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SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
_________
Form 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OR THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission file number: 000-27723
_______________
SonicWALL, Inc.
(Exact name of registrant as specified in its charter)
California 77-0270079
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
1160 Bordeaux Drive
Sunnyvale, California 94089
(408) 745-9600
(Address of registrant's principal executive offices)
_______________
Not Applicable
(Former name, former address and former fiscal year, if changed since last
report)
________________
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No___
-
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
TITLE OF EACH CLASS OUTSTANDING AT SEPTEMBER 30, 2000
Common Stock, no par value 52,530,932 Shares
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TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
3. PART I. FINANCIAL INFORMATION
3. ITEM 1. Financial Statements
8. ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
13. ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
13. PART II. OTHER INFORMATION
13. ITEM 1. Legal Proceedings
13. ITEM 2. Changes in Securities and Use of Proceeds
13. ITEM 3. Defaults Upon Senior Securities
13. ITEM 4. Submission of Matters to a Vote of Security Holders
14. ITEM 5. Other Information
14. ITEM 6. Exhibits and Reports on Form 8-K
15. SIGNATURES
</TABLE>
2
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Condensed Consolidated Balance Sheets as of September 30, 2000 and December 31, 1999...................... 4
Condensed Consolidated Statements of Operations for the three and nine month periods
ended September 30, 2000 and 1999....................................................................... 5
Condensed Consolidated Statements of Cash Flows for the nine month periods ended
September 30, 2000 and 1999............................................................................. 6
Notes to Condensed Consolidated Financial Statements...................................................... 7
</TABLE>
3
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SONICWALL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
-------- -------
(Unaudited)
ASSETS
<S> <C> <C>
Current Assets:
Cash and cash equivalents.............................. $159,464 $62,589
Short-term investments................................. 94,444 -
Accounts receivable, net............................... 8,034 3,687
Inventories............................................ 1,300 558
Deferred income taxes.................................. 8,263 1,556
Prepaid expenses and other current assets.............. 2,271 1,015
-------- -------
Total current assets.................................. 273,776 69,405
Property and equipment, net............................. 2,540 435
Intangibles and other assets............................ 786 1,399
-------- -------
$277,102 $71,239
======== =======
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable....................................... $ 3,289 $ 2,692
Accrued payroll and related benefits................... 4,266 1,205
Other accrued liabilities.............................. 3,324 1,839
Deferred revenue....................................... 7,675 3,732
Income taxes payable................................... 1,370 1,021
-------- -------
Total current liabilities............................. 19,924 10,489
-------- -------
Shareholders' Equity:
Common stock........................................... 234,884 64,809
Other.................................................. 11,464 (3,209)
Retained earnings (accumulated deficit)................ 10,830 (850)
-------- -------
Total shareholders' equity............................ 257,178 60,750
-------- -------
$277,102 $71,239
======== =======
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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SONICWALL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Revenue
Internet security.................................. $18,405 $ 5,203 $48,285 $10,677
Ethernet........................................... - 258 - 1,474
------- ------- ------- -------
Total revenue..................................... 18,405 5,461 48,285 12,151
Cost of revenue..................................... 4,337 1,464 12,058 3,462
------- ------- ------- -------
Gross margin........................................ 14,068 3,997 36,227 8,689
Operating expenses
Research and development........................... 2,533 817 7,035 2,198
Sales and marketing................................ 3,816 1,554 9,972 3,408
General and administrative......................... 1,414 495 3,480 1,189
Deferred stock compensation........................ 330 518 3,325 1,301
------- ------- ------- -------
Total operating expenses.......................... 8,093 3,384 23,812 8,096
------- ------- ------- -------
Income from operations.............................. 5,975 613 12,415 593
Other income, net................................... 2,897 73 7,204 205
------- ------- ------- -------
Income before income taxes.......................... 8,872 686 19,619 798
Provision for income taxes.......................... 3,129 452 7,939 787
------- ------- ------- -------
Net income $ 5,743 $ 234 $11,680 $ 11
======= ======= ======= =======
Net income per share (1):
Basic.............................................. $0.11 $0.01 $0.23 $0.00
======= ======= ======= =======
Diluted............................................ $0.10 $0.01 $0.21 $0.00
======= ======= ======= =======
Shares used in computing net income per share (1):
Basic.............................................. 51,886 32,792 50,356 32,734
======= ======= ======= =======
Diluted............................................ 57,683 40,262 56,226 38,842
======= ======= ======= =======
</TABLE>
(1) Share and per share amounts have been adjusted to reflect the two-for-one
stock split effective September 15, 2000.
