SonicWALL Inc. Q1 2009 Earnings Call Transcript

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 |  About: Sonic WALL Inc. (SNWL)
by: SA Transcripts

SonicWALL (SNWL) Q1 2009 Earnings Call April 27, 2009 5:00 PM ET

Operator

Welcome to the SonicWALL first quarter 2009 earnings conference call. At this time I would like to turn the call over to Ms. Kelly Blough. Please go ahead ma’am.

Kelly Blough

Thank you. Welcome to our first quarter 2009 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 but are not limited to, revenue expectations for the second quarter of 2009, GAAP and non-GAAP earning per share and gross margin guidance for the second quarter of 2009, the benefit to future periods of subscription billing for deferred revenue and the ability of the company to capitalize on future demand conditions. 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 10K for the year ended December 31, 2008.

The Company undertakes no obligation to update forward-looking statements at any time or for any reason. In addition, the following information contains 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 Medeiros

Thank you, Kelly. Good afternoon everybody and thank you for joining our call. SonicWALL's total revenue in the first quarter was $47.1 million. The demand environment was difficult in the first quarter. Product revenue was down across all product lines and all geographies sequentially and year-over-year with particular weakness in Europe.

Despite the weak product demand environment we experienced solid growth in subscriptions billings due primarily to strong seasonal renewals and promotional activities. The strength in subscription billings led to strong deferred revenue growth which will benefit future periods.

We reported our 16th consecutive quarter of positive cash from operations with GAAP operating cash flow of $6.3 million. In spite of the challenging revenue environment SonicWALL continued to make progress against our profitability objective. Non-GAAP earnings per share were $0.07, above our guidance range of $0.04 to $0.06 and our operating margins were 12% versus 5% one year ago.

In the first quarter we continued to make key investments in the future of our business. We were granted additional patents that will strengthen our overall intellectual property position and we will release several new products.

We updated our SSL VPN line up, launched a global management appliance and introduced the new TZ210 which is already receiving industry and end-customer recognition. The TZ210 earned SonicWALL another five star review from SC Magazine which called the TZ210, and I quote, “One of the most feature rich UTM’s we have seen and an excellent value for the money.”

SoniceWALL’s award winning line continues to maintain or gain market share against our primary competitors. In the first quarter a Midwest hotel chain deployed TZ210’s throughout their properties and replaced the Cisco security solutions at their headquarters with the SonicWALL E5500. In a [bank] off at a large financial institution between Cisco’s ASA platform and SonicWALL’s E-class NSA platform the customer chose SonicWALL when they realized that our solution would accomplish with two appliances what Cisco needed to do with four.

One of the world’s largest commercial real estate brokers chose to deploy SonicWALL’s UTM appliance over incumbent Fortinet. With strong competition from both Juniper and Fortinet, SonicWALL won the deal based on superior manageability and UTM performance. In a six figure deal with competition from Juniper, a large communications company chose to deploy a suite of SonicWALL’s products including NSA appliances, CDP and the E-class SSL VPN.

We continue to hear stories such as these from our partners and end customers around the world confirming that SonicWALL is making inroads against entrenched competitors in this tough economic environment. The improvements we have made in operational efficiencies and profitability, the strong performance in subscription billings and deferred revenue and our ongoing investment in technical innovation and product performance are positioning the company to capitalize on growth as demand conditions improve.

Now let me turn it over to review our financials.

Rob Selvi

Thanks Matt. Good afternoon everyone. Of the $47.1 million in total first quarter revenue, UTM solutions contributed 77%, secure content management solutions contributed 11%, SSL VPN solutions contributed 8% and CDP contributed 4%. Total revenue units shipped in the quarter were 37,000.

Product revenue was $15.5 million, down 29% sequentially and 35% year-over-year. As Matt mentioned, the sequential and year-over-year decline in product revenue was spread across all products and geographies. As a percent of total product revenue 83% was generated from products with average net revenue per unit below $1,500; 15% was generated from products with average net revenue per unit of $1,500 to $5,000 and 2% was generated from products with average net revenue per unit of above $5,000.

