WGRD Watchguard Technologies

WatchGuard Technologies, Inc. (Nasdaq:WGRD), a leading provider of network security solutions, today announced its financial results for the second quarter of 2006. WatchGuard reported net revenue of $16.5 million for the second quarter of 2006, compared to $18.6 million in the previous quarter, and $20.3 million in the second quarter of 2005. Product revenue was $8.4 million in the second quarter of 2006, compared to $10.9 million in the previous quarter, and $12.9 million in the second quarter of 2005. Service revenue was $8.1 million for the second quarter of 2006, compared to $7.7 million in the previous quarter, and $7.4 million in the second quarter of 2005. Reflecting increased sales of WatchGuard subscription services during the second quarter, deferred revenue increased from $22.5 million at March 31, 2006, to $22.9 million at June 30, 2006. Product revenue for the second quarter of 2006 was affected by WatchGuard's transition to a sell-through revenue recognition model during the quarter in the U.K and Germany- Austria-Switzerland ("DACH"). WatchGuard estimates the transition to a sell-through model in these regions reduced product revenues by approximately $1.9 million for the second quarter of 2006, not including changes in customer buying patterns upon conversion to a sell-through model. WatchGuard reported a net loss of $3.4 million, or $0.10 per share, in the second quarter of 2006, compared to a net loss of $4.1 million, or $0.12 per share, in the previous quarter, and a net loss of $2.0 million, or $0.06 per share, in the second quarter of 2005. Excluding amortization of acquisition-related costs, non-cash stock-based compensation, and restructuring charges, WatchGuard reported a non-GAAP net loss of $2.3 million, or $0.07 per share, in the second quarter of 2006, compared to a non-GAAP net loss of $2.8 million, or $0.08 per share, in the previous quarter, and a non-GAAP net loss of $0.8 million, or $0.02 per share, in the second quarter of 2005. The reconciliation of WatchGuard's GAAP operating results to WatchGuard's non-GAAP operating results for the quarters ended June 30, 2006, March 31, 2006, and June 30, 2005, are set forth at the end of this release. WatchGuard ended the second quarter of 2006 with $75.4 million in cash and securities, of which $2.4 million is restricted cash under the terms of certain real estate lease agreements. Cash and securities were unchanged from the $75.4 million on hand at March 31, 2006. "In Q2 we continued to make progress on our turnaround," said Ed Borey, Chief Executive Officer of WatchGuard. "Costs are under control, we launched our new hardware and software platforms and we completed our transition from sell-in to sell-through revenue recognition in the U.K. and DACH." Webcast Information An Internet broadcast and replay of WatchGuard's conference call discussing its second quarter of 2006 results (2:00 PM Pacific / 5:00 PM Eastern) will be available on August 7, 2006, at www.watchguard.com under "Investor Relations." Investors may access the live conference call by calling 866-700-7173 (U.S. and Canada) and 617-213-8838 (International). The participant pass code is 70837820. About WatchGuard Technologies, Inc. WatchGuard provides network security. The company's Firebox X family of upgradeable appliances delivers the performance, functionality and security strength to meet the needs of organizations of any size. WatchGuard's Intelligent Layered Security protects against emerging threats and provides the platform to integrate additional services offered by the company. All WatchGuard products include a LiveSecurity Service subscription for vulnerability alerts, software updates, expert security instruction, as well as individualized and self-help customer care. WatchGuard is headquartered in Seattle, Washington, with offices throughout Europe and Asia. For more information, please visit www.watchguard.com. Certain statements in this press release, including statements about our ability to improve our results of operations and other statements about our plans, objectives, intentions, and expectations are "forward-looking statements" within the meaning of the Securities Exchange Act of 1934, as amended. Forward-looking statements are based on the opinions and estimates of management at the time the statements are made and are subject to known and unknown risks and uncertainties and inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risk that we will be unable to improve our results of operations as expected or at all and the other risks described under "Risk Factors" in our quarterly report on Form 10-Q for the quarter ended March 31, 2006, and in our Securities and Exchange Commission filings from time to time. Readers are cautioned not to place undue reliance upon these forward-looking statements, which speak only as of the date of this release. WatchGuard, Firebox and LiveSecurity are either registered trademarks or trademarks of WatchGuard Technologies, Inc. in the United States and/or other countries. All other trademarks are the property of their respective owners. -0- *T WATCHGUARD TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data and percentages) unaudited Three Months Ended Six Months Ended ----------------------------- ------------------ June 30, March 31, June 30, June 30, June 30, 2006 2006 2005 2006 2005 ---------- --------- -------- --------- -------- Revenues: Product $ 8,390 $ 10,873 $12,878 $ 19,263 $22,009 Service 8,078 7,717 7,445 15,795 14,929 --------- -------- ------- -------- ------- Total revenues 16,468 18,590 20,323 35,058 36,938 --------- -------- ------- -------- ------- Cost of revenues: Product (1) 3,626 4,568 5,265 8,194 9,348 Service (1) 1,835 1,704 1,457 3,539 2,928 --------- -------- ------- -------- ------- Total cost of revenues 5,461 6,272 6,722 11,733 12,276 --------- -------- ------- -------- ------- Gross margin 11,007 12,318 13,601 23,325 24,662 --------- -------- ------- -------- ------- Gross margin percent 66.8% 66.3% 66.9% 66.5% 66.8% Operating expenses: Sales and marketing (1) 6,630 7,101 7,607 13,731 15,553 Research and development (1) 4,734 5,433 4,821 10,167 9,264 General and administrative (1) 3,444 4,327 3,368 7,771 6,124 Amortization of other intangible assets 243 243 243 486 487 Restructuring charges 92 - - 92 - --------- -------- ------- -------- ------- Total operating expenses 15,143 17,104 16,039 32,247 31,428 --------- -------- ------- -------- ------- Operating loss (4,136) (4,786) (2,438) (8,922) (6,766) Interest and other income, net 814 720 488 1,534 940 --------- -------- ------- -------- ------- Loss before income taxes (3,322) (4,066) (1,950) (7,388) (5,826) Provision for income taxes 30 18 29 48 71 --------- -------- ------- -------- ------- Net loss $ (3,352) $ (4,084) $(1,979) $ (7,436) $(5,897) ========= ======== ======= ======== ======= Basic and diluted net loss per share $ (0.10) $ (0.12) $ (0.06) $ (0.22) $ (0.17) ========= ======== ======= ======== ======= Shares used in calculation of basic and diluted net loss per share 34,535 34,282 33,792 34,410 33,755 ========= ======== ======= ======== ======= (1) Includes stock-based compensation as follows: Cost of revenues: Product $ 5 $ 8 $ 10 $ 13 $ 10 Service 28 35 52 63 52 Sales and marketing 158 235 252 393 252 Research and development 151 252 415 403 415 General and administrative 416 541 238 957 238 ----- -------- ------- ------- ------ Total $ 758 $ 1,071 $ 967 $ 1,829 $ 967 ===== ======== ======= ======= ====== WATCHGUARD TECHNOLOGIES, INC. RECONCILIATION OF GAAP NET LOSS TO NON-GAAP NET LOSS (In thousands) unaudited Three Months Ended Six Months Ended ----------------------------- ----------------- June 30, March 31, June 30, June 30, June 30, 2006 2006 2005 2006 2005 --------- --------- --------- -------- -------- GAAP net loss $ (3,352) $ (4,084) $(1,979) $(7,436) $(5,897) Adjustments to reconcile GAAP net loss to non-GAAP net loss: Stock-based compensation 758 1,071 967 1,829 967 Amortization of other intangible assets 243 243 243 486 487 Restructuring charges 92 - - 92 - -------- -------- ------- ------- ------- Non-GAAP net loss $ (2,259) $ (2,770) $ (769) $(5,029) $(4,443) ======== ======== ======= ======= ======= Non-GAAP basic and diluted net loss per share $ (0.07) $ (0.08) $ (0.02) $ (0.15) $ (0.13) ======== ======== ======= ======= ======= Shares used in calculation of basic and diluted non-GAAP net loss per share 34,535 34,282 33,792 34,410 33,755 ======== ======== ======= ======= ======= Use of Non-GAAP Financial Information To supplement our consolidated financial statements presented on a GAAP basis, WatchGuard uses a non-GAAP measure of net loss (including on a per share basis), which is adjusted to exclude certain costs and expenses. WatchGuard believes this non-GAAP measure is useful to enhance an overall understanding of our past financial performance and also our prospects for the future. This adjustment to our GAAP net loss is presented with the intent of providing both management and investors a more complete understanding of WatchGuard's underlying operational results and trends and our marketplace performance. For example, this non-GAAP measure is an indication of our baseline performance before other charges that are considered by management to be nonrecurring and otherwise outside of our core operating results. This adjusted non-GAAP measure is among the primary indicators management uses as a basis for planning and forecasting of future periods. Non-GAAP results exclude the following items. Stock-Based Compensation. Non-GAAP net loss excludes stock-based compensation expenses, which consist primarily of expenses for stock options, restricted stock awards and purchases of common stock under our Employee Stock Purchase Plan. WatchGuard began recording stock-based compensation expenses under SFAS 123(R) in the first quarter of 2006. Prior to 2006, WatchGuard's stock-based compensation expenses resulted primarily from the variable accounting treatment of certain stock options issued to employees and directors, restricted stock issued to directors and officers, stock options granted to consultants and certain restricted common stock and common stock subject to repurchase issued in connection with the RapidStream, Inc. acquisition. WatchGuard excludes stock-based compensation expenses from its non-GAAP financial measures primarily because these costs are non-cash expenses with no current effect on cash or the future uses of cash. WatchGuard does not consider these expenses as part of its ongoing operating results when assessing the performance of the Company. For these reasons, management believes that exclusion of stock-based compensation expense may be important to an understanding of WatchGuard's ongoing operational performance. Amortization of other intangible assets. Non-GAAP net loss also excludes amortization