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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SONICWALL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
2000 1999
-------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income .................................................................. $ 11,680 $ 11
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................................... 827 669
Provision for allowance for doubtful accounts............................... 612 216
Amortization of deferred stock compensation................................. 3,325 1,301
Changes in operating assets and liabilities:
Accounts receivable........................................................ (4,959) (1,582)
Inventories................................................................ (742) (175)
Prepaid expenses and other current assets.................................. (1,272) (399)
Deferred income taxes...................................................... 143 (1,190)
Accounts payable........................................................... 597 397
Accrued payroll and related benefits....................................... 3,061 705
Other accrued liabilities.................................................. 1,485 1,058
Deferred revenue........................................................... 3,943 1,468
Income taxes payable....................................................... 6,474 77
-------- -------
Net cash provided by operating activities................................. 25,174 2,556
-------- -------
Cash flows from investing activities:
Purchase of property and equipment........................................... (2,303) (180)
Purchase of short-term investments........................................... (94,444) --
-------- -------
Net cash used in investing activities..................................... (96,747) (180)
-------- -------
Cash flows from financing activities:
Proceeds from exercise of stock options...................................... 1,595 138
Proceeds from issuance of redeemable Series A convertible preferred stock ... -- 4,971
Proceeds from issuance of common stock, net of issuance costs................ 166,553 --
Payments of notes receivable from shareholders............................... 300 230
-------- -------
Net cash provided by financing activities................................. 168,448 5,339
-------- -------
Net increase in cash and cash equivalents..................................... 96,875 7,715
Cash and cash equivalents at beginning of period.............................. 62,589 1,051
-------- -------
Cash and cash equivalents at end of period.................................... $159,464 $ 8,766
======== =======
Supplemental disclosure of cash flow information:
Cash paid for income taxes................................................... $ 1,320 $ 1,901
Supplemental disclosure of noncash investing activities:
Issuance of notes receivable upon the exercise of stock options.............. $ -- $ 300
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements.
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SONICWALL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
The accompanying condensed consolidated financial statements have been
prepared by SonicWALL, Inc. (the "Company"), are unaudited and reflect all
adjustments which are, in the opinion of management, necessary for a fair
presentation of the financial position and the results of operations of the
Company for the interim periods. The statements have been prepared in accordance
with the regulations of the Securities and Exchange Commission ("SEC").
Accordingly, they do not include all information and footnotes required by
generally accepted accounting principles. The results of operations for the nine
months ended September 30, 2000 are not necessarily indicative of the operating
results to be expected for the full fiscal year or future operating periods. The
information included in this report should be read in conjunction with the
audited consolidated financial statements and notes thereto for the fiscal year
ended December 31, 1999 and the risk factors as set forth in the Company's Form
10-K, including without limitation, risks relating to limited operating history,
management of growth, maintaining profitability, dependence on new products,
customer concentration, dependence on OEM orders, product pricing, risks
associated with international sales and operations, dependence on components,
product liability, dependence on contract manufacturer, management of
acquisitions of products and technologies, protection of intellectual property,
dependence on key personnel, rapid technological change, competition, government
regulation affecting Internet security, concentration of stock ownership,
possible volatility of stock price and effect of certain charter provisions. Any
party interested in reviewing these publicly available documents should write to
the SEC or the Chief Financial Officer of the Company.
2. CONSOLIDATION
The condensed consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries. All intercompany accounts and
transactions have been eliminated.
