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Executives

Matthew T. Medeiros - Chief Executive Officer, President

Rob Selvi - Chief Financial Officer and Vice President

Robert B. Knauff - Chief Accounting Officer, VP of Finance and Corporate Controller

Frederick M. Gonzalez - Vice President, Corporate Secretary and General Counsel

Analysts

Sterling Auty - J.P. Morgan

Kenneth Muth - Robert W. Baird & Co., Inc.

Catherine Trebnick - Avian Securities LLC

Scott Zeller - Needham & Company

Robert Breza - RBC Capital Markets

Analyst for Robert Breza - RBC Capital Markets

Craig Nankervis - First Analysis Corp

Israel Hernandez - Barclays Capital

Rob Owens - Pacific Crest

SonicWALL Inc. (SNWL) Q4 2008 Earnings Call Transcript February 11, 2009 5:00 PM ET

Operator

Good day and welcome to the SonicWALL fourth quarter 2008 earnings conference call. Today’s conference is being recorded. At this time I would like to turn the conference over to Ms. Kelly Blough. Please go ahead ma’am.

Kelly Blough

Thank you, Sherlon. Welcome to our fourth quarter and fiscal year 2008 earnings conference call. With us today are Matt Medeiros, President and CEO of SonicWALL and Rob Selvi, CFO.

Before we begin, I would like to remind everyone that during this conference call we will be making forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 as amended and Section 21E of the Securities Exchange Act of 1934 as amended.

Forward-looking statements include without limitation, revenue GAAP and non-GAAP earning per share and gross margin guidance for the first quarter of 2009, the growth trajectory for our UTM NSA product line, our enhanced competitive position, the benefit associated with our Channel 2.0 initiative, the incremental market opportunities as stated with our new product offering, the market acceptance of new updated and existing products and the impact of macroeconomic conditions on demand for our products and services in future quarters.

All forward-looking statements made on this call are subject to risks, uncertainties and assumptions that could cause actual results or events to differ materially from those contained in the forward-looking statements.

For a detailed description of the risks and uncertainties that could cause actual results to differ materially from those expressed or implied in these forward-looking statements, as well as the risks related to our business in general, we refer you to the periodic reports that the Company has filed from time to time with the SEC, including discussion and risk factor section of the Company’s annual report on Form 10-K for the year ended December 31st, 2007.

The Company undertakes no obligation to update forward-looking statements at any time or for any reason. In addition, the following information include non-GAAP results, which exclude amortization of purchased technology and the cost of goods sold, amortization of intangible assets and operating expenses, restructuring charges and stock-based compensation expense.

Please see our website and our Form 8-K filed with the SEC earlier today for reconciliation of non-GAAP and GAAP results. I will now turn the call over to Matt Medeiros.

Matthew T. Medeiros

Thank you, Kelly. Good afternoon and thank you for joining our call. SonicWALLs total revenue in the fourth quarter was $54.3 million, slightly higher than our guidance range of $50 million to $54 million. Stability in gross margins and ongoing cost management resulted in an improved operating margin. Non-GAAP earnings were $0.11 per share exceeding the high end of our guidance by $0.04. GAAP earnings per share were $0.06.

We ended 2008 with a $167 million in cash and total investments. In the fourth quarter, operational cash flow was $5.4 million marking the 15th straight quarter in which SonicWALL has produced positive cash flow from operations. For fiscal year 2008, total revenue grew 10% year-over-year to $219 million. Non-GAAP earnings per share were $0.29. GAAP earnings per share were $0.08. Our unified threat management, NSA product line drove revenue performance in the fourth quarter of 2008, growing 16% sequentially. Since, it is launch, the product line has grown from under 10% of hardware revenue to now nearly 40% in the fourth quarter of last year.

These high performance products have proven to be extremely competitive against entrenched providers. Across all the NSA product lines from the E7500 down to the most recently released 240. The products are receiving rave reviews by beating the competition in the market, as well as in head-to-head independent performance testing.

For example, a recent review published in Communications News on the NSA E7500 against competitive products from Fortinet, Juniper, and Watchguard, found that SonicWALL’s E7500 offered customers the best network throughput across the board, regardless of services enabled. Like its E-class NSA predecessors, the NSA 240 designed specifically for small businesses and branch offices, establishes a new standard for technical performance at its price point.

