of our future operating performance. Further, as a result of the increased scale of our business, we believe that it is unlikely that we will be able to maintain the historical rate of growth of our revenue in future periods, and we cannot assure you that decreases in our operating margins will not continue.

 

We may not be able to manage our growth effectively, which could harm our business and operating results, and we may need to incur significant expenditure to address the additional operational requirements of our growth.

 

We have recently experienced a period of significant growth and expansion and we plan to pursue a strategy of continued growth, which has required and will continue to require substantial managerial and financial resources. Our current systems, procedures and staffing may not be adequate to support our future operations. To accommodate our recent and future growth, we must continue to expand our operational, engineering and financial systems and IT infrastructure, improve our accounting and other internal management procedures and systems and hire additional staff. In addition, our efforts to expand our business geographically include developing local language versions of our security software solutions, opening new offices and call centers,

 

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including centers to support our solutions in additional languages, hiring staff in new areas and adding additional functionality to our solutions. If we fail to manage our growth adequately, to adapt our operational, financial and management information systems and IT infrastructure, or to motivate or manage our employees effectively, the quality of our products and the management of our operations and costs would suffer, which could adversely affect our operating results. Furthermore, like many peer companies, we engage contractors as well as employees. There is some risk that relevant authorities, both in jurisdictions where we have well-established operations and those we have recently entered, could seek to reclassify our arrangements with certain contractors as employment relationships, with potentially adverse tax and regulatory consequences.

 

In addition, we regularly evaluate and, where appropriate, implement changes to, our internal control structure. Implementing any such changes to our internal control structure may divert management attention, entail substantial costs and take significant time to complete. These changes may not, however, be effective in maintaining the adequacy of our internal control structure in line with the growth of the business, and any failure to maintain that adequacy, or consequent inability to produce financial statements or provide accurate data from which we derive our key metrics, or monitor business developments on a timely basis, could have a material adverse effect on our business.

 

If our revenue growth for any period falls short of our expectations, we may not be able to adjust our costs in a timely manner, which could reduce our profit margin in that period.

 

Although we base our planned operating expenses in part on our expectations of future revenue, a substantial portion of our expenses is fixed in the short term and cannot be reduced quickly if our future revenue falls short of expectations. Accordingly, if the rate of growth of our revenue in any period is significantly less than we anticipated, because either our user base is smaller, our subscription renewal rate is lower than expected or our efforts to monetize our active user base fall short, we may be unable to adjust our cost base proportionally on an accurate and timely basis, which would reduce our operating margin.

 

Our current operations are international in scope and we plan further geographic expansion, creating a variety of operational challenges.

 

Our offices, personnel and customers are dispersed around the world. We face difficulties including costs associated with developing software and providing support in many languages, varying seasonality patterns, potential adverse movement of currency exchange rates, longer payment cycles and difficulties in collecting accounts receivable in some countries, tariffs and trade barriers, a variety of regulatory or contractual limitations on our ability to operate, adverse tax events, reduced protection of intellectual property rights in some countries and a geographically and culturally diverse workforce and customer base. Failure to overcome any of these difficulties could negatively affect our results of operations. We intend to further expand our operations globally by initially seeking to expand our user base, developing a local version of our product, seeking to introduce localized services and finding a local distributor to manage the distribution of our premium solutions. If these efforts are unsuccessful in creating and expanding our global user base, or if our expansion increases the difficulties of running a global company, our results of operations could be harmed.

 

We may not be able to integrate businesses we have acquired or may in the future acquire and those acquisitions may fail to provide us with the benefits we anticipated.

 

We have acquired and made investments in other companies and services to expand our technology capabilities, our product breadth and functionalities, our user base and our geographical presence, and we intend to continue to make acquisitions and investments in the future. The integration of those businesses and their operations, technologies and products involves the incurrence of acquisition costs and may expose us to liabilities, including unanticipated liabilities and tax liabilities, operating difficulties and expenditures associated with the assimilation and retention of employees of the acquired business, acquisition legal contingencies, risks related to maintaining procedures, controls and quality standards and other risks and difficulties. We may not be able to achieve the anticipated benefits from any acquisition or investment and the consideration paid for an acquisition or investment may also affect our financial results. Such acquisitions and investments could divert

 

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management’s time and focus from operating our business and divert other resources needed in other parts of our business. The financing of acquisitions or investments in other companies may require us to use a substantial portion of our available cash, raise debt, which would increase our interest expense, or to issue shares or other rights to purchase shares, which may result in dilution to existing shareholders and decrease our earnings per share. Moreover, acquisitions may result in write-offs and restructuring charges as well as in creation of goodwill and other intangible assets that are subject to regular impairment testing, which could result in future impairment charges. All of these factors could adversely affect our business, results of operations and financial condition.

 

We are subject to fluctuations in our financial results, making it difficult to project future results.

 

A variety of factors cause volatility in our financial results, making any projections of future results uncertain. Such factors include but are not limited to fluctuations in demand for or pricing of our products, impacts of acquisitions, timing of product orders and payments, issues relating to alliances with third parties, product and geographic mix, timing of new products and customers, currency exchange fluctuations and potential accelerations of prepaid expenses and deferred costs.

 

Accurately measuring the number and retention of our active and subscription users is difficult and our failure to accurately measure the number and retention of our active and subscription users at any time will compromise our ability to monitor our key performance indicators, which in turn could adversely affect our ability to manage our business.

 

We measure the number of our active users as the number who (i) have downloaded and installed our free software on a PC or mobile device and have connected to our server twice in the preceding 30-day period or (ii) have a valid subscription license for our software. We measure the number of our subscription users as the number who have a valid subscription license for our software. We made a series of improvements to our tracking capabilities in 2009 and early 2010 in order to mitigate the double-counting arising from the previous system’s inability to distinguish active users who may have had multiple installations during the relevant period, but these improvements also render our active users metric from previous dates not directly comparable. We have continued to have difficulties measuring the number of our active users, in part due to system constraints during upgrade campaigns. For example, at times during the second half of 2009 and the first nine months of 2010, we experienced double-counting issues due to the launch of new products and related issues with service capacity caused by high download volumes. We have also continued to have difficulties measuring the number of our subscription users, as the variety of channels by which we sell licenses requires us to draw on disparate and variously-dated data sources and employ manual calculations in the measurement. For the periods prior to June 30, 2009, our active and subscription user measurements should be viewed as being indicative only and as management’s best estimate for the reasons noted above, as we have not been able to quantify the extent to which the figures may not be comparable and there is an inherent degree of uncertainty in these metrics. We will continue to attempt to improve the accuracy of our measurement of the numbers of our active and subscription users, but we cannot assure you that we will be successful in doing so. For example, we have made various adjustments to our counting methodology over time, including by changing the way users are recognized and counted during upgrade campaigns. While we believe these adjustments have improved the overall accuracy of our user numbers, we have still discovered some errors. As a result, we also recently introduced two new systems for counting user numbers. This project is ongoing, however, and will not be fully implemented until all users have migrated to the new version of our products. Once these counting systems are fully implemented, based on initial results, we expect that we will have greater confidence in the accuracy of our user counts, but these systems remain new and have not been tested over time, and there can be no assurance that they will meet our expectations. Our understanding and management of our business depends on accurate measures of the numbers of our active and subscription users and other key performance indicators derived from these metrics and our management decisions may be suboptimal if our measurements of these key metrics are inaccurate. Furthermore, if a significant understatement or overstatement of our active users or subscription users metrics were to occur, the market might perceive us to be underperforming or to have inadequate systems, which would adversely affect our share price.

 

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We also face difficulties in quantifying user retention, both in terms of user churn and subscription renewal rates. This difficulty is in part due to our limited ability to track non-subscription users based on personally identifiable information. For instance, when a non-subscription user replaces a device on which he or she uses our products and services, this event typically registers as the loss of an existing user and the gain of a new one, causing no change to the size of our user base but inflating the level of apparent churn. We compile renewal rates for users of particular subscription products, but such rates only describe the activities of subscription users representing a small portion of our total active user base. Furthermore, we offer a variety of products and online services and do not have integrated methods of quantifying retention of our users across these products and services. This inability to quantify certain aspects of aggregate user behavior may adversely affect our business if we are unable to accurately monitor the results of our strategic decisions on pricing and product introduction and marketing. In particular, if we are unable to accurately assess and predict user behavior, our initiative to up-sell and cross-sell our expanding set of products and services to users across our platform may be harmed.

 

We depend on download sites and search engines to attract a significant percentage of our users and if those sites or search engines change their listings, increase their pricing or experience a material reduction in their online traffic, our ability to attract new users would be adversely affected.

 

Many of our users locate our products and online services and our website through download sites and search engines. In the nine months ended September 30, 2011, a significant number of new users of our endpoint security solution acquired that software through just one of the many download sites that features our products, CNET’s Download.com website. If any of our key download sites such as Download.com cease to feature or carry our solutions, fewer potential users may download our products, particularly our AVG Anti-Virus Free Edition. Search engines typically provide two types of search results—algorithmic and purchased listings—and we rely on both types. Algorithmic listings cannot be purchased and are determined and displayed based on criteria formulated by the relevant search engine. Search engines revise their algorithms from time to time in an attempt to optimize their search results. If the search engines on which we rely for algorithmic listings modify their algorithms in a manner that reduces the prominence of our listings, fewer potential users may click through to our websites, requiring us to resort to more costly methods of attracting this traffic. Furthermore, the majority of our traffic from search engines came from a single source, Google. This traffic is unrelated to our agreement with Google to steer search queries to Google in connection with our dynamic secure search solution. The concentration of search traffic from a single search engine increases our vulnerability to potential algorithm modifications by that search engine. Any failure to replace the traffic to our website coming from search engines could reduce our revenue or require us to increase our customer acquisition expenditures.

 

Similarly, we have in the past and may in the future be the target of so-called “cybersquatters,” who seek to register Internet domain names that are confusingly similar to our own domains or marks. Although we have not suffered material losses due to cybersquatters to date, we nonetheless make diligent efforts to block their activities. Some cybersquatters have taken our free product and sold it to users, which could lead to confusion among our users and, ultimately, a loss of these users, which would reduce any platform revenue that we would have received from these users. In addition, although no cyber-squatting incidents have raised material security concerns relating to our business and products to date, there can be no guarantee that future cybersquatting incidents will not cause material losses or raise security concerns. If search engines rank cybersquatters’ imitation websites above our own sites, existing or potential customers may be misled, and this could harm our reputation, cost us consumer goodwill and negatively affect our operating results.

 

Adverse conditions in national and global economies or adverse information technology spending trends in the consumer and small business markets may adversely affect our business and financial results.

 

National and global economies have recently experienced a prolonged downturn and the future severity of adverse economic conditions and the length of time such conditions may persist is unknown. In particular, ongoing concerns about sovereign debt in both the European Union and the United States have increased economic uncertainty and raised the possibility of further disruption in the global capital markets. During challenging economic times, periods of high unemployment and in tight credit markets, many of our users may

 

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delay or reduce technology purchases. This is true of both consumers and small businesses, which we define as businesses with 100 seats or less, where a seat is an identified computer workstation, whether independent or part of a network. Such delays or reductions in purchasing could result in reductions in sales primarily of our online services, as well as our products, difficulties in collecting our accounts receivable, slower adoption of new technologies, lower renewal rates and increased price competition.

 

Other trends (whether the result of economic factors or otherwise), such as declines in the demand for PCs, servers and other computing devices, or softness in small business and consumer information technology spending, could have similar effects. The persistence of any of these conditions would likely harm our business, operating results, cash flows and financial condition.

 

In 2010 and the nine months ended September 30, 2011, 64.0% and 61.0%, respectively, of our total revenue was comprised of sales into the Americas. We are therefore exposed to conditions in the Americas and particularly in the United States, which accounted for 58.9% and 55.3% of our total revenue in 2010 and the nine months ended September 30, 2011, respectively. Any continuation of or further deterioration in these conditions or a reduction in consumer or small business information technology spending for any reason could result in a downturn in sales of our premium software solutions, which, in turn, could have a material adverse effect on our growth, business, revenue and results of operations.

 

False detection of viruses or other security threats by our products and online services could adversely affect our business.

 

Some of our solutions identify threats by “behavioral monitoring,” which is a methodology that seeks to identify threats by their behavior rather than scanning for malicious code. There are inherent inaccuracies in the detection of threats based on behavioral monitoring and as a result, our anti-virus and other Internet security services may falsely indicate the presence of viruses and other threats that do not actually exist even when these programs are working correctly. These “false positives” may impair the perceived reliability of our services and may therefore harm our market reputation. Also, our anti-spam and anti-spyware services may falsely identify emails or programs as unwanted spam or potentially unwanted programs, or alternatively fail to properly identify unwanted emails or programs, particularly as spam emails or spyware are often designed to circumvent Internet security software. Parties whose emails or programs are blocked by our services may seek redress against us for labeling them as spammers or spyware, or for interfering with their business. In addition, false identification of emails or programs as unwanted spam or potentially unwanted software may reduce the popularity and adoption of our services. If our system restricts important files or applications based on falsely identifying them as malware or some other item that should be restricted, this could adversely affect customers’ systems and cause material system failures. Any such false identification of important files or applications could result in negative publicity, loss of customers and sales, increased costs to remediate and costly litigation.

 

Our software products and IT infrastructure may be subject to intentional disruption that could harm our reputation and future sales.

 

We have been the target of spam attacks on our email addresses and denial of service and other sophisticated attacks on our websites, mail system and firewalls. Although we believe we have sufficient controls in place to prevent intentional disruptions, we expect to be an ongoing target of attacks specifically designed to impede the performance of our products. Similarly, experienced computer programmers, including programmers on our staff, could attempt to penetrate our network security or the security of our solutions and misappropriate proprietary information or cause interruption of our services. Because the techniques used by such computer programmers to access or sabotage networks change frequently and may not be recognized until launched against a target, we may be unable to anticipate these attacks. In addition, hackers have created pirated versions of our software, malware that attacks our software after it has been downloaded onto customers’ computers and malware that deceptively assumes our brand name and imitates the interface of our software, encouraging our users and potential users to download it in place of our software. We may face legal liability, our activities could be adversely affected and our reputation, brand and future sales could be harmed if these intentionally disruptive efforts are or are perceived to be successful.

 

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We may be required to expend significant resources both to protect us against system architecture and network failure and disruption and to enable us to grow our business.

 

Our web server content is stored in five separate data centers, which are located in Amsterdam, London, Toronto, Hong Kong and Brno (Czech Republic). Virus definition files are sent to Akamai Technologies GmbH, a software distributor, for distribution to our customers and backed up at our primary and secondary data centers, which are located at separate sites in Brno for redundancy purposes. At present, we have no written or formal business continuity plan with regard to our virus research specifically, or systems and system architectures in general. Furthermore, our systems are composed of various components which were not designed to interoperate with one another, potentially leading to significant system breakdowns. Although we believe we have the technical knowledge necessary to mitigate problems relating to our systems and system architecture, we may at any time be required to expend significant capital or other resources (including staff and management time and resources) to protect ourselves against network failure and disruption, including the replacement or upgrading of our existing business continuity systems, procedures and security measures. In addition, our evolving business model and growth plan will require expansion and upgrading of our systems to support additional users, localities, products and online services. These expansions and upgrades will likely consume significant capital and managerial resources.

 

If replacements, expansions, upgrades and/or other maintenance are not implemented successfully or completed efficiently, or there are operational failures, the quality of our product portfolio and service experienced by our users will be adversely affected. If, as a result, users were to reduce or stop their use of our Internet security solutions, this could have a material adverse effect on our operations, financial performance and prospects.

 

We may become subject to unanticipated tax liabilities that have a material adverse effect on us or our shareholders.

 

AVG Technologies N.V. is a company incorporated under the laws of the Netherlands and on this basis is subject to Netherlands tax laws as a Netherlands resident taxpayer. We believe that it is resident solely in the Netherlands for tax purposes and that we, and in certain cases, the holders of our shares, can rely on this position for purposes of the application of tax treaties concluded by the Netherlands with other jurisdictions. However, if our tax position were successfully challenged by applicable tax authorities, or if there were changes in the tax laws, tax treaties, or the interpretation or application thereof (which could in certain circumstances have retroactive effect) or in the manner in which we conduct our activities, AVG Technologies N.V. could be considered or may become a resident of a jurisdiction other than the Netherlands, which could subject us to unanticipated tax liabilities, possibly on a retroactive basis and holders of our shares could become subject to different tax treatment in respect of the acquisition, holding (including in respect of dividend payments on our shares), redemption or disposal of our shares.

 

Challenges by various tax authorities to our international structure may, if successful, increase our effective tax rate and adversely affect our earnings.

