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Sourcefire, Inc. (NASDAQ:FIRE)

Q4 2008 Earnings Call

February 26, 2009 5:00 pm ET

Executives

Tania Almond – IR Officer

John Burris – CEO

Todd Headley – CFO and Treasurer

Tom McDonough – President and COO

Analysts

Analyst for Adam Holt – Morgan Stanley

Aaron Husock – Lanexa Global Management

Nick Selby - The 451 Group

Analyst for Katherine Egbert – Jefferies & Company

Jeff Meyers – Wachovia Capital

Michael Schechter – Mentor Partners

Jeff Silver – [Meridian]

Operator

Welcome to the fourth 2008 Sourcefire, Inc. earnings conference call. (Operator instructions) I would now like to turn the call over to Ms. Tania Almond, Investor Relations Officer with Sourcefire. Please proceed.

Tania Almond

This is Tania Almond, Sourcefire’s Investor Relations Officer. I want to thank you for joining our fourth quarter and full year 2008 earnings conference call. Joining me today on the call is John Burris, Sourcefire’s Chief Executive Officer; Tom McDonough, Sourcefire’s Chief Operating Officer and Todd Headley, our Chief Financial Officer.

Before we begin, I must remind you that statements made in this conference call and our public filings, releases and website which are not historical facts may be considered to be forward-looking statements that involve risks and uncertainties and are subject to change at any time.

We caution investors that any forward-looking statements made by us are management’s beliefs based on currently available information and should not be taken as a guarantee of future results or performance which may differ materially as a result of a variety of factors discussed in our earnings release that was issued today and in our latest Form 10Q, filed with the Securities and Exchange Commission in November 2008.

We disclaim any obligations to update any of these forward-looking statements or to announce publicly the results of any revisions to any of the forward-looking statements to reflect future events or developments. There is more complete information regarding forward-looking statements, risks and uncertainties in the company’s filings with the SEC available on our website at www.sourcefire.com.

In addition, we may discuss non-GAAP financial information on the call. This information is reconciled to comparable GAAP financial information in the earnings release. The full earnings release can be found on our website. An online replay of this call will be available on the Investors section of our website for at least 90 days.

With that, I’ll turn the call over to John Burris, Sourcefire’s CEO.

John Burris

Thanks Tania. Happy very belated New Year everyone and thank you for joining us for our fourth quarter and full year 2008 earnings call. Let’s start today’s call with a brief review of the quarterly and full year results, highlight some of our accomplishments in the quarter and full year and provide an update on the trends in the business. I will then provide some insight into our strategic priorities and I will conclude with our financial guidance for the first quarter 2009.

As we announced in our press release earlier today, total revenues for the fourth quarter 2008 were $25.7 million, 33% above fourth quarter 2007 revenues. Gross profit for the quarter increased 38% to $20 million or 78% of revenues compared to $14.5 million or 75% of revenues in the fourth quarter of 2007. Net income attributable to common stockholders increased to $2.3 million in the fourth quarter 2008 compared with around $800,000 in the year-ago period.

We had a very strong quarter beating the top end of our revenue, net income and adjusted net income guidance ranges across the board. I am very pleased with the marked improvement in our bottom line. In spite of the strong Q3 that we had Q4 continued to be our seasonally strongest quarter with 34% of our revenue for the full year. This makes six years in a row now that this seasonal trend has occurred.

We also continued to see improvement in our operating expense margins in Q4 versus the fourth quarter of 2007 and we will continue to focus on the absolute dollars we are spending in all areas especially in light of the macro economic environment. We are keenly focused on leveraging our business model to reach and sustain profitability. Let me say that again, we are keenly focused on leveraging our business model to reap and sustain reach and sustain profitability. This is a top priority for the company to make progress on in 2009 and you will hear me refer to this throughout the year.

During the quarter our sales force and channel closed 46 six-figure transactions, 15 of which represent new Sourcefire 3D customers. We had eight transactions in the quarter in excess of $500,000. We expanded our international sales delivering revenues of $5.6 million this quarter from $5.4 million in the year-ago quarter or an increase of 3% but for the full year 2008 international revenues were up 30% over 2007 to $18.1 million.