An SC Magazine review for the NSA 240, in January told readers and I quote, “If you have considered SonicWALL before and have not taken the plunge, now is the time.” Our UTM NSA solution has now completely populated the price performance curve from $2,000 all the way up to $25,000. Completing the full spectrum of our UTM offering, we recently brought the advanced reprocessing technology found in the NSA Series to our TZ product line. With the release of the TZ210, we now offer small business performance about 200 megabits per second while delivering unsurpassed UTM protection. With 100 megabits per second performance, not surprisingly, the 210 also has been well received. Just last month, eWeek’s Channel Insider said that the 210 and I quote, “Has the potential to become an 800-pound gorilla of the channel security market, with enterprise level features that challenge the giants of enterprise security from Cisco, F5 Networks, and Juniper Networks.”

Shipping for the first time in the fourth quarter, the TZ210 product generated unit growth at higher ASPs than our existing TZ product line. Our investments in innovation and product development have made us more competitive and positioned us as a technology leader and alternative to premium price vendors.

We saw the benefits of this again in the fourth quarter with customers deploying SonicWALL solutions throughout their organizations. We experienced solid performance across Europe in Q4, led by some large NSA deals in France, Germany and Italy. A major retail in France bought hundreds of NSA2400 to secure its branch locations. SonicWALL won this business with over three quarters of a million dollars in a bake-off against Cisco and Checkpoint.

A global insurer based in the UK, consolidated its multiple remote access platforms from Cisco and Citrix to our SonicWALL Aventail infrastructure based on the comprehensiveness and the ease of administration of our products.

Japan also closed with a relatively strong quarter. Our team won a six-figure deal with the Japanese Government Agency for an extensive deployment of NSA 3500 and 2400 appliances. Beating competition from Juniper, based on performance, wholesales’ technical support and price.

Our North American revenue has remained relatively level for the past few quarters. We saw some success in the fourth quarter in terms of large, mid-tier and enterprise deals, particularly for SSL VPN and NSA products. For example in the fourth quarter we won a contract with a well known Hollywood entertainment studio, which chose the SonicWALL Aventail SSL VPN solution to secure all of its remote users. SonicWALL won this six-figure contract in competition with Juniper based on the stability and the performance of our offering.

A large North American communications company expanded this relationship with SonicWALL in the quarter, completing its global deployment of SonicWALL Aventail appliances with an EX7500 at its headquarters in the US. Across all regions we had several examples of large transactions in the fourth quarter. Customer wins and product reviews, such as these, continue to validate the strength of our technical platform and competitive positive while allowing us to maintain consistent gross margins over the past year.

Before I hand the call over to Rob to review our financials I want to spend a few moments recapping 2008. We are acutely aware of the challenges in the global economy and specifically the impact it is had on the global SMB market. However, I am very proud of what we have been able to accomplish in spite of these economic headwinds.

In 2008 we gained UTM and SSL VPN market share. According to IDC, SonicWALL UTM unit market share significantly in the third quarter to 12.5%, also for the third quarter, Infonetics data says SonicWALL regained the number one unified threat management market share position in both units and revenue in the 500 to 1,500 segments.

In 2008 we improved operating profitability. In the fourth quarter, SonicWALL’s non-GAAP operating income grew 155%, compared to the same period in 2007. Earnings per share grew 83%, compared to the same period in 2007. In the fourth quarter, we also delivered on the objective of reaching the mid-teen operating margin. In 2008, SonicWALL generated $19.2 million in operating cash flow while investing heavily in the future of the business.

We brought technical support in-house resulting in better customer satisfaction scores and lower costs to SonicWALL. We opened development sales and support centers in Bangalore, India and Tempe, Arizona; and our technology accomplishments were unprecedented. In 2008, we doubled our patent filings to a total of 70 and we nearly doubled the number of patents that we have been issued.

We spent much of 2008 enhancing and revitalizing our award winning Channel program that has been the hallmark of SonicWALL success. In January of this year we rolled out Channel 2.0, an initiative that will further differentiate our Channel program, adding benefits, tailoring incentives based on performance and enhancing pre and post sale technical support for our partners worldwide.

In 2008, we released 14 new appliances, including five new members of our flagship multicore NSA UTM appliance series, the first product in our new TZ platform; two new versions of the SonicWALL Aventail secure remote access appliance, and four new CDP hardware offerings. We also released major new software reversions of our email security offering, our global management system and our CDP, all of which are receiving strong reviews from trade press, analysts, and end customers.

Today we have a full suite of high performance hardware, software and services that provide incremental market opportunities for SonicWALL. These new products and services and the success of these product transitions greatly contributed to our consistent gross margin performance for the year which average 71.2%.

Now, let me hand it over to Rob for our financial results.