 

We are a Dutch public limited liability company holding subsidiaries that operate in multiple jurisdictions, including the United States, Czech Republic, Germany, Cyprus, United Kingdom, France, China and other jurisdictions. Our income taxes are based upon the applicable tax laws and tax rates in the Netherlands and such jurisdictions as well as upon our operating structures in these countries. We determine the amount of taxes we are required to pay based on our interpretation of the applicable laws and regulations in the jurisdictions in which we operate and our application of the general transfer pricing principles to our cross-border intercompany transactions. Many countries’ tax laws and international treaties impose taxation upon entities that conduct a trade or business or operate through a permanent establishment in those countries. However, these applicable laws and treaties are subject to interpretation. The tax authorities in these countries may contend that a greater portion of the income of the group should be subject to income or other tax in their respective jurisdictions. This may result in an increase to our effective tax rate and adversely affect our results of operations.

 

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Changes in tax laws or in the channels in which we distribute our solutions may adversely affect our reported results.

 

Changes in tax laws, regulations, related interpretations and tax accounting standards in the United States, Czech Republic, Germany, Cyprus, United Kingdom, France, China, the Netherlands and other jurisdictions may result in a higher tax rate on our earnings, which may result in a significant negative impact on our earnings and cash flow from operations. Governments are increasingly considering tax law changes as a means to cover budgetary shortfalls resulting from the recent economic environment. If such proposals were enacted, or if modifications were made to certain existing tax treaties, or if tax authorities were to change their interpretations of such existing laws or treaties, the consequences may have a material adverse impact on us, including increasing our tax burden, increasing costs of our tax compliance or otherwise adversely affecting our financial condition, results of operations and cash flows. Moreover, tax audits may expose us to potential adverse tax consequences, including interest payments and potential penalties.

 

In addition, even if tax laws and regulations remain unchanged, a change in the channels in which we distribute our solutions could adversely affect our effective tax rate. For example, growth in retail “box-on-shelf” sales would subject us to additional income tax in the jurisdiction of the relevant selling entity, resulting in a higher portion of our income being subject to a higher tax rate. These events could increase our effective tax rate and therefore reduce our net profits.

 

Potential changes in the tax deductibility of interest in the Netherlands may adversely affect our financial position.

 

The Dutch government has approved new legislation limiting the deductibility of interest. The new law limits the interest deductions in respect of all loans used to acquire a Dutch target company which is either (1) included in a corporation tax consolidation (i.e. fiscal unity) with the acquirer or (2) merged with the acquirer. Interest expenses incurred on borrowings obtained to finance such acquisition structures would be deductible against the stand-alone taxable income of the acquirer only (i.e., in effect, the fiscal unity or legal merger is disregarded). A grandfathering applies for leveraged acquisitions that resulted in the inclusion of the Dutch target company in a fiscal unity or legal merger with the acquirer before November 15, 2011. The new legislation should not limit the tax deductibility of the interest payable by us under our current indebtedness. However, in certain circumstances if we were to incur new indebtedness, the new legislation would limit the tax deductibility of the interest payable by us in the future and could therefore have a material adverse effect on our financial condition and results of operation.

 

U.S. states may seek to impose state and local business taxes.

 

Even if AVG’s non-U.S. entities are not subject to U.S. federal income tax, those entities could still be liable for U.S. state and local business activity taxes based upon income or gross receipts. States generally impose business activity taxes on entities deriving revenue from customers located within the state, owning or leasing property in the state or employing personnel in the state. States are becoming increasingly aggressive in asserting nexus for business activity tax purposes. Therefore, in states where we have customers, employees, agents or any activity, state tax authorities may attempt to assert nexus. If, based on our sale of products or services in the state, a state tax authority asserts that our activities give rise to nexus, we could be subject to an increased state and local tax burden.

 

End-user taxation in our key sales jurisdictions could impact our revenues and a successful assertion that we should have been collecting (or collecting additional) sales tax or other transaction taxes on prior sales of products or services could result in substantial tax liabilities.

 

Point-of-sale taxation, including U.S. state and local sales/use taxes, of our products and of services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet, may be imposed on our end users and/or on us. Increased taxation on our end users for the purchase or use of our products and online services could have a material impact on the purchasing decisions of

 

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our end users and adversely affect our revenues and could also increase our internal costs. If we do not collect reimbursement for such assessments from our customers, we would become liable for these taxes. In addition, a successful assertion by any state, local jurisdiction or country that we should have been collecting (or should have been collecting additional) sales or other transaction taxes on the sale of our products or services could result in substantial tax liabilities related to past sales.

 

Historically, we have taken the position that our sales of software delivered over the Internet are not subject to sales/use taxes in the states in the U.S. This conclusion was based on one or both of the following propositions: (i) many states do not impose sales/use tax on electronic delivery of our products; and (ii) AVG Cyprus (and, subsequent to our internal reorganization, AVG Ecommerce) did not have a physical presence and did not have nexus in any state in the U.S. However, it is possible that a state or local jurisdiction in which we do not charge and collect sales/use tax or other transaction taxes could assert that we should have previously been collecting such taxes in prior periods; if successful, such challenges could require us to pay substantial amounts of taxes, interest and penalties, which could have an adverse effect on our business.

 

In addition, national and local governments are facing deteriorating fiscal situations and tax authorities are currently reviewing the appropriate treatment of transactions and companies engaged in electronic commerce. New or revised tax laws and regulations are being passed that may subject us or our customers to additional sales, income and other taxes. In particular, there has recently been much activity and legislation as well as audits and court cases involving imposition of sales/use taxes on e-commerce transactions in several U.S. states.

 

For example, some states are adopting statutes (sometimes colloquially referred to as “Amazon Laws”) which attribute to out-of-state vendors the in-state physical presence of a referral source, and these laws may adversely affect our business. If the vendor compensates even unrelated parties for driving business to its website (i.e., by click-through) then, in some states, there is a rebuttable presumption the vendor has nexus, which enables the state to charge sales tax on the vendor’s transactions. We use referral sources which we compensate, and there is a risk that we will have to collect sales/use taxes or terminate our relationship with important referral sources, including those based in key states such as California and New York that have adopted these so-called “Amazon Laws.” In addition to click-through nexus statutes, some states have introduced extensive and onerous reporting requirements that are burdensome and costly and could affect our business. Although the constitutionality of these “click-through” statutes and reporting requirements is being challenged on various grounds, if these laws are upheld as constitutional, such a result likely would lead to more widespread adoption of similar legislation which could further negatively impact our business.

 

We rely on software licensed from third parties, including server software, and intellectual property rights associated with such software, that are required for the provision of our services. These licenses may be difficult to retain or the third-party software could cause errors or failures of our solutions.

 

We rely on software licensed from third parties to offer our services, including server software from Mailshell and Agnitum, and other patented third-party technology. In addition, we may need to obtain future licenses from third parties to use intellectual property rights associated with the development of our solutions, which might not be available to us on acceptable terms, or at all. Any loss of the right to use any third-party software required for the development and maintenance of our solutions could result in delays in the provision of our solutions until equivalent technology is either developed by us, or, if available, is identified, obtained and integrated, which could harm our business. Any errors or defects in third-party software could result in errors or a failure of our solutions which could harm our business.

 

Some of our solutions contain “open source” software, which may pose increased risk to our proprietary software.

 

We may have in the past and could in the future combine our proprietary software with certain open source software in a certain manner, which could, under certain of the open source licenses, require us to release the source code of our proprietary software. In addition to risks related to license requirements, usage of certain open

 

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source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or controls on the origin of software. We cannot be sure that all open source code is submitted by our developers to our internal review process for approval prior to its inclusion in our products. In addition, many of the risks associated with the usage of open source software may be difficult to eliminate and could, if not properly addressed, negatively affect our business.

 

We could be subject to claims for infringing third-party intellectual property rights, which could adversely affect our business.

 

Because of the nature of our business, including development and acquisition of intellectual property rights and the hiring of employees formerly employed by competitors, we may become subject to material claims of infringement by competitors and other third parties with respect to current and future software solutions, trademarks, licenses or other intellectual property rights. In addition, we license and utilize certain third-party “proprietary” and “open source” software as part of our solutions offering. If an author or another third party that distributes such third-party or open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur significant legal expenses defending against such allegations and could be subject to significant damages, required to disclose and/or provide part of the source code of our proprietary software for no fee, enjoined from the sale of our services and required to comply with conditions that could disrupt the distribution and sale of some of our services.

 

To the extent that we gain greater visibility and market exposure as a public company, we may face a higher risk of being the subject of intellectual property rights infringement claims. Moreover, some of these claims may involve patent holding companies or other adverse patent owners who have no relevant product revenue of their own and against whom our own patent portfolio may therefore provide little or no deterrence. Any claims of infringement by a third party, even those without merit, could damage our reputation and the value of our brand, cause us to incur substantial defense costs and distract our management and employees from our business. Furthermore, a party making such a claim, if successful, could secure a judgment that requires us to pay substantial damages. A judgment could also include an injunction or other court order that could prevent or limit us from offering our software. In addition, we might be required to seek a license for the use of the infringed intellectual property rights, which may not be available on commercially reasonable terms or at all. Alternatively, we might be required to develop non-infringing technology, which could require significant effort and expense and which might not be successful.

 

Third parties may also assert infringement claims relating to our software against our customers. Any of these claims might require us to initiate or defend potentially protracted and costly litigation on their behalf, regardless of the merits of these claims. If any of these claims were to succeed, we might be forced to pay damages on behalf of our customers, which could adversely affect our business.

 

Protection of our intellectual property rights is currently limited and any misuse of our intellectual property rights by others could adversely affect our revenue and results of operations.

 

Proprietary technology used in our software is important to our success. To protect our intellectual property proprietary rights related to our software, product, services, solutions and development, we have to date focused primarily on copyrights, trademarks, trade secrets, confidentiality procedures and protections afforded by contractual provisions. For example, we have registered trademarks such as “AVG” and our logo in the United States, the European Union and in various countries throughout the world where we currently do business or are planning to do business.

 

Intellectual property rights laws and regulations are uncertain.

 

The protection from and enforcement of any intellectual property rights in the markets in which we operate are uncertain. The laws of countries in which we operate or intend to expand our operations, including China, may afford little or no protection to our copyrights, trade secrets and other intellectual property rights. While we

 

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monitor the use of and respect for our intellectual property rights, policing unauthorized use of our copyrighted and trade secret technologies and proving misappropriation of our technologies are difficult. In addition, certain of our licenses are “click-through” licenses or are unsigned, which may render them unenforceable under the laws of some jurisdictions. Furthermore, any changes in, or unexpected interpretations of, the copyright, trade secret and other intellectual property rights laws in any country in which we operate or intend to expand our operations may adversely affect our ability to enforce our copyright, trade secret and other intellectual property rights. Costly and time-consuming litigation could be necessary to enforce or defend our intellectual property rights and/or to determine the scope of our confidential information, intellectual property right and trade secret protection. If we are unable to protect our intellectual property rights or if third parties independently develop similar technologies to ours or otherwise gain legal access to our or similar technologies, our competitive position and brand recognition could suffer and our revenue, financial condition and results of operations could be adversely affected.

 

Protection of trade secrets is limited.

 

We seek to protect our software, trade secrets and proprietary information, in part, by generally requiring our employees and consultant contractors to enter into agreements providing for the maintenance of confidentiality and the assignment of rights to inventions made by them while employed by or providing consulting services to us. We also enter into non-disclosure agreements with our distributors, resellers and other business partners to protect our confidential and proprietary information. There can be no assurance that our confidentiality agreements with our employees and third parties will not be breached, that we will be able effectively to enforce these agreements or to have adequate remedies for any breach or that our trade secrets and other proprietary information will not be disclosed or otherwise cease to be protected. Accordingly, despite our efforts, we may be unable to prevent third parties infringing or misappropriating our intellectual property rights and using our technology for their competitive advantage. Any such infringement or misappropriation could have an adverse effect on our business, results of operations and financial condition.

 

We may encounter difficulties and uncertainties in obtaining patents.

 

Currently we have several patent applications pending in various jurisdictions, including the United States, the European Patent Organization, Canada and Russia, and filed under the Patent Cooperation Treaty. For example, to date we have applied for patent protection for our LinkScanner technology, as well as our software for detection of harmful software, code analyses and removal of harmful software. We do not know whether any pending patent applications we have filed or will file in the future will result in the issuance of patents. Moreover, any patents that are granted may be opposed, contested or designed around by a third party, or may be subject to other limitations. We therefore may not receive significant competitive advantages from any patent rights that may ultimately be granted to us.

 

Our business will suffer if the small business market for our products and online services proves less lucrative than projected or if we fail to effectively acquire and service small business customers.

 

We market and sell a significant proportion of our products and online services to small businesses. Some of our competitors, by contrast, have emphasized sales to larger enterprises, which are attractive customers due to the high revenue and low relative costs they offer per transaction and their low failure and high renewal rates. Small businesses frequently have limited budgets and may choose to allocate resources to items other than our products and online services, especially in times of economic uncertainty. We believe that the small business market is underserved, however, and we intend to continue to devote substantial resources to it. We aim to grow our revenue by adding new small business customers, selling additional services to existing small business customers and encouraging existing small business customers to renew their subscriptions to our premium products. If the small business market fails to be as lucrative as we project or we are unable to market and sell our services to small businesses effectively, our ability to grow our revenue quickly and remain profitable will be harmed.

 

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Our business relies on the significant experience and expertise of our senior management and technical staff and we must continue to attract and retain highly skilled personnel in order to grow our business successfully.

 

Our future performance depends on the continued service and performance of our key management, research and development and sales personnel. In particular, we rely on J.R. Smith, our Chief Executive Officer, or CEO, and member of our Management Board, who has been critical in developing our core strategy and vision and in leading execution of our business model over the four years of his tenure as CEO. We may fail to retain our key management, research and development and sales employees, or to attract the qualified staff needed to manage and grow our business. We may also fail to attract or retain highly qualified technical, services and management personnel in the future, or may face time-consuming and costly integration of replacement personnel. Any of these factors could adversely affect our business, revenue and results of operations.

 

Our ability to sell our products is partially dependent on the quality of our support services and our failure to offer adequate support services could have an adverse effect on our reputation and results of operations.

 

Our users depend on us and, to some extent, on our user community, to resolve installation, technical or other issues relating to our security software solutions. We consider a high level of service to be critical for the successful marketing and sale of our software as well as for retaining our existing users. In providing that service, we rely in part on the feedback and knowledge shared through our active online user community. Also, we have outsourced certain of our consumer support functions to third-party service providers, which may fail to perform at the level specified in our contracts with them. If we, our user community or our third-party service providers do not provide accurate technical assistance or otherwise succeed in helping our users resolve issues related to the use of our security software solutions, our reputation could be harmed and our results of operations could be adversely affected.

 

In addition to our direct sales and distribution channels, we rely on third-party distributors and resellers to sell our software. If we fail to sell our products effectively through our third-party distributors and resellers, our results of operations could be adversely affected.

 

Sales made indirectly through third-party distributors and resellers accounted for 30.6% and 25.8% of our total revenue in 2010 and for the nine months ended September 30, 2011, respectively, and we expect this sales channel to continue to represent a large portion of our total revenue. We have limited control over the amount of software that these indirect sales partners purchase from us or sell on our behalf. Weakness in the end-user market could negatively affect the cash flow of our distributors and resellers who could, in turn, delay paying their obligations to us. Furthermore, a change in the credit quality at one of our distributors or other counterparties can increase the risk that such counterparty is unable or unwilling to pay amounts owed to us, which could directly or indirectly (through a disruption in our distribution network) have a material adverse effect on our results of operations. Any material decrease in the volume of revenue generated by our indirect sales channels could adversely affect our revenue and results of operations.

 

While we believe we conduct appropriate due diligence on our sales partners, we may not be able to monitor their activities for regulatory compliance. Furthermore, certain national regulations could require licenses from governments or government agencies for the use of our products and these regulations may limit our penetration of certain markets by us or our indirect sales partners. For instance, we were required to obtain a business license to begin distribution of our products in China, which took approximately two months, entailed defining the scope of our business and would require a revised license if that scope changed. China is the only jurisdiction important to our business in which we have sought a license to date, but developments such as release of new products, entry into new markets or regulatory changes in existing markets could oblige us to seek additional licenses in other jurisdictions in the future. If we violate the terms of a required license, it could cause us to lose the license, damage our reputation or require the reorganization of our distribution model.

 

While we have standard contract terms for our third-party distributors and resellers that allow those parties the flexibility to decide where to sell our solutions and the price at which they are sold, some of our distribution and resale contracts contain provisions relating to exclusivity or allocation of territories and/or minimum price requirements. It is possible that resellers or distributors may seek to challenge these contractual provisions on the

 

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basis of local competition law, which, regardless of its merit, could divert management time and attention and have a material adverse effect on our financial condition and results of operations. This risk may be highest among third-party distribution contracts that we may seek to terminate.