3. NET INCOME PER SHARE
The following is a reconciliation of the numerators and denominators of the
basic and diluted net income per share computations for the periods presented:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
(In thousands, except per share amounts) 2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Numerator:
Net income.......................................... $ 5,743 $ 234 $11,680 $ 11
======= ======= ======= =======
Denominator:
Weighted average common shares outstanding.......... 52,308 33,357 50,815 32,992
Weighted average unvested common shares subject to
repurchase......................................... (422) (565) (459) (258)
------- ------- ------- -------
Denominator for basic calculation................... 51,886 32,792 50,356 32,734
Common stock equivalents............................ 5,797 7,470 5,870 6,108
------- ------- ------- -------
Denominator for diluted calculation................. 57,683 40,262 56,226 38,842
Basic net income per share........................... $ 0.11 $ 0.01 $ 0.23 $ 0.00
======= ======= ======= =======
Diluted net income per share......................... $ 0.10 $ 0.01 $ 0.21 $ 0.00
======= ======= ======= =======
</TABLE>
4. EQUITY MATTERS
The Company effected a two-for-one stock split effective September 15,
2000. All share and per share amounts have been adjusted accordingly throughout
this document to reflect the stock split.
7
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5. INVENTORIES
Inventories consist of the following:
<TABLE>
<CAPTION>
(In thousands) September 30, December 31,
2000 1999
---- ----
<S> <C> <C>
Raw materials $1,155 $ 25
Finished goods 145 533
------ -----
$1,300 $ 558
====== =====
</TABLE>
6. FOLLOW-ON OFFERING
In March 2000, the Company completed a secondary offering of 7,000,000
shares of its common stock at a price of $50 per share, of which 3,500,000
shares were sold by the Company and 3,500,000 shares were sold by selling
shareholders. The Company received approximately $166 million in net proceeds
after deducting underwriting discounts and commissions and offering expenses.
The Company expects to use the proceeds from the offering to support growth,
working capital and potential acquisitions of complementary products and
technologies.
7. NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement 133, "Accounting for Derivative Instruments and Hedging Activities."
The new statement established accounting and reporting standards for derivative
instruments and for hedging activities and is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000. The Company does not expect the
adoption of Statement 133 to have a material impact on the Company's results of
operations.
In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for revenue recognition under certain
circumstances. The Company implemented SAB 101 in the quarter ended March 31,
2000 and it did not have a material impact on the financial statements.
In March 2000, the FASB issued FASB interpretation No. 44 "Accounting for
Certain Transactions Involving Stock Compensation - an interpretation of APB
Opinion No.25". This interpretation has provisions that are effective on
staggered dates, some of which began after December 15, 1998 and others that
become effective after June 30, 2000. The adoption of this interpretation did
not have a material impact on the financial statements.
8. SUBSEQUENT EVENT
In October 2000, we entered into a definitive agreement to acquire
privately-held Phobos Corporation ("Phobos"), a developer of products that
offload and accelerate secure transaction processing for servers tasked with
Internet-based applications. Under the terms of the agreement, we will acquire
Phobos for approximately $268 million in common stock, assumed options, and
cash. The acquisition will be accounted for using the purchase method of
accounting.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Form 10-Q contains forward-looking statements about future results,
which are subject to risks and uncertainties, including those discussed below.
These statements relate to future events or our future financial performance. In
many cases you can identify forward-looking statements by terminology such as
"may", "will," "should," "expects," "plans," "anticipates," "believes,"
"estimates," "predicts," "potential," "intend" or "continue," or the negative of
such terms and other comparable terminology. These statements are only
predictions. Our actual results may differ significantly from the results
discussed in the forward-looking statements as a result of a variety of factors,
including, but not limited to, those set forth in our Form 10-K filed with the
Securities and Exchange Commission. References to "we," "our," and "us" refer to
SonicWALL, Inc.
8
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OVERVIEW
From inception through 1996, we derived substantially all of our revenue
from the development and marketing of networking products for Apple Macintosh
computers. These products enable Apple Macintosh computers to connect to
computer networks using Ethernet communications standards. The Ethernet standard
was developed in the 1970s by Xerox Corporation and is the most widely used
technology to facilitate communication between computers on local area networks.