Rob Selvi

Thanks Matt. Good afternoon. Of the $54.3 million in total fourth quarter revenue, UTM solutions contributed 76%, secure content management solutions contributed 10%, SSL VPN solutions contributed 9% and CDP products contributed 4%.

Total revenue units shipped in the quarter were 42,000. Product revenue was $21.9 million, up 2% sequentially and down 20% year-over-year. The sequential improvement in product revenue was due to the increase sales of NSA, CDP, and SSL VPN products offset by declines in TZ and PRO products. The year-over-year decline in product revenue was primarily the result of declines in TZ, PRO, CDP, and SSL VPN products offset by increases in NSA products. As a reminder, the declines in the PRO product revenue are the result of our planned phase out of that product line.

As a percent of total product revenue, 78% was generated from products with average net revenue per unit below $1,500, 22% was generated from products with average net revenue per unit of $1,500 to $5,000, and 8% was generated from products with average net revenue per unit above $5,000. License and services revenue of $32.4 million increased 2% sequentially, an increase of 13% over the same period last year.

The sequential improvement in license and services revenue was primarily the result of increased sales of our comprehensive gateway security service, and increased licensing of our VPN client. The year-over-year increase in license and services revenue was the result of increased sales of comprehensive gateway security, client antivirus, and email security offset by a decline in license revenue.

License and services revenue represented 60% of total revenue in the quarter. License revenue represented 8% of total license and services revenue during the quarter, as compared to 7% in the prior quarter and 11% in the same period last year.

Total subscription services billings were $30 million, down 8% from the prior quarter and down 6% from the same period last year. Multi-year subscriptions accounted for approximately 32% of subscription service billings in the fourth quarter. The sequential and year-over-year declines in subscription services billings were predominantly attributable to lower TZ unit sales.

On a percentage basis, North America represented 66%, and international represented 34% of total revenue. Europe, the Middle East and Africa contributed 23%. Asia-Pacific and Japan contributed 9% and Latin America contributed 2%.

Non-GAAP gross margin increased to 71.3%, compared to 70.7% in the third quarter. Product gross margin declined to 50% from 51% in the third quarter due primarily to the mix of products sold.

Non-GAAP operating expenses declined again in the quarter to $30 million from $32 million in Q3. The decrease in operating expenses reflects the benefits of lower contractor expenses, sequential declines in salary and incentive compensation expenses and lower travel and facilities expenses offset somewhat by increased accounting and legal fees.

In terms of non-GAAP results, the total operating expenses represented approximately 56% of revenue for the quarter, compared to 60% in the prior quarter. Operating expenses for research and development represented 16.7% of revenue.

Sales and marketing expenses represented 32.2% of revenue, and general and administrative expenses represented 7% of revenue. At the end of the fourth quarter total regular employee headcount was 820 compared to 841 at the end of the third quarter.

Interest income in the fourth quarter was $1 million, compared to $1.1 million in the prior quarter and $2.9 million in the same period last year. For the quarter, non-GAAP tax expense was $3.5 million against non-GAAP income before taxes of $9.4 million. Non-GAAP net earnings for the fourth quarter were $5.9 million or $0.11 per diluted share. Non-GAAP net earnings for the fourth quarter excluded a million dollars of amortization of purchased intangible assets and $2.5 million of stock-based compensation expense.

GAAP earnings for the fourth quarter were $3.5 million or $0.06 per diluted share. Stock-based compensation expense before tax primarily associated with the expensing of stock options was approximately $2.5 million.

And now I will review the balance sheet and cash flow statement. During the quarter, we generated operating cash flow of $5.4 million. Total cash, cash equivalents and short term investments were $105.5 million. Investments classified as long term represented $61.5 million.

During the fourth quarter, we accepted an offer from UBS, one of our money managers to allow for the sale of auction rate securities at their par value during the two-year period beginning in June 2010. This relates to approximately $45 million or 73% of our total long term investment balance at the end of the fourth quarter. We also recorded an additional unrealized loss of approximately $4.8 million in long term investments which was related to the degradation of value estimates for other auction rate and asset backed securities during the quarter.

Net accounts receivable were $20.9 million in the fourth quarter, compared to $22.4 million in the prior quarter. DSO was 35 days, compared to 38 days in the prior quarter. Net inventories were $8.9 million in the fourth quarter, compared to $7.6 million in the previous quarter and $6 million in the same period last year.

Net inventories consist of inventory of two of our top US distributors and finished goods at our third party manufacturers and logistics provider. The year-over-year and sequential increases in net inventories is primarily associated with new product releases and stocking at higher value NSA products.