 

Any material disruption of our relationships with major providers of Internet distribution services, including Akamai, and payment services could adversely affect our business.

 

Third parties supply us with certain products and services that are integral to our business. For example, we depend on Akamai for the distribution of our security software, for software updates to our active users and for acceleration and caching of our Web pages. We consider the possibility of Akamai failing to be remote and we have not developed a formal back-up or business continuity plan in the event of Akamai’s failure. If Akamai’s systems were to fail, we would be able to accommodate the distribution of our software and software updates on our own systems, but the delivery of our content would be slower. These services are material to our business. Accordingly, any disruption in the relationship between us and Akamai or between us and one of our Internet payment service providers, including any disruption of service, or the existence of any dispute, may harm our business and results of operations.

 

We are exposed to risks associated with credit card fraud and credit card payment processing.

 

Our customers use credit and debit cards to pay for our services and products. We may suffer losses as a result of orders placed with fraudulent credit and debit cards. We, our payment providers and our reseller network may not have the means to detect or control payment fraud, which could have an adverse effect on our results of operations. The secure transmission of confidential credit and debit card information is essential to maintain customer and supplier confidence in us. Advances in technology or other developments could make it possible to compromise or breach the technology that we use to protect subscriber and transaction data. It is possible that our security measures may not prevent security breaches, and we may be unsuccessful in, protecting against these potential exposures. Security breaches, whether of our system or third party systems, could significantly harm our business or our reputation. In addition, we currently do not adhere to the Payment Card Industry Data Security Standard, which is a worldwide information security standard defined by the Payment Card Industry Data Security Standards Council. The standard was created to help payment card industry organizations that process card payments prevent credit and debt card fraud through increased controls around data and its exposure to compromise. Efforts to mitigate and comply with the standard, or similar standards, and even the perception of a breach of such standards increase the risk that such incidents will lead to sanctions (including fines and other penalties), claims by banks, card holders and others and disclosure leading to public knowledge of such incidents, potentially causing reputational damage to our business.

 

For credit and debit card transactions we pay interchange and other fees which may increase over time and raise our operating costs and lower profitability. In addition, our credit card fees may be increased by credit card companies if our chargeback rate, or the rate of payment refunds, exceeds certain minimum thresholds. If we are unable to maintain our chargeback rate at acceptable levels, our credit card fees for chargeback transactions, or for all credit card transactions, may be further increased, and credit card companies may increase our fees or terminate their relationship with us. Any increase in the credit card fees we are required to pay could adversely affect our results of operations and cash flows. The termination of our ability to process payments on any major credit or debit card could significantly impair our ability to operate and grow our business.

 

We are also subject to rules regarding payments of disputed charges, and if we have disputed charges over the permitted amount, we could be subject to fines and penalties and our ability to use credit cards and debit cards as a payment mechanism may be terminated. We rely on third parties to provide payment processing services, including the processing of credit and debit cards, and it could disrupt our business if these companies become unwilling or unable to provide these services to us on commercially reasonable terms or at all. We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted or otherwise make it difficult or impossible for us to

 

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comply. If we fail to comply with these rules or requirements, we may be subject to fines and higher transaction fees and lose our ability to accept credit and debit card payments from our customers, process or facilitate other types of online payments, and our business and operating results could be adversely affected.

 

We may be unable to obtain additional financing or generate sufficient cash flows to make additional investments or fund potential acquisitions.

 

We may need to raise additional funds in the future in order to invest in or acquire complementary businesses, technologies, products or services. Additional financing may not be available on terms acceptable to us, or at all. If we raise additional funds by issuing equity securities, you may experience further dilution of your ownership interest. If we raise additional funds by issuing debt securities or obtaining loans from third parties, the terms of those debt securities or financing arrangements may include covenants or other restrictions on our business that could impair our operational flexibility and would also require us to fund additional interest expense. If additional financing is not available or is not available on acceptable terms when required, we may be unable successfully to develop or enhance our security software solutions, which could materially adversely affect our business, results of operations and financial condition.

 

Our indebtedness could affect our financing options and liquidity.

 

On March 15, 2011, we borrowed $235 million under our credit agreement. In addition, our credit agreement permits us to request up to an additional $100 million in borrowings subject to lender consent and covenant compliance. Our indebtedness is secured by substantially all of our assets and could have important consequences to our business or the holders of our ordinary shares, including:

 

   

limiting our ability to obtain additional financing in the future for working capital, capital expenditures or acquisitions;

 

   

requiring a significant portion of our net cash provided by operations to be dedicated to the payment of the principal of and interest on our indebtedness, thereby reducing funds available for other purposes;

 

   

making us more vulnerable to economic downturns, interest rate changes and limiting our ability to withstand competitive pressures; and

 

   

preventing us from paying dividends on our ordinary shares.

 

We are subject to debt covenants that impose operating and financial restrictions on us and could limit our ability to grow our business.

 

Covenants in our credit agreement impose significant operating and financial restrictions on us. These restrictions prohibit or limit, among other things, our incurrence of additional indebtedness, creation of certain types of liens, mergers or consolidations, asset sales, payment of dividends, investments and transactions with affiliates. These restrictions could limit our ability to take advantage of business opportunities. Furthermore, our indebtedness requires us to maintain a maximum leverage ratio and a minimum interest coverage ratio. Our ability to comply with this ratio may be affected by events beyond our control, including prevailing economic, financial and industry conditions. If we are unable to comply with the covenants and ratios in our credit agreement in the future, we may be in default under the agreement. A change in control, including our current shareholders’ failing to continue to own at least 30% of our issued share capital, would also constitute an event of default. A default would result in an increase in the rate of interest and may cause the loan to be accelerated. These developments could have a material adverse effect on our business.

 

Changes in the relative value of currencies against the U.S. dollar could adversely affect our results of operations.

 

At the parent company level, our reporting currency is the U.S. dollar and our revenue and costs are reported in U.S. dollars. The majority of our revenue is earned in U.S. dollars while a significant portion is earned in British pounds sterling, Czech crowns and euros. A substantial portion of our costs are incurred in Czech crowns.

 

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We are exposed to transaction currency risk from fluctuations in exchange rates between the U.S. dollar and British pound sterling, Czech crown and euro. In addition, we are exposed to translational risk resulting from our international sales denominated in currencies other than U.S. dollars and the resulting foreign currency balances held on our balance sheet. We enter into foreign exchange contracts to hedge much of our transactional exposure between the U.S. dollar and British pound sterling, Czech crown and euro. However, these hedging arrangements may not fully protect us from currency risk. In addition, due to Czech regulations, the functional currency of our primary Czech operating subsidiary is the Czech crown. This gives rise to a profit and loss revaluation charge on the U.S. dollar denominated assets of that Czech subsidiary. We manage this balance sheet exposure but do not use financial instruments to hedge these positions as we believe these are technical accounting exposures only. As a result, currency exchange rate fluctuations could adversely affect our results of operations and financial condition.

 

If we fail to maintain proper and effective internal controls, our ability to produce accurate financial statements would be impaired, which could adversely affect our operating results, our ability to operate our business and our share price.

 

We must ensure that we have adequate internal financial and accounting controls and procedures in place to produce accurate financial statements on a timely basis. Section 404 of the Sarbanes-Oxley Act will require annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. We are only at the beginning stages of implementing systems and controls to comply with Section 404. In addition, we may need to implement additional systems and controls with respect to new acquisitions and as our business model evolves. Both we and our independent auditors will be testing our internal controls in connection with the Section 404 requirements and could identify areas for further attention or improvement, including identifying issues that individually or taken together could represent a significant deficiency or material weakness in our internal control over financial reporting.

 

Implementing changes to our internal controls will require compliance training for our directors, officers and employees, will entail substantial costs to modify our accounting systems and may take a significant period of time to complete. For instance, we have no existing risk compliance staff. Such changes may not, however, be effective in maintaining the adequacy of our internal control over financial reporting and any failure to maintain that adequacy, or consequent inability to produce accurate financial statements on a timely basis, could increase our operating costs and could materially impair our ability to operate our business. In addition, investors’ perceptions that our internal control over financial reporting is inadequate or that we are unable to produce accurate financial statements may materially adversely affect our share price.

 

We will have new compliance burdens as a public company and as a foreign company reporting in the United States.

 

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act and rules of the Securities and Exchange Commission, or SEC, and the NYSE impose various requirements on public companies beyond establishment and maintenance of effective disclosure and financial controls. We will need to strengthen our internal procedures in a range of areas to match the standards expected of public companies. In addition, our entry into the U.S. capital markets imposes new and complex tax burdens and disclosure obligations unfamiliar to us as a company foreign to the United States. Similarly, our financial statements historically were prepared and will continue to be prepared in accordance with international financial reporting standards as adopted by the European Union, but in connection with this offering we have prepared and will continue to prepare our financials under U.S. GAAP as well. Compliance with these laws and standards will increase our legal, insurance and financial compliance costs and consume staff and management time, particularly while we are setting up new compliance initiatives, potentially harming our business and financial position.

 

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Risks Relating to this Offering and Ownership of our Ordinary Shares

 

There is no existing market for our ordinary shares and we do not know whether one will develop to provide you with adequate liquidity.

 

Prior to this offering, there has not been a public market for our ordinary shares. If an active trading market does not develop, you may have difficulty selling any of our ordinary shares that you buy. We cannot predict the extent to which investor interest in our company will lead to the development of an active trading market on the NYSE, or otherwise or how liquid that market might become. The initial public offering price for our ordinary shares will be determined by negotiations between us and the underwriters and may not be indicative of prices that will prevail in the open market following this offering. Consequently, you may not be able to sell our ordinary shares at prices equal to or greater than the price paid by you in this offering.

 

Our share price may be volatile due to fluctuations in our quarterly financial results or other factors and you could lose a significant part of your investment.

 

Actual or anticipated fluctuations in our quarterly financial or operating results, the risks described above and additional factors listed below, some of which are beyond our control, may cause significant volatility in our share price. These additional factors include:

 

   

the failure of financial analysts to cover our ordinary shares after this offering or changes in financial estimates by analysts;

 

   

changes in financial estimates by financial analysts, or any failure by us to meet or exceed any of these estimates, or changes in the recommendations of any financial analysts that elect to follow our ordinary shares or the shares of our competitors;

 

   

announcements by us or our competitors of significant contracts or acquisitions;

 

   

future sales of our shares; and

 

   

investor perceptions of us and the industries in which we operate.

 

In addition, the stock market in general has experienced substantial price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of particular companies affected. These broad market and industry factors may materially harm the market price of our ordinary shares, regardless of our operating performance. In the past, following periods of volatility in the market price of certain companies’ securities, securities class action litigation has been instituted against these companies. This litigation, if instituted against us, could adversely affect our financial condition or results of operations.

 

The initial public offering price per ordinary share is substantially higher than our net tangible book value per ordinary share immediately after this offering and you will incur immediate and substantial dilution for this reason and due to expected option exercises in connection with this offering, as well as, if applicable, conversion rate adjustments for the Class D shares at certain prices below the range set forth on the front cover of this prospectus.

 

The initial public offering price per ordinary share is substantially higher than our net tangible book value per ordinary share immediately after this offering. As a result, you will pay a price per share that substantially exceeds the tangible book value of our assets after subtracting our liabilities. Investors who purchase ordinary shares in this offering will be diluted by $20.21 per share after giving effect to the sale of ordinary shares in this offering and the exercise of options expected to be exercised at the closing of this offering. See “Dilution.” Furthermore, if the initial public offering price is below $14.85, assuming that the closing of this offering occurs on or around February 7, 2012, the holder of the Class D preferred shares will be entitled to additional ordinary shares such that the value of the ordinary shares such holder receives upon conversion will be $178.2 million, causing additional dilution to investors who purchase ordinary shares in this offering. See “Description of Share Capital—Share Capital—Share Conversion.” If we grant options in the future to our employees and those options are exercised, or if other issuances of ordinary shares are made, there will be further dilution.

 

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Our management will have broad discretion over the use of the proceeds we receive in this offering and may not apply the proceeds in ways that increase the value of your investment.

 

Our management will have broad discretion to use the net proceeds to us from this offering and you will be relying on the judgment of our management regarding the application of these proceeds. Our management might not apply the net proceeds from this offering in ways that increase the value of your investment. As described in “Use of Proceeds,” we have not allocated the net proceeds from this offering for any specific purpose. Until we use the net proceeds to us from this offering, we plan to invest them, and these investments may not yield a favorable rate of return. If we do not invest or apply the net proceeds from this offering in ways that enhance shareholder value, we may fail to achieve expected financial results.

 

Following this offering, a substantial sale of our ordinary shares, or a perception that such sales may occur, could cause the price of our ordinary shares to decline.

 

In connection with this offering, the selling shareholders have agreed to certain restrictions on the sale or other disposition of our ordinary shares or any shares or other securities convertible into, or exercisable or exchangeable for, our ordinary shares, except with the prior written consent of Morgan Stanley & Co. LLC, J.P. Morgan Securities LLC and Goldman, Sachs & Co. (subject to certain exceptions). The selling shareholders have agreed to a lock-up period of 180 days from the date of the final prospectus relating to this offering. We cannot predict whether substantial numbers of our ordinary shares will be sold by the selling shareholders or others in the open market following the expiration of the applicable lock-up period, or during the lock-up period with the prior consent of Morgan Stanley & Co. LLC, J.P. Morgan Securities LLC and Goldman, Sachs & Co. A future sale of a substantial number of our ordinary shares by the selling shareholders, or the perception that such sales could occur, could adversely affect the market price of our ordinary shares and could also impede our ability to raise capital through an issue of ordinary shares in the future.

 

The selling shareholders will continue to exert significant influence on us following this offering.

 

Following the closing of this offering and assuming no exercise of the underwriters’ over-allotment option, the selling shareholders will continue to beneficially own an aggregate of approximately 57.2% of our outstanding ordinary shares. In case of full exercise of the over-allotment option, approximately 55.0% of our issued share capital will be owned by the selling shareholders. As a result, the selling shareholders will be in a position to exert significant influence over the outcome of matters submitted to a vote of our shareholders, including matters such as approval of the financial statements, declarations of dividends, the appointment and removal of the members of our management board and our supervisory board, capital increases and amendments to our articles of association. In addition, following completion of this offering, four of the members of our supervisory board will be affiliated with the selling shareholders.

 

In addition, the selling shareholders’ significant shareholdings in us may have the effect of making certain transactions more difficult without the support of the selling shareholders and may have the effect of delaying or preventing our acquisition or other change in control.

 

Anti-takeover provisions in our articles of association may prevent or delay change-of-control transactions.

 

Our articles of association contain provisions that may have the effect of making a takeover of our company more difficult or less attractive, including:

 

   

the staggered four-year terms of our supervisory board members, as a result of which only approximately one-fourth of our supervisory board members will be subject to election in any one year;

 

   

a provision that our management board and supervisory board members may only be removed at the general meeting of shareholders by a two-thirds majority of votes cast representing at least 50% of our outstanding share capital if such removal is not proposed by our supervisory board;

 

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the authorization of a class of preference shares that may be issued by our management board, subject to the approval of our supervisory board, in such a manner as to dilute the interest of any potential acquirer;

 

   

requirements that certain matters, including an amendment of our articles of association, may only be brought to our shareholders for a vote upon a proposal by our management board that has been approved by our supervisory board; and

 

   

minimum shareholding thresholds, based on nominal value, for shareholders to call general meetings of our shareholders or to add items to the agenda for those meetings.

 

We are a Dutch public company with limited liability. The rights of our shareholders may be different from the rights of shareholders in companies governed by the laws of U.S. jurisdictions.

 

We are a Dutch public company with limited liability (naamloze vennootschap). Our corporate affairs are governed by our articles of association and by the laws governing companies incorporated in the Netherlands. The rights of shareholders and the responsibilities of members of our management board and supervisory board may be different from the rights and obligations of shareholders in companies governed by the laws of U.S. jurisdictions. In the performance of its duties, our management board and supervisory board are required by Dutch law to consider the interests of our company, its shareholders, its employees and other stakeholders, in all cases with due observation of the principles of reasonableness and fairness. It is possible that some of these parties will have interests that are different from, or in addition to, your interests as a shareholder. See “Description of Share Capital—Corporate Governance.

 

We will be a foreign private issuer and, as a result, we will not be subject to U.S. proxy rules and will be subject to Exchange Act reporting obligations that, to some extent, are more lenient and less frequent than those of a U.S. domestic public company.