The Ethernet standard is defined by the Institute of Electrical and Electronics
Engineers and specifies the speed and other characteristics of a computer
network. In 1998, we made a strategic business decision to concentrate our
resources in the Internet security market due to our belief that this market had
better long-term growth prospects. As a result, we stopped shipments of our
Ethernet product line during December 1999. In October 1997, we introduced our
first Internet security appliance, the SonicWALL DMZ, and began volume shipments
in 1998. In 1998 we began offering content filtering subscriptions to our
SonicWALL customers. Customers can purchase subscriptions for one to four years,
and they receive weekly updated lists of objectionable web site addresses to
which they can block access. We now focus all our development, marketing and
sales efforts on the Internet security appliance market. Our shift to selling
Internet security products has not required any significant restructuring of our
personnel, facilities, manufacturing or operations. We have not, and do not
expect any significant charges related to our Ethernet product inventories or
warranty obligations. In 1999, our Internet security products represented
approximately 92% of our total revenue and in 2000 they represent 100% of our
total revenue. In 1999, our Ethernet products represented 8% of our total
revenue and in 2000, Ethernet products are no longer being sold.
Our SonicWALL products are sold primarily through distributors who then
resell our products to resellers and selected retail outlets. These resellers
then sell our products to end-users. Two of our distributors, Ingram Micro, Inc.
and Tech Data Corp., both of which are global computer equipment and accessory
distributors, account for approximately 50% of our revenue. In 1999, sales to
Ingram Micro and Tech Data accounted for 34% and 12% of our revenue,
respectively.
Our revenue consists primarily of product sales and, to a lesser extent,
subscription fees from content filtering services and extended warranty contract
fees. Product sales comprise approximately 95% of total revenue for the year
ended December 31, 1999. We generally recognize revenue when we ship products to
our customers. Agreements with many of our distributors provide for stock
rotation, price protection and co-op advertising rights. Stock rotation rights
provide a distributor the right to exchange unsold inventory for alternative
products. Ingram Micro's right to return or rotate its stock on-hand is
unlimited, and therefore we recognize revenue for product sales to Ingram Micro
when it has sold the product to its customers. Ingram Micro does not have the
right to return non-defective products to us if a customer of Ingram Micro
returns such a product to Ingram Micro. For all other distributors, the value of
stock that can be rotated is generally limited to 15% of the prior quarter's
purchases. Co-op advertising rights provide a distributor the right to be
reimbursed up to 3% of the prior quarter's sales for costs it has incurred
associated with advertising our products. For all of our distributors, we
provide an allowance for sales returns, price protection rights and reserves for
warranty and co-op advertising costs at the time of revenue recognition. Price
reductions which may result in price protection require the approval of our
president, chief financial officer, and vice president of sales. Subscription
fees and extended warranty fees are deferred and amortized over the period of
the related contracts. Subscription and extended warranty fees to date have not
been material.
To date, a significant portion of our revenue has been dependent on large
purchase orders from a limited number of distributors. These purchase orders
typically have short lead times and are subject to delay or cancellation without
penalty. We anticipate that our operating results for a given period will
continue to depend on a small number of customers. If we experience a decline in
revenue from any of our significant distributors in a given quarter, our revenue
for that quarter, or following quarters, will be adversely affected. This could
adversely affect our business, prospects, results of operations and financial
condition. Furthermore, if any of our significant customers experiences
financial difficulties, our sales to these customers may be reduced, and we may
have difficulty collecting accounts receivable from these customers. Any delay
in large customer orders or customer financial difficulties could have a
material adverse effect on our business, prospects, results of operations and
financial condition.
We primarily use one contract manufacturer to manufacture our products. We
also rely on single or limited source suppliers to provide key components of our
products. A significant portion of our cost of revenue is related to these
suppliers. These relationships are subject to a variety of risks.