Total annualized inventory turns on a non-GAAP basis for eight times relatively level with the prior quarter. Deferred revenue decreased $2.6 million to $103.5 million. The decrease in deferred revenue was related primarily to the decline in inventory at our two largest distributors. Deferred revenue attributable to subscription services was $89.5 million relatively level with the prior quarter and up 7% in comparison with the same period last year.

I will go over the financial results for fiscal year 2008. Total revenue for 2008 was $218.6 million, compared to $199.2 million in 2007, representing an increase of 9.8%. Product revenue for fiscal year 2008 was $91 million, compared to $99 million in fiscal year 2007. License and services revenue for fiscal year 2008 was $128 million, compared to $100 million in fiscal year 2007.

GAAP net earnings for fiscal year 2008 were $4.9 million or $0.08 per diluted share, this compares to GAAP net earnings of $28.6 million or $0.43 per diluted share in fiscal year 2007. It is important to note for comparison purposes; however, that 2007 GAAP earnings were positively affected by a one time $24 million tax benefit in the fourth quarter of 2007.

GAAP net income for fiscal year 2008 includes $4.1 million of amortization of purchased intangible assets, $10.6 million in share based compensation expense and $1.7 million of restructuring charges. GAAP income for fiscal year 2007 included $2.9 million of amortization of purchased intangible assets, $14 million in share based compensation expense, $1.9 million of in-process research and development and no restructuring charges.

Non-GAAP net earnings for fiscal year 2008 were $16.9 million or $0.29 per diluted share, compared to $18.8 million or $0.28 per diluted share in fiscal year 2007. Non-GAAP net earnings exclude amortization of purchased intangible assets, share based compensation expense, restructuring charges and in-process research and development. Cash flow from operating activities totaled $19.2 million in fiscal year 2008.

And now, I will complete my comments with guidance for the first quarter of 2009. We expect first quarter revenue in the range of $48 million to $52 million, reflecting the ongoing effect of macroeconomic conditions, as well as seasonal demand expectations.

Our forecast for gross margin in the quarter is in the range of 71% to 72%. We expect non-GAAP earnings in the first quarter to be in the range of $0.04 to $0.06 per diluted share. Our earnings guidance reflects an increase on non-GAAP operating expenses, primarily related to seasonal spending requirements, such as FICA and 401-K expenses, variable pay plans, Channel programs and sales driven costs. We expect GAAP earnings of nil to $0.02 per diluted share.

I will turn the call back over to Matt.

Matthew T. Medeiros

Thanks Rob. As I mentioned before, we are proud of our accomplishments in 2008 and we believe that they have positioned us well for the challenges and opportunities that we will face in 2009. We have an experienced management team that has proven its willingness to take decisive actions to streamline the organization, enhance productivity, and create cost efficiencies.

We have made the necessary investments to equip our sales team and our partners with technically leading competitive products that exceed customers’ needs while providing great value and we are committed to remaining agile and responsive to the evolving market conditions.

This year we will continue to focus on the alignment of our resources for the best revenue growth potential. Continued cost management, balancing our operating expenses to revenue, and to deliver uncompromised technical advantages to now our over $1.4 million installed base users as well as our new customers.

I would like to thank our employees and our partners for a strong finish to 2008 and now I will turn this over to questions.

Kelly Blough

Operator, will you please poll for questions?

Question-and-Answer Session

Operator

(Operator's instruction) Your first question comes from the line of Sterling Auty - J.P. Morgan.

Sterling Auty - J.P. Morgan

Couple of questions. First, I am sorry if I miss this, can you actually talk about what you are seeing in terms of the renewals rates on the subscription side?

Rob Selvi

We do not really provide renewal rate as a metric.

Sterling Auty - J.P. Morgan

Could you at least add some color to it because as we look at, we are talking at a good unit shipment, but I think one of the strong point parts of the business has always been the subscription and are you seeing as some of those are coming up for renewal. What is kind of the customer's attitude towards it? Are the rates high or they are starting to tail off?

Rob Selvi

Yes I understand the question. I think we have seen relatively good consistency with renewal rates in general. However, we have seen a bit of fall off in products that have been discontinued most notably on the pro product family and with respect to support renewals as oppose to other subscription services renewal. So, it appears that some customers have elected to at least delay the renewal of their support contracts with respect to older products perhaps because they intend to upgrade to a future or new generation product or for some other reason that we do not know. But that is one thing and then we did have in the quarter a bit of a seasonal decline in client antivirus renewals but that is really related to the opportunity for renewal in Q4 as compared to Q3 and not so much a function of a decline in the renewal rate.