 

Upon consummation of this offering, we will report under the Securities Exchange Act of 1934, as amended, or the Exchange Act, as a non-U.S. company with foreign private issuer status. Because we qualify as a foreign private issuer under the Exchange Act and although we are subject to Dutch laws and regulations with regard to such matters and intend to furnish quarterly financial information to the SEC, we are exempt from certain provisions of the Exchange Act that are applicable to U.S. domestic public companies, including (i) the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations in respect of a security registered under the Exchange Act; (ii) the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and liability for insiders who profit from trades made in a short period of time; and (iii) the rules under the Exchange Act requiring the filing with the SEC of quarterly reports on Form 10-Q containing unaudited financial and other specified information, or current reports on Form 8-K, upon the occurrence of specified significant events. In addition, for fiscal years ending on or after December 15, 2011, foreign private issuers will not be required to file their annual report on Form 20-F until 120 days after the end of each fiscal year, while U.S. domestic issuers that are accelerated filers are required to file their annual report on Form 10-K within 75 days after the end of each fiscal year. Foreign private issuers are also exempt from the Regulation Fair Disclosure, aimed at preventing issuers from making selective disclosures of material information. As a result of the above, you may not have the same protections afforded to shareholders of companies that are not foreign private issuers.

 

As a foreign private issuer and as permitted by the listing requirements of the New York Stock Exchange, we will rely on certain home country governance practices rather than the corporate governance requirements of the New York Stock Exchange.

 

We will be a foreign private issuer. As a result, in accordance with the listing requirements of the NYSE, we will rely on home country governance requirements and certain exemptions thereunder rather than relying on the corporate governance requirements of the NYSE. For an overview of our corporate governance principles, see

 

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Description of Share Capital—Corporate Governance,” including the section describing the differences between the corporate governance requirements applicable to our ordinary shares listed on the NYSE and the Dutch corporate governance requirements. Accordingly, you may not have the same protections afforded to shareholders of companies that are not foreign private issuers.

 

We are not obligated to and do not comply with all the best practice provisions of the Dutch Corporate Governance Code. This may affect your rights as a shareholder.

 

As a Dutch company we are subject to the Dutch Corporate Governance Code, or DCGC. The DCGC contains both principles and best practice provisions for management boards, supervisory boards, shareholders and general meetings of shareholders, financial reporting, auditors, disclosure, compliance and enforcement standards. The DCGC applies to all Dutch companies listed on a government-recognized stock exchange, whether in the Netherlands or elsewhere, including the NYSE. The principles and best practice provisions apply to our management board and our supervisory board (in relation to role and composition, conflicts of interest and independency requirements, board committees and remuneration), shareholders and the general meeting of shareholders (for example, regarding anti-takeover protection and obligations of the company to provide information to its shareholders) and financial reporting (such as external auditor and internal audit requirements). We do not comply with all the best practice provisions of the DCGC. See “Description of Share Capital—Dutch Corporate Governance.” This may affect your rights as a shareholder and you may not have the same level of protection as a shareholder in a Dutch company that fully complies with the DCGC.

 

We expect that only a relatively small percentage of our ordinary shares will be publicly traded following this offering, which may limit the liquidity of your investment and may have a material adverse effect on the price of our ordinary shares.

 

After this offering, 8,000,000 of our ordinary shares, representing 14.7% of our outstanding ordinary shares, will be held by parties other than the selling shareholders, directors, senior management, existing shareholders holding 5% or more of our ordinary shares and their respective affiliates. As a result, we expect that only a relatively small number of our ordinary shares will be actively traded in the public market following this offering. Reduced liquidity may have a material adverse effect on the price of our ordinary shares.

 

You will not be able to trade our ordinary shares on any exchange outside the United States.

 

We have applied to list our ordinary shares only in the United States on the NYSE and we have no plans to list our ordinary shares in any other jurisdiction. As a result, a holder of our ordinary shares outside the United States may not be able to effect transactions in our ordinary shares as readily as the holder may if our securities were listed on an exchange in that holder’s home jurisdiction.

 

We may not be able and currently have no intention to pay further dividends for the foreseeable future.

 

Payment of future dividends may be made only if our equity exceeds the amount of the paid-in and called-up part of the issued share capital, increased by the reserves required to be maintained by law or by our articles of association. We currently intend to retain future earnings, if any, to finance the growth and development of our business. Also, our credit agreement restricts the payment of dividends to holders of our ordinary shares. As a result, we currently have no intention to pay dividends apart from payment of accrued and unpaid dividends on our Class D preferred shares in connection with the automatic conversion of such preferred shares into ordinary shares upon the closing of this offering. Accordingly, investors cannot rely on dividend income from our ordinary shares and any returns on an investment in our ordinary shares will likely depend entirely upon any future appreciation in the price of our ordinary shares.

 

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Raising additional capital by issuing securities may cause dilution to existing shareholders, restrict our operations or require us to relinquish proprietary rights.

 

We may in the future seek the additional capital necessary to fund acquisitions through public or private equity offerings. To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, unless pre-emptive rights are granted, and the terms of such securities may include liquidation or other preferences that adversely affect your rights as a shareholder. Debt financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions such as incurring additional debt, making capital expenditures or declaring dividends.

 

Certain holders of our ordinary shares, including holders in the United States, may not be able to exercise pre-emptive rights and as a result may experience substantial dilution upon future issuances of ordinary shares.

 

Holders of our ordinary shares will in principle have a pre-emptive right with respect to any issue of ordinary shares or the granting of rights to subscribe for ordinary shares, unless explicitly provided otherwise in a resolution by the general meeting of shareholders or by a resolution of our management board with the approval by our supervisory board (if our management board has been designated by the general meeting of shareholders or the articles of association for this purpose). See “Description of Share Capital—Issuance of New Ordinary Shares and Pre-Emptive Rights.” However, certain holders of ordinary shares, including holders in the United States, may not be able to exercise pre-emptive rights unless local securities laws have been complied with. Specifically, certain holders in the United States of ordinary shares may not be able to exercise any pre-emptive rights in respect of ordinary shares held by them unless a registration statement under the Securities Act is effective with respect to ordinary shares issuable upon exercise of such rights or an exemption from the registration requirements under the Securities Act is available. We currently have no intention of filing such a registration statement and can give no assurance that any such registration statement would be filed or that any exemption from registration would be available to enable the exercise of a United States holder’s pre-emptive rights. As a result, in the future we may sell ordinary shares or other securities to persons other than our existing shareholders at a lower price than the ordinary shares being sold in the initial public offering, which would cause holders in the United States to experience substantial dilution of their interest in us. Similar laws may apply in other jurisdictions.

 

Claims of U.S. civil liabilities may not be enforceable against us.

 

We are incorporated under the laws of the Netherlands and substantial portions of our assets are located outside of the United States. In addition, the members of our management board, certain members of our supervisory board, certain members of our senior management and certain experts named herein reside outside the United States. As a result, it may be difficult for investors to effect service of process within the United States upon us or such other persons residing outside the United States, or to enforce outside the United States judgments obtained against such persons in U.S. courts in any action, including actions predicated upon the civil liability provisions of the U.S. federal securities laws. In addition, it may be difficult for investors to enforce, in original actions brought in courts in jurisdictions located outside the United States, rights predicated upon the U.S. federal securities laws.

 

There is no treaty between the United States and the Netherlands for the mutual recognition and enforcement of judgments (other than arbitration awards) in civil and commercial matters. Therefore, a final judgment for the payment of money rendered by any federal or state court in the United States based on civil liability, whether or not predicated solely upon the U.S. federal securities laws, would not be enforceable in the Netherlands unless the underlying claim is re-litigated before a Dutch court of competent jurisdiction. Under current practice however, a Dutch court may be expected to recognize the binding effect of a final, conclusive and enforceable money judgment of a federal or state court in the United States without re-examination or re-litigation of the substantive matters adjudicated thereby, if (i) that judgment resulted from legal proceedings

 

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compatible with Dutch notions of due process, (ii) that judgment does not contravene public policy of the Netherlands and (iii) the jurisdiction of the U.S. federal or state court has been based on internationally accepted principles of private international law.

 

Based on the foregoing, there can be no assurance that U.S. investors will be able to enforce against us or members of our management board or supervisory board, officers or certain experts named herein who are residents of the Netherlands or countries other than the United States any judgments obtained in U.S. courts in civil and commercial matters, including judgments under the U.S. federal securities laws.

 

In addition, there is doubt as to whether a Dutch court would impose civil liability on us, the members of our management board or supervisory board, our officers or certain experts named herein in an original action predicated solely upon the U.S. federal securities laws brought in a court of competent jurisdiction in the Netherlands against us or such members, officers or experts, respectively.

 

U.S. investors could suffer adverse U.S. federal income tax consequences if we are a “passive foreign investment company.”

 

There can be no assurance that we will not be a passive foreign investment company, or PFIC, for any taxable year, which could result in adverse U.S. federal income tax consequences to U.S. holders of our ordinary shares. A non-U.S. corporation will be a PFIC for any taxable year if either (i) at least 75% of its gross income is passive income or (ii) at least 50% of the value of its assets (based on an average of the quarterly values of the assets during the taxable year) is attributable to assets that produce or are held for the production of passive income. Passive income generally includes dividends, interest, rents and royalties.

 

Based upon the projected composition of our income and assets and estimates of the valuation of our assets, including goodwill, which is based, in part, on the expected price of our ordinary shares in this offering, we do not expect to be a PFIC for the 2012 taxable year or in the foreseeable future. However, the determination of whether we are a PFIC is an annual test based on the composition of our income and assets and the value of our assets from time to time. Because we expect to continue to hold following this offering a substantial amount of cash and other passive assets and because the determination of whether we are a PFIC will depend on the character of our income and assets and the value of our assets from time to time, which may be based in part on the market price of our ordinary shares, which is likely to fluctuate after this offering, we cannot assure you that we will not be a PFIC for any taxable year. If we were a PFIC for any taxable year during which a U.S. holder held ordinary shares, certain adverse U.S. federal income tax consequences could apply to such U.S. holder. In addition, if we are a PFIC for any year, we do not intend to provide information necessary for a U.S. holder to make a qualified electing fund election, which if available could in certain circumstances help mitigate the adverse consequences of PFIC status. Accordingly, if we are a PFIC for any year, a U.S. holder will not be able to make this election. See “Material Tax Considerations—Material U.S. Federal Income Tax Considerations—Passive Foreign Investment Company Rules.

 

We may not be able to make distributions or repurchase shares without subjecting our shareholders to Dutch withholding tax.

 

Dutch dividend withholding tax may be levied on dividends and similar distributions made by us to our shareholders at the statutory rate of 15%. If dividend distributions are structured as a repayment of capital or a repurchase of shares, Dutch withholding tax may still be due at 15%. Such repayment of capital or repurchase of shares will be exempt from dividend withholding tax only in limited circumstances. See also the section titled “Material Tax Considerations” below.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

 

This prospectus contains forward-looking statements about us, our markets and our industry. These statements involve known and unknown substantial risks, uncertainties and other factors as described in detail under the section titled “Risk Factors” in this prospectus that may cause our actual results, levels of activity, performance or achievement to be materially different from those expressed or implied by the forward-looking statements. All statements, other than statements of historical fact, included in this prospectus regarding our strategy, future operations, future financial position, future net sales, projected expenses, prospects and plans and objectives of management are forward-looking statements.

 

In some cases, you can also identify forward-looking statements by terms such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “project,” “will,” “would,” “should,” “could,” “can,” “predict,” “potential,” “continue,” “objective,” or the negatives of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words.

 

All forward-looking statements reflect our current views about future events and are based on assumptions and subject to risks and uncertainties. Forward-looking statements in this prospectus include, but are not limited to, statements about:

 

   

our growth strategies;

 

   

our future prospects, business development, results of operations and financial condition;

 

   

changes to the online and computer threat environment and the endpoint security industry;

 

   

competition from local and international companies, new entrants in the market and changes to the competitive landscape;

 

   

the adoption of new, or changes to existing, laws and regulations;

 

   

flaws in the assumptions underlying the calculation of the number of our active users;

 

   

the termination of or changes to our relationships with our partners and other third parties;

 

   

our plans to launch new products and online services and monetize our full user base;

 

   

our ability to attract and retain active and subscription users;

 

   

our ability to retain key personnel and attract new talent;

 

   

our ability to adequately protect our intellectual property;

 

   

flaws in our internal controls or IT systems;

 

   

our geographic expansion plans;

 

   

the anticipated costs and benefits of our acquisitions;

 

   

the outcome of ongoing or any future litigation or arbitration, including litigation or arbitration relating to intellectual property rights;

 

   

our legal and regulatory compliance efforts;

 

   

our planned use of proceeds; and

 

   

worldwide economic conditions and their impact on demand of our products and services.

 

Given these risks and uncertainties, you should not place undue reliance on these forward-looking statements.

 

Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this prospectus. You should read this prospectus and the documents that we have filed as exhibits to the

 

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registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

 

Except as required by law, we assume no obligation to update these forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

 

Some of the industry and market data contained in this prospectus are based on independent industry publications, including those generated by DomainTools.com, IDC and Forrester Research Inc. or other publicly available information. This information involves a number of assumptions and limitations. Although we believe that each source is reliable as of its respective date, neither we, the selling shareholders nor the underwriters have independently verified the accuracy or completeness of this information.

 

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USE OF PROCEEDS

 

We estimate that we will receive net proceeds of approximately $53.7 million from the sale of 4,000,000 ordinary shares in this offering, assuming an initial public offering price of $17.00 per share, the midpoint of the estimated price range set forth on the cover page of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

 

We intend to use the proceeds of this offering for general corporate purposes, including, without limitation, investments in property and equipment and intangible assets. We may also use a portion of the net proceeds for the acquisition of, or investment in, technologies, teams or businesses that complement our business, although we have no present commitments or agreements to enter into any material acquisitions or make any such material investments. We have no specific plans or commitments with respect to the proceeds to us from this offering and therefore are unable to quantify the allocation of such proceeds among various potential uses at this time. Our management will have significant flexibility and discretion in applying the net proceeds of this offering.

 

We will not receive any proceeds from the sale by the selling shareholders in this offering, the net proceeds of which will be received by the selling shareholders, or from the sale by certain of the selling shareholders of the over-allotment shares upon an exercise (if any) of the over-allotment option, the net proceeds of which will be received by the selling shareholders. The selling shareholders will include certain entities affiliated with or controlled by members of our supervisory board.

 

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DIVIDEND POLICY

 

We currently intend to retain future earnings, if any, to finance the growth and development of our business and to provide additional liquidity. As a result, we currently have no intention to pay dividends and will not make additional distributions or dividends in respect of the year ended December 31, 2012 apart from payment of accrued and unpaid dividends on our Class D preferred shares in connection with the automatic conversion of such preferred shares into ordinary shares upon the closing of this offering. The amount of such accrued dividends will be equal to (1) approximately $1.8 million, which would have been the amount of accrued dividends if the closing had occurred on December 31, 2011, plus (2) approximately $20,000 per day for the period from December 31, 2011 to the date of the closing.

 

General

 

We may make distributions to shareholders only to the extent that the Company’s equity exceeds the amount of the paid-in and called-up part of the issued share capital, increased by the reserves we are required to maintain pursuant to our articles of association or the provisions of applicable law. Any distribution of profits will be made after the adoption of the annual accounts showing that such distribution of profits is permitted.

 

Under our articles of association, our management board determines, subject to the approval of our supervisory board, what portion of our profits will be reserved. Any profits remaining will be put at the disposal of the general meeting of shareholders. Our management board, with the approval of the supervisory board, is required to make a proposal for that purpose, which is then dealt with as a separate agenda item at the general meeting of shareholders. Our management board is permitted, subject to certain requirements and subject to approval of our supervisory board, to declare interim dividends without the approval of the general meeting of shareholders. See “Description of Share Capital—Dividends and Other Distributions.

 

Our management board may, subject to the approval of our supervisory board, resolve to make distributions on the ordinary shares not in cash, but in ordinary shares, or resolve that shareholders shall have the option to receive a distribution in cash and/or in ordinary shares, provided that our management board is designated by the general meeting of shareholders as the competent corporate body to resolve to issue ordinary shares. See “Description of Share Capital—Issuance of New Ordinary Shares and Pre-Emptive Rights.

 

In addition, our term loan facility restricts the payment of dividends to holders of our ordinary shares. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.

 

In principle, dividend payments are subject to withholding tax in the Netherlands. See “Material Tax Considerations.

 

Dividend History

 

The number of our outstanding shares as of December 31, 2008, 2009 and 2010 was, respectively, 45 million, 48 million and 48 million, as adjusted for a share issuance having the effect of a 10 for 1 share split, or the Share Split, that occurred in 2009. The following table sets forth details of dividends paid on the then-outstanding shares in the past three years, also as adjusted for the Share Split. It shows the dividend per ordinary share, dividend per preferred share and the aggregate dividends paid.

