WatchGuard Reports Second Quarter 2006 Results

WatchGuard reported net revenue of $16.5 million for the secondquarter of 2006, compared to $18.6 million in the previous quarter,and $20.3 million in the second quarter of 2005. Product revenue was$8.4 million in the second quarter of 2006, compared to $10.9 millionin the previous quarter, and $12.9 million in the second quarter of2005. Service revenue was $8.1 million for the second quarter of 2006,compared to $7.7 million in the previous quarter, and $7.4 million inthe second quarter of 2005. Reflecting increased sales of WatchGuardsubscription services during the second quarter, deferred revenueincreased from $22.5 million at March 31, 2006, to $22.9 million atJune 30, 2006.

Product revenue for the second quarter of 2006 was affected byWatchGuard's transition to a sell-through revenue recognition modelduring the quarter in the U.K and Germany- Austria-Switzerland("DACH"). WatchGuard estimates the transition to a sell-through modelin these regions reduced product revenues by approximately $1.9million for the second quarter of 2006, not including changes incustomer buying patterns upon conversion to a sell-through model.

WatchGuard reported a net loss of $3.4 million, or $0.10 pershare, in the second quarter of 2006, compared to a net loss of $4.1million, or $0.12 per share, in the previous quarter, and a net lossof $2.0 million, or $0.06 per share, in the second quarter of 2005.Excluding amortization of acquisition-related costs, non-cashstock-based compensation, and restructuring charges, WatchGuardreported a non-GAAP net loss of $2.3 million, or $0.07 per share, inthe second quarter of 2006, compared to a non-GAAP net loss of $2.8million, or $0.08 per share, in the previous quarter, and a non-GAAPnet loss of $0.8 million, or $0.02 per share, in the second quarter of2005. The reconciliation of WatchGuard's GAAP operating results toWatchGuard's non-GAAP operating results for the quarters ended June30, 2006, March 31, 2006, and June 30, 2005, are set forth at the endof this release.

WatchGuard ended the second quarter of 2006 with $75.4 million incash and securities, of which $2.4 million is restricted cash underthe terms of certain real estate lease agreements. Cash and securitieswere unchanged from the $75.4 million on hand at March 31, 2006.

"In Q2 we continued to make progress on our turnaround," said EdBorey, Chief Executive Officer of WatchGuard. "Costs are undercontrol, we launched our new hardware and software platforms and wecompleted our transition from sell-in to sell-through revenuerecognition in the U.K. and DACH."

Webcast Information

An Internet broadcast and replay of WatchGuard's conference calldiscussing its second quarter of 2006 results (2:00 PM Pacific / 5:00PM Eastern) will be available on August 7, 2006, at www.watchguard.comunder "Investor Relations." Investors may access the live conferencecall by calling 866-700-7173 (U.S. and Canada) and 617-213-8838(International). The participant pass code is 70837820.

About WatchGuard Technologies, Inc.

WatchGuard provides network security. The company's Firebox Xfamily of upgradeable appliances delivers the performance,functionality and security strength to meet the needs of organizationsof any size. WatchGuard's Intelligent Layered Security protectsagainst emerging threats and provides the platform to integrateadditional services offered by the company. All WatchGuard productsinclude a LiveSecurity Service subscription for vulnerability alerts,software updates, expert security instruction, as well asindividualized and self-help customer care. WatchGuard isheadquartered in Seattle, Washington, with offices throughout Europeand Asia. For more information, please visit www.watchguard.com.

Certain statements in this press release, including statementsabout our ability to improve our results of operations and otherstatements about our plans, objectives, intentions, and expectationsare "forward-looking statements" within the meaning of the SecuritiesExchange Act of 1934, as amended. Forward-looking statements are basedon the opinions and estimates of management at the time the statementsare made and are subject to known and unknown risks and uncertaintiesand inaccurate assumptions that could cause actual results to differmaterially from those expected or implied by the forward-lookingstatements. Our actual results could differ materially from thoseanticipated in the forward-looking statements for many reasons,including the risk that we will be unable to improve our results ofoperations as expected or at all and the other risks described under"Risk Factors" in our quarterly report on Form 10-Q for the quarterended March 31, 2006, and in our Securities and Exchange Commissionfilings from time to time. Readers are cautioned not to place unduereliance upon these forward-looking statements, which speak only as ofthe date of this release.

WatchGuard, Firebox and LiveSecurity are either registeredtrademarks or trademarks of WatchGuard Technologies, Inc. in theUnited States and/or other countries. All other trademarks are theproperty of their respective owners.