Sterling Auty - J.P. Morgan

Okay and then Matt, from a high level as you look at the first quarter and given the experience that you have had so far in the first quarter, how would you characterize kind of the tone or your segment of the market in the different geographic regions? Are you encouraged at all in any of the regions? Are we starting to see any stabilization or do you think that there is just continuing deterioration?

Matthew T. Medeiros

Yes, so our guidance really does represent the view of our demand situation up to this point. We do see continued opportunity both in Japan. Japan, this is their end-of-year quarter so it is a normally a better season for Japan. Europe is at this point doing quite well and we feel comfortable with the quotas and the expectations that we have set for Europe. We do see concerns in China. We see concerns in Latin America today.

Sterling Auty - J.P. Morgan

Okay and then last question, I think back in December there was some press around the technology side initiative that may have happened. Can you just address that? What happened and is it behind you at this point?

Matthew T. Medeiros

You are talking about the licensing manager that we run so all of our products, again everybody should know that all of our products communicate home and then that process of communicating home, we have misconfigured, it was a human error. Well we misconfigured one of our servers that impacted a very small percentage of the units that are being talked to by the server. It is completely behind us. The problem was resolved within hours of the time that we had delivered, if you will, kind of this misconfigured server but it is a 100% behind us and I can tell you that we have learned a lot how not to repeat that mistake in the future.

Operator

Your next question comes from the line of Kenneth Muth - Robert W. Baird & Co., Inc.

Kenneth Muth - Robert W. Baird & Co., Inc.

Just a little bit more on the geography side. North America has been very resilient for you. I guess a couple of follow up is why do you think that is? Is it new virus or channel improvements or is it just the new product portfolio of new mix kind of being impact in that, just kind of being flat as quite a positive achievement in this kind of environment?

Matthew T. Medeiros

We certainly give most of the credits to our new product offering. In the prepared remarks, 2008 was a year where we actually had a tremendous amount of new products sitting in the market. They are very well received. They are very competitive at both price to performance ratio but more importantly against the competition and we certainly are pleased with that. In the US and Rob noted this is that we really still see a very turbulent time in the SMB market. The chief new product is still not meeting our previous example or expectations and we are just pleased that the antidote has been a lot of the new products that we have been able to introduce into the mid-tier and enterprise market.

Kenneth Muth - Robert W. Baird & Co., Inc.

And then what about just in Europe and the EMEA that you guys had talked about, I mean obviously a great up tick sequentially there but just the macro environment seems very incrementally challenging there from last quarter, even the last maybe 45 days. Do you still see that same similar type of take in penetration, kind of in early half of 2009?

Rob Selvi

We benefited from a pretty strong end of quarter performance in EMEA that was influenced and propelled by some pipeline conversions that we realized at the end of the quarter with some pretty sizable transaction. So, as we look forward, although we continue to monitor closely the pipeline activity in Q1 and beyond, what becomes less certain is our ability to close those transactions at the same phase as we are able to at the end of Q4.

Kenneth Muth - Robert W. Baird & Co., Inc.

On those kind of the last follow up that I have is just in the way of how you guys are seeing deals and transactions there, do you have any kind of sense of just are you seeing any cancellations or is it more normalized where deals are just getting downsized a little bit so they are not maybe purchasing as much initially as you will that might be prolonged at the next six to nine quarters whatever, or six to nine months, sorry?

Matthew T. Medeiros

Yes, Ken. I think you are absolutely right. First thing is that sale cycles are just a little longer. Other people are postponing but the other is that we do see people not willing to take the entire installation. They are prorated. I mean we have got companies that purchased our very high-end products. We will take now a month and month and a half to really truly install the hardware before they leave and adapt and buy and purchase the software to support it. So, there is no question. I think most customers are coveting cash and they are doing that in a very proactive way of managing their purchases.

Operator

Your next question comes from the line of Catherine Trebnick - Avian Securities LLC.

Catherine Trebnick - Avian Securities LLC

More on the SMB market, there has been some chattering about a lot of the SMB looking possibly at more hosted solutions or fast solutions to manage security. I want to kind of; could you give us a background on that?

Matthew T. Medeiros

Catherine, you are absolutely right. I think one of the successes of SonicWALL is that we have enabled our partners to be MSSPs, to be Manage Security Solutions Providers. So they have been hosting these services for a large number of our customers for quite some time whether it be on premise equipment at that customer or whether it be aggregated virtually at the bar. So for the last three or four years, this has been a very important part of our SMB process but that too, I think is still subject to the fact that we just see no new business starts and we see declining payrolls in SMB. But we are certainly very aware of it and continue to emphasize this as part of our go-forward business plan.