In August 1998, we acquired all the partnership interest of AckFin
Networks, a California general partnership, in exchange for an aggregate of
10,852,368 shares of all common stock with an estimated value of $0.45 per
share, or $4,883,000, and the assumption of $150,000 in liabilities. The
controlling partners of AckFin, Sreekanth Ravi and Sudhakar Ravi, two of our
executive officers and principal shareholders, were also the majority
shareholders of SonicWALL, Inc. and, therefore, were deemed to be a control
group for purposes of determining the amount of purchase price to be "stepped-
up." The value of the exchanged shares for AckFin was accounted for as a
reorganization of entities under common control. Accordingly, net assets
acquired were valued by applying carryover basis to the control group interest
and a stepped-up basis to the minority interest. The step-up of the minority
9
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interest resulted in an intangible asset of $2,517,000. This intangible asset
was attributed to acquired completed technology and is being amortized over a
period of three years. The intangible assets acquired by the Company were rights
to the completed core technology developed by AckFin that provides the
foundation for our Internet products. Since this transaction occurred between
entities that were under common control, the financial results of AckFin have
been combined with our results for the period since the inception of AckFin,
April 1997, through the date of exchange, August 1998. AckFin did not have any
revenue transactions with unrelated third parties. All financial transactions
for AckFin were eliminated upon combination with SonicWALL, Inc.
In 1998, we recorded total deferred stock compensation of approximately
$48,000 in connection with stock and stock options granted during 1998 at prices
subsequently deemed to be below fair market value on the date of grant. Options
granted are typically subject to a four-year vesting period. Restricted stock
acquired through the exercise of unvested stock options is subject to our right
to repurchase the unvested stock at the price paid, which right lapses over a
four-year period. We are amortizing the deferred stock compensation over the
vesting periods of the applicable options and the repurchase periods for the
restricted stock. In 1999, we recorded approximately $6.1 million in additional
deferred stock compensation for stock options granted in the year ended December
31, 1999, at prices subsequently deemed to be below fair market value on the
date of grant. We amortized approximately $2.9 million of deferred stock
compensation for the year ended December 31, 1999, including amortization for
granted options to certain consultants in exchange for services rendered. These
options are subject to variable plan accounting with fair value re-measurements
at the end of each quarterly reporting period.
RESULTS OF OPERATIONS
The following table sets forth certain consolidated financial data for the
periods indicated as a percentage of total revenue:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenue
Internet Security.............. 100.0% 95.3% 100.0% 87.9%
Ethernet....................... - 4.7 - 12.1
----- ----- ----- -----
Total revenue................. 100.0 100.0 100.0 100.0
Cost of revenue................. 23.6 26.8 25.0 28.5
----- ----- ----- -----
Gross margin.................... 76.4 73.2 75.0 71.5
Operating expenses
Research and development....... 13.8 15.0 14.6 18.1
Sales and marketing............ 20.7 28.5 20.6 28.0
General and administrative..... 7.7 9.0 7.2 9.8
Deferred stock compensation.... 1.8 9.5 6.9 10.7
----- ----- ----- -----
Total operating expenses...... 44.0 62.0 49.3 66.6
----- ----- ----- -----
Income from operations.......... 32.5 11.2 25.7 4.9
Other income, net............... 15.7 1.3 14.9 1.7
----- ----- ----- -----
Income before income taxes...... 48.2 12.6 40.6 6.6
Provision for income taxes...... (17.0) (8.3) (16.4) (6.5)
----- ----- ----- -----
Net income...................... 31.2% 4.3% 24.2% 0.1%
===== ===== ===== =====
</TABLE>
Internet Security Revenue - Revenue from sales of our products and
subscriptions increased to $18.4 million in the three months ended September 30,
2000 from $5.2 million in the three months ended September 30, 1999. Revenue
from sales of our products increased to $48.3 million in the nine months ended
September 30, 2000 from $10.7 million in the nine months ended September 30,
1999. This increase was attributable to a higher volume of products shipped,
expansion of our distribution channel, expansion of our product offerings to
include the SonicWALL ProVX, SonicWALL XPRS, and SonicWALL Telecomuter,
expansion of our subscription products to include Anti-Virus Protection, and
increasing demand in our target markets. The increase in shipping volume
resulted primarily from increased market acceptance of the SonicWALL products
over the corresponding period of the prior year. In addition, during the nine
months ended September 30, 2000 we increased shipments under an OEM relationship
that was entered in July 1999.
