WatchGuard Reports Fourth Quarter and Year-End Results

    Business Editors/High-Tech Writers

    SEATTLE--(BUSINESS WIRE)--March 30, 2005--WatchGuard Technologies, Inc. (Nasdaq:WGRD), a leading provider of network security solutions, today announced its financial results for the fourth quarter and year ended December 31, 2004.

    Fourth Quarter Results

    WatchGuard reported net revenue of $19.3 million for the fourth quarter of 2004, compared to $19.6 million in the fourth quarter of 2003, and $20.8 million in the previous quarter, the third quarter of 2004. Product revenue was $11.9 million, compared to $13.1 million in the fourth quarter of 2003, and $13.4 million in the previous quarter. Service revenue was $7.4 million, compared to $6.4 million in the fourth quarter of 2003, and $7.4 million in the previous quarter.
    On a generally accepted accounting principles, or GAAP, basis, WatchGuard reported a net loss of $2.9 million, or $0.08 per share, in the fourth quarter, compared to a net loss of $4.4 million, or $0.13 per share, in the fourth quarter of 2003, and a net loss of $1.5 million, or $0.05 per share, in the previous quarter. Excluding amortization of acquisition-related costs, impairment charges, non-cash stock-based compensation, and restructuring charges, WatchGuard reported a non-GAAP net loss of $2.6 million, or $0.08 per share, in the fourth quarter, compared to a non-GAAP net loss of $2.8 million, or $0.08 per share, in the fourth quarter of 2003, and a non-GAAP net loss of $0.9 million, or $0.03 per share, in the previous quarter.

    2004 Results

    For 2004, WatchGuard reported net revenue of $82.8 million, up 4% from $79.6 million in 2003. Product revenue was $54.4 million, up 4% from $52.5 million in 2003. Service revenue was $28.4 million, up 5% from $27.1 million in 2003.
    On a GAAP basis, WatchGuard reported a net loss of $7.7 million, or $0.23 per share, in 2004, compared to a net loss of $16.1 million, or $0.49 per share, in 2003. Excluding amortization of acquisition-related costs, impairment charges, non-cash stock-based compensation, and restructuring charges, WatchGuard reported a non-GAAP net loss of $6.3 million, or $0.19 per share, in 2004, compared to a non-GAAP net loss of $9.4 million, or $0.28 per share, in 2003. The reconciliation of WatchGuard's GAAP net loss per share to WatchGuard's non-GAAP net loss per share for the quarter and year ended December 31, 2004, and the quarter and year ended December 31, 2003, is set forth at the end of this press release.
    WatchGuard ended December 31, 2004, with $79.8 million in cash and securities, of which $3.0 million is restricted cash under the terms of certain real estate lease agreements.
    "We continue to make progress in executing the first stages of our long-term strategic plan by focusing on product development, channel development, and infrastructure development," said Ed Borey, Chief Executive Officer of WatchGuard. "Over the past quarter, we have launched several new products, including our new gateway anti-virus subscription service and the Firebox X Edge Wireless. Both of these new products have exceeded all internal expectations. We have added new channels around the world. In Europe, we added Ingram Micro, AlgolProducts, the largest Italian distributor of network computing technologies, and Feeder, one of the leading French distributors of professional IT services. In Asia, we added PacRim Technologies in Hong Kong, Transition Systems in the Philippines, Afiintra Technologies in Malaysia, NTT West in Japan, and Blitz IT in Singapore. In addition, we have improved many of the ways in which WatchGuard does business by supplying our partners around the world with enhanced tools, reporting, and other services that will help them to drive their WatchGuard business."
    "The Firebox X Core recently won the 'Best Small Business Security Solution' award from SC Magazine and our Firebox X Edge was a finalist for the U.S. Excellence Award in the 'Best SOHO Security Solution' category. We believe WatchGuard is headed in the right direction -- our network security solutions continue to gain traction and recognition, and we have exciting new products and services planned for the remainder of the year."
    As previously disclosed, during the financial statement close and audit process for the year ended December 31, 2004, WatchGuard discovered certain errors in its previously issued consolidated financial statements. These errors pertained to (i) inaccurate income statement classification of early pay incentive discounts taken by customers, (ii) under-accrual of customer rebate obligations, and (iii) timing of revenue recognition associated with specific products and services (resulting in an overstatement of product revenue and an understatement of deferred revenue).
    GAAP requires early pay incentive discounts to be recorded as a reduction to revenue, not as a component of interest expense, as previously reported by WatchGuard. Accordingly, WatchGuard reclassified early pay incentive discounts from interest expense to revenue for all previously issued consolidated financial statements. This reduced revenue by approximately $288,000 in 2002, $585,000 in 2003 and $509,000 in the first three quarters of 2004, but reduced interest expense by the same amounts. Accordingly, these adjustments will have no effect on our previously reported net losses for these periods.
    WatchGuard conducted a comprehensive and detailed evaluation of all errors identified, both individually and in the aggregate, in order to assess the materiality and financial statement impact on its previously issued consolidated financial statements. The evaluation was limited to previously issued consolidated financial statements for all interim periods in 2003 and 2004, as well as prior-period consolidated financial statements required for comparative purposes in WatchGuard's Form 10-K for 2004.
    Based on WatchGuard's analysis, it does not believe that the impact of the errors identified, either individually or in the aggregate, would be material to the annual period in which they were reported in 2002 or the annual or interim periods in which they were reported in 2003. However, WatchGuard determined that errors identified and reported in previously issued consolidated financial statements for interim periods in 2004 would have a material impact on those periods. Accordingly, WatchGuard restated its previously issued consolidated financial statements for the first three quarters of 2004. The cumulative financial impact of these restatements on the first three quarters of 2004 resulted in a reduction in revenues of approximately $1.8 million and a corresponding increase in net loss for the nine-month period. These adjustments will also result in an increase in deferred revenue at December 31, 2004, of approximately $1.2 million, which will be recognized as incremental service revenue in 2005.
    WatchGuard also determined that it did not properly gross up tenant improvement incentives relating to its Seattle headquarters facility at the inception of its lease in 2000 in accordance with FASB Technical Bulletin 88-1. Based on WatchGuard's analysis, it determined that this had no impact on any prior reported statements of operations, and only minimal impact on certain classifications on its balance sheet and statement of cash flows, such that restatement was not required.
    "WatchGuard is fully committed to providing a proper control environment, full transparency, and accurate financial reporting," concluded Borey. "We are working diligently to address any and all issues."