Our international channel initiatives continue to make progress. During the fourth quarter we added ten new premier partners in our EMEA region three of which were in the middle east reflecting growth in that region and three in Germany. In fact, we won our first customer from the Middle East as well this quarter. In Asia Pacific we signed up seven new value added resellers and added a distribution partner. EMEA and Asia Pacific are focused growth areas for us in 2009.

Federal sector performance continued to show strength in the fourth quarter 2008 with revenues of $5.1 million or 20% of total revenues versus the year-ago period revenues of $1.7 million or 9% of total revenues. That is 195% year-over-year. The CNCI, Comprehensive National Cyber Security Initiative, has been a positive driving force for our business that did not exist in 2007. We continue to expect CNCI to positively influence our federal business throughout 2009.

On the commercial side of our business we continue to monitor all sectors as the world works its way through the effects of this historical global economic crisis. We remain guarded about the timing and probability of some transactions due to potential budgetary cuts and related purchase deferrals.

Turning to our full year 2008 results highlights included another record year of revenues totaling $75.7 million which was up 35% from $55.9 million in 2007. Gross profit increased 36% to $58.3 million or 77% of revenues in 2008 compared with $43 million or 10% of revenues in 2007. Net loss attributable to common stock holders for the full year of 2008 improved to $6.1 million compared with a net loss attributable to common stock holders of $6.5 million in 2007.

As you may know, Sourcefire was founded in 2001 by our CTO Martin Roesch. The open source project Snort which Martin created in the late 90’s actually turned 10 years old recently. So happy birthday to Snort. Throughout 2008 customers, media and industry analysts continue to award our technology leadership and corporate growth. Some of the highlights include, and I’m going to go through all of these because we are very proud of them:

Sourcefire is recognized by Gardner as being a leader in the Magic quadrant for network intrusion prevention system appliances. Sourcefire also earned certification from ICSA Labs, an independent division of Verizon Business. Sourcefire won the product award category for Best Network Security for Snort from the SC Magazine 2008 Europe. The Sourcefire 3D system won Network Product Guide’s 2008 Product Innovation Award in Enterprise Threat management. We were named winner of the 2008 Best Products and Services Award in the Best in Network Security Solutions category by Network Products Guide. Sourcefire founder and CTO Martin Roesch was named to E-Week’s Top 100 Most Influential People in IT. Sourcefire was named to the 2008 Deloitte Technology Fast 50 for Maryland for the fourth time and we were also named to the 2008 Deloitte Technology Fast 500 list for the second consecutive time.

Obviously we had a great year in terms of third-party recognition. I would like to extend my thanks and congratulations to all Sourcefire employees. You might ask how we are able to add hundreds or new Sourcefire 3D customers and achieve all this third party recognition in 2008. We attribute our success in 2008 to the simple fact that 3D system is the only fully integrated intrusion prevention system. It is highly automated and requires fewer human resources to operate and provides an enhanced return of our customer’s investment.

The Sourcefire 3D system provides the following unique combination of capabilities: First, passively and automatically profiles every asset running on a network and identifies potentially vulnerable systems thereby allowing customers to remove those systems before they are compromised. Two, identifies the abnormal behavior and attacks targeted at network and allows customers to block these attacks in real time and enables customers to develop customized detection rules to identify non-public exploits being launched by Nation Safe to the government enterprise systems.

We believe this combination of capabilities is unique to Sourcefire and provides us with a competitive advantage. I would now like to share with you at a high level our strategic imperatives for the next few years. Our four key areas of focus are accelerating our leadership in network security solutions. That is doing more than with what we already have. Two, evolving our go-to-market strategy into a more leveraged model. More is the key word here because we already have a leverage model but we are going to do more. Three, capturing value from select acquisitions. What I talk about there is being non-dilutive with momentum in the marketplace. Four, recruiting, training, developing and retaining world class people.

Obviously there is a lot of detail behind each one of these imperatives which you will likely hear more about over the coming quarters and years as we execute them. In fact, just this week our new Vice President of Human Resources, Leslie [Pendergrast], started working with Sourcefire. Leslie will report to me and will be responsible for Human Resources strategy and programs on a global basis. She will be instrumental in helping us execute some of our strategic imperatives.