Catherine Trebnick - Avian Securities LLC

And how about on the credit side, are you seeing the same type of tight credit that you did like last second quarter for SMB or access to cash by?

Matthew T. Medeiros

Oh, yes. There is no question. None of that is changed in our mind. We surveyed the channel quite frequently. We certainly work with our major distributors, those people that can afford to provide you the leasing lines or credit terms. It is definitely getting tied all over or it has not loosened up at all.

Catherine Trebnick - Avian Securities LLC

Okay and then my last question before I turn it over is on the enterprise side. How are you doing against Fortinet and Cisco and Juniper relative to, are you winning most debate off in that mid-tier market?

Matthew T. Medeiros

I think the evidence of how we are winning is our market shares going up. I think that is the true measure of the situation. In the current economy, how I am telling the team to look at success here is on market share growth in the categories that we participate. We certainly have had as I mentioned in the script, we had our share of wins against all the competitors that you just mentioned and we are feeling pretty good about the pipeline and our positioning against those same competitors for this quarter and next. So our technology is what is winning the bake off. Our price to performance ratio is what is allowing the customer now to kind of open up the wall and spend the money. We are just delivering the best possible solution at the lowest total cost for the customer.

Catherine, if I could also just add one of the comments, we certainly believe that when this economy starts to turnaround, it will be on the backbone of SMB. History is going to repeat itself and it will turn around back on the SMB and I certainly think that whether it be through the stimulus plan, whether it be some through our technology, we are going to start to see that SMB business start to turn around.

Operator

Your next question comes from the line of Scott Zeller - Needham & Company.

Scott Zeller - Needham & Company

Regarding the, there have been some questions on subscriptions, could you walk us through what exactly the impact would be on a cancellation would there be? And what would happen to deferred for instance? Would you be able to keep cash or you have to give it back? How does that work exactly?

Rob Selvi

Well, the contracts are all payable in advance Scott. So, if we sell the product, if we sell the subscription services product, we get paid for that in advance. So there is not really cancellation. I mean there maybe some corner case from time to time but in fact, I know of none. So, cancellation does not really entered into the picture.

Scott Zeller - Needham & Company

So it sounds as if you do not have to worry about cancellations affecting revenue.

Rob Selvi

That is correct.

Scott Zeller - Needham & Company

Okay, no impact to deferred or…okay. And could you remind us again with your inventory, could you walk us through the commentary you had earlier on why inventories had gone up?

Rob Selvi

I did not say inventories gone up. I said that in deferred revenue, the inventory that we maintained through our largest distributors in the US is in deferred revenue and they actually went down quarter over quarter, not up.

Operator

Your next question comes from the line of Robert Breza - RBC Capital Markets.

Analyst for Robert Breza - RBC Capital Markets

Hey guys. This is Matt sitting in for Rob. First off, congratulation on the quarter. Great top line bid and the margins were, as far as I can tell, the best that I have seen in the long, long time especially after the Adventail acquisition. So congratulations on wrapping those back up to, I looks like north of 15% here.

I am wondering how sustainable is, I mean obviously Rob, you talked about Q1 being down on an operating margin perspective. It looks that you guys took some cost out of the R&D line. I am wondering, do you guys think you have the right cost structure now? Headcount looks like it was reduced maybe about 20 sequentially. I mean do you think you guys have the right cost structure now to handle a squishy 2009 market?

Rob Selvi

Well, it is a matter degree discussion I would say and I think we have acted appropriately given what we know so far and given our current revenue forecast. We do not really know how this year is going to shake out and I think we have a balance of optimism and concern about the year in general and I think we will behave accordingly when we, more of the pictures revealed. I know that it is kind of a vague answer but that is the truth and in terms of our objective to sustain operating margins along the order of what you saw in Q4 that continues to be a key objective of our business.

Analyst for Robert Breza - RBC Capital Markets

Was the reduction in headcount, was that attrition or was that an actual headcount reduction or maybe walk us through the dynamics of that.

Rob Selvi

I think we have been very cautious with respect to headcount and very careful about how we resource and we have certainly made every attempt to optimize our resource allocation across all the functions of the business and so the way that should get is that we have some attrition in the quarter and we are careful in terms of maintaining what we thought was inappropriate level of employees given the current revenue outlook.