Ethernet Revenue - Revenue from our Ethernet products declined by $0.3
million from $0.3 million in the three months ended September 30, 1999 to $0 in
the three months ended September 30, 2000. Revenue from our Ethernet products
declined by $1.5 million from $1.5 million in the nine months ended September
30, 1999 to $0 in the nine months ended September 30, 2000.
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This decrease was directly related to our decision to focus on development,
sales and marketing efforts on our Internet security appliance products. We
stopped shipment of Ethernet products during December 1999.
There can be no assurance that the Company's net sales will continue to
increase in absolute dollars or at the rate at which they have grown in recent
fiscal periods.
Cost of Revenue; Gross Margin - Cost of revenue includes all costs
associated with the production of our products, including cost of materials,
manufacturing and assembly costs paid to contract manufacturers and related
overhead costs associated with our manufacturing operations personnel.
Additionally, all warranty costs and any inventory provisions or write-downs are
expensed as cost of revenue. Cost of revenue increased to $4.3 million in the
three months ended September 30, 2000 from $1.5 million in the three months
ended September 30, 1999. Cost of revenue increased to $12.1 million in the nine
months ended September 30, 2000 from $3.5 million in the nine months ended
September 30, 1999. Gross margin increased from 73.2% for the three months ended
September 30, 1999 to 76.4% for the three months ended September 30, 2000. Gross
margin increased from 71.5% for the nine months ended September 30, 1999 to
75.0% for the nine months ended September 30, 2000. The increase in gross margin
was primarily attributable to the increase in sales of higher gross margin
security appliance products, and the Company's decision to cease shipping of the
lower gross margin Ethernet products in December 1999. In addition, we
experienced increased manufacturing efficiencies and lower overhead and
component costs per unit, due to the economies of scale. Gross margin was also
favorably impacted by growth in content filter subscriptions and service
revenues due to a larger installed base. Factors contributing to the gross
margin growth were partially offset by the effect of increased sales of OEM
products, which generate lower gross margins product.
The Company's gross margin has been and will continue to be affected by a
variety of factors, including competition; the mix and average selling prices of
products; new product introductions and enhancements and the cost of components
and manufacturing labor.
Research and Development - Research and development expenses primarily
consist of personnel costs related to engineering and technical support,
contract consultants, outside testing services, amortization of acquired
technology from AckFin, and equipment and supplies associated with enhancing
existing products and developing new products. Research and development expenses
increased by 210% from $0.8 million for the three months ended September 30,
1999 to $2.5 million for the three months ended September 30, 2000. These
expenses represented 15.0% and 13.8%, respectively, of net sales for such
periods. Research and development expenses increased by 220% from $2.2 million
for the nine months ended September 30, 1999 to $7.0 million for the nine months
ended September 30, 2000. These expenses represented 18.1% and 14.6%,
respectively, of net sales for such periods. These increases were primarily
attributable to increased personnel costs, increased facility expenses related
to the new leased facility, prototyping expenses associated with the development
of new products and ongoing support of current and future product development
and enhancement efforts. The Company believes that significant investments in
research and development will be required to remain competitive and expects that
such expenditures will continue to increase in absolute dollars.
Sales and Marketing - Sales and marketing expenses primarily consist of
personnel costs, including commissions, costs associated with the development of
our business and corporate identification, and costs related to customer
support, travel, trade shows, promotional and advertising costs. Sales and
marketing expenses increased 145% from $1.6 million for the three months ended
September 30, 1999 to $3.8 million for the three months ended September 30,
2000. These expenses were 28.5% and 20.7% of net sales for such periods,
respectively. Sales and marketing expenses increased 193% from $3.4 million for
the nine months ended September 30, 1999 to $10.0 million for the nine months
ended September 30, 2000. These expenses were 28.0% and 20.6% of net sales for
such periods, respectively. The increases in absolute dollars were primarily
related to the expansion of the Company's sales and marketing organization,
including growth in the domestic and international sales force, increased
commission and bonus expenses related to higher sales volumes and increased
travel expenses. Facility expenses, depreciation and amortization also increased
over the corresponding period of the prior year due to the move to a larger
facility in October 1999 and to related leasehold improvements. The Company
expects to continue to increase its sales and marketing expenses in an effort to
expand domestic and international markets, introduce new products and establish
and expand new distribution channels and OEM relationships.