I had the pleasure of working with Leslie at Citrix for several years where she had a similar role and was responsible for developing and leading Human Resources infrastructure to support the company’s growth from an 80 person company to a global organization of over 2500 people before she left in 2005. Leslie participated in more than ten M&A projects at Citrix and we will leverage that experience to guide us through any acquisition integrations we take on. Welcome Leslie.

As it relates to our 2009 operating plan as I mentioned last time with the backdrop of added uncertainty in the macro economic environment we are focused more closely on the items that are within our direct control in addition to taking a more selective approach to our expansion and growth. In 2009 our primary goals will be to: Maintain at least low double digit annual revenue growth. Two, we are going to spend no more in absolute dollars for operating expenses than we did in 2008 and we are going to build a path towards annual profitability on an adjusted basis.

Regarding our financial guidance for the first quarter of 2009, we are establishing revenue guidance in the range of $16.2 million to $17.7 million. We expect a net loss per share in the range of $0.09 to $0.05 and on an adjusted basis a range of net loss of $0.05 to $0.01. Our forecast of adjusted net loss per share excludes stock based compensation expense in the expected range of $1.1 million to $1.2 million. As a reminder, our historical seasonal revenue trend which is akin to a jagged saw tooth pattern up to the right typically has our first quarter of the year as our lightest one. We see no reason why this trend would not continue again this year.

With that I will hand it over to Todd Headley, Sourcefire’s Chief Financial Officer for a more detailed review of our performance for the fourth quarter. Todd?

Todd Headley

Thank you John. Starting with the statement of operations, as John noted in the fourth quarter 2008 we achieved a 33% increase in total revenue over the fourth quarter 2007. We segment our revenues into two categories; products and services.

Total product revenues for the fourth quarter of 2008 were $17.1 million, up 29% from $13.2 million in the year-ago period mostly driven by higher demand for our higher performance 3D centered products. Service revenue in the fourth quarter of 2008 reached $8.7 million compared with $6.1 million in the year-ago period for an increase of 42%. The increase in service revenue primarily resulted from providing technical support to an expanded install base of Sourcefire 3D customers.

In the fourth quarter of 2008 our revenue composition yielded the following; 45% from existing customers in product sales, 22% from new customer product sales, 30% from recurring technical support services and 3% from professional services and training. This compares with 39%, 30%, 27% and 4% respectively in the year-ago period. Additionally, revenue distribution by fulfillment method yielded 71% through partners while 29% went direct. This weighting towards indirect distribution is a result of our continuing efforts to leverage our go-to-market strategy, a strategy that our CEO John Burris indicated would be a primary area of focus upon his arrival here at Sourcefire last July.

Turning to cost of revenue, total cost of product revenue in the fourth quarter of 2008 was $4.3 million which compares with $3.7 million in the year-ago period. The increase in product cost of revenue was primarily driven by higher volume demand for our sensor products for which we must procure and provide the hardware platform to our customers. In the fourth quarter of 2008 our product gross margin was 75%, up from 72% in the year-ago period. This increase in margin was primarily due to a combination of reduced cost for a few of our hardware platforms, customer discounting in line with our historical observations and the product mix that we sold.

Cost of services revenue in the fourth quarter of 2008 was $1.4 million versus $1.1 million last year. The increase in our services cost of revenue was primarily attributable to an increase in the amount we pay to third parties to manage and service the hardware component of our products for an expanded install base of customers and our hiring of additional personnel for customer support.

The service gross margin in the fourth quarter of 2008 was 84% versus 82% in the year-ago period. This increase was primarily due to our installed customer base expanding more rapidly than our cost structure. Total blended gross margin in the fourth quarter of 2008 was 78% compared to 75% in the fourth quarter 2007. The fourth quarter 2008 figure continues to be within the range we have experienced over the past several quarters while the year-over-year quarterly increase is attributable to the previously mentioned platform cost reduction, product mix and growth in our installed customer base.

Looking at operating expenses research and development decreased to $3.1 million in the fourth quarter of 2008 versus $3.8 million in the fourth quarter of 2007 and decreased as a percentage of revenue to 12% from 20%. Please note that in the fourth quarter of 2007 we incurred a one-time, $1 million charge for the receipt of certain additional source codes associated with our August 2007 purchase of the assets of ClamAV. Excluding this charge, research and development in the fourth quarter of 2008 increased by approximately $300,000 or 10%.