Analyst for Robert Breza - RBC Capital Markets

Great and then on the unit shift, 42,000, that is on the low end of the past several years. Based of that, you would not necessarily anticipate the revenue numbers that you guys put up and obviously it looks like you are getting a little bit more shift from the under 5,000 units to maybe more that mid-tier $1,500 to $5,000. Can you walk us through maybe that unit number and just make sure that we understand how that correlates to revenue because just looking at that alone, you think it would have been that great of result?

Rob Selvi

Sure. Well you probably saw in the product revenue by the price span that we had, more significant portion of our total product revenue coming from the $1,500 to $5,000 price span and we also have the reduction quarter to quarter in the amount of product revenue contributed from products with average revenue per unit below $1,500 and so what we saw in the quarter was on average, an up tick in average revenue per unit and as it relates to the specific product lines, I think we had a down performance from a unit standpoint that was predominantly in the TZ product family which is our lowest ASP offering.

So, that is pretty much the way it should it shook out. We had a good NSA performance both from a unit standpoint and from average revenue per unit standpoint and that really was the reason for the performance from the product revenue standpoint and in total.

Analyst for Robert Breza - RBC Capital Markets

Okay. One final question on the full year top line results, I think you said it was about 10% year-on-year growth. Can you give us a perspective, was it organically? Was it still positive?

Matthew T. Medeiros

It is all organic.

Rob Selvi

Well the first half of 2007 did not have Aventail revenue so you are asking what would have been…

Analyst for Robert Breza - RBC Capital Markets

Yes, if you would add Aventail with the first two quarters of 2007.

Rob Selvi

Yes, I have to go back and look at that specifically out. I do not want to just wing it for you.

Analyst for Robert Breza - RBC Capital Markets

That is fine. Okay, great, great performance and keep up the good work in a tough, tough market.

Operator

You have a follow up question from the line of Sterling Auty - J.P. Morgan.

Sterling Auty - J.P. Morgan

I just want to follow up on a couple of things. First the comment about the TZ product line that you made. Is that simply, not simply but is it just the demand issue because of the macro environment or is there any other kind of impacts as you look at the lower end just the lower end of the product line?

Matthew T. Medeiros

I think it is pretty exclusively from what we can tell so far function of the macro economic environment and that is supported by what we have seen to date in terms of our market shares. It is not mentioned earlier. So, we have not seen fourth quarter market share reports from people like Infonetics and IDC but we do not expect erosion in our share position and I think the only other culprit can be macroeconomic environment.

Sterling Auty - J.P. Morgan

Without the recovery in TZ as you look at the subscription side, is there something that could be done or is there a possibility that subscription business could still kind of recover from the down results on the billing portion or do you really need the TZ line to really come back to give the support necessary?

Matthew T. Medeiros

Sterling, there is no question that if units continue to decay that is going to effect the ability for us to sell as much license or software and services. But with that said, let me tell you what we are trying to do and what we have been successful at doing. We have been adding software features. We have been adding new software blade, if you will, to all hardware products so by way of example, you can buy our SSL VPN technology now on a UTM device. You can buy antivirus on a SSL VPN device plant antivirus. So what we are trying to do is build more opportunities to sell to those customers that we can in fact sell appliances too.

Operator

Your next question comes from the line of Craig Nankervis - First Analysis Corp.

Craig Nankervis - First Analysis Corp.

Maybe just first tacking on to the last subject there, how do you feel you are doing in realizing the software as cash potential for your e-class sales? Can you comment on that?

Rob Selvi

I think we are doing rather well with respect to attach against what the full potential of that would be with respect to e-class products. I mean on the high end, customers tend to take advantage of certainly the support offering and in most cases, the software blazers I would say or subscription services offering that enhance the value of the product.

Craig Nankervis - First Analysis Corp

I mean because that was one of the interesting possibilities with your higher end products is you could theoretically have larger software or blade sales into these accounts. So, what you are saying you are feeling okay about that or you are just..?

Rob Selvi

There is always room for improvement. I think we are feeling okay about that. I think we, as Matt have said in the general sense not just really into e-class but we are certainly putting a full core press if you will on subscription services opportunities with the installed base and that has to deal with both renewal effectiveness as well as in attach and I think operationally, we are behaving well and I think we are making some strides there. So, whether or not those will overcome the decline associated with new unit sales is yet to be seen but that certainly was not the case in Q4.

Craig Nankervis - First Analysis Corp

Right, okay. And do you have a feel for what portion of e-class business is to your existing base versus just brand new customers?

Rob Selvi

I do not think we can venture a guess of that today at least or…?