General and Administrative - General and administrative expenses were $1.4
million for the three months ended September 30, 2000, compared to $0.5 million
for the three months ended September 30, 1999. These expenses represented 7.7%
and 9.0% of net sales for such periods, respectively. General and administrative
expenses were $3.5 million for the nine months ended September 30, 2000,
compared to $1.2 million for the nine months ended September 30, 1999. These
expenses represented 7.2% and 9.8% of net sales for such periods, respectively.
The increases in absolute dollars were primarily related to increased personnel
costs, increased facility expenses related to the new leased facility and the
growth of other expenses. The Company believes that its general and
administrative expenses will increase in absolute dollars as the Company
continues to build its
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infrastructure.
Deferred Stock Compensation - Amortization of deferred stock compensation
was $0.3 million for the three months ended September 30, 2000 and $0.5 million
for the three months ended September 30, 1999. Amortization of deferred stock
compensation was $3.3 million for the nine months ended September 30, 2000 and
$1.3 million for the nine months ended September 30, 1999. This amortization
relates to deferred compensation of $6.1 million, related to stock options
granted in the year ended December 31, 1999. We are amortizing this amount over
the vesting periods of the applicable options.
Other Income, net - Other income, net, consists primarily of interest
income on the Company's cash, cash equivalents and short-term investments, and
increased to $2.9 million for the three months ended September 30, 2000 from
$73,000 in the three months ended September 30, 1999. Other income, net, was
$7.2 million for the nine months ended September 30, 2000, compared to $0.2
million for the nine months ended September 30, 1999. This increase was related
primarily to higher interest earnings on cash, cash equivalents and short term
investments that increased in amount from $8.8 million at September 30, 1999, to
$254 million at September 30, 2000 primarily as a result of the initial public
offering in November 1999 and the secondary public offering in March 2000.
Provision for Income Taxes - The Company's effective tax rate, including
the effect of noncash deferred stock compensation, for the first nine months of
fiscal 2000 was 34.5% compared with 37.5% in the first nine months of fiscal
1999. The lower tax rate in fiscal 2000 is a result of the implementation of a
foreign sales corporation in February 2000 and tax benefits related to
investments in tax exempt securities.
The Company's quarterly operating results have in the past varied and may
in the future vary significantly depending on a number of factors including the
level as competition; the size and timing of significant orders; product mix;
market acceptance of new products and product enhancements; new product
announcements or introductions by the Company or its competitors; deferrals of
customer orders in anticipation of new products or product enhancement; changes
in pricing by the Company or its competitors; the ability of the Company to
develop, introduce and market new products and product enhancements on a timely
basis; hardware component costs; supply constraints; the Company's success in
expanding its sales and marketing programs; technological changes in the
Internet security market; the mix of sales among the Company's sales channels;
levels of expenditure on research and development; changes in Company strategy;
personnel changes; the Company's ability to successfully expand domestic and
international operations; general economic trends and other factors.
LIQUIDITY AND CAPITAL RESOURCES
For the nine months ended September 30, 2000, the Company's cash, cash
equivalents and short-term investments increased by $191 million to $254
million. This increase related primarily to the follow-on offering in March 2000
which generated $166.6 million in net proceeds to the Company. The Company's
working capital increased for the nine months ended September 30, 2000 by $195
million to $254 million. For the nine months ended September 30, 2000, the
Company generated cash from operating activities totaling $25.2 million,
principally related to net income of $11.7 million and an increase in deferred
revenue, partially offset by increases in accounts receivable and inventories.
Net cash provided by operating activities in the nine months ended September 30,
1999, principally related to net income and an increase in deferred revenues,
offset by an increase in accounts receivable.
The Company purchased $94 million of short-term investments and used $2.3
million to purchase property and equipment during the nine months ended
September 30, 2000. The Company spent approximately $0.2 million on investing
activities in the nine months ended September 30, 1999.