As mentioned on previous calls we continue to invest [inaudible] dollars in driving product innovation and enhancements primarily through hiring of additional engineering personnel.

Sales and marketing expense totaled $9.3 million in the fourth quarter 2008 up from $7.3 million in the fourth quarter 2007 and as a percentage of revenue totaled 36% compared to 38% last year. The increase in the amount of sales and marketing expenses was primarily due to the hiring of federal and international sales personnel, additional incentive compensation earned due to the achievement of higher sales volumes and advertising and promotional expenses in support of our network security solutions.

General and administrative expenses were $4.8 million or 19% of revenues in the fourth quarter of 2008 compared to $3.3 million or 17% of revenues in the year-ago period. The increase in G&A expense for the fourth quarter of 2008 over 2007 was driven by several factors. First, we incurred approximately $300,000 for costs associated with compliance work for the first year adoption of Section 404 under Sarbanes Oxley. We also increased our accounts receivable allowance by approximately $300,000 to reflect the tightening global credit markets and the slower collections experienced in these uncertain economic times. Compensation for executives as well as additional finance and legal personnel to bolster our public company infrastructure cost us an additional $600,000 while incremental stock based compensation charges amounted to $200,000. Lastly, we accrued $100,000 for our portion of the tentative settlement of the litigation stemming from our IPO.

In looking at our operating expenses for all of 2008 we spent more on an absolute dollar basis versus that experienced in 2007. However, as planned the ratio of research and development costs and sales and marketing costs to total revenue declined between years. Full year 2008 G&A expense as a percentage of revenue increased that experienced in 2007 due to the full effect of external costs of the first year implementation under 404 of Sarbanes Oxley, training and documentation costs for the implementation of our ERP system, the expansion of our board of directors, the transition to a new CEO and the incremental hiring of finance and legal staff to meet the growing obligations of public filings, tax planning and international operational support.

For 2009 in line with what John indicated we anticipate spending less for G&A while reinvesting these dollars into research and development for continued innovation of our products and into sales and marketing for further expansion into both the federal sector and international regions.

Total operating expenses for the fourth quarter of 2008 were $18 million which compares to $14.9 million in the fourth quarter of 2007 or an increase of 21%. The increase in the fourth quarter of 2008 revenues was greater than the increase in our operating expenses resulting in a fourth quarter 2008 operating profit of $2 million. This compares with an operating loss of $365,000 in the fourth quarter 2007. The company’s GAAP net income was $2.3 million in the fourth quarter 2008 compared with a GAAP net income of $808,000 in the fourth quarter of 2007. In the fourth quarter 2008 net income attributable to common shareholders was $0.08 per share compared to net income of $0.03 per share in the fourth quarter of 2007.

The average shares outstanding in the fourth quarter of 2008 were $25.9 million and $26.9 million on a basic and diluted basis respectively. While for the fourth quarter of 2008 the corresponding figures were $24.6 million and $26.4 million respectively. Included in GAAP net income for the fourth quarter of 2008 was a non-cash stock based compensation charge of $1.1 million. This compares to a non-cash stock based compensation charge of $736,000 in the prior year period. Excluding non-cash stock based compensation expense our adjusted net income for the fourth quarter of 2008 was $3.4 million or $0.13. This compares to an adjusted net income of $2.6 million or $0.10 per share in the fourth quarter 2007.

As of December 31, 2008 cash, cash equivalents and investments totaled $101.6 million. As such we believe that Sourcefire is adequately capitalized to execute on our strategic initiatives. Our customers on average continue to pay us slightly beyond terms that typically range from 30-60 days and as previously noted our year-end accounts receivable aging is reflective of the tighter credit markets and general economic turmoil. We continue to monitor our credit and collections closely and are comfortable with both our aging and the increase in the accounts receivable allowance.

It should be noted that we have experienced less than $25,000 in account write offs for all of 2008. Given the continued market attention to potential impairments in the carrying value of investments I think it relevant to provide a little detail into our investment process and analysis. We perform regular, detailed assessments of our investments, their quality, their performance and the level of risk inherent in those assets. All investment purchases are executed by experienced investment managers and are made in full compliance with the investment policy approved by our audit committee.