    Webcast Information

    An Internet broadcast and replay of WatchGuard's conference call discussing its fourth quarter and year end results (2:00 PM Pacific/5:00 PM Eastern) will be available on March 30, 2005, at www.watchguard.com under "Investor Relations."

    About WatchGuard Technologies, Inc.

    WatchGuard is a leading provider of network security solutions for small- to mid-sized enterprises worldwide, delivering integrated products and services that are robust as well as easy to buy, deploy and manage. The company's Firebox X line of expandable integrated security appliances is designed to be fully upgradeable as an organization grows and to deliver the industry's best combination of security, performance, intuitive interface and value. WatchGuard Intelligent Layered Security architecture protects against emerging threats effectively and efficiently and provides the flexibility to integrate additional security functionality and services offered through WatchGuard. Every WatchGuard product comes with an initial LiveSecurity Service subscription to help customers stay on top of security with vulnerability alerts, software updates, expert security instruction and superior customer care. For more information, please call 206-521-8340 or visit www.watchguard.com.

    Certain statements in this press release, including statements about our ability to grow our business and improve our results of operations, statements about the potential demand for, and market acceptance of, our Firebox X platform, statements about expected new products, services, features or functionality, statements about when we expect to file our annual report on Form 10-K for the year ended December 31, 2004, and other statements about our plans, objectives, intentions, and expectations are "forward-looking statements" within the meaning of the Securities Act of 1933, as amended. Forward-looking statements are based on the opinions and estimates of management at the time the statements are made and are subject to known and unknown risks and uncertainties and inaccurate assumptions that could cause actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from those anticipated in the forward-looking statements for many reasons, including the risk that our future operating results will fall below expectations, the risk that we are unable to grow our business or improve our results of operations as expected or at all, the risk that our Firebox X platform does not achieve market acceptance or does not perform as we expect, the risk that new products, services, features or functionality will not be available when expected or at all, the risk that we will not file our annual report on Form 10-K for the year ended December 31, 2004, when expected and the other risks described under "Important Factors That May Affect Our Operating Results, Our Business and Our Stock Price" in our quarterly report on Form 10-Q for the quarter ended September 30, 2004, in our annual report on Form 10-K for the year ended December 31, 2004, that we expect to file by March 31, 2005, and in our Securities and Exchange Commission filings from time to time. Readers are cautioned not to place undue reliance upon these forward-looking statements, which speak only as of the date of this release.