License and services revenue of $31.7 million declined 2% sequentially and was level with the same period last year. License and services revenue represented 67% of total revenue in the quarter compared to 60% in the prior quarter and 57% in the same period last year. License revenue represented 8% of total license and services revenue during the quarter compared to 8% in the prior quarter and 11% in the same period last year.

Total subscription services billings increased to $38 million, up 10% from the fourth quarter and 3% from the same period last year. Multi-year subscriptions accounted for approximately 35% of subscription service billings in the first quarter. The sequential and year-over-year growth in subscription services billings were predominately attributable to a strong renewal cycle in Q1 and the successful upgrade promotion for existing users of competitive products.

On a percentage basis, North America represented 70% and international represented 30% of total revenue. Europe, the Middle East and Africa contributed 18%. Asia Pacific and Japan contributed 10% and Latin America contributed 2%.

Non-GAAP gross margin increased to 74% compared with 71.3% in the fourth quarter. Product gross margin declined to 47% from 50% in the fourth quarter due primarily to the mix of products sold. Non-GAAP operating expenses declined in the quarter to $29.4 million from $30.3 million in Q4 and $37.1 million in the same period last year. The sequential decrease in operating expenses reflects declines in salary and vertical selling expenses, partially offset by payroll taxes, 401K matching costs and other employee expenses. The year-over-year decrease in operating expenses resulted from a reduction in contractor, variable selling, salary, sales meeting and other employee expenses.

Total non-GAAP operating expenses represented approximately 62% of revenue for the quarter compared to 56% in the prior quarter. Operating expenses for research and development represented 19.5% of revenue; sales and marketing expenses represented 35% of revenue and general and administrative expense represented 8% of revenue.

At the end of the first quarter total regular employee headcount was 810 compared to 820 at the end of the fourth quarter. Interest income net in the first quarter was $800,000 compared to $1 million in the prior quarter and $2.6 million in the same period in 2008. The sequential and year-over-year decline in interest income is due primarily to a reduction in available yields and investment vehicles.

For the quarter non-GAAP tax expense was $2.3 million versus non-GAAP income before taxes of $6.2 million. Non-GAAP net earnings for the first quarter were $3.9 million or $0.07 per diluted share. Non-GAAP net earnings for the first quarter exclude $1 million of amortization and purchased intangible assets and $2 million of stock based compensation expense.

GAAP earnings for the first quarter were $1.7 million or $0.03 per diluted share. Stock based compensation expense before tax primarily associated with the expensing of stock options was approximately $2 million.

Now I will review the balance sheet and cash flow statement.

We had a solid cash flow quarter generating GAAP operating cash flow of $6.2 million net of a $5.1 million escrow payment related to the acquisition of Aventail. At the end of the quarter total cash, cash equivalents and short-term investments were $116.6 million compared to $105.5 million at the end of the fourth quarter. Investments classified as long-term were $62.7 million.

Net accounts receivable were $19.2 million in the first quarter compared to $20.9 million in the prior quarter and DSO was 37 days compared to 35 days in the prior quarter. Net inventories were $6.4 million in the first quarter compared to $8.9 million in the previous quarter and $8.1 million in the same period last year. Net inventories consist of inventory at our two largest distributors in finished goods at our third party manufacturers and logistics provider.

The year-over-year and sequential decline in net inventories is primarily associated with inventory in transit from our off-shore manufacturers. Total annualized inventory turns on a non-GAAP basis were seven times compared to eight times in the prior quarter. Deferred revenue increased $4.6 million to $108.1 million, up 4% sequentially and 2% year-over-year. The increase in deferred revenue is related primarily to an increase in subscription deferred revenue and to a lesser extent increases in inventory at two of our largest distributors.

Deferred revenue attributable to subscription services was $92.8 million, up 4% sequentially and up 8% in comparison with the same period of last year.

Now I will complete my comments with guidance for the second quarter of 2009.

We expect second quarter revenue in the range of $46-49 million. Our forecast of gross margin in the quarter is in a range of 72-74%. We expect non-GAAP earnings for the second quarter will be in a range of $0.06 to $0.07 per diluted share and GAAP earnings of $0.02 to $0.03.

Now I will turn the call back over to Matt to conclude.