As of year end no investment had a maturity beyond 13 months and the average days to maturity for the portfolio is less than 90 days. Additionally, all our investment maturities during 2008 occurred at their full par value. Thus, while our earned interest income is down significantly from the year-ago period due to the reduction in interest rates and the market value on some of our investments have dipped below their cost basis our regular investment reviews indicate that we do not have any permanently impaired or high risk assets in our current investment portfolio.

With that we would like to now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Analyst for Adam Holt – Morgan Stanley.

Analyst for Adam Holt – Morgan Stanley

I was wondering if you could provide some color on your sales force activity. It seems like you still made some hires in Q4 and how is that progressing?

Tom McDonough

We have expanded our sales force in the Nordic regions, in Germany and the U.K., Australia and Singapore last year and as a result of those hires we have seen incremental business which is reflected in the numbers John outlined during his discussion. In 2009 we will continue to invest internationally as John indicated as well as in our federal business segment. So we expect to see increased sales and productivity as a result of that in addition to what we are already seeing in the United States.

Operator

The next question comes from Aaron Husock – Lanexa Global Management.

Aaron Husock – Lanexa Global Management

Can you give us an update on the federal business how you are reading the budget and stimulus plan that President Obama has put out so far, what you think it means to your business and whether you expect any disruption in the budget related to CNCI during the transition period here?

Tom McDonough

That is a great question. As far as the budgeting process goes there are three agencies that currently have approved budgets; DoD, DHS and the Veterans Administration. However there is money that has been allocated to all major departments within the government for the CNCI projects. We do not expect for there to be any interruption or disruption in the flow of funding for these specific projects to protect federal networks. The stimulus package it may augment some of the funding that is already there but for all intents and purposes most of the money has already been allocated to those agencies or is in the process of being allocated. So we consider ourselves to be in a pretty good position relative to the government and future federal business.

Aaron Husock – Lanexa Global Management

On the European, EMEA channel moved by the addition of various resellers. When do you think we will start to see that impact in the financial results in a more tangible way?

Tom McDonough

I think we saw it last year. We brought on a very seasoned channel executive into EMEA last January and he has put together some great programs and I think we began to see the benefit of his efforts back in Q3 and Q4 and actually they are continuing into Q1 of this year. We are very pleased with what he has done.

Aaron Husock – Lanexa Global Management

Your account receivables were still a little elevated. I had thought that after going up in Q3 we were going to see them come down a little. Is Q1 the quarter where we can come back into that historic range?

Todd Headley

That’s correct. The receivables balance escalates historically in Q4 due to the seasonality of our business as John noted 34% of our business over the last six years has occurred in Q4 so the accounts receivable balance is reflective of all of those billings. Those billings are extremely current as of the end of the year and I can offer that the of the balance we have collected more than 55% of that balance through the mid point of February. So the way we see it collections have been proceeding pretty much as normal. We do have some customers that are starting to extend us by a couple to several days and we think again that is due to the tightening credit markets and general economic uncertainty. People are just starting to slow pay a little bit but they are not doing a no pay. We think that is a critical important thing to keep monitoring and make sure we stay on top of it.

Operator

The next question comes from Nick Selby - The 451 Group.

Nick Selby - The 451 Group

Is the guidance for the first quarter of 2009 as conservative as the guidance for Q4, can you pinpoint any specific concerns? Are you seeing any increase in the sales cycle or slowing in the pipeline? Anything we should look at specifically? Also if you could just repeat those large deal stats, the deals over $500k and the number over six figures?

Todd Headley

You are asking us if we are sandbagging is what you are asking?

Nick Selby - The 451 Group

I didn’t say that.

John Burris

We saw a normal Q4 budget flush which is great. We are seeing a normal Q1 for us. We didn’t want to guide beyond Q1 because a lot of companies smarter and bigger than us haven’t and we understand some of the visibility and guidance challenges around that. We don’t think that we are totally immune but we are trying to be reasonably cautious about the future. Our Q1 we feel good about our guidance. Beyond that we are going to play it like all the other guys in the industry are playing it right now as a wait and see. We have been very, very careful with our spending. We are very, very careful with how we have structured our plan for this year. As I said we are very focused on we are a public company so earnings call means you report earnings. That is what we intend to do this year. We are close on that Q1 thing but we are not quite there on some of the guidance we gave on the bottom line but I would expect that to improve if we don’t see a dramatic worsening of the world. I have to quit reading the paper because every time I read it it brings me down more.