Financing activities provided $168 million and $5.3 million for the nine
months ended September 30, 2000 and September 30, 1999, respectively. In
February 1999, the Company completed a private placement and issued 1,438,377
shares of redeemable Series A convertible preferred stock for net proceeds of $5
million. In March 2000, the Company successfully completed its follow-on
offering of common stock which generated approximately $166.6 million in net
proceeds after deducting underwriting discounts and commissions and estimated
offering expenses.
YEAR 2000
We believe that we have successfully rendered our products, internal
management and other administrative systems and external information systems
year 2000 compliant. In addition, we have surveyed the vendors of the third-
party technologies we incorporate into our products and services and applied
updates or arrangements to correct potential year 2000 compliance problems.
Since January 1, 2000, we have experienced no disruptions in our business
operations as a result of year 2000 compliance problems or otherwise, and have
received no reports of any year 2000 compliance problems with our products and
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services. To date, the total cost of our efforts to address year 2000 compliance
has not been material.
Nonetheless, some problems related to the year 2000 risks may not appear
until after January 1, 2000. Year 2000 issues could include problems with our
own products and services or with third-party products or technology that we use
or with which our products exchange data. Any problems that are not identified
and corrected successfully and completely could adversely affect our business.
NEW ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement 133, "Accounting for Derivative Instruments and Hedging Activities."
The new statement established accounting and reporting standards for derivative
instruments and for hedging activities and is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000. The Company does not expect the
adoption of Statement 133 to have a material impact on the Company's results of
operations.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101 (SAB 101), "Revenue Recognition in Financial
Statements." SAB 101 provides guidance for the recognition, presentation and
disclosure of revenue in financial statements filed with the SEC. The Company
implemented SAB 101 in the quarter ended March 31, 2000. The adoption of SAB 101
did not have a material impact on the Company financial statements.
In March 2000, the FASB issued FASB interpretation No. 44 "Accounting for
Certain Transactions Involving Stock Compensation - an interpretation of APB
Opinion No.25". This interpretation has provisions that are effective on
staggered dates, some of which began after December 15, 1998 and others that
became effective after June 30, 2000. The adoption of this interpretation did
not have a material impact on the Company's financial statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk for changes in interest rates relates primarily
to our cash, cash equivalents and short-term investments. We do not use
derivative financial instruments in our investment portfolio. As stated in our
investment policy, we are averse to principal loss and ensure the safety and
preservation of our invested funds by limiting default and market risk. We
mitigate default risk by investing in only investment-grade instruments. A
hypothetical 10% increase in market interest rates from levels at September 30,
2000, would cause the fair value of these short-term investments to decline by
an immaterial amount. Because we have the ability to hold these investments
until maturity we would not expect any significant decline in value of our
investments caused by market interest rate changes. Declines in interest rates
over time will, however, reduce our interest income.
We invoice all of our foreign customers from the United States in U.S.
dollars and all revenue is collected in U.S. dollars. As a result, we do not
have significant market risks associated with foreign currencies or related to
sales and collections.
The hypothetical changes and assumptions discussed above will be different
from what actually occurs in the future. Furthermore, such computations do not
anticipate actions that may be taken by management, should the hypothetical
market changes actually occur over time. As a result, the effect on actual
earnings in the future will differ from those described above.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
None
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
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ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
27.1 Financial Data Schedule for the period ended September 30, 2000
(b) REPORTS ON FORM 8-K
The following reports were filed on Form 8-K during the quarter ended
September 30, 2000.
. Current Report on Form 8-K dated August 2, 2000 was filed on August
8, 2000 pursuant to Item 5 - Other Events.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of Sunnyvale, State
of California.
SonicWALL, Inc.
/s/ MICHAEL J. SHERIDAN
------------------------------------------
By: Michael J. Sheridan,
Vice President, Finance and Chief Financial
Officer and Secretary (Principal Financial
Officer, Chief Accounting Officer and
Authorized Signer)
Dated: November 13, 2000
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INDEX TO EXHIBITS
Number Description
------ -----------
27.1 Financial Data Schedule.
16