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

Three Months Ended Six Months Ended
----------------------------- ------------------
June 30, March 31, June 30, June 30, June 30,
2006 2006 2005 2006 2005
---------- --------- -------- --------- --------
Revenues:
Product $ 8,390 $ 10,873 $12,878 $ 19,263 $22,009
Service 8,078 7,717 7,445 15,795 14,929
--------- -------- ------- -------- -------
Total revenues 16,468 18,590 20,323 35,058 36,938
--------- -------- ------- -------- -------
Cost of revenues:
Product (1) 3,626 4,568 5,265 8,194 9,348
Service (1) 1,835 1,704 1,457 3,539 2,928
--------- -------- ------- -------- -------
Total cost of
revenues 5,461 6,272 6,722 11,733 12,276
--------- -------- ------- -------- -------
Gross margin 11,007 12,318 13,601 23,325 24,662
--------- -------- ------- -------- -------
Gross margin percent 66.8% 66.3% 66.9% 66.5% 66.8%
Operating expenses:
Sales and marketing
(1) 6,630 7,101 7,607 13,731 15,553
Research and
development (1) 4,734 5,433 4,821 10,167 9,264
General and
administrative (1) 3,444 4,327 3,368 7,771 6,124
Amortization of other
intangible assets 243 243 243 486 487
Restructuring charges 92 - - 92 -
--------- -------- ------- -------- -------
Total operating
expenses 15,143 17,104 16,039 32,247 31,428
--------- -------- ------- -------- -------
Operating loss (4,136) (4,786) (2,438) (8,922) (6,766)
Interest and other
income, net 814 720 488 1,534 940
--------- -------- ------- -------- -------
Loss before income
taxes (3,322) (4,066) (1,950) (7,388) (5,826)
Provision for income
taxes 30 18 29 48 71
--------- -------- ------- -------- -------
Net loss $ (3,352) $ (4,084) $(1,979) $ (7,436) $(5,897)
========= ======== ======= ======== =======

Basic and diluted net
loss per share $ (0.10) $ (0.12) $ (0.06) $ (0.22) $ (0.17)
========= ======== ======= ======== =======

Shares used in
calculation of basic
and diluted net loss
per share 34,535 34,282 33,792 34,410 33,755
========= ======== ======= ======== =======


(1) Includes stock-based compensation as follows:

Cost of revenues:
Product $ 5 $ 8 $ 10 $ 13 $ 10
Service 28 35 52 63 52
Sales and marketing 158 235 252 393 252
Research and
development 151 252 415 403 415
General and
administrative 416 541 238 957 238
----- -------- ------- ------- ------
Total $ 758 $ 1,071 $ 967 $ 1,829 $ 967
===== ======== ======= ======= ======





WATCHGUARD TECHNOLOGIES, INC.
RECONCILIATION OF GAAP NET LOSS TO NON-GAAP NET LOSS
(In thousands)
unaudited

Three Months Ended Six Months Ended
----------------------------- -----------------
June 30, March 31, June 30, June 30, June 30,
2006 2006 2005 2006 2005
--------- --------- --------- -------- --------
GAAP net loss $ (3,352) $ (4,084) $(1,979) $(7,436) $(5,897)
Adjustments to
reconcile GAAP net
loss to non-GAAP net
loss:
Stock-based
compensation 758 1,071 967 1,829 967
Amortization of
other intangible
assets 243 243 243 486 487
Restructuring
charges 92 - - 92 -
-------- -------- ------- ------- -------
Non-GAAP net loss $ (2,259) $ (2,770) $ (769) $(5,029) $(4,443)
======== ======== ======= ======= =======

Non-GAAP basic and
diluted net loss per
share $ (0.07) $ (0.08) $ (0.02) $ (0.15) $ (0.13)
======== ======== ======= ======= =======
Shares used in
calculation of basic
and diluted non-GAAP
net loss per share 34,535 34,282 33,792 34,410 33,755
======== ======== ======= ======= =======

Use of Non-GAAP Financial Information

To supplement our consolidated financial statements presented on a
GAAP basis, WatchGuard uses a non-GAAP measure of net loss (including
on a per share basis), which is adjusted to exclude certain costs and
expenses. WatchGuard believes this non-GAAP measure is useful to
enhance an overall understanding of our past financial performance and
also our prospects for the future. This adjustment to our GAAP net
loss is presented 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, this non-GAAP measure is an indication of our baseline
performance before other charges that are considered by management to
be nonrecurring and otherwise outside of our core operating results.
This adjusted non-GAAP measure is among the primary indicators
management uses as a basis for planning and forecasting of future
periods. Non-GAAP results exclude the following items.