What was the other question?

Todd Headley

There were 46 six-figure transactions during Q4 and eight of those transactions were in excess of $500,000.

Nick Selby - The 451 Group

You mentioned a three prong approach, a freeze on operating costs, low double digit growth at least and growth towards profitability. You mentioned briefly the acquisition and I was wondering if you could give any color to that at all?

Tom McDonough

We think with the customer base we have now well over 2,000 customers worldwide we think there is an opportunity for us to sell additional adjacent space product into that space. We know that because our customers have told us they have a lot of confidence in us, we are best of breed at what we do and we have talked to them and they have suggested several things to us that have made sense. It is the age old saying we don’t want to have just one thing.

With that said I have been involved in maybe 14-15 M&A activities and I know what can happen. We have a very, very detailed shopping list of characteristics and one of them is non-dilutive. Closely behind that is we want to have revenue momentum and right down below that is it needs to be channelizable. There are about 15 things on the list. I won’t bore you with the details. We are not going to buy something that is a recovery or something like that and we don’t think we have to buy anything to have really good performance this year either. We do think it is an opportunity and we are going to look carefully at that. We think in this environment there could be some decent valuations that might materialize in the coming months.

Operator

The next question comes from Analyst for Katherine Egbert – Jefferies & Company.

Analyst for Katherine Egbert – Jefferies & Company

Can you give us an update on your ERP implementation and what are your expected cost savings from it this year?

Tom McDonough

In terms of an update, we started the implementation and planning back in January of 2008. We have the final pieces of some of our supplier facing and customer facing attributes going live in the early part of Q2. We then plan to bring the ERP system into a steady state. Two things we did in order to try to keep costs down was one we went with a hosted version to handle all of the changes associated with updates, upgrades, bug fixes and the like. We also went with out of the book features. So purposefully not getting into the customization game which increases costs and elongated implementation cycles. For us it is about a 15 month end to end process. We will have an ERP system that takes us all the way through the supply chain so that we can do not only our financials but provide services to our customers, interact with our manufacturers. In terms of a cost savings, I don’t know they are necessarily a savings in a general operating costs versus 2008. We plan to keep that steady.

We pay a hosting fee and we pay a per month support fee. Both of those for 2009 are locked in at the same level as they were for 2008. The one cost where we will see some reduction for 2009 is that we did have some consulting costs for training as well as the preparation of some manuals. That is a cost that won’t be repeated for 2009. So it is possible there is about a $200,000 savings relative to that for this year.

Operator

The next question comes from Jeff Meyers – Wachovia Capital.

Jeff Meyers – Wachovia Capital

The OpEx is going to be flat year-over-year and that is based on the low double digit growth, is that right?

Todd Headley

The plan is to be very prudent and keep operating expenses in line. We had a number of unusual transactions relative to the implementation of the ERP system and the handling of our IPO matter where we have recently reached a tentative settlement. The dollars spent on those activities are going to be repatriated into incremental spending for research and development as well as adding additional personnel to our federal sales team as well as some international territories we aren’t covering at this point. So overall the idea is to keep those constant between years and by having that low double digit growth we get a heck of a lot closer to profitability certainly on an adjusted basis we expect to do that.

Jeff Meyers – Wachovia Capital

My question is if revenue growth is beyond what you are expecting now how much additional OpEx are you going to need or is most of that going to flow to the bottom line?

Todd Headley

There will be a ratio there. Basically if you take a look at our gross margin I usually use 75% as kind of the marker. So for every dollar we can increase the top line versus our plan we will have $0.75 on that dollar potentially to invest in the business. We would spend some portion of that if we saw certain market segments where it made sense for us to continue to expand more rapidly than our current plan allows us. So we would still expect for those additional dollars to put more on the bottom line and therefore again get closer to GAAP profitability if it was there and available.

Operator

The next question comes from Michael Schechter – Mentor Partners.

Michael Schechter – Mentor Partners

You are basically saying you are going to hold your operating expenses flat this year? Meaning R&D, SG&A?