Matthew Medeiros

Thanks Rob. Over the last four quarters we have demonstrated a commitment to operational improvements that have positioned us well for future growth and profitability. We will remain agile and responsive to the evolving market conditions and for the remainder of this year you can expect us to continue to deliver on these three key objectives: First, delivering uncompromised technical advantages to our growing base of partners and customers. Second, align our resources for the best revenue growth potential. Third, continued cost management, closely calibrating our operating expenses to revenue.

I would like to thank our employees and our partners for their hard work in the first quarter. Now we will take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Kenneth Muth - Robert W. Baird & Co., Inc.

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

Obviously the environment was very challenging for the quarter but are you seeing any areas starting to pick up at all recently whether it be SMB versus enterprise? Any geographies that are kind of thawing out so to speak?

Matthew Medeiros

We are seeing an improved April compared to January. We are seeing it in larger deals or if you will kind of the pipeline that in the first quarter was pushed to the right. We are seeing some levels of that thawing out and we are getting the benefit of that. So a little bit of more improvement here in North America than any of the other regions and mostly at the enterprise or larger deal opportunities.

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

How would you characterize visibility relative to what you had last quarter back in February? Has that changed or is it a little better now?

Matthew Medeiros

I think it is challenged. I don’t think there is a whole lot of change in it. We do review the pipeline routinely and I don’t think those conditions have improved at all.

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

Rob, the guidance you gave for gross margin the revenue guidance is roughly flat so I guess what would be kind of the factors that would cause the gross margin to tick down from this quarter’s 74%. Is that mostly external?

Rob Selvi

It is product mix and product revenue. You are exactly right.

Operator

The next question comes from Robert Breza - RBC Capital Markets.

Robert Breza - RBC Capital Markets

Matthew, in your prepared remarks you talked about the competitive upgrades and maybe that was a comment from Rob. I was wondering if you could talk a little bit about what you are seeing in the market from a competitive perspective and specifically with the success of the upgrades who do you think you are taking share from and where do you think you maybe have some more work to do?

Matthew Medeiros

I think that if you look at the wins we talked about we are taking share from those competitors that we see as the chief competitors still in the market. It is the Cisco’s, the Junipers, the Checkpoint’s and the Fortinet’s. Those are usually the larger deals. We are moving into that mid-tier in enterprise successfully with our technology. Let me have Rob explain a little bit about the competitive program we put in place.

Rob Selvi

The program that we offered in Q1 was a program to offer a very compelling upgrade of competitive products that feature a 3-year service commitment for a pretty steep discount on the overall product. That promotion was very successful and ran hot throughout the quarter. Whether or not we continue the program exactly as put together for Q1 is still something that is under review.

Robert Breza - RBC Capital Markets

So maybe Rob as you think about that and the impact to deferred revenue, do you see the average term lengthen much? How would you characterize the term length for deferred revenue?

Rob Selvi

On a blended basis, it probably could change by approximately a month.

Robert Breza - RBC Capital Markets

Pretty minor?

Rob Selvi

It is pretty minor but what we saw was about 35% of total billings in multi-year and that was the primary driver of that change quarter-over-quarter.

Robert Breza - RBC Capital Markets

One follow-up, is there any more kind of one time payments? You mentioned the escrow payment for Aventail I think of $5.1 million. Is there any other payments out there over the next 9 months as we finish 2009?

Rob Selvi

No. There aren’t any similar unusual payments like that.

Operator

The next question comes from Rob Owens - Pacific Crest.

Rob Owens - Pacific Crest

Do you have any sense of how large your installed base is now with active customers on maintenance? Either in terms of customers or units that are out there?

Matthew Medeiros

We have an installed base of about 1.4 million units and on any given week we see about one million of those units pinging home and requesting some level of support.

Rob Owens - Pacific Crest

Is that 1.4 cumulative or is that active?

Matthew Medeiros

1.4 is cumulative and the active would be one million.

Rob Owens - Pacific Crest

So one million is kind of a good number there?

Matthew Medeiros

Yes.

Rob Owens - Pacific Crest

In terms of maintenance renewal rates what are you seeing right now?

Matthew Medeiros

We actually don’t provide renewal statistics.

