This Form 10-Q contains forward-looking statements which 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," "expect," "plan," "anticipate," "believe," "estimate," "predict," "potential," "intend" or "continue," or the negative of such terms and other comparable terminology. In addition, forward-looking statements in this document include, but are not limited to, those regarding the dedication of resources to develop new products and services and marketing those products and services to channel partners and customers; the introduction of more service offerings on our platforms as a vehicle to generate additional revenue from our installed base of products; our ability to deliver comprehensive and profitable solutions to our channel partners; the growth opportunity associated with sales through our indirect channel to larger distributed enterprises; weakening economic conditions that could lead to decreases in IT spending that could adversely impact operating results; the level of comfort of our channel partners in offering our solutions to their customers; the growth of the Network Security, Secure Content Management and Business Continuity markets; the impact of a failure to achieve greater international sales; our ability to maintain and enhance current product lines, develop new products, maintain technological competitiveness and meet the expanding range of customer requirements; the market opportunity for license and service revenue growth; our ability to deliver comprehensive solutions to channel partners, the positive characteristics of our software license and service revenue model on future revenue growth and the predictability of our revenue stream; the impact on revenue of the combination of subscription services sold in conjunction with new product offerings; expected competition in the Internet security market and our ability to compete in markets in which we participate; impact of service renewal rates on lowering selling and marketing expense; our ability to achieve increased incremental revenue per transaction through success of our software license and service revenue model; the impact of IT spending on demand for our products and services; the current and likely future impact of share-based compensation expense on reported operating results, anticipated revenue contributions of new products including continuous data protection, email security and SSL-VPN products and related services; the impact of growth in international operations on our exposure to foreign currency fluctuations; the possible impact of uncertainties in the auction rate and asset backed securities markets on the Company's financial performance; our ability to access funds held as auction rate securities in our investment portfolio; the impact of significant fluctuations in the exchange rate of some foreign currencies in relation to the US Dollar; diverging economic conditions in foreign markets in which we do business; pricing pressures on our solution based offerings; anticipated higher gross margins associated with our license and service offerings; the probability of realization of all deferred tax assets; assessment of future effective tax rates and the continued need for a partial tax valuation allowance; the potential for product gross margins to erode based upon changes in product mix; downward pressure on product pricing or upward pressure on production costs; the impact of product mix on product gross profits; the impact of the completion of "in sourcing" certain technical support functions on period over period comparisons of cost of license and service revenue and gross margin; the implementation of a second phase of technical support "in sourcing" activity; our ability to maintain investment in current and future product development and enhancement efforts; the introduction of new products and the broadening of existing product offerings; planned investments and expenses in current and future product development; production costs and sales volume comparisons between the NSA and SSL-VPN products and other hardware appliances; the rate of change of general and administrative expenses; the impact of geopolitical and macro-economic conditions on demand for our offerings; the ability of our contract manufacturers to meet our requirements; the belief that existing cash, cash equivalents and short-term investments will be sufficient to meet our cash requirements at least through the next twelve months; factors potentially impacting operating cash flows in future periods; and expected fluctuations in days sales outstanding. These statements are only predictions, and they are subject to risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a variety of factors, including, but not limited to, those set forth herein under the heading "Risk Factors". References to "we," "our," and "us" refer to SonicWALL, Inc. and its subsidiaries.

Overview

SonicWALL provides network security, secure remote access, content security, and business continuity solutions for businesses of all sizes. Our solutions are typically deployed at the edges of networks. These networks are often aggregated into broader distributed deployments to support companies that do business in multiple physical locations, interconnect their networks with trading partners, or support a mobile or remote workforce. Our solutions are sold in over 50 countries worldwide. Our descriptions of regions of the world in which we do business specifically excludes Cuba, Iran, Syria, Sudan and any other country identified by the United States Government as being state sponsors of terrorism and subject to economic sanctions and export controls.

The Company groups revenue into the following primary product categories of similar products:

(1) Unified Threat Management ("UTM") including both NSA and TZ products; subscription services such as Comprehensive Gateway Security Suite, Comprehensive Anti-Spam Service, integrated Gateway Anti-Virus, and Intrusion Prevention; software licenses such as our enhanced "SonicOS" operating system, node upgrades, and other services such as extended warranty and service contracts, training, consulting and engineering services.

(2) Secure Content Management ("SCM") including CSM and email security appliances, subscription services such as internet filtering and email protection term and perpetual licenses, and other services such as extended warranty and service contracts, training, consulting and engineering services.

(3) SSL VPN Secure Remote Access ("SSL") including SSL-VPN appliances, add-on software licenses and other services such as extended warranty and service contracts, training, consulting and engineering services.