Todd Headley

We look a operating expenses overall and combine all of those elements. We think we had some unusual spend relative to G&A this year. Again, you can’t underestimate the cost associated with a first year implementation of Section 404 under Sarbanes Oxley. Like I said we had the litigation that recently went to a tentative settlement agreement and we had implementation of ERP systems. So you look at those three things there is a number of dollars there we can then invest back in the business in research and development and sales and marketing without spending more total operating expenses. That is our plan. The overall real dollars we are not going to spend any more.

Michael Schechter – Mentor Partners

The $66 million in operating expenses and how you are going to piece it together between R&D and SG&A, however you do it $66 million is your target?

Todd Headley

That is correct.

Operator

The next question comes from Jeff Silver – Meridian.

Jeff Silver – [Meridian]

I have a follow-up on the acquisition question and some other. Is there any reason for you to confine your search for acquisition opportunities to open source or would you go outside of the open source model? Maybe give us an update if there is anything to say on ClamAV project?

Tania Almond

Can you please speak up? We’re having a lot of trouble hearing you.

Jeff Silver – [Meridian]

With respect to acquisitions is there any reason for you to confine yourselves to the open source model or would you consider expanding beyond that? Can you talk a little bit about or if there is an update on ClamAV?

John Burris

We like open source. Obviously that is our root. That is not a constraint for what we would be looking for in opportunistic, well matched acquisitions for the company. We would be looking for something to benefit our customers and an emerging demand for it. With regards to Clam, it is a very successful open source project. We continue to work on it and we are excited about the progress we have seen to date. Stay tuned for an alert for announcements that may be coming in the next couple of months around what our plans are to commercialize that product. To take another step to say don’t expect for it to be a material impact to our plan this year. We are working on this and we feel good that it was a proper investment and there are some things happening with it I am not in a position to go into detail right now with some of the negotiations we have going on.

Operator

The final question is a follow-up from Aaron Husock – Lanexa Global Management.

Aaron Husock – Lanexa Global Management

On the product gross margins you went through the reasons why they were up. Do you think they are sustainable at that level? Can you talk a little bit about the pricing environment right now?

Todd Headley

Sure. I’ll answer the first part of that question and I’ll probably turn it over the current environment to Tom since the field sales organization reports go through him. Again, historically we have gotten to that mid to high 70 range in terms of the gross margin. The gross margin on our services revenue has been pretty significant because the pace at which we have grown our install based. If you just take a look at the product margin the number of factors that play in there are three. One is certainly how much we have to discount the product and the environment is certainly changing a little bit with regard to customer expectation there. The other piece is how much we spend for the actual hardware platform itself. We do outsource all of our manufacturing and they are built to specifications that we determine but that is a cost that we have to incur. Then lastly is the product mix. We have product that we do deliver on that hardware platform. We also have software only products. If we had revenues that were more weighted to the software only license version obviously the margin would go higher.

We are comfortable where that margin has been historically and including what we realized in Q4. I think going forward as I turn it over here to Tom we are starting to see some signs of pressure and we are keeping our ear to the ground in terms of what type of pricing and discounting might have in terms of an impact on that going forward.

Tom McDonough

Just to follow-up with Todd, we are seeing heavier discounting in selected opportunities. That is a normal course of business. They have each gone up a little bit just based on the general macro economic environment out there. We have a pretty methodical formula that we use when we get into heavy discounting in order to try to keep our margins as high as we can. We are going to continue to apply that discipline as much as we can.

Aaron Husock – Lanexa Global Management

You talked about in general your [inaudible] being relatively aggressive during Q4 as well. You still posted upside to the product gross margin. Is it kind of more of the same or will you consider it a meaningful change in the discounting activity?

Tom McDonough

I would characterize it as more of the same. I mean, this is a relatively competitive space. Like I said you see a heavy discount on selected opportunities. Again a lot of it is the product mix or existing customers or new prospects we are trying to close. We try to use a disciplined approach to our discounting and pricing.

Operator

Ladies and gentlemen thank you. I would now like to turn the call back over to Ms. Almond for closing remarks. Please proceed.

Tania Almond

Since there are no further questions we would like to thank everyone for your continued interest and support of Sourcefire and we look forward to speaking with you again next quarter. Have a great afternoon.

Operator

Ladies and gentlemen thank you for your participation in today’s conference. That does conclude the presentation. You may disconnect. Have a wonderful day.

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Source: Sourcefire, Inc. Q4 2008 Earnings Call Transcript
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