 

     Year ended December 31,  
     2008      2009      2010  

Cash dividends declared per ordinary share

   $ 0.44       $ 3.28       $ 0.83   

Cash dividends declared per preferred share

                   $ 1.43   

Total dividends paid

     $20,000,000         $118,066,000         $47,210,000   

 

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CAPITALIZATION

 

The following table sets forth our cash and cash equivalents and capitalization as of September 30, 2011. Our cash and cash equivalents and capitalization are presented:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect the automatic conversion upon the closing of this offering of all classes of our outstanding shares into the same number of ordinary shares, with all special rights associated with the existing classes of shares ceasing to be applicable, and the payment in cash of accrued and unpaid dividends on our Class D preferred shares in connection with such conversion (assuming a closing on September 30, 2011), such conversion referred to as the Share Conversion; and

 

   

on a pro forma, as adjusted basis to give effect to (i) the Share Conversion and payment of associated dividends, (ii) the sale of ordinary shares by us in this offering (at an assumed initial public offering price of $17.00 per share, the midpoint of the range set forth on the cover page of this prospectus, and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us) and the use of proceeds therefrom, (iii) 806,760 ordinary shares that are issuable to the sellers of TuneUp immediately upon the closing of this offering (assuming an initial public offering price of $17.00 per share, the midpoint of the price range set forth on the front cover of this prospectus, and a euro/U.S. dollar exchange rate of $1.27 per euro), which shares will remain in escrow following this offering subject to satisfaction of certain vesting criteria, including continuing employment by TuneUp of the sellers of TuneUp and (iv) our receipt of the proceeds from the exercise of share options to purchase 2,382,591 ordinary shares, 650,000 of which will be sold in this offering.

 

You should read this table together with the sections of this prospectus titled “Use of Proceeds,” “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and related notes beginning on page F-1.

 

The table below shows what the capitalization would have been had the Share Conversion already been completed on such date and adjusted to reflect the net proceeds of this offering and assuming that the over-allotment option has not been exercised.

 

     As of September 30, 2011  
     (unaudited)  
     Actual     Pro forma     Pro forma,
as adjusted
 
     (in thousands)  

Cash and cash equivalents

   $ 73,288      $ 71,486      $ 125,532   
  

 

 

   

 

 

   

 

 

 

Long-term debt

     225,155        225,155        225,155   

Class D preferred shares

     191,954                 

Shareholders’ deficit

      

Ordinary shares

     476        639        732   

Distributions in excess of capital

     (389,861     (199,872     (145,908

Accumulated other comprehensive loss

     (4,482     (4,482     (4,482

Retained earnings

     72,841        72,841        72,841   
  

 

 

   

 

 

   

 

 

 

Total shareholders’ deficit

     (321,026     (130,874     (76,817
  

 

 

   

 

 

   

 

 

 

Total capitalization

   $ 96,083      $ 94,281      $ 148,338   
  

 

 

   

 

 

   

 

 

 

 

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DILUTION

 

If you invest in our ordinary shares, you will experience immediate and substantial dilution in the pro forma as adjusted net tangible book value per ordinary share after this offering.

 

Dilution will result from the fact that the per share offering price of our ordinary shares is substantially in excess of the book value per share attributable to the existing shareholders for our currently outstanding ordinary shares.

 

The historical net tangible book value of our ordinary shares (on an as-converted basis) as of September 30, 2011 was $(4.72) per share. Historical net tangible book value per share represents our total tangible assets (total assets less intangible assets) less total liabilities divided by the number of outstanding ordinary shares. After giving effect to (i) the Share Conversion and payment of associated dividends (assuming a closing on September 30, 2011), (ii) the sale of 4,000,000 ordinary shares in this offering at an assumed initial public offering price of $17.00 per share, the midpoint of the price range set forth on the front cover of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses payable by us, (iii) the application of the net proceeds we will receive from this offering in the manner described in “Use of Proceeds,” and (iv) our receipt of the proceeds from the exercise of share options to purchase 2,382,591 ordinary shares, 650,000 of which will be sold in this offering, the pro forma as adjusted historical net tangible book value of our ordinary shares as of September 30, 2011 would have been $(174.5 million), or $(3.21) per share. This represents an immediate increase in net tangible book value of $1.52 per share to existing shareholders and an immediate dilution of $20.21 per share to new investors purchasing shares in this offering. The following table illustrates this dilution on a per share basis to new investors:

 

Assumed initial public offering price per share

     $ 17.00   

Historical net tangible book value per share as of September 30, 2011

   $ (4.72  
  

 

 

   

Increase per share attributable to new investors in this offering

     1.52     

Pro forma as adjusted net tangible book value per share after this offering

       (3.21
    

 

 

 

Dilution in pro forma as adjusted net tangible book value per share to new investors

     $ 20.21   
    

 

 

 

 

Dilution is determined by subtracting pro forma as adjusted net tangible book value per share after this offering from the initial offering price per share. A $1.00 increase (decrease) in the assumed initial public offering price of $17.00 per share would increase (decrease) our pro forma as adjusted net tangible book value by $0.07 per share and increase (decrease) the dilution to new investors by $0.07 per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

 

The following table summarizes, as of September 30, 2011, the number of ordinary shares purchased from us, the total consideration paid, or to be paid, and the average price per share paid, or to be paid, by existing shareholders and by the new investors, at an assumed initial public offering price of $17.00 per share, the midpoint of the range set forth on the cover page of this prospectus, before deducting underwriting discounts and commissions and estimated offering expenses payable by us. The following table is illustrative only and the total consideration paid and the average price per share is subject to adjustment based on the actual initial public offering price per share and other terms of this offering determined at pricing.

 

     Shares Purchased     Total Consideration
(in thousands)
    Average Price
per Share
 
     Number      Percent     Amount      Percent    

Existing shareholders

     48,000,000         88   $ 48,661         41   $ 1.01   

Holders of options expected to be exercised at the closing of this offering

     2,382,591         5        316         1        0.13   

New investors

     4,000,000         7        68,000         58        17.00   
  

 

 

    

 

 

   

 

 

    

 

 

   

Total

     54,382,591         100   $ 116,977         100  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

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A $1.00 increase (decrease) in the assumed initial public offering price of $17.00 per share would increase (decrease) total consideration paid by new investors by $4.0 million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same.

 

Sales by the selling shareholders in this offering will reduce the number of shares held by existing shareholders to 44,650,000 or approximately 82% of the total ordinary shares outstanding after this offering, or 43,450,000 shares or approximately 80% of the total ordinary shares outstanding after this offering if the over-allotment option is exercised in full.

 

The number of shares to be purchased by new investors will be 8,000,000 shares or approximately 15% of the total ordinary shares outstanding after this offering, or 9,200,000 shares or approximately 17% of the total ordinary shares outstanding after this offering if the over-allotment option is exercised in full.

 

The foregoing discussion and tables are based on 48,000,000 ordinary shares issued and outstanding as of September 30, 2011, and:

 

   

includes 2,382,591 ordinary shares issuable upon the exercise of certain options outstanding as of September 30, 2011, at a weighted-average exercise price of $0.13 per share, which are held by certain of the selling shareholders and are expected to be exercised at the closing of this offering, 650,000 of which are being sold in the offering for the purpose of payment of the exercise price of these options and certain potential associated tax liabilities (see “Principal and Selling Shareholders”);

 

   

excludes 1,710,029 ordinary shares issuable upon the exercise of options outstanding as of September 30, 2011, at a weighted-average exercise price of $15.68 per share, which are not expected to be exercised at the closing of this offering;

 

   

excludes 554,638 ordinary shares issuable upon the exercise of options that have been granted since September 30, 2011, at a weighted average exercise price of $23.37, which are not expected to be exercised at the closing of this offering;

 

   

excludes 806,760 ordinary shares issuable to the sellers of TuneUp immediately upon the closing of this offering, assuming an initial public offering price of $17.00 per share, the midpoint of the price range set forth on the front cover of this prospectus, and a euro/U.S. dollar exchange rate of $1.27 per euro, which shares will remain in escrow following this offering subject to satisfaction of certain vesting criteria, including continuing employment by TuneUp of the sellers of TuneUp;

 

   

excludes 1,366,351 ordinary shares issuable upon the exercise of options expected to be granted immediately following the pricing of this offering to certain members of our management and supervisory boards, certain members of senior management and certain other employees at an exercise price equal to the initial public offering price; and

 

   

excludes 2,146,339 additional ordinary shares reserved for issuance under our amended and restated option plan.

 

To the extent that any additional outstanding options are exercised, new investors will experience further dilution.

 

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UNAUDITED PRO FORMA CONDENSED COMBINED FINANCIAL INFORMATION

 

On August 19, 2011, AVG Technologies GER GmbH, or AVG Technologies Germany, our wholly owned subsidiary, acquired 100% of the share capital of TuneUp Software GmbH, or TuneUp, a German based provider of intelligent software tools that enable users to optimize use of their operating systems and programs. Previously, on August 17, 2011, AVG Technologies CY Limited (formerly our wholly owned subsidiary, which has since merged into our wholly owned subsidiary AVG Netherlands B.V.), or AVG Technologies CY, entered into an asset purchase agreement pursuant to which it acquired certain assets of TuneUp. The foregoing transactions are referred to below as the Acquisition. The total purchase price was approximately $45.0 million and included cash consideration of €23.9 million ($34.4 million), and contingent cash consideration of up to €10.0 million ($14.4 million), which we have estimated to have a fair value of €7.4 million ($10.6 million), which is contingent on TuneUp meeting certain EBITDA and revenue targets for the full year 2011 generated by TuneUp. We incurred acquisition-related transaction costs of $1.8 million, which will be recorded in general and administrative expenses subsequent to the Acquisition.

 

As part of the Acquisition and apart from the contingent cash consideration above, the former owners of TuneUp will receive shares of AVG with a total value of €11.5 million ($16.5 million), subject to their continued employment by TuneUp and other vesting conditions. We determined that this contingent equity component constitutes compensation for services and accordingly the value of the contingent equity component is not included as part of the purchase price for purposes of U.S. GAAP. We will recognize the expense relating to these shares over a four-year vesting period.

 

We are in the process of preparing the purchase price allocation. Therefore, the preliminary pro forma acquisition adjustments described in Note 2 are based on available information and certain assumptions made by our management and may be revised as additional information becomes available.

 

In connection with the pro forma financial information, we allocated the purchase price using our best estimates of fair value. These estimates are based on the most recently available information. To the extent there are significant changes in TuneUp’s business, the assumptions and estimates used herein could change significantly. The purchase price allocation is dependent upon certain valuations that are not yet final. Accordingly, the pro forma purchase price adjustments are preliminary and subject to further adjustment as additional information becomes available and as additional analyses are performed. The pro forma financial information does not reflect potential expenses and efficiencies that may result from combining the companies.

 

The unaudited pro forma condensed combined statements of comprehensive income for the year ended December 31, 2010 and the nine-month period ended September 30, 2011 illustrate the effect of the Acquisition as if it had occurred on January 1, 2010.

 

The unaudited pro forma condensed combined financial information is presented for informational purposes only and is not necessarily indicative of the results of operations that would have resulted had the acquisition described above been consummated at the dates indicated, nor is it necessarily indicative of the results of operations which may be realized in the future.

 

The unaudited pro forma condensed combined statements of comprehensive income included herein has been prepared pursuant to the rules and regulations of the SEC. Certain information and certain footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to these rules and regulations.

 

The unaudited pro forma condensed combined statements of comprehensive income and accompanying notes thereto should be read together with our consolidated financial statements for the years ended December 31, 2008, 2009 and 2010, the condensed consolidated financial statements for the nine months ended September 30, 2011, TuneUp’s financial statements for the year ended December 31, 2010 and TuneUp’s condensed consolidated financial statements for the six months ended June 30, 2011, included elsewhere in this prospectus.

 

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The unaudited pro forma condensed combined statement of comprehensive income for the nine months ended September 30, 2011 of AVG includes TuneUp’s post-acquisition results from August 19, 2011 to September 30, 2011. TuneUp’s separate financial information disclosed in the unaudited pro forma condensed combined statement of comprehensive income for the nine months ended September 30, 2011 consists of pre-acquisition results from January 1, 2011 to August 18, 2011.

 

Due to our application of business combination accounting rules, we are required to reduce deferred revenue balances at acquired companies to the estimated fair value, at the acquisition date, of the support obligations assumed. As TuneUp does not have vendor-specific evidence of fair value for sales of its software license agreements, it recognizes all fees generated in a contract over the expected term for providing post-contract customer support, or PCS, services, which TuneUp’s management has deemed as being two years. As a consequence of this revenue recognition policy, Tune Up’s total deferred revenue on the date of acquisition was $14.9 million, including deferred license fees for delivered products, whereas the fair value of deferred revenue is made up only of the support obligations for acquisition accounting purposes and is preliminarily estimated to be $1.2 million. Accordingly, we will not be able to recognize approximately $3.1 million of revenue in the fourth quarter of 2011 and $8.3 million in 2012, which would have been recognized had TuneUp remained an independent company. To the extent customers chose to take advantage of the additional functionality in TuneUp’s new software products and buy upgrades of existing perpetual license arrangements, we will recognize revenues earned on the software license and related PCS over the expected term for providing PCS services. The acquired business is currently cash flow positive.

 

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AVG Technologies N.V.

Unaudited Pro Forma Condensed Combined Statement of Comprehensive Income

(in thousands of U.S. Dollars—except share and per share information)

 

     AVG Technologies     TuneUp                     
     Year ended
December 31, 2010
    Year ended
December 31, 2010
    Pro Forma
Adjustments
           Combined  

Revenue:

           

Subscription

   $ 166,904      $ 11,242                $ 178,146   

Platform-derived

     50,314                         50,314   
  

 

 

   

 

 

   

 

 

      

 

 

 

Total revenue

   $ 217,218      $ 11,242                $ 228,460   
  

 

 

   

 

 

   

 

 

      

 

 

 

Cost of revenue:

           

Subscription

     26,686        818      $ 1,587        2A         29,091   

Platform-derived

     2,293                         2,293   
  

 

 

   

 

 

   

 

 

      

 

 

 

Total cost of revenue

     28,979        818        1,587           31,384   
  

 

 

   

 

 

   

 

 

      

 

 

 

Gross profit

     188,239        10,424        (1,587        197,076   

Operating expenses:

           

Sales and marketing

     58,562        6,913                  65,475   

Research and development

     23,364        3,772                  27,136   

General and administrative

     40,683        2,175        10,235        2B         53,093   
  

 

 

   

 

 

   

 

 

      

 

 

 

Total operating expenses

     122,609        12,860        10,235           145,704   
  

 

 

   

 

 

   

 

 

      

 

 

 

Operating income (loss)

     65,630        (2,436     (11,822        51,372   

Other income (expense):

           

Interest income

     52        12                  64   

Interest expense

     (23     (1               (24

Other, net

     1,693        53                  1,746   

Translation loss reclassified from other comprehensive income

                               
  

 

 

   

 

 

   

 

 

      

 

 

 

Other income (expense), net

     1,722        64                  1,786   
  

 

 

   

 

 

   

 

 

      

 

 

 

Income before income taxes and loss from investment in equity affiliate

     67,352        (2,372     (11,822        53,158   

Provision for income taxes

     (9,394     (470     620        2C         (9,244

Loss from investment in equity affiliate

     (46                      (46
  

 

 

   

 

 

   

 

 

      

 

 

 

Net income

   $ 57,912      $ (2,842   $ (11,202      $ 43,868   

Other comprehensive income (loss):

     (1,734     578                  (1,156
  

 

 

   

 

 

   

 

 

      

 

 

 

Comprehensive income

   $ 56,178      $ (2,264   $ (11,202      $ 42,712   
  

 

 

   

 

 

   

 

 

      

 

 

 

Net income available to ordinary shareholders

   $ 38,026               27,493   

Net income (loss) per common share

           

Basic

   $ 1.06             $ 0.76   

Diluted

   $ 0.99             $ 0.70   

Weighted-average shares outstanding

           

Basic

     36,000,000               36,000,000   

Diluted

     38,585,664               39,337,437   

 

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AVG Technologies N.V.