Rob Owens - Pacific Crest

Are you seeing much slippage in this environment?

Rob Owens - Pacific Crest

This last quarter we actually saw an up tick in renewals as we pointed out in the script. Part of that was we had a strong seasonal opportunity ending. We haven’t seen an erosion of effectiveness in renewals.

Rob Owens - Pacific Crest

Lastly, what was the linearity in the quarter? How back-end weighted was it?

Rob Selvi

January was not all that good at all. We ended up having a very linear February and March.

Rob Owens - Pacific Crest

Matthew, on the margin side you did a good job driving margins but how should we think of investment going forward number one in this environment and number two especially given the lackluster top line growth?

Matthew Medeiros

Good question. We are going to continue to invest organically. As I mentioned we have made some pretty strong investments in the UTM market. In fact, the products we will release this quarter will be the final phase of our product transition in the TZ space. We are going to continue to make organic investment in the area of SSL VPN. We believe that remote access including VPN has been extremely popular with our customers. Then of course because of our balance sheet we are definitely looking at opportunities as to if there is technology in search of a channel. We have done five acquisitions and all five have been pretty important to us in creating more relevancy with our customers.

Rob Owens - Pacific Crest

When you are seeing push outs or lack of close in your pipeline what is coming back to you guys in terms of the reasoning right now more often than not?

Matthew Medeiros

It is really interesting at least last quarter it wasn’t about not having the budget. It was just timing. It was literally coming down to I’ve got my budget approved I just need to make sure I have the timing right at when I can spend that money.

As I had mentioned, April is looking a little bit better and clearly there is some windfall that came out of that pipeline that pushed to the right.

Rob Owens - Pacific Crest

Given your target customer, the SMB markets, and people moving towards UTM like functionality, did Conficker have any positive influence on the quarter or anything to do there?

Matthew Medeiros

Not measurably. We still did our steady pace of anti virus at the end point. So we had a decent quarter of anti virus and that showed up obviously in the deferred revenue line but I would say we didn’t see a spike in demand for a new purchases standpoint.

Operator

The next question comes from Scott Zeller - Needham & Company.

Scott Zeller - Needham & Company

Just looking at the distribution of product revenue by price band, the high end continues to tighten and shrink. In other areas we have seen that “low end enterprise” or enterprise security spending is holding up. Was it surprising to you to see the higher end continues to shrink in your business?

Matthew Medeiros

As I mentioned before the higher end actually shifted more to the right. That was the pipeline we were talking about. We have had a pretty strong, successful quarter of growing that top line and I believe it was just basically demand was soft.

Scott Zeller - Needham & Company

Have you seen people trading down, meaning to a smaller box?

Matthew Medeiros

I don’t think we are seeing people trade down. I think the real interesting thing is on a comparative basis the functionality is getting much stronger at a less expensive solution and that has been one of our competitive advantages over people that have lower performing product at a higher price. SSL VPN we saw people take advantage of our new Aventail line where it is less expensive but for a higher performing solution. So I wouldn’t say we are seeing people buy down. I think they are buying technology and price matters.

Operator

The next question comes from Catherine Trebnick - Avian Securities LLC.

Catherine Trebnick - Avian Securities LLC

I noticed your DSO went to 35, down from 41 right, from a year ago?

Rob Selvi

Yes. That is right.

Catherine Trebnick - Avian Securities LLC

So, anything in particular going on there?

Rob Selvi

Really, the efficiency in accounts receivable is primarily related to the timing of shipments and billings in particular in the last month of the quarter. As Matt said earlier I think we were relatively linear as we went through March. So I think that was a primary factor.

Catherine Trebnick - Avian Securities LLC

Another question on the SMB market relative to what you are seeing in terms of more color or flavor and I’m sorry I’m asking this again because I know other people did but maybe are you seeing any change in behavior for the SMB? I know I did some channel checks in January and February and at the time you were seeing some of these smaller businesses prefer maybe to move home if they could or close down their office and do other types of remote access service, security. What kind of trends are you seeing from that aspect from the economy or not?