    WatchGuard, LiveSecurity, and Firebox are either registered trademarks or trademarks of WatchGuard Technologies, Inc. or its subsidiaries in the United States and/or other countries.

WATCHGUARD TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data and percentages)

Twelve Months Three Months Ended Ended ----------------------------------- ------------------ December September December December December 31, 30, 31, 31, 31, 2004 2004 2003 2004 2003 ----------- ----------- ----------- -------- --------- (unaudited) (unaudited) (unaudited) (restated) (2) Revenues: Product (1) $ 11,904 $ 13,393 $ 13,145 $54,398 $ 52,470 Service 7,357 7,381 6,423 28,369 27,095 ---------- ---------- ---------- ------- -------- Total revenues 19,261 20,774 19,568 82,767 79,565 Cost of revenues: Product 5,547 6,379 6,691 24,889 23,580 Service 1,389 1,390 1,344 5,554 6,082 ---------- ---------- ---------- ------- -------- Total cost of revenues 6,936 7,769 8,035 30,443 29,662 ---------- ---------- ---------- ------- --------

Gross margin 12,325 13,005 11,533 52,324 49,903

Gross margin percent 64.0% 62.6% 58.9% 63.2% 62.7%

Operating expenses: Sales and marketing 8,465 7,740 7,503 32,900 31,665 Research and development 4,493 4,403 4,914 18,143 20,793 General and administrative 2,442 2,055 2,155 8,828 8,045 Stock-based compensation 3 - 35 21 244 Amortization of other intangible assets acquired 244 243 338 974 1,963 Impairment of other intangible assets acquired - - 230 - 3,530 Restructuring charges - 400 1,000 400 1,000 ---------- ---------- ---------- ------- -------- Total operating expenses 15,647 14,841 16,175 61,266 67,240 ---------- ---------- ---------- ------- -------- Operating loss (3,322) (1,836) (4,642) (8,942) (17,337)

Interest income, net: Interest income 362 322 274 1,256 1,288 Interest expense (1) (9) (12) (7) (40) (19) ---------- ---------- ---------- ------- -------- Total interest income, net 353 310 267 1,216 1,269 ---------- ---------- ---------- ------- -------- Loss before income taxes (2,969) (1,526) (4,375) (7,726) (16,068)

Income tax provision (benefit) (111) 23 10 (45) 34 ---------- ---------- ---------- ------- -------- Net loss $ (2,858) $ (1,549) $ (4,385) $(7,681) $(16,102) ========== ========== ========== ======= ========

Basic and diluted net loss per share $ (0.08) $ (0.05) $ (0.13) $ (0.23) $ (0.49) ========== ========== ========== ======= ========

Shares used in calculation of basic and diluted net loss per share 33,667 33,575 33,066 33,489 32,889 ========== ========== ========== ======= ========

(1) Prior period results have been revised to reflect the reclassification of early pay incentive discounts from interest expense to product revenues in accordance with generally accepted accounting principles, or GAAP. (2) Operating results for the three months ended September 30, 2004 have been restated to correct certain accounting errors reflected in previously reported financial statements.

WATCHGUARD TECHNOLOGIES, INC. NON-GAAP PRO FORMA CONSOLIDATED STATEMENTS OF OPERATIONS Excluding Stock-Based Compensation, Amortization and Impairment of Other Intangible Assets Acquired and Restructuring Charges (In thousands, except per share data and percentages) unaudited

Twelve Months Three Months Ended Ended ---------------------------- ------------------ December September December December December 31, 30, 31, 31, 31, 2004 2004 2003 2004 2003 -------- ---------- -------- -------- --------- (restated) (2) Revenues: Product (1) $11,904 $13,393 $13,145 $54,398 $ 52,470 Service 7,357 7,381 6,423 28,369 27,095 ------- ------- ------- ------- -------- Total revenues 19,261 20,774 19,568 82,767 79,565 Cost of revenues: Product 5,547 6,379 6,691 24,889 23,580 Service 1,389 1,390 1,344 5,554 6,082 ------- ------- ------- ------- -------- Total cost of revenues 6,936 7,769 8,035 30,443 29,662 ------- ------- ------- ------- --------