Matthew T. Medeiros

I do not think because…we talked or we discussed basically the upgrade programs and the penetration of those upgrade programs, Craig but I think it is fair to say that a lot of our, what were small businesses grow up and become midsize businesses, what were a remote branch office maybe can turn out to be 20 offices and we have been able to successfully maintain our customers. I think that is one of the hallmarks in our channel program is that we build an off lot of loyalty with both our end customers and our reselling partners.

Craig Nankervis - First Analysis Corp

Okay and I guess, Rob, on the OpEx for Q4 that was down sequentially and you had a little bit of commentary on Q1 guidance for OpEx but I wonder if could just get a better feel for, is this a new baseline what you did in Q4? How much of the savings that we saw were maybe anomalies just to the quarter?

Rob Selvi

Well, I would not say they are anomalies but sequentially, certainly we are not establishing the new baseline because unfortunately we are saddled with things that are unavoidable that we did not have in Q4 that we did have in Q1 and we mentioned things like FICA and 401-K. With respect to our sales compensation programs, we would expect that our sales force would perform against target at a more effective rate than they did in Q4 and so we would expect those things to increase. So, now I do not think we are establishing a new baseline for every quarter going forward because of these things, the seasonal things that I mentioned for Q1 but I do think we have opportunity to as I mentioned continue to sort of right size offering expenses along with revenue but also requires that we see more of the picture with respect to revenue and how it is going to pull throughout the year.

Operator

Your next question comes from the line of Israel Hernandez - Barclays Capital.

Israel Hernandez - Barclays Capital

A matter just for you, Nokia is in the process of selling its appliance business to CheckPoint. Can you talk about what impact if any that may have on SonicWALL’s business? Are you guys putting any programs, new programs in place perhaps to exploit some of the uncertainties that might abound out there given the transition? If you could just comment on ways that the impact will be.

Matthew T. Medeiros

Yes. We certainly understand what is going on between the Checkpoint acquisitions of Nokia. We have really never competed directly with Nokia before. We just do not understand exactly what the impact might be. Having said that, though, we actually won a couple of deals against Checkpoint this quarter for our solutions and again I think customers are looking at, not just the price point, but the ease of use and the ease of management of our product over Checkpoint. Those tend to become that the points were demonstrating clear differences in our product offering.

Israel Hernandez - Barclays Capital

Great. And just a quick question around the pricing environment as business conditions slow. Are you seeing anything different from some of your competitors out there in terms of their willingness to negotiate on price?

Matthew T. Medeiros

There are several competitors that are really I think only negotiating on price and that is why I am so pleased with the new product offerings that we have where our performance is so strong that we standup to differentiate based on technology first if you want to talk about price, we think our price to performance ratios specifically on things like UTM performance throughput, cannot be matched by any of our competitors today. So, our gross margins have stood up in a pretty testing environment and I think a lot of that is because we have more been able to manage price with our customers.

Operator

Your final question comes from the line of Rob Owens - Pacific Crest.

Rob Owens - Pacific Crest

Focus a little bit on how the quarter progressed. Did you see a fall off at the end? Did it start on a low base and I guess just looking sequentially given the relative flatness on the license side and I believe the unit is being down modestly sequentially.

Matthew T. Medeiros

The quarter did start off slow. I think October was a testing month for everyone not just in the security industry but the world at large. It has certainly caused I think a lot of customers to stay on the fence and wait a little longer to see what might really be transpiring relative to this massive economic change in the environment, but with that said, our sales continue to progress specifically around our new NSA products through the quarter. As Rob mentioned, we did see a good conversion of products in the pipeline. There is no question that we were probably we benefited from the end of year budget flush toward the end of the quarter, but overall Rob, I think October brought up some pause but in the rest of the quarter seemed to be pretty much as normal.

Rob Owens - Pacific Crest

So, with 2% sequential growth and really modest sequential product growth, how do you think you benefited from end of year budget flush because it seemed more pronounced for other people out there?

Matthew T. Medeiros

The benefited was in the market share gained, Rob. At the end of the day you can go off and you can continue to compare the unit to unit that we gained share in the competitive space that we are in against all competition.

Rob Owens - Pacific Crest

And are you measuring that on units or you measuring that on revenue?

Matthew T. Medeiros

Well, IDC measured it on both units and revenue and we gained share on both and Infonetics also did the same and we gained on units.

Operator

And that concludes today’s conference.

Kelly Blough

Thank you very much everyone.

Matthew T. Medeiros

Thank you very much everyone and look forward to talking to you again shortly. Bye now.

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Source: SonicWALL Inc. Q4 2008 Earnings Call Transcript
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