Matthew Medeiros

I think the SMB market continues to be probably the biggest problem for us. We just see no growth whether it be payroll growth, whether it be business starts. I also think there has been a pretty strong churn at our reseller level because of the economy and that is not just SonicWALL it is just general resellers at large. So I do think this economy is putting far more strain on the SMB. They are quick to spend and they are also quick to cut. I think in this particular environment they are all looking at every possible way to reduce their OpEx so we are still in that challenged environment with SMB.

Catherine Trebnick - Avian Securities LLC

What are you seeing for the next year as far as trends? I was on the Juniper call and he was talking about more stability they were seeing on the carrier and the enterprise side. How could you kind of lay out the landscape as far as what you are seeing now and going into next year?

Matthew Medeiros

I think what we are going to build our foundation of stability on is just by having the best new products out there. As I mentioned we have now completely refreshed our product offering and I think technology is going to bring us an awful lot of opportunity and trump a lot of the competitors. We are going to stay focused at delivering the best possible technology at a value price and I think that formula has been working for us and it is clearly something that we are able to manage both gross margins in or our OpEx associated with it. We are certainly going to play that card as number one for us.

Operator

The next question comes from Sterling Auty - J.P. Morgan.

Sterling Auty - J.P. Morgan

Can you remind us what the percentage of revenue from products under $1,500 was last quarter?

Rob Selvi

70%.

Sterling Auty - J.P. Morgan

And you talked about discounting in the quarter. What product, in other words if it was done in products over $1,500 did you consider them at the discounted price to be a product under $1,500 or I just want to make sure that I’m clear in terms of how the product mix looked.

Rob Selvi

Products that were below $1,500 represented a stronger percentage of the total mix of products sold in the quarter. Part of that was due to promotions we had in the quarter but we also had some promotional activity, most notably the competitive upgrade program that I mentioned previously that related to some of the NSA products as well. Also in the quarter we substantially completed and sell out of the lowest end of our TZ product line which was the TZ150. That had some impact on the quarter as well. ASP’s were down but units were also relative.

Sterling Auty - J.P. Morgan

Just trying to get a feeling for how much of the impact came from the discounting versus the lower TZ because I was actually a little bit surprised that you did 37,000 units in a quarter relative to the product revenue that you actually reported. Is there a way I can get a handle on what portion of the 37,000 units actually sold through because of promotion and discount? Maybe it will be hard to get a handle on but maybe you can qualitatively?

Matthew Medeiros

I think that would be a hard number to just put our hands on quickly. I mean TZ represented 67% of total unit volume, 67.5% up from 66% in the prior quarter and as I mentioned we did have some promotional activity going on in the NSA product line.

Sterling Auty - J.P. Morgan

As you look at the next couple of quarters you mentioned the strong renewals in the first quarter. What do the next couple of quarters look like in terms of the renewals that you have coming up?

Matthew Medeiros

Well the second quarter isn’t quite as seasonally strong from a renewal standpoint as the first quarter so the opportunities will be down slightly in the second quarter. Assuming consistency and effectiveness in renewals, from a billing standpoint we would see some quarter-over-quarter decline in renewals. Of course the other variables are new attach to stand alone units, bundled attach for new unit sell through as well and we will have to see how we step through the quarter to see how we do on those aspects of the business.

Sterling Auty - J.P. Morgan

You mentioned a much bigger percentage of multi-year deals. Can you remind us what your collection policy is on those multi-year and what that may have contributed incrementally to cash flow in the quarter?

Rob Selvi

We collect up front for those contracts. So regardless of whether they are annual, 2-year or 3-year contracts the terms are payable at the time of contract signing so they are additive to cash flow in the quarter. Immediately additive to deferred revenue and additive to cash flow as well.

Sterling Auty - J.P. Morgan

So if you look at the step up you have done versus the last couple of quarters was that a couple of million of incremental cash flow in the quarter in deferred revenue or was it more?

Rob Selvi

For the multi-year program we were up to 35% on the total billings up from 32% in the prior quarter. So from a dollar standpoint that was up about $2 million quarter-over-quarter.

Operator

Thank you. At this time we have no further questions. That does conclude today’s call. You may disconnect your lines at this time.

Matthew Medeiros

Thank you.

Rob Selvi

Thank you.

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