Unaudited Pro Forma Condensed Combined Statement of Comprehensive Income

(in thousands of U.S. Dollars—except share and per share information)

 

     AVG Technologies     TuneUp                     
     Nine months ended
September 30, 2011
    Period begun
January 1, 2011
and ended
August 18, 2011
    Pro Forma
Adjustments
           Combined  

Revenue:

           

Subscription

   $ 130,071      $ 9,114      $         $ 139,185   

Platform-derived

     68,022                         68,022   

Sale of intellectual property to AVG

            7,147        (7,147     2D           
  

 

 

   

 

 

   

 

 

      

 

 

 

Total revenue

     198,093        16,261        (7,147        207,207   
  

 

 

   

 

 

   

 

 

      

 

 

 

Cost of revenue:

           

Subscription

     17,287        397        1,190        2A         18,874   

Platform-derived

     6,517                         6,517   

Sale of intellectual property to AVG

                               
  

 

 

   

 

 

   

 

 

      

 

 

 

Total cost of revenue

     23,804        397        1,190           25,391   
  

 

 

   

 

 

   

 

 

      

 

 

 

Gross profit

     174,289        15,864        (8,337        181,816   

Operating expenses:

           

Sales and marketing

     53,904        4,132                  58,036   

Research and development

     24,478        2,826                  27,304   

General and administrative

     35,984        3,202        1,847        2B         41,033   
  

 

 

   

 

 

   

 

 

      

 

 

 

Total operating expenses

     114,366        10,160        1,847           126,373   
  

 

 

   

 

 

   

 

 

      

 

 

 

Operating income (loss)

     59,923        5,704        (10,184        55,443   

Other income (expense):

           

Interest income

     38                         38   

Interest and finance costs

     (11,319                      (11,319

Other, net

     (997     115                  (882
  

 

 

   

 

 

   

 

 

      

 

 

 

Other income (expense), net

     (12,278     115                  (12,163
  

 

 

   

 

 

   

 

 

      

 

 

 

Income before income taxes and loss from investment in equity affiliate

     47,645        5,819        (10,184        43,280   

Benefit (Provision) for income taxes

     52,212        (1,703     1,372        2E         51,881   

Loss from investment in equity affiliate

     (180                      (180
  

 

 

   

 

 

   

 

 

      

 

 

 

Net income

     99,677        4,116        (8,812      $ 94,981   

Other comprehensive income (loss):

     (2,910     (834               (3,744
  

 

 

   

 

 

   

 

 

      

 

 

 

Comprehensive income

   $ 96,767      $ 3,282      $ (8,812      $ 91,237   
  

 

 

   

 

 

   

 

 

      

 

 

 

Net income available to ordinary shareholders

   $ 66,758             $ 63,236   

Net income (loss) per common share

           

Basic

   $ 1.85             $ 1.75   

Diluted

   $ 1.72             $ 1.61   

Weighted-average shares outstanding

           

Basic

     36,000,000               36,187,943   

Diluted

     38,837,773               39,227,740   

 

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AVG Technologies N.V.

Notes to the Unaudited Pro Forma Combined Condensed Financial Information

(in thousands of U.S. Dollars—except share and per share information)

 

1. Preliminary Purchase Price Allocation

 

The total purchase price for TuneUp is allocated to acquired tangible and intangible assets and liabilities assumed based on preliminary estimates of their respective fair values as of the date of the Acquisition as determined by us and a third-party valuation firm. The preliminary allocation of the purchase price was initially allocated to the fair values of the assets acquired and liabilities assumed as follows:

 

      Fair value  

Assets acquired:

  

Cash and cash equivalents(1)

   $ 2,567   

Trade accounts receivable, net

     829   

Inventories

     74   

Prepaid expenses and other current assets

     2,019   

Property and equipment, net

     815   

Intangible assets(2)

     17,152   

Goodwill(3)

     28,689   

Total assets acquired

     52,145   
  

 

 

 

Liabilities assumed:

  

Accounts payable

     658   

Accrued and other liabilities

     1,940   

Deferred revenues(4)

     1,157   

Deferred taxes

     3,370   
  

 

 

 

Total liabilities assumed

     7,125   

Net assets acquired

   $ 45,020   
  

 

 

 

Components of consideration:

  

Cash consideration paid(1)

   $ 34,430   

Cash consideration expected to be paid in earn out payments(5)

     10,590   
  

 

 

 
   $ 45,020   
  

 

 

 

 

  (1)   Included in cash consideration paid is euro 5 million ($7.1 million) paid by AVG Technologies CY in exchange for the internally developed intellectual property of TuneUp, which was received by TuneUp on August 17, 2011, prior to the closing of the Acquisition. This has been adjusted from the cash and cash equivalents at acquisition of TuneUp along with a dividend payment of euro 3.5 million ($5.0 million) paid to the founders of TuneUp, which was paid using the funds received from AVG Technologies CY immediately prior to the closing of the Acquisition.
  (2)   Intangible assets included developed technology of $6.3 million, customer relationships of $1.4 million, and brand and domain names of $9.4 million. Developed technology, customer relationships, brand and domain names and other intangibles are amortized over their estimated useful lives of four years, five years, eight years and four years, respectively.
  (3)   Deferred revenue on acquisition at historic cost was $14.9 million, which has been estimated to have a fair value on acquisition of $1.2 million, to reflect the cost of the fulfillment of our obligations to existing customers.
  (4)   Goodwill is not tax deductible. The goodwill resulted primarily from the Company’s expectation of synergies from the integration of TuneUp software with the Company’s existing solutions.
  (5)   Contingent cash consideration up to euro 10.0 million or $14.4 million, which has been estimated to have a fair value by the Company at $10.6 million, is contingent based on the EBITDA value achieved and revenues generated from sales of TuneUp during the full year 2011.

 

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The preliminary valuation of the identifiable intangible assets acquired was based on management’s estimates, currently available information and reasonable and supportable assumptions. The allocation was generally based on the fair value of these assets determined using the income and market approaches. Of the total purchase price, $17.1 million was allocated to amortizable intangible assets. These intangible assets included developed technology of $6.3 million, brand and domain names of $9.4 million and customer relationships of $1.4 million, which will be amortized over their estimated useful lives of four years, eight years, and five years, respectively.

 

2. Pro Forma Adjustments

 

The accompanying unaudited pro forma condensed combined financial information has been prepared as if the Acquisition was completed on September 30, 2011 for balance sheet purposes and on January 1, 2010 for purposes of the statements of comprehensive income and reflects the following pro forma adjustments:

 

  (A)   adjustments to cost of revenue represent amortization of intangibles of $1.6 million and $1.2 million for the year ended December 31, 2010 and nine months ended September 30, 2011, respectively;

 

  (B)   adjustments to general and administrative expenses represent amortization of intangibles of $1.5 million and $1.1 million and share-based compensation of $8.7 million and $3.4 million for the year ended December 31, 2010 and nine months ended September 30, 2011, respectively and adjustments to eliminate acquisition related costs incurred of $2.7 million in the historic statements of comprehensive income for the nine months ended September 30, 2011 of both the Company ($1.8 million) and TuneUp ($0.9 million), respectively. As part of the Acquisition, the former owners of TuneUp will receive shares of AVG Technologies N.V. with a total value of €11.5 million ($16.5 million) subject to their continued employment with TuneUp and other vesting conditions;

 

  (C)   adjustment to record the tax effect of the amortization of intangibles of $0.6 million for the year ended December 31, 2010. This estimate could change based on changes in the applicable tax rates and finalization of our tax position following the Acquisition;

 

  (D)   adjustment to revenue represents elimination of the consideration received by TuneUp from AVG Technologies CY in exchange for the internally developed intellectual property of $7.1 million, which was part of the Acquisition and which was received by TuneUp on August 17, 2011, prior to the closing of the Acquisition; and

 

  (E)   adjustment to record the tax effect of the revenue reversal, amortization of intangibles and elimination of acquisition related costs of $1.4 million for the nine months ended September 30, 2011. This estimate could change based on changes in the applicable tax rates and finalization of our tax position following the Acquisition.

 

The pro forma basic and diluted net income per share in the Unaudited Pro Forma Condensed Combined Statement of Comprehensive Income is based on the historical number of our outstanding ordinary shares used in computing basic and diluted net income per share, adjusted for the impact of shares to be issued and assumed to have been issued to TuneUp former owners as discussed in adjustment B above for the period ending December 31, 2010 and September 30, 2011.

 

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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

 

We have derived the following consolidated statement of comprehensive income data for 2006 and 2007 and consolidated balance sheet data as of December 31, 2006, 2007 and 2008 from our unaudited consolidated financial statements not included in this prospectus and the following consolidated statement of comprehensive income data for 2008, 2009 and 2010 and consolidated balance sheet data as of December 31, 2009 and 2010 from our audited consolidated financial statements included elsewhere in this prospectus. The financial data for the nine months ended September 30, 2010 and 2011 have been derived from our unaudited condensed consolidated financial statements included elsewhere in this prospectus, which have been prepared on a basis consistent with our annual audited consolidated financial statements. Operating expenses were calculated on a different basis for the year ended December 31, 2006, than for later years. Where such figures cannot be made consistent with those for later years without unreasonable effort and expense, they have been excluded. You should read the consolidated financial data set forth below in conjunction with our consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our reporting currency is the U.S. dollar. Our historical results are not necessarily indicative of our results to be expected in any future period. We have prepared the financial statements included in this prospectus in accordance with U.S. GAAP.

 

    Year ended December 31,     Nine months ended
September 30,
 
    2006     2007     2008     2009     2010     2010     2011  
    (in thousands, except for share data and per share data)  
    (unaudited)     (unaudited)                       (unaudited)     (unaudited)  

Statement of Comprehensive Income Data and Other Operating Metrics:

             

Revenue:

             

Subscription

  $ 15,901      $ 52,010      $ 104,762      $ 151,365      $ 166,904      $ 125,417      $ 130,071   

Platform-derived

                  9,079        30,603        50,314        34,373        68,022   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

    15,901        52,010        113,841        181,968        217,218        159,790        198,093   

Cost of revenue:(1)

             

Subscription

    7,272        14,611        24,458        30,112        26,686        19,736        17,287   

Platform-derived

                         1,308        2,293        1,801        6,517   

Total cost of revenue

    7,272        14,611        24,458        31,420        28,979        21,537        23,804   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

    8,629        37,399        89,383        150,548        188,239        138,253        174,289   

Operating expenses:(1)

             

Sales and marketing

      17,826        26,963        45,988        58,562        39,007        53,904   

Research and development

      6,190        13,725        19,533        23,364        16,730        24,478   

General and administrative

      9,763        18,997        24,404        40,683        29,371        35,984   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

    15,604        33,779        59,685        89,925        122,609        85,108        114,366   

Operating income

    (6,975     3,620        29,698        60,623        65,630        53,145        59,923   

Other income (expense), net

    (973     (1,363     1,313        (1,600     1,722        1,377        (12,278
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) before income taxes and loss from investment in equity affiliate

    (7,948     2,257        31,011        59,023        67,352        54,522        47,645   

Benefit/provision for income taxes

    1,291        (506     (1,643     (6,538     (9,394     (6,748     52,212   

Loss from investment in equity affiliate

                                (46            (180
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

    (6,657     1,751        29,368        52,485        57,912        47,774        99,677   

Preferred share dividends

                         (1,802     (7,210     (5,407     (5,406

Distributed and undistributed earnings to preferred shares

                                (12,676     (10,592     (27,513
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income available to ordinary shareholders

  $ (6,657   $ 1,751      $ 29,368      $ 50,683      $ 38,026      $ 31,775      $ 66,758   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per ordinary share—basic(2)

  $ (0.15   $ 0.04      $ 0.65      $ 1.19      $ 1.06      $ 0.88      $ 1.85   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per ordinary share—diluted(2)

  $ (0.15   $ 0.04      $ 0.62      $ 1.09      $ 0.99      $ 0.82      $ 1.72   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average ordinary shares outstanding—basic(2)

    45,000,000        45,000,000        45,000,000        42,750,000        36,000,000        36,000,000        36,000,000   

Weighted-average ordinary shares outstanding—diluted(2)

    45,000,000        46,489,256        47,423,334        48,155,490        38,585,664        38,519,783        38,837,773   

 

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  (1)   We have recognized employee share-based compensation in the consolidated statements of comprehensive income for the periods indicated as follows:

 

     Year ended December 31,      Nine months ended
September 30,
 
     2008      2009      2010          2010              2011      
     (in thousands)  
                          (unaudited)  

Cost of revenue

   $ 85       $ 178       $ 61       $ 46       $ 17   

Sales and marketing

     604         2,520         2,049         1,323         614   

Research and development

     514         1,108         1,008         608         1,019   

General and administrative

     1,006         4,483         3,655         2,871         1,362   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total share based compensation expense

   $ 2,209       $ 8,289       $ 6,773       $ 4,848       $ 3,012   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

  (2)   The shares issued in March 2009, which had the effect of a 10 for 1 share split, are considered as outstanding for purposes of calculating earnings per ordinary share and weighted-average ordinary shares outstanding in 2006, 2007 and 2008, as this issuance of shares was in substance a recapitalization of our share capital.

 

Other operating metrics:

 

     As of December 31,      As of September 30,  
     2006      2007      2008      2009      2010          2010              2011      
     (unaudited)      (unaudited)                           (unaudited)      (unaudited)  

Cash dividends declared per ordinary share(1)

   $ 0.13       $ 0.23       $ 0.44       $ 3.28       $ 0.83       $ 0.83       $ 4.53   

Cash dividends declared per preferred share

                                   $ 1.43       $ 1.28       $ 4.98   

 

  (1)   The shares issued in March 2009, which had the effect of a 10 for 1 share split, are considered as outstanding for purposes of calculating cash dividends declared per ordinary share in 2006, 2007 and 2008, as this issuance of shares was in substance a recapitalization of our share capital.

 

     For the year ended or as of December 31,     For the nine months ended
or as of September 30,
 
         2008             2009             2010             2010             2011      
                       (unaudited)  

Adjusted net income(1) (unaudited, in thousands)

   $ 33,084      $ 62,796      $ 67,192      $ 54,380      $ 104,836   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities (in thousands)

   $ 64,282      $ 79,483      $ 87,911      $ 61,843      $ 62,716   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities (in thousands)

   $ (3,318   $ (19,157   $ (15,340   $ (9,296   $ (46,552
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in financing activities (in thousands)

   $ (21,522   $ (71,702   $ (54,367   $ (51,993   $ (6,963
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow(2) (unaudited, in thousands)

   $ 60,299      $ 72,680      $ 76,196      $ 56,526      $ 66,244   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Active users(3) (unaudited, in millions)

     83        99        98        98        106   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Subscription users(4) (unaudited, in millions)

     10        10        12        12        15   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Revenue per average active user(5) (unaudited)

   $ 1.53      $ 2.00      $ 2.21      $ 1.63      $ 1.94   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1)   Adjusted net income is defined as net income for the period, adding back share-based payments and acquisition-related intangible asset amortization expense less the consequent effect of taxes on such adjustments. For a reconciliation of adjusted net income to net income, the most comparable U.S. GAAP measure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-U.S. GAAP Measures—Adjusted net income.
  (2)   Free cash flow is defined as net cash provided by operating activities less capital expenditures (which we define as being made up of payments for property and equipment and intangible assets) less interest income (expense), net. For a reconciliation of free cash flow to net cash provided by operating activities, the most directly comparable U.S. GAAP financial measure, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Non-U.S. GAAP Measures—Free cash flow.
  (3)   Active users are those who (i) have downloaded and installed our free software on a PC or mobile device and have connected to our server twice in the preceding 30-day period or (ii) have a valid subscription license for our software. For further detail on our definition and counting of active users, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Metrics—Active and subscription users.

 

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  (4)   Subscription users are a subset of active users who subscribe to one or more of our premium products. Payments from subscription users make up the substantial majority of subscription revenue. For further detail on our definition and counting of subscription users, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Metrics—Active and subscription users.
  (5)   The number of average active users is calculated as the simple average of active users at the beginning of a period and the end of a period.

 

     As of December 31,     As of
September 30,
 
     2006     2007     2008     2009     2010     2011  
     (in thousands)  
     (unaudited)     (unaudited)     (unaudited)                 (unaudited)  

Consolidated Balance Sheet Data:

            

Cash and cash equivalents

   $ 11,462      $ 23,623      $ 58,585      $ 47,711      $ 63,146      $ 73,288   

Working capital (deficit)

     (10,443     (26,581     (13,933     (41,804     (34,234     (80,305

Goodwill and other intangible assets, net

     5,522        23,242        21,970        40,711        42,213        97,680   

Total assets

     32,429        68,202        120,020        143,787        175,957        296,555   

Deferred revenue, current

     24,547        51,003        84,324        101,147        107,214        111,771   

Deferred revenue, less current portion

     8,518        17,401        20,321        27,925        28,213        28,396   

Long-term debt

                   806        1,072        1,050        225,155   

Total liabilities

     41,734        83,443        124,450        159,518        176,717        425,627   

Class D preferred shares(1)

                          191,954        191,954        191,954   

Total shareholders’ deficit(1)

     (9,435     (15,241     (4,430     (207,685     (192,714     (321,026

 

(1)   In connection with the initial investment in us in October 2009 by TA Coöperatief (which subsequently transferred such investment to TA Sárl), we amended our articles of association and converted 5,850,000 outstanding Class A ordinary shares and 3,150,000 outstanding Class B ordinary shares into an aggregate of 9,000,000 Class D preferred shares, which our shareholders then sold to TA Coöperatief. At the same time we also issued 3,000,000 Class D preferred shares to TA Coöperatief for $47.8 million, net of issuance costs. We recorded a distribution in excess of capital in shareholders’ equity (deficit) of $144.1 million in connection with the conversion into 9,000,000 Class D preferred shares of ordinary shares and the issuance of 3,000,000 Class D preferred shares to TA Coöperatief.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following information should be read together with our selected consolidated financial and operating data and the consolidated financial statements and notes included elsewhere in this prospectus. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this prospectus particularly in “Risk Factors” and “Special Note Regarding Forward-looking Statements.” We have prepared our consolidated financial statements in this prospectus in accordance with U.S. GAAP.