(4) Continuous Data Protection ("CDP") including the CDP appliances, off-site data backup subscription services, site-to-site back-up licenses, and other services such as extended warranty and service contracts, training, consulting and engineering services.

We generate revenue within these product categories primarily from the sale of:
(1) products, (2) software licenses, (3) subscriptions for services such as content filtering, anti-virus protection and intrusion prevention, offsite data backup, email protection, and (4) other services such as extended warranty and service contracts, training, consulting and engineering services.

We currently outsource our hardware manufacturing and assembly to third party contract manufacturers and some of the key components in the Company's products come from single or limited number of suppliers. Outsourcing our manufacturing and assembly enables us to reduce fixed overhead and personnel costs and to provide flexibility in meeting market demand.

We design and develop the key components for the majority of our products. In addition, we generally determine the components that are incorporated in our products and select the appropriate suppliers of these components. Product testing and burn-in are performed by our contract manufacturers using tests that we typically specify.

We sell our solutions primarily through distributors and value-added resellers, who in turn sell our products to end-users. Some of our resellers are carriers or service providers who provide solutions to the end-user customers as managed services. Channel sales accounted for 99% of the total revenue in the three and nine month periods ended September 30, 2009 and 2008, respectively. Alternative Technology, Tech Data, and Ingram Micro, all of whom are technology product distributors, collectively accounted for approximately 46% and 48% of our total revenue in the three and nine month periods ended September 30, 2009, respectively, compared to approximately 50% and 49%, respectively, in the same periods last year.

We seek to provide our channel partners and customers with differentiated solutions that are innovative, easy to use, reliable, and provide good value. To support this commitment, we dedicate significant resources to developing new products and marketing our products to our channel partners and customers.

Key Success Factors of our Business

We believe that there are several key success factors of our business and that we create value in our business by focusing on our execution in these areas.

Channel

Our distributors and authorized resellers provide a valuable service in assisting end-users in the design, implementation, and service of our network security, content security, and business continuity solutions. We support our distribution and channel partners with sales, marketing, and technical support to help them create and fulfill demand for our offerings. We also focus on helping our channel partners succeed with our solutions by concentrating on comprehensive reseller training and certification, and support for our channel's sales activities.

Product and Service Platform

Our products serve as a platform for revenue generation for both us and our channel partners. Most product sales can result in additional revenue through the simultaneous or subsequent acquisition of software licenses, such as our Global Management System, or through the sale of additional value-added subscription services, such as Content Filtering; client Anti-Virus and integrated Gateway Anti-Virus; Anti-Spyware and Intrusion Prevention Services; email protection and off-site data backup.

Distributed Architecture

Our security solutions are based on a distributed architecture, which we believe allows our offerings to be deployed and managed at the most efficient location in the network. We are providing our customers and their service providers with mechanisms to enforce the networking and security policies they have defined for their business. We also use the flexibility of a distributed architecture to allow us to enable new functionality in already-deployed platforms through the provisioning of an electronic key, which may be distributed through the Internet.

Market Acceptance

We began offering integrated security appliances in 1997, and since that time we have shipped about 1.5 million revenue units. Our experience in serving a broad market and our installed base of customers provides us with opportunities to sell our new network security, content security, and business continuity solutions as they become available. The market acceptance of our current solutions provides our current and prospective channel partners with an increased level of comfort when deciding to offer our new solutions to their customers.

Integrated Design

Our platforms utilize a highly integrated design in order to improve ease-of-use, lower acquisition and operational costs for our customers, and enhance performance. Various models also integrate functionality to support different internet connection alternatives. Every appliance also ships with pre-loaded firmware to provide for rapid set up and easy installation. Each of these tasks can be managed through a simple web-browser session.

Our Opportunities, Challenges, and Risks

We serve substantial markets for network security, content security, and business continuity. Our goal is to deliver comprehensive and profitable solutions to our channel partners which address their customers' needs. We pursue the creation of these solutions through a blend of organic and inorganic growth strategies including internal development efforts, licensing and OEM opportunities, and acquisition of other companies. To the extent that these efforts result in solutions which fit well with our channel and end-users, we would expect to generate increasing sales. To the extent that these efforts are not successful, we would expect to see loss of sales and/or increased expenses without commensurate return.

International Growth

We expect that international revenue will continue to represent a substantial portion of our total revenue in the foreseeable future. Our percentage of sales from international territories does not represent the same degree of penetration of those markets as we have achieved domestically. We believe that a significant opportunity exists to grow our revenue by increasing our international penetration rate to match our penetration rate in the domestic market.

If we fail to structure our distribution relationships in a manner consistent with marketplace requirements and on favorable terms, the percentage of sales from international territories will decline and the revenue from our international operations may decrease.