of other intangible assets arising from WatchGuard's acquisition of RapidStream in April 2002. These non-cash charges represent a non-cash expense that has no effect on current or future period cash flows or operations of the Company. The amortization expense results from WatchGuard's acquisition of RapidStream in April 2002, a non-recurring event outside of the course of WatchGuard's normal business operations. Due to the nonrecurring nature of this event, management believes that exclusion of the related amortization charges may be important to an understanding of WatchGuard's ongoing operational performance. Restructuring charges. Finally, non-GAAP net loss excludes restructuring charges resulting from our restructuring plans initiated in 2001 and 2002. Again, these charges represent a non-recurring, non-cash expense that has no effect on current or future period cash flows or operations. These restructuring charges resulted from the Company's restructuring plan initiated in 2001, in an effort to streamline operations and reduce operating costs, and an unrelated restructuring in 2002, to eliminate redundancies and excess headcount resulting from the acquisition of RapidStream. Due to the nonrecurring nature of these events, management believes that exclusion of the related restructuring charges may be important to an understanding of WatchGuard's ongoing operational performance. Management believes that presentation of non-GAAP net loss provides an additional tool for investors to evaluate ongoing operating results and trends. The presentation of this additional information is not meant to be considered in isolation or as a substitute for operating results prepared in accordance with generally accepted accounting principles in the United States. Investors are encouraged to review the reconciliation of non-GAAP net loss to the GAAP net loss, as presented herein. WATCHGUARD TECHNOLOGIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands) June 30, December 31, 2006 2005 ---------------- -------------- (unaudited) ASSETS Current assets: Cash and cash equivalents $ 22,298 $ 20,390 Short-term available-for-sale investments 48,375 54,379 Trade accounts receivable, net 3,173 4,883 Inventories, net 4,532 4,093 Prepaid expenses and other 2,728 2,442 Short-term restricted cash 600 1,200 --------------- ------------- Total current assets 81,706 87,387 Property and equipment, net 5,986 6,197 Long-term restricted cash 1,800 1,800 Long-term available-for-sale investments 2,279 - Goodwill 66,605 66,605 Other intangibles, net, and other non- current assets 1,202 1,735 --------------- ------------- Total assets $ 159,578 $ 163,724 =============== ============= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,340 $ 4,654 Accrued expenses and other liabilities 7,035 6,985 Short-term accrued restructuring costs 1,029 1,119 Short-term deferred revenues 19,966 18,278 --------------- ------------- Total current liabilities 30,370 31,036 Long-term deferred rent 1,162 1,302 Long-term accrued restructuring costs 2,390 2,756 Long-term deferred revenues 2,917 2,163 --------------- ------------- Total liabilities 36,839 37,257 Total stockholders' equity 122,739 126,467 --------------- ------------- Total liabilities and stockholders' equity $ 159,578 $ 163,724 =============== ============= WATCHGUARD TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) unaudited Three Months Ended Six Months Ended ------------------- ------------------- June 30, June 30, June 30, June 30, 2006 2005 2006 2005 --------- --------- --------- --------- Operating activities: Net loss $ (3,352) $ (1,979) $ (7,436) $ (5,897) Adjustments to reconcile net loss to net cash used in operating activities: Noncash expenses: Depreciation and amortization of property and equipment 719 647 1,397 1,303 Amortization of other intangible assets 243 243 486 487 Stock-based compensation 758 967 1,829 967 Changes in operating assets and liabilities: Trade accounts receivable, net 2,259 457 1,710 951 Inventories, net (478) (106) (439) (1,761) Prepaid expenses and other current assets (159) 306 (286) 116 Other assets 109 (192) 46 (175) Accounts payable (474) (499) (2,314) (790) Accrued expenses, other liabilities and deferred rent 55 (772) (90) 1,130 Accrued restructuring costs (218) (169) (456) (484) Deferred revenues 344 436 2,442 116 -------- -------- -------- -------- Net cash used in operating activities (194) (661) (3,111) (4,037) -------- -------- -------- -------- Investing activities: Purchases of property and equipment, net (912) (346) (1,186) (413) Proceeds from maturities of marketable securities 25,170 14,925 41,376 41,572 Purchases of marketable securities (21,032) (12,692) (37,539) (32,835) -------- -------- -------- -------- Net cash provided by investing activities 3,226 1,887 2,651 8,324 -------- -------- -------- -------- Financing activities: Proceeds from stock option exercises and issuances of common stock under the employee stock purchase plan 1,031 10 1,768 356 Change in restricted cash - - 600 - -------- -------- -------- -------- Net cash provided by financing activities 1,031 10 2,368 356 -------- -------- -------- -------- Net increase in cash and cash equivalents 4,063 1,236 1,908 4,643 Cash and cash equivalents at beginning of period 18,235 8,067 20,390 4,660 -------- -------- -------- -------- Cash and cash equivalents at end of period $ 22,298 $ 9,303 $ 22,298 $ 9,303 ======== ======== ======== ======== *T