 

Overview

 

We provide software and online services that deliver peace of mind to users by simplifying, optimizing and securing their Internet experiences. Our business model, based on delivering high-quality solutions in high volume and at no cost to our users, enables us to rapidly acquire new users. Through our large user community, we are able to better understand the needs of our users, become a trusted provider of peace-of-mind software solutions, and thereby intelligently monetize our user base through premium products and value-added online services. Our solutions, which today range from desktop, laptop and mobile security software to dynamic secure Internet search solutions, can be accessed and utilized with minimal effort and limited technical know-how from the user. In choosing our solutions, which can be downloaded from the Internet, users become part of a trusted global community that benefits from network effects such as the mutual protection and support of a large user base. Our sales and marketing activities benefit from word-of-mouth recommendations from our large user network to create a viral marketing effect, which is amplified by the speed and ease of use of our products and allows us to gain new customers at a low acquisition cost. This strategy has allowed us to grow our user base to approximately 106 million active users as of September 30, 2011.

 

We believe that our community of approximately 106 million active users is one of our most valuable assets. We establish a trusted relationship with our community through our solutions with the goal of driving greater user engagement. Community engagement provides important contributions to our product development initiatives, enables rapid response to online threats and assists in our customer support initiatives, enabling us to accurately deliver compelling products and online services that meet the evolving needs of our users. The contributions from our community lower our costs, enabling us to offer free and low-cost offerings that further build upon the value we can deliver. We believe further monetization of our user base through online services represents a significant market opportunity for us.

 

Our product portfolio targets the consumer and small business markets and includes Internet security, PC performance optimization, online backup, mobile security, identity protection and family safety software. While a significant majority of our active users have been users of our free products and online services, we also offer products with premium functionality and enhanced customer support when customers purchase an annual or multi-year subscription. As of September 30, 2011, we had approximately 15 million subscription users. In addition, our online services, accessed primarily through our browser toolbar, provide dynamic secure search capabilities through agreements with leading Internet search providers. We have been successful in growing our product portfolio over time through internal development and select acquisitions.

 

We employ a differentiated business model focused on monetizing and expanding our user base through (i) subscription revenue from the sale of premium products and (ii) platform-derived revenue from value-add online services that are free to our users. While users often download our subscription solutions directly from our websites, we also utilize resellers and distributors globally, including CNET, Ingram Micro and Wal-Mart. In 2010 and for the nine months ended September 30, 2011, 69.4% and 74.2%, respectively, of our revenue was generated online, with the remainder generated through resellers and distributors. AVG Antivirus Free Edition has been downloaded more times than any other software on CNET’s Download.com website. Today, we derive

 

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substantially all of our platform-derived revenue through agreements with leading Internet search providers, in particular, Google. Our success has been built on our innovative, proven and self-reinforcing business model, which leverages our large and engaged user base, low-cost Internet-based distribution and cost-effective research and development.

 

We were founded in 1991 as a consumer-focused IT security company. While we have increased the breadth of our solutions over the years, we remain focused on our core mission of providing our users with differentiated solutions that simplify, optimize and secure their Internet experience, collectively providing peace of mind to a connected world.

 

Our development and business milestones include:

 

   

In 2000, after nearly a decade of operations selling anti-virus software as Grisoft, we introduced a free version of our anti-virus product to consumers, giving rise to our free-to-paid business model.

 

   

In 2006, we acquired the business and assets of Ewido and integrated its anti-spyware product into our portfolio as part of AVG Anti-Malware. This acquisition enabled us to launch AVG Internet Security, our first endpoint security solution deployed as a suite.

 

   

In 2007, we acquired Exploit Prevention Labs, which provided the technology for our AVG LinkScanner product. We also acquired F1 Services, an AVG distributor in the United Kingdom, which operated its own web-based distribution platform.

 

   

In 2008, we developed an e-commerce platform to sell and distribute our software. We also entered into a search agreement with Yahoo!, allowing us to recognize platform-derived revenue from our large user base without charging our users. We introduced AVG Small Business Server (SBS) Edition to address the needs of small businesses.

 

   

From 2009 through 2011, we expanded our management team and hired additional professional staff to build a leadership team comprised of experienced software industry veterans.

 

   

In 2009, we acquired Sana Security, a developer of behavioral technology security software to block attackers from accessing sensitive information. We also launched AVG 9.0.

 

   

In 2010, we entered into a new search agreement with Google, replacing Yahoo! as our primary search provider.

 

   

In 2011, we acquired Visionize, a leading provider of toolbars for web browsers, DroidSecurity, a developer of cloud-based mobile security solutions, which enabled us to enter the mobile security market, TuneUp, a leading provider of PC optimization software, and Bsecure, a provider of applications for cloud-based management of information technology, and acquired a non-controlling minority stake in Ookla, which provides network performance solutions. We launched AVG Mobilation for Android, as well as the first security solution for tablet devices. In addition, we launched AVG LiveKive, a cloud-based storage, sync and share solution, and MultiMi, an innovative solution to streamline the various ways our users engage in online communication across social media, email and web channels.

 

   

In 2012, we acquired OpenInstall, which provides a cloud-based software installation platform.

 

Other than the initial start-up capital provided by our founder, we have not raised equity financing for our operations. Our net cash provided by operations has been sufficient to fund our growth to date. Our principal shareholders became investors in us principally through the purchase of shares from existing shareholders, either directly or indirectly through their purchase of shares from us and our concurrent dividend of the associated proceeds from such share issuances to our existing shareholders. As of September 30, 2011, our total shareholders’ deficit was $321.0 million, or $130.9 million as adjusted to give effect to conversion of our preferred shares upon the closing of this offering, with the shareholders’ deficit being principally a result of the aggregate of $557.5 million in dividends and distributions in excess of capital paid since January 1, 2008. We currently expect to retain future earnings, if any, to finance the growth and development of our business and to provide additional liquidity. See the section titled “Dividend Policy” in this prospectus.

 

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In 2010, we generated revenue of $217.2 million, net income of $57.9 million, adjusted net income of $67.2 million, net cash provided by operations of $87.9 million and free cash flow of $76.2 million. For the nine months ended September 30, 2011, we generated revenue of $198.1 million, net income of $99.7 million, adjusted net income of $104.8 million, net cash provided by operations of $62.7 million and free cash flow of $66.2 million. See “—U.S. Non-GAAP Measures” below for discussions of adjusted net income and free cash flow as non-U.S. GAAP measures and reconciliations of these measures to net income and net cash provided by operating activities, respectively.

 

How We Generate Revenue

 

We generate our revenue by selling our premium products and by monetizing our active user base through online services. The sources of our revenue are geographically diversified. In 2010, Europe, Middle East and Africa (EMEA) and the Americas represented 31.3% and 64.0% of our total revenue, respectively, with the balance of our total revenue attributable to other geographic regions. For the nine months ended September 30, 2011, Europe, Middle East and Africa (EMEA) and the Americas represented 34.0% and 61.0% of our total revenue, respectively, with the balance of our total revenue attributable to other geographic regions.

 

The following table summarizes the growth in our subscription revenue and our platform-derived revenue for the years ended December 31, 2008, 2009 and 2010, and the nine months ended September 30, 2010 and 2011:

 

     Year ended December 31,     Nine months ended
September 30,
 
     2008     2009     2010     2010     2011  
     (in thousands, except percentages)  
                       (unaudited)  

Revenue by type:

          

Subscription revenue

   $ 104,762      $ 151,365      $ 166,904      $ 125,417      $ 130,071   

Platform-derived revenue

     9,079        30,603        50,314        34,373        68,022   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

   $ 113,841      $ 181,968      $ 217,218      $ 159,790      $ 198,093   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Percentage of total revenue by type:

          

Subscription revenue

     92.0     83.2     76.8     78.5     65.7

Platform-derived revenue

     8.0     16.8     23.2     21.5     34.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     100.0     100.0     100.0     100.0     100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

Subscription revenue

 

The primary component of our subscription revenue is derived from the sale of premium products and online services. Payments are made upfront for the ability to access our premium products or online services, usually for a term of one or two years. These solutions include end market products offerings in security, online data backup, PC performance optimization and messaging consolidation, among others. Our premium products and solutions include additional features as well as maintenance and support services (including the right to receive unspecified future upgrades/enhancements of our products, when and if available) during the fixed term of the license. Subscription revenue is generated from the sale of fixed-term software license arrangements, which are generally sold and downloaded over the Internet or sold as packaged products through multi-tiered distribution channels. This subscription revenue is recognized ratably over the term of the related license agreement. Due to the upfront nature of the cash payments for these products, the majority of this subscription revenue is released from deferred revenue on the balance sheet.

 

We also sell through our reseller network. The sales through our reseller network are undertaken by intermediaries and we offer these intermediaries a discount on our products. As a result, we receive less revenue per customer from sales through our reseller network than we do through our online channel. We recognize revenue for products sold through our reseller network on a sell-through basis.

 

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Growth in our subscription revenue will largely depend on our ability to sell premium versions of our software products to new users as well as our ability to sell new and additional solutions and upgrades to our existing users. This growth will also depend on our continued ability to develop new solutions for our customers.

 

Platform-derived revenue

 

To date, our platform-derived revenue consists primarily of revenue generated via our dynamic secure search solution and to a lesser extent, the sale of threat analysis data. While the searches conducted by users via our dynamic secure search solution are free to our users, we receive a proportion of the revenue generated by search providers from our users’ search activity. We intend to continue our monetization initiatives to drive a greater percentage of our active users to utilize our services more broadly and regularly and to offer services to users outside of our current user base. This platform-derived revenue is recognized at the time the service is provided. eMarketer, a market research company, estimated in September 2011 that spending on advertising on mobile devices will be $1.2 billion in 2011, with search making up approximately 29% of that spending, a share projected to grow to 40% of a mobile advertising market of $4.4 billion in 2015. While this remains a small proportion of the total search market, and although we believe that our strategy for online growth will allow us to grow our revenues independent of this trend, we also believe mobile search represents an opportunity for us, and we will seek to develop it through a combination of product development and partnerships.

 

We have used our dynamic secure search solution to generate revenue through our search agreements with Yahoo!, from February 2008 to November 2010, and, since the implementation of our agreement in November 2010, with Google. Users of our free and paid Internet security solutions have been able to conduct dynamic secure Internet searches via Yahoo!, until May 2011, and Google, beginning in November 2010, through a search field we place in our toolbar, among other routes. In exchange for directing our active users’ search queries to search providers, we earn a percentage of the search revenue generated by such search providers. We launched our Yahoo! commercial arrangement in February 2008. We terminated our agreement with Yahoo! effective November 2010 and entered into an agreement with Google, implemented in November 2010, to serve as our primary search provider. Our platform segment is thus predominantly dependent on revenue generated by a single search results provider, which was Yahoo! from February 2008 to November 2010, and has been Google from November 2010. Our revenue generated by Yahoo! accounted for 21.6% of our total revenue while revenue generated by Google accounted for less than 10% of our revenue in 2010 (reflecting the fact that our commercial arrangement with Google only began in November 2010). Under our previous Yahoo! contract there was a transition period ending in May 2011, during which users of Yahoo! sourced search through our toolbar could continue to use Yahoo! sourced search, thereby still generating revenue under our Yahoo! contract, until they chose to switch to our Google sourced search. Revenue generated by Yahoo! and Google accounted for less than 10% and more than 10%, respectively, of our revenue in the nine months ended September 30, 2011.

 

Growth in our platform-derived revenue will depend on our ability to effectively monetize and expand our user base through additional online services and search agreements, greater user engagement and extended overall lifetimes of our products.

 

Key Metrics

 

We monitor a number of metrics to evaluate our business, measure our performance, identify trends affecting our business, formulate financial projections and make strategic decisions.

 

Active and subscription users

 

Active users are those who (i) have downloaded and installed our free software on a PC or mobile device and have connected to our server twice in the preceding 30-day period or (ii) have a valid subscription license for our software. Subscription users are active users who subscribe to our premium products and online services, the primary component of our subscription revenue. We include in the number of free users trial licenses and

 

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licenses distributed for promotional purposes. We believe that our methodology for counting our user base is more conservative than methodologies used by other software companies, some of which count users with less frequent interaction.

 

We believe that the number of active users is the most accurate depiction of our user engagement and that active users are the most likely users of the new products and cloud-based services we intend to offer in the future. The active user metric is calculated on a per device basis, so in some cases, a single user may use multiple devices, which may increase this number, while in other cases multiple people may use a single device, which may decrease this number.

 

Our number of subscription users equals our number of eligible license sales multiplied by the numbers of devices protected per license. If the license is sold through the web-based channel, subscription users are counted at the time of purchase. If the license is sold through the retail channel, all subscription users under a license are counted the first time any installation under that license occurs. For example, if a user purchases a three-device license and protects only two devices, this would be counted as three users for our subscription user calculation. We apply this method consistently as we exclude unlicensed or “unauthorized” devices of abusing users (those users who are protecting more devices than authorized under their license) from our user base calculations. We also exclude illegal users (those who use manufactured or illicit license keys). Although we incur costs to support these users and provide them with updates we believe they form an important part of our viral marketing. Subscription users are counted as such for the entirety of their valid license period, irrespective of their connectivity to our servers. They are converted to free users upon the expiration of the license, unless the license is renewed.

 

While our system for measuring active users has been consistent since 2008, we have sought to continuously refine the accuracy of this measurement. The most significant improvement was the introduction of a license server in the first half of 2009. Prior to this, active users were calculated using the same methodology as described above (i.e., on the basis of at least two software update requests in the previous 30 days) but without certain detailed information, which adversely affected the accuracy of the calculation. For example, prior to our introduction of the license server, when we upgraded our product offering, our inability to track individual users or devices would result in double-counting of active users during the transition phase in which both the previous and upgraded solution were active. Accordingly, user numbers as of periods prior to June 30, 2009 should be viewed as being indicative only and as management’s best estimate of our total user numbers. In addition, at times during the second half of 2009 and the first nine months of 2010, we also experienced double-counting issues due to the launch of new products and related issues with service capacity caused by high download volumes.

 

We recognize that potential flaws in our user metrics may exist and we will continue to assess opportunities to improve our methodology of calculating these metrics. See “Risk Factors—Accurately measuring the number of our active and subscription users is difficult….” While we recently introduced two new systems for counting user numbers, these systems will not be fully implemented until all users have migrated to the new version of our products. Once these counting systems are fully implemented, based on initial results we expect that we will have greater confidence in the accuracy of our user counts, but these systems remain new and have not been tested over time, and there can be no assurance that they will meet our expectations. We may choose in the future to alter this calculation methodology to reflect changing circumstances or additional information.

 

In this prospectus, unless otherwise indicated, user base numbers have been rounded to the nearest million. Active users as of September 30, 2011, includes approximately four million users of products and services added upon our recent acquisition of TuneUp. Subscription users as of September 30, 2011, includes approximately two million subscription users of products and services added upon our recent acquisition of TuneUp.

 

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Revenue per active user

 

Revenue per active user is defined as total revenue divided by the average number of active users in that period. The increasing revenue per active user is a reflection of our success in increasing the monetization of our active user base. The number of active users for 2008 is indicative only and not directly comparable to the number of active users for periods after June 30, 2009 as described above. We monitor revenue per active user because we believe it reflects whether we have been successful in our strategies to increase the combined platform and subscription revenue from each user. We monitor total revenue per active user, rather than monitoring platform revenue per active user or subscription revenue per active user in isolation, because each active user provides opportunities for us to realize both platform and subscription revenue through our platform monetization initiatives, such as our dynamic secure search solution, and through our multiple product strategy of up-selling and cross-selling our expanding set of premium products and online services to all of our users. We monitor revenue per active user to assist us in making strategic decisions primarily in three ways:

 

   

seeking to optimize the revenue per user we currently receive from our existing user base in order to increase our revenue per active user in the near term, including by optimizing the monetization methods used with different user base segments;

 

   

determining whether to invest in increasing the size of different user base segments to the extent that we have current opportunities to monetize them; and

 

   

determining whether to invest in increasing the size of different user base segments to the extent that we have identified opportunities to monetize them in the future.