Growth in Enterprises

We believe that sales through our indirect channel to enterprise class customers represent a growth opportunity for the Company. Our percentage of revenues from such customers does not represent the same degree of penetration of that segment as we have achieved with small to medium sized businesses. We believe that a significant opportunity exists to grow our revenue by increasing our penetration rate with this segment by leveraging the company's technological and channel strengths.

If we fail to establish competitive products and services for this segment, or fail to develop the correct channel partners and resources, the percentage of our revenue derived from enterprise class customers will not increase, and may, in fact, decrease.

License and Services Revenue

We believe that the software license and services component of our revenue has several characteristics that are positive for our business as a whole: our license and services revenue is associated with a higher gross profit than our product revenue; the subscription services component of license and services revenue is recognized ratably over the service periods, and thus provides, in the aggregate, a more predictable revenue stream than product or license revenue, which are generally recognized at the time of the sale; and to the extent that we are able to achieve good renewal rates, we have the opportunity to lower our selling and marketing expenses attributable to that segment. We expect our revenue from software licenses and services to continue to represent the majority of our total revenue subject to (1) continuing demand from our installed base of customers for the renewal and upgrading of such service, (2) the number of new hardware appliances sold, and (3) the demand for such services as attached to new hardware appliances sold.

Macro-Economic Factors Affecting IT Spending

We believe that our products and services are subject to the macro-economic factors that affect much of the information technology ("IT") market. Growing IT budgets and an increased funding for projects to provide security, mobility, data protection, and productivity could drive product upgrade cycles and/or create demand for new applications of our solutions. Contractions in IT spending can affect our revenue by causing projects incorporating our products and services to be delayed and/or canceled. We believe that demand for our solutions correlate with increases or decreases in global IT spending and we believe that current economic uncertainties, including fluctuating energy prices, difficulties in the financial sector, the availability of credit, softness in the housing market, underlying market liquidity, and geopolitical uncertainties may continue to have an adverse impact on IT spending in the markets in which we do business.

Critical Accounting Policies and Critical Accounting Estimates

The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions, and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. We believe that the judgments, assumptions and estimates upon which we rely are reasonable based upon information available to us at the time that these judgments, assumptions and estimates are made. However, any differences between these judgments, assumptions and estimates and actual results could have a material impact on our statement of operations and financial condition. The current volatility in the financial markets and associated general economic uncertainty increase the risk that such differences may be realized. The accounting policies that reflect our most significant judgments, assumptions and estimates and which we believe are critical in understanding and evaluating our reported financial results include: (1) revenue recognition; (2) sales returns and other allowances, allowance for doubtful accounts and warranty reserve; (3) valuation of inventory; (4) accounting for income taxes; (5) valuation of long-lived and intangible assets and goodwill; (6) share-based compensation; and
(7) fair value of investments. There have been no material changes to any of our critical accounting policies and critical accounting estimates as disclosed in Part II, Item 7 of our annual report on Form 10-K for the year ended December 31, 2008.

RESULTS OF OPERATIONS

The following table sets forth certain consolidated financial data for the
periods indicated as percentage of total revenue:

                                                 Three Months Ended           Nine Months Ended
                                                   September 30,                September 30,
                                                 2009          2008           2009          2008
Revenues:
Product                                           38.0%         40.2%          35.0%         42.0%
License and service                               62.0%         59.8%          65.0%         58.0%
Total revenues                                   100.0%        100.0%         100.0%        100.0%
Cost of revenues:
Product                                           19.5%         19.9%          18.5%         19.8%
License and service                               7.4%          9.7%           8.1%          9.4%
Amortization of purchased technology              1.5%          1.4%           1.5%          1.4%
Total cost of revenues                            28.4%         31.0%          28.1%         30.6%
Gross profit                                      71.6%         69.0%          71.9%         69.4%
Operating expenses:
Research and development                          18.6%         21.4%          19.2%         20.9%
Sales and marketing                               34.2%         36.5%          35.5%         38.9%
General and administrative                        8.7%          7.4%           8.6%          8.6%
Amortization of purchased intangible assets       0.5%          0.5%           0.6%          0.5%
Restructuring charges (reversals)                 0.0%         (0.2%)          0.0%          1.0%
Total operating expenses                          62.0%         65.6%          63.9%         69.9%
Income (loss) from operations                     9.6%          3.4%           8.0%         (0.5%)
Interest income and other expense, net            1.1%          2.1%           1.6%          3.2%
Income before income taxes                        10.7%         5.5%           9.6%          2.7%
Provision for income taxes                       (4.7%)        (4.3%)         (4.0%)        (1.9%)
Net income                                        6.0%          1.2%           5.6%          0.8%

The following table shows share-based compensation cost before taxes as a percent of total revenue for the periods indicated:

                                     Three Months Ended          Nine Months Ended
                                        September 30,              September 30,
                                     2009           2008         2009           2008
Cost of revenue                        0.3%           0.3%         0.2%          0.2%
Research and development               1.3%           1.6%         1.3%          1.6%
Sales and marketing                    1.5%           1.9%         1.6%          1.7%
General and administrative             1.1%           1.5%         1.2%          1.4%
Share-based compensation expense       4.2%           5.3%         4.3%          4.9%

Total Revenue

Total revenue by product category (in thousands, except for percentage data)

                           Three Months Ended                            Nine Months Ended
                             September 30,                                 September 30,
                           2009          2008         % Variance        2009          2008         % Variance

UTM                     $   39,450     $  40,918          (4%)        $ 112,943     $ 123,391          (8%)
% of total revenues            78%           77%                            77%           75%
SCM                          4,670         5,535          (16%)          15,023        17,513          (14%)
% of total revenues             9%           10%                            10%           11%
SSL                          4,438         4,600          (4%)           12,312        15,539          (21%)
% of total revenues             9%            9%                             8%            9%
CDP                          2,161         2,225          (3%)            6,150         7,944          (23%)
% of total revenues             4%            4%                             5%            5%
Total revenues          $   50,719     $  53,278          (5%)        $ 146,428     $ 164,387          (11%)

The 4% decline in revenue in the UTM product category for the three month period ended September 30, 2009 compared to the corresponding period of 2008 was due to the combination of a 6% decrease in product revenue and a 3% decrease in revenue from software license and subscription services contracts. The decline in product revenue was due to the combination of a 9% decrease in average net revenue per unit, offset by a 3% increase in units sold. The 3% decrease in software license and subscription services revenue was primarily due to declines in software license and anti-virus subscription services revenue, offset by an 11% increase in revenue from our CGSS subscription services. The 16% decline in revenue in the SCM product category for the three month period ended September 30, 2009 compared to the corresponding period of 2008 was due to the combination of a 52% decrease in product revenue and an 11% decrease in revenue from software license and subscription services contracts. The decline in product revenue was due to a 54% decrease in units sold, offset by a 3% increase in average net revenue per unit. The 4% decline in revenue in the SSL product category for the three month period ended September 30, 2009 compared to the corresponding period of 2008 was due to the combination of a 33% decrease in product revenue and an 8% decrease in subscription services contracts, offset by a 200% increase in software license revenue. The decrease in product revenue was due to the combination of a 32% decrease in units sold and a 2% decrease in average net revenue per unit. The increase in software license revenue was primarily due to a change that was effected in the fourth quarter of 2008 to the pricing structure of Aventail SSL-VPN solutions that offered end user licenses separately from the base appliances. The 3% decline in revenue in the CDP product category for the three month period ended September 30, 2009 compared to the corresponding period of 2008 was due to an 11% decrease in product revenue, offset by a 7% increase in revenue from software license and subscription services contracts. The decline in product revenue was due to a 23% decrease in units sold, offset by a 15% increase in average net revenue per unit.

The 8% decline in revenue in the UTM product category for the nine month period ended September 30, 2009 compared to the corresponding period of 2008 was due to the combination of a 19% decrease in product revenue and a 32% decrease in software license revenue, offset by a 3% increase in revenue from subscription services contracts. The decline in product revenue was due to the combination of an 11% decrease in units sold and a 9% decrease in average net revenue per unit. The increase in subscription services contract revenue was primarily due to an 18% increase in revenue from our CGSS subscription services. The 14% decline in revenue in the SCM product category for the nine month period ended September 30, 2009 compared to the corresponding period of 2008 was due to the combination of a 52% decrease in product revenue and a 9% decrease in revenue from software license and subscription services contracts. The decline in product revenue was due to the combination of a 48% decrease in units sold and an 8% decrease in average net revenue per unit. The 21% decline in revenue in the SSL product category for the nine month period ended September 30, 2009 compared to the corresponding period of 2008 was due to the combination of a 54% decrease in product revenue and a 3% decrease in subscription services contracts, offset by a 95% increase in software license revenue. The decrease in product revenue was due to the combination of a 29% decrease in units sold and a 36% decrease in average net revenue per unit. The increase in software license revenue was primarily due to a change that was effected in the fourth quarter of 2008 to the pricing structure of Aventail SSL-VPN solutions that offered end user licenses separately from the base appliances. The 23% decline in revenue in the CDP product category for the nine month period ended September 30, 2009 compared to the corresponding period of 2008 was due to a 39% decrease in product revenue, offset by a 3% increase in revenue from software license and subscription services contracts. The decline in product revenue was primarily due to a 41% decrease in units sold.

Total Revenue by Geographic Area (in thousands, except for percentage data) . . .