Gross margin 12,325 13,005 11,533 52,324 49,903

Gross margin percent 64.0% 62.6% 58.9% 63.2% 62.7%

Operating expenses: Sales and marketing 8,465 7,740 7,503 32,900 31,665 Research and development 4,493 4,403 4,914 18,143 20,793 General and administrative 2,442 2,055 2,155 8,828 8,045 ------- ------- ------- ------- -------- Total operating expenses 15,400 14,198 14,572 59,871 60,503 ------- ------- ------- ------- -------- Pro forma operating loss (3,075) (1,193) (3,039) (7,547) (10,600)

Interest income, net: Interest income 362 322 274 1,256 1,288 Interest expense (1) (9) (12) (7) (40) (19) ------- ------- ------- ------- -------- Total interest income, net 353 310 267 1,216 1,269 ------- ------- ------- ------- -------- Pro forma loss before income taxes (2,722) (883) (2,772) (6,331) (9,331)

Income tax provision (benefit) (111) 23 10 (45) 34 ------- ------- ------- ------- -------- Pro forma net loss $(2,611) $ (906) $(2,782) $(6,286) $ (9,365) ======= ======= ======= ======= ========

Basic and diluted pro forma net loss per share $ (0.08) $ (0.03) $ (0.08) $ (0.19) $ (0.28) ======= ======= ======= ======= ========

Shares used in calculation of basic and diluted pro forma net loss per share 33,667 33,575 33,066 33,489 32,889 ======= ======= ======= ======= ========

(1) Prior period results have been revised to reflect the reclassification of early pay incentive discounts from interest expense to product revenues in accordance with GAAP. (2) Operating results for the three months ended September 30, 2004 have been restated to correct certain accounting errors reflected in previously reported financial statements.

WATCHGUARD TECHNOLOGIES, INC. RECONCILIATION OF THE ABOVE NON-GAAP PRO FORMA AMOUNTS TO GAAP NET LOSS IN THE FINANCIAL STATEMENTS (In thousands) unaudited

Twelve Months Three Months Ended Ended --------------------------- ------------------ December September December December December 31, 30, 31, 31, 31, 2004 2004 2003 2004 2003 -------- --------- -------- -------- --------- Pro forma net loss $(2,611) $ (906) $(2,782) $(6,286) $ (9,365) Adjustments to reconcile pro forma net loss to GAAP net loss in the financial statements: Stock-based compensation 3 - 35 21 244 Amortization of other intangible assets acquired 244 243 338 974 1,963 Impairment of other intangible assets acquired - - 230 - 3,530 Restructuring charges - 400 1,000 400 1,000 ------- ------- ------- ------- -------- Net effect of pro forma adjustments 247 643 1,603 1,395 6,737 ------- ------- ------- ------- -------- Net loss $(2,858) $(1,549) $(4,385) $(7,681) $(16,102) ======= ======= ======= ======= ========

Use of Non-GAAP Pro Forma Financial Information

To supplement our consolidated financial statements presented on a GAAP basis, WatchGuard uses pro forma measures of operating results, net income, and earnings per share, which are adjusted to exclude certain costs and expenses we believe appropriate to enhance an overall understanding of our past financial performance and also our prospects for the future. These adjustments to our GAAP results are made with the intent of providing both management and investors a more complete understanding of WatchGuard's underlying operational results and trends and our marketplace performance. For example, the pro forma results are an indication of our baseline performance before other charges that are considered by management to be outside of our core operating results. In addition, these adjusted pro forma results are among the primary indicators management uses as a basis for planning and forecasting of future periods. The presentation of this additional information is not meant to be considered in isolation or as a substitute for operating results prepared in accordance with generally accepted accounting principles in the United States. Pro forma results exclude:

-- non-cash stock-based compensation expenses originating from employee stock options granted at less than fair value, stock options granted to consultants and certain restricted common stock and common stock subject to repurchase issued in connection with the Qiave Technologies Corporation and RapidStream, Inc. acquisitions;

-- the amortization and impairment of other intangible assets obtained in WatchGuard's acquisition of Qiave Technologies Corporation in October 2000 and RapidStream, Inc. in April 2002; and

-- restructuring charges.

