It's only been a few hours since Internet security company McAfee (NYSE:MFE) reported its first-quarter 2005 results, and already the headlines are rolling in: "McAfee net profit slumps" complains one pundit; "38 Percent Earnings Drop" laments another.

And yet the stock was up more than 5% in after-hours trading yesterday -- because sometimes the market gets it right. Let's look first at the news that spawned the headlines, then turn to the real news that gave rise to the market's buying spree.

Bad news first: Profits per diluted share declined 36% in comparison with Q1 2004, to $0.21. OK, so that looks bad. But the reason for the decline is clear: Last year, the company had $65 million in one-time gains from asset sales and the like. Those items made up the bulk of the year-ago quarter's pre-tax profits, and were not repeated in Q1 2005. So, of course, net profit slumped. And naturally, that resulted in an earnings drop. In four words, two of them hyphenated, the decline is a "red herring" and a "non-issue."

Much more interesting are a couple of other facts from the company's income statement. Take a look, for example, at the relationship between McAfee's increase in sales, and the increase in the cost of producing those sales. Over the past year, sales rose from $219 million to $236 million -- a $17 million increase. Now look at the incremental cost of that improvement: Cost of sales grew from $34 million to $35 million.

So it cost the company just $1 million to collect $17 million more in cash. Right there, you've got a wonderful case study in the economics of an asset-lite software company. Companies like McAfee, rival Symantec (NASDAQ:SYMC), and, of course, the poster boy for profitable software companies, Microsoft (NASDAQ:MSFT), all make wonderful investments because it costs them just so darn little to produce extra revenues from their products. Each of these companies sports net profit margins north of 20%, and operating margins above 30%. And that's why investors love them.

The other trend I think investors should keep an eye on is operating costs. Revenues were up, and that's good. Profits were down, and that's irrelevant. But ongoing operating costs were down, too, and that's key, because they appeared to be down in all the wrong areas, and up in the wrong areas, as well. R&D got cut by 16% in comparison to the same quarter last year. Marketing expenditures were slashed by 23%. But administrative costs increased 21%.

If McAfee is to continue growing sales and dropping huge fractions of each sale dollar to the bottom line, it needs to continue funding research. It needs to keep its marketing muscles toned to fight off competition from Symantec and Microsoft. Those line items, however, suggest that the company is neglecting the areas most deserving of funds, while perhaps pouring a bit too much cash into overhead. If there's anything to worry about in McAfee's report, that's it.

Read all about McAfee and archrivals Symantec and Microsoft in:

Fool contributor Rich Smith has no position in any of the companies mentioned in this article.