 

As a result, revenue per active user represents the outcome of our strategic priorities and may vary across periods depending on the extent to which we are pursuing each of the strategies described above.

 

     For the year ended or as of
December 31,
     For the nine months ended
or as of September 30,
 
         2008              2009              2010              2010              2011      
                          (unaudited)  

Total revenue (in thousands)

   $ 113,841       $ 181,968       $ 217,218       $ 159,790       $ 198,093   

Active users at period end(1) (in millions)

     83         99         98         98         106   

Average active users(2) (in millions)

     74         91         98         98         102   

Revenue per average active user

   $ 1.53       $ 2.00       $ 2.21       $ 1.63       $ 1.94   

 

  (1)   The number of active users at year end for 2008 is indicative only and not directly comparable to the number of active users for periods after June 30, 2009.
  (2)   The number of average active users is calculated as the simple average of active users at the beginning of a period and the end of a period.

 

Non-U.S. GAAP Measures

 

Adjusted net income and free cash flow and their related ratios are non-U.S. GAAP measures and should not be considered alternatives to the applicable U.S. GAAP measures. In particular, adjusted net income and free cash flow, and their related ratios, should not be considered as measurements of our financial performance or liquidity under U.S. GAAP, as alternatives to income, operating income or any other performance measures derived in accordance with U.S. GAAP or as alternatives to cash flow from operating activities as a measure of our liquidity.

 

Adjusted net income and free cash flow are measures of financial performance or liquidity and have limitations as analytical tools, and should not be considered in isolation from, or as substitutes for, analysis of our results of operations, including our cash flows, as reported under U.S. GAAP. We use them in evaluating our business as supplemental measures of our operating performance and liquidity. Some of the limitations of adjusted net income and free cash flow and their related ratios as measures are:

 

   

they do not reflect our cash expenditure or future requirements for capital expenditure or contractual commitments, nor do they reflect the actual cash contributions received from customers;

 

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they do not reflect changes in, or cash requirements for, our working capital needs;

 

   

they do not reflect the interest expense, or the cash requirements necessary to service interest or principal payments, on our debt;

 

   

although amortization and share-based compensation are non-cash charges, the assets being amortized will often have to be replaced in the future and such measures do not reflect any cash requirements for such replacements; and

 

   

other companies in our industry may calculate these measures differently than we do, limiting their usefulness as comparative measures.

 

Because of these limitations, investors should rely on our consolidated financial statements prepared in accordance with U.S. GAAP and treat our adjusted net income and free cash flow as supplemental information only.

 

Adjusted net income

 

Adjusted net income is defined as net income for the period, adding back share-based payments and acquisition-related intangible asset amortization expense less the consequent effect of taxes on such adjustments. We have included adjusted net income in this prospectus because it is a basis upon which our management assesses financial performance and identifies controllable expenses. In addition, we present this measure because it is used by securities analysts, investors and other interested parties as a measure of the financial performance of companies in our industry. Adjusted net income is helpful as it eliminates the impact of items that we do not consider indicative of our core operating performance, facilitating comparison of operating performance from period to period and company to company by backing out potential variations in items such non-cash expenses as share-based compensation and the amortization of acquired intangibles.

 

In evaluating adjusted net income, you should be aware that in the future we will incur expenses similar to the adjustments reflected below. For example, while share-based compensation is a component of cost of revenue and operating expenses, the impact to our consolidated financial statements compared to other companies can vary significantly due to such factors as assumed life of the options and assumed volatility of our ordinary shares. Our presentation of adjusted net income should not be construed as an inference that our future results will be unaffected by amortization, share-based compensation or any unusual or non-recurring items.

 

The following table presents a reconciliation of adjusted net income to net income, the most comparable U.S. GAAP measure, for each of the periods indicated.

 

     Year ended December 31,     Nine months ended
September 30,
 
     2008     2009     2010     2010     2011  
     (in thousands)  
                       (unaudited)  

Adjusted net income:

          

Net income

   $ 29,368      $ 52,485      $ 57,912      $ 47,774      $ 99,677   

Add back: Share compensation

     2,209        8,289        6,773        4,848        3,012   

Add back: Acquisition amortization(1)

     1,757        2,435        2,951        2,076        2,560   

Less: Tax effect(2)

     (250     (413     (444     (318     (413
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted net income

   $ 33,084      $ 62,796      $ 67,192      $ 54,380      $ 104,836   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1)   Includes amortization of acquired intangibles.
  (2)   The tax effect in adjusted net income calculation is based on effective tax rates of the relevant jurisdiction for the respective adjustments.

 

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Free cash flow

 

Free cash flow is defined as net cash provided by operating activities less capital expenditures (which we define as being made up of payments for property and equipment and intangible assets) less interest income (expense), net. We have included free cash flow in this prospectus because we believe free cash flow reflects the actual net cash surplus available to fund the operation and expansion of our business after payment of capital expenditures related to IT infrastructure required to maintain or expand our asset base.

 

In evaluating free cash flow, you should be aware that in the future we will incur expenses similar to the adjustments reflected below. Our presentation of free cash flow should not be construed as an inference that our future results will be unaffected by these expenses or any unusual or non-recurring items.

 

The following table presents a reconciliation of free cash flow to net cash provided by operations, the most comparable U.S. GAAP measure, for each of the periods indicated.

 

     Year ended December 31,     Nine months ended
September 30,
 
     2008     2009     2010     2010     2011  
     (in thousands)  
                       (unaudited)  

Net cash provided by operating activities

   $ 64,282      $ 79,483      $ 87,911      $ 61,843      $ 62,716   

Less: Payments for property and equipment and intangible assets

     (3,318     (6,632     (11,686     (5,300     (7,753

Less: Interest income (expense), net(1)

     (665     (171     (29     (17     11,281   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Free cash flow

   $ 60,299      $ 72,680      $ 76,196      $ 56,526      $ 66,244   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1)   The tax adjustments for interest income (expense), net are not material to the calculation for all periods. For the nine months ended September 30, 2011, the tax adjustments would have reduced free cash flow by approximately $1.3 million based on an assumed tax rate of approximately 11.4%, which is a blended rate based on internal estimates of what our effective tax rate will be for that period.

 

Key Factors Affecting Our Performance

 

The following discussion highlights the key factors we believe affect our results of operations.

 

Increasing platform monetization of our active user base

 

A key element of our anticipated growth is our ability to increasingly monetize our platform by providing new premium products and online services that drive subscription and platform-derived revenue. We believe platform-derived revenue will represent an increasing percentage of our overall revenue in the near term as we pursue additional search agreements. The primary component of platform-derived revenue is from search agreements, whereby we deliver user Internet search requests submitted into our dynamic secure search solution to our search providers. Our subscription revenue includes the sale of premium products and solutions, including our premium Internet Suite, identity protection, system optimization and PC optimization software, among others.

 

Platform-derived revenue is dependent upon the volume of Internet searches conducted. We have formed a number of strategic alliances and agreements that allow us to market and cross-sell products and online services to our active users. If we are not able to provide additional products and online services that enable us to further monetize our platform, grow the number of users who use our dynamic secure search solution, increase the amount of premium products sold, or continue and extend key agreements that provide a substantial portion of our platform-derived revenue our revenue and profitability could be adversely affected. Further, currently our search revenues are derived solely from PC-based search partnerships. Products and solutions that will allow us to monetize search from mobile and tablet devices are currently under development. Our revenue and

 

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profitability will be harmed if these products and solutions are unsuccessful. Given the anticipated growth in the overall search market, including the mobile segment, we believe that our opportunity will continue to grow provided that we execute our plans for products and solutions targeting these new markets. However, failure to expand successfully into mobile and tablet search could negatively impact the rate of growth we may achieve.

 

Growth of our user base

 

Growth of our user base is a primary driver of our revenue. Growth in our subscription user base is the primary driver of our subscription revenue and growth in our active user base, along with aggregate paid clicks and cost per click, drives platform-derived revenue.

 

Active users

 

The primary driver of growth of our active user base has been increasing user awareness of our solutions and the AVG brand, which we promote through online viral marketing, including word-of-mouth advertising, blogs and other media referrals. In addition, periodic enhancements and functionality additions made to our free solutions also contribute to overall active user base growth. Growth of our active user base also reflects our general strategy toward localization, i.e., producing versions of our products in local languages and in some cases adapted for specific markets. We build a presence in new markets through the introduction of our free Internet security software in advance of our premium products. If these various strategies do not work and we are not able to grow our active user base over the long term, our business and profitability could be adversely affected.

 

Subscription users

 

Subscription users are those who subscribe to premium products, the primary component of subscription revenue. Growth in our subscription user base is driven by increasing user awareness of our premium products and brand, leading to both greater numbers of visits to our website and increasing traffic to our web-based distribution platform, which generates direct sales (i.e., without an upgrade from the free product). Enhancements and functionality additions to our premium solutions (as compared with our free product) have contributed to the growth of our subscription user base, particularly as those solutions have evolved to more comprehensive software suites. The growth of our active user base has also contributed to growth of our subscription user base by increasing the pool of users who may potentially upgrade to our premium solutions (and are accordingly converted into subscription users). As with direct sales, this dynamic is driven by the enhancements and additional functionality of our premium solutions. If users do not recognize the value of our premium solutions, or do not find our solutions compelling relative to the cost of these solutions, they may choose to utilize our free solutions. If users choose not to purchase or renew access to our premium solutions and we experience a significant decline in our subscription user base, our revenue and profitability may suffer.

 

User retention

 

One variable affecting the growth and stability of our user base is our ability to retain existing users, which is influenced by a variety of factors. For example, our ability to retain both subscription users and active users is affected by the frequency with which our users replace their personal computers, as free trial versions of antivirus and other software are typically preinstalled on new personal computers. In addition, due to our limited ability to track users based on personally identifiable information, even if existing users continue using our products on new personal computers, it historically has appeared to us as the loss of an existing customer and the addition of a new customer. Assessment of retention of free users is particularly difficult as we collect little or no identifiable information on these users. User retention also depends on the mix of products sold to consumers versus small businesses, as different user types have different retention characteristics. Another factor affecting subscription user retention is the extent to which we invest in various marketing and customer loyalty programs, such as discounted pricing for renewals and two-year subscriptions. We may adjust our pricing strategy from time to time with the objective of increasing our revenue per active user, which may cause decreases in our subscription renewal rates even if it increases overall revenue. For example, we may reduce discounts given to renewing users, which could increase overall revenue if the increase in revenue from each renewing user is not fully offset

 

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by the decrease in revenue caused by the resulting decline in renewal rates. We have begun implementing auto-renewals for subscription users (an opt-in option selected by the user at the time of purchase to automatically renew the relevant subscription and to charge the user’s pre-designated debit or credit card) where possible and permitted by law to increase our retention of subscription users. Approximately 18% of subscription users purchasing a license online in 2010 and 30.9% of those purchasing a license online in the nine months ended September 30, 2011 have opted for auto-renewal. However, certain proposed regulations in the European Union and the United States may not allow for auto-renewal in the future, which may result in a lower renewal rate by our existing subscription users. Finally, many of our products and services apart from anti-virus software were introduced recently, so we have little information on retention of users of these products and services. Additional factors relating to these products and services may also prove to impact retention.

 

Advertising clicks and revenue per click

 

The substantial majority of our platform-derived business to date and expected for the near term is based on secure Internet searches. When users install our toolbar or various other applications, we provide them with our dynamic secure Internet search functionality. Except for DNS-error-page-related queries, which are sent to Yahoo!, each request for an Internet search query by a user is generally sent to our primary search provider, which is currently Google. Google’s advertisers pay Google a fee each time a user clicks on one of the advertisers’ ads displayed on Google’s sponsored links. We receive a percentage of the fee Google receives as platform-derived revenue, which in turn is dependent on the fees Google receives from the click-through of a user. The fees per click are based on a variety of factors that are beyond our control and our revenue and profitability may be harmed if these factors do not move in our favor. If we are not able to grow the aggregate number of clicks or searches, conversion of search queries to click-throughs, number of toolbar installations and lifetime value of the toolbar, our platform-derived revenue may be impacted.

 

Security demand and awareness

 

Our free Internet security software serves as our primary customer acquisition vehicle. Internet users view security software as a prerequisite for a secure, safe Internet experience.

 

The size of our user base, and consequently our result of operations, are influenced by general growth in the consumer and small business security market, broader interest in security software and changes in the awareness among consumers and small businesses as to the need for Internet security. The growing use and popularity of the Internet has led to increased demand for Internet security solutions, including our products. In addition, newsworthy events involving or predicting harm caused by significant and extensive breaches of Internet security, cause demand for our products to increase. As cybercrime has increased in both frequency and sophistication, our users have demanded more comprehensive Internet security solutions. We believe that as online activity and the interconnectivity of devices continues to increase, the security requirements of our users will also increase.

 

Online marketing and distribution

 

Our business model benefits our profitability by facilitating and encouraging viral marketing and soliciting product development ideas from our active users, which can reduce operating expenses. In particular, our model helps to limit the growth in our sales and marketing and customer acquisition expenses.

 

From 2008 to 2010, our revenue was increasingly derived from our own online channels, including sales of our software solutions through our own web-based distribution platform and our platform-derived revenue, as opposed to our reseller network (which includes offline sales and sales through third- party distributors (whether in retail stores or on the Internet)). Growth in our web-based distribution has had the effect of increasing the percentage contribution of our sales to our overall profitability by eliminating costs incurred with respect to third-party distributors and lowering our own cost of sales. Over the near term, we expect sales from online channels to increase as a percentage of total revenue.

 

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The following table summarizes our revenue by distribution channel for each of the years ended December 31, 2008, 2009 and 2010, and the nine months ended September 30, 2010 and 2011:

 

     Year ended December 31,      Nine months ended
September 30,
 
     2008      2009      2010      2010      2011  
     (in thousands)  
                          (unaudited)  

Reseller network

   $ 42,315       $ 58,126       $ 68,886       $ 49,001       $ 51,202   

Web-based and platform-derived

     71,526         123,841         148,332         110,789         146,891   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 113,841       $ 181,968       $ 217,218       $ 159,790       $ 198,093   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

Currency fluctuations

 

Our reporting currency is the U.S. dollar, notwithstanding that we are organized under the laws of the Netherlands. In 2010, 77% of our revenue was generated in U.S. dollars, while 11% was generated in British pounds sterling, 3% in Czech crowns and 9% in euros. In addition, in 2010 we incurred 34% of our costs in Czech crowns. For the nine months ended September 30, 2011, 77% of our revenue was generated in U.S. dollars, while 10% was generated in British pounds sterling, 2% in Czech crowns and 10% in euros, and we incurred 30% of our costs in Czech crowns. As a result, we have both transaction and translation currency exposures to the pound sterling, Czech crown and euro. In 2008, we began to hedge our transaction currency exposure to the pound sterling, Czech crown and euro. The effects of these hedges are accounted for in our finance income and expenses.

 

In addition, due to Czech regulations, the functional currency of our primary Czech operating subsidiary is the Czech crown. This gives rise to a profit and loss revaluation charge on our U.S. dollar assets of that Czech subsidiary denominated in U.S. dollars. We manage this balance sheet exposure but do not use financial instruments to hedge these positions as we believe these are technical accounting exposures only. In 2010 and in the first nine months of 2011, the effect of this exposure was immaterial.

 

Effective tax rate

 

Through May 31, 2011, our effective tax rate was mainly determined by the nominal corporate tax rate of 10% in Cyprus and the corporate tax rate in the Czech Republic, where we benefit from a relatively low corporate tax rate. In 2007, the Czech corporate tax rate was 24%, and by 2011, that rate had declined to 19%. As a result, our effective tax rate was 5.3% in 2008, 11.1% in 2009 and 13.9% in 2010. On June 1, 2011, we entered into an innovation tax regime in the Netherlands and recognized tax benefits (deferred tax assets) which significantly impacted our effective tax rate. As a result, we received a credit, or a benefit to our income statement, of $52.2 million for the nine-month period ended September 30, 2011.

 

As of June 1, 2011, we reorganized our operating model by centralizing the ownership of certain intangible intellectual property rights (and the future development of those rights) in the Netherlands. As a result, our effective tax rate will in future mainly be determined by the Innovation Box tax regime in the Netherlands, the nominal corporate tax rate of 10% in Cyprus and the corporate tax rate in the Czech Republic. Effective January 1, 2007, and as further amended on January 1, 2010, Dutch corporate tax legislation provides for a specific tax benefit for income generated by the exploitation of technology that results, among other things, from research and development activities, generally referred to as the Innovation Box. On May 31, 2011, we entered into an agreement with the Dutch tax authorities regarding the application of this regime to AVG. The agreement confirms the application of the tax incentive to the Dutch operations, and establishes the methodology to be used to determine our income from the technology. In addition, this agreement confirms the am