WATCHGUARD TECHNOLOGIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (In thousands)

December 31, December 31, 2004 2003 (1) ------------ ------------ ASSETS Current assets: Cash and cash equivalents $ 4,660 $ 3,899 Short-term and available for sale investments 72,189 74,890 Trade accounts receivable, net 7,305 6,700 Inventories, net 3,145 3,068 Prepaid expenses and other current assets 2,780 3,924 ----------- ----------- Total current assets 90,079 92,481 Property and equipment, net 6,303 6,512 Restricted cash 3,000 3,000 Goodwill 66,605 66,605 Other intangibles, net and other assets 2,494 3,562 ----------- ----------- Total assets $ 168,481 $ 172,160 =========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities: Accounts payable $ 3,214 $ 3,676 Accrued expenses and other liabilities 7,581 6,335 Short-term accrued restructuring and acquisition costs 1,289 2,271 Short-term deferred revenues 17,402 15,675 ----------- ----------- Total current liabilities 29,486 27,957 Long-term deferred rent 1,447 1,525 Long-term accrued restructuring costs 3,599 4,268 Long-term deferred revenues 1,818 1,072 ----------- ----------- Total liabilities 36,350 34,822

Total stockholders' equity 132,131 137,338 ----------- ----------- Total liabilities and stockholders' equity $ 168,481 $ 172,160 =========== ===========

(1) Balances reflect reclassification of certain prior-year items to conform to the current year presentation.

WATCHGUARD TECHNOLOGIES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)

Three Months Ended Twelve Months Ended ----------------------- -------------------- December December December December 31, 31, 31, 31, 2004 2003(1) 2004 2003(1) ----------- ----------- --------- ---------- (unaudited) (unaudited) Operating activities: Net loss $ (2,858) $ (4,385) $ (7,681) $ (16,102) Adjustments to reconcile net loss to net cash provided by (used in) operating activities: Noncash expenses: Depreciation and amortization of property and equipment 620 734 2,724 2,996 Amortization of other intangible assets acquired 244 338 974 1,963 Impairment of other intangible assets acquired - 230 - 3,530 Stock-based compensation 3 35 21 244 Changes in operating assets and liabilities: Trade accounts receivable, net 847 (603) (605) 2,113 Inventories, net 34 1,301 (77) 1,374 Prepaid expenses and other current assets 509 (94) 1,144 511 Other assets (6) 40 94 170 Accounts payable 206 (1,080) (462) (1,003) Accrued expenses, other liabilities and deferred rent 1,374 1,917 1,168 1,295 Accrued restructuring and acquisition costs (514) 421 (1,651) (2,496) Deferred revenues 520 (328) 2,473 (1,704) -------- -------- -------- --------- Net cash provided by (used in) operating activities 979 (1,474) (1,878) (7,109)

Investing activities: Purchases of property and equipment (1,114) (296) (2,515) (1,836) Proceeds from maturities of marketable securities 18,644 17,651 51,674 119,503 Proceeds from sales of marketable securities - 2,000 - 3,819 Purchases of marketable securities (16,886) (21,165) (49,158) (121,070) -------- -------- -------- --------- Net cash provided by (used in) investing activities 644 (1,810) 1 416

Financing activities: Proceeds from stock option exercises and issuances of common stock under employee stock purchase plan 62 452 2,638 1,702 -------- -------- -------- --------- Net cash provided by financing activities 62 452 2,638 1,702 -------- -------- -------- ---------

Net increase (decrease) in cash and cash equivalents 1,685 (2,832) 761 (4,991) Cash and cash equivalents at beginning of period 2,975 6,731 3,899 8,890 -------- -------- -------- --------- Cash and cash equivalents at end of period $ 4,660 $ 3,899 $ 4,660 $ 3,899 ======== ======== ======== =========

(1) Balances reflect reclassification of certain prior-year items to conform to the current-year presentation.

--30--APG/se*

CONTACT: WatchGuard Technologies, Inc. Miles Goda, 206-613-0826

KEYWORD: WASHINGTON INDUSTRY KEYWORD: SOFTWARE NETWORKING INTERNET E-COMMERCE EARNINGS CONFERENCE CALLS SOURCE: WatchGuard Technologies, Inc.

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