Stock-Based Compensation. Non-GAAP net loss excludes stock-based
compensation expenses, which consist primarily of expenses for stock
options, restricted stock awards and purchases of common stock under
our Employee Stock Purchase Plan. WatchGuard began recording
stock-based compensation expenses under SFAS 123(R) in the first
quarter of 2006. Prior to 2006, WatchGuard's stock-based compensation
expenses resulted primarily from the variable accounting treatment of
certain stock options issued to employees and directors, restricted
stock issued to directors and officers, stock options granted to
consultants and certain restricted common stock and common stock
subject to repurchase issued in connection with the RapidStream, Inc.
acquisition. WatchGuard excludes stock-based compensation expenses
from its non-GAAP financial measures primarily because these costs are
non-cash expenses with no current effect on cash or the future uses of
cash. WatchGuard does not consider these expenses as part of its
ongoing operating results when assessing the performance of the
Company. For these reasons, management believes that exclusion of
stock-based compensation expense may be important to an understanding
of WatchGuard's ongoing operational performance.

Amortization of other intangible assets. Non-GAAP net loss also
excludes amortization of other intangible assets arising from
WatchGuard's acquisition of RapidStream in April 2002. These non-cash
charges represent a non-cash expense that has no effect on current or
future period cash flows or operations of the Company. The
amortization expense results from WatchGuard's acquisition of
RapidStream in April 2002, a non-recurring event outside of the course
of WatchGuard's normal business operations. Due to the nonrecurring
nature of this event, management believes that exclusion of the
related amortization charges may be important to an understanding of
WatchGuard's ongoing operational performance.

Restructuring charges. Finally, non-GAAP net loss excludes
restructuring charges resulting from our restructuring plans initiated
in 2001 and 2002. Again, these charges represent a non-recurring,
non-cash expense that has no effect on current or future period cash
flows or operations. These restructuring charges resulted from the
Company's restructuring plan initiated in 2001, in an effort to
streamline operations and reduce operating costs, and an unrelated
restructuring in 2002, to eliminate redundancies and excess headcount
resulting from the acquisition of RapidStream. Due to the nonrecurring
nature of these events, management believes that exclusion of the
related restructuring charges may be important to an understanding of
WatchGuard's ongoing operational performance.

Management believes that presentation of non-GAAP net loss provides an
additional tool for investors to evaluate ongoing operating results
and trends. 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. Investors are encouraged to review
the reconciliation of non-GAAP net loss to the GAAP net loss, as
presented herein.




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

June 30, December 31,
2006 2005
---------------- --------------
(unaudited)
ASSETS

Current assets:
Cash and cash equivalents $ 22,298 $ 20,390
Short-term available-for-sale
investments 48,375 54,379
Trade accounts receivable, net 3,173 4,883
Inventories, net 4,532 4,093
Prepaid expenses and other 2,728 2,442
Short-term restricted cash 600 1,200
--------------- -------------
Total current assets 81,706 87,387
Property and equipment, net 5,986 6,197
Long-term restricted cash 1,800 1,800
Long-term available-for-sale
investments 2,279 -
Goodwill 66,605 66,605
Other intangibles, net, and other non-
current assets 1,202 1,735
--------------- -------------
Total assets $ 159,578 $ 163,724
=============== =============

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 2,340 $ 4,654
Accrued expenses and other liabilities 7,035 6,985
Short-term accrued restructuring costs 1,029 1,119
Short-term deferred revenues 19,966 18,278
--------------- -------------
Total current liabilities 30,370 31,036
Long-term deferred rent 1,162 1,302
Long-term accrued restructuring costs 2,390 2,756
Long-term deferred revenues 2,917 2,163
--------------- -------------
Total liabilities 36,839 37,257

Total stockholders' equity 122,739 126,467
--------------- -------------
Total liabilities and stockholders'
equity $ 159,578 $ 163,724
=============== =============





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

Three Months Ended Six Months Ended
------------------- -------------------
June 30, June 30, June 30, June 30,
2006 2005 2006 2005
--------- --------- --------- ---------
Operating activities:
Net loss $ (3,352) $ (1,979) $ (7,436) $ (5,897)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Noncash expenses:
Depreciation and
amortization of property
and equipment 719 647 1,397 1,303
Amortization of other
intangible assets 243 243 486 487
Stock-based compensation 758 967 1,829 967
Changes in operating assets
and liabilities:
Trade accounts receivable,
net 2,259 457 1,710 951
Inventories, net (478) (106) (439) (1,761)
Prepaid expenses and other
current assets (159) 306 (286) 116
Other assets 109 (192) 46 (175)
Accounts payable (474) (499) (2,314) (790)
Accrued expenses, other
liabilities and deferred
rent 55 (772) (90) 1,130
Accrued restructuring costs (218) (169) (456) (484)
Deferred revenues 344 436 2,442 116
-------- -------- -------- --------
Net cash used in operating
activities (194) (661) (3,111) (4,037)
-------- -------- -------- --------

Investing activities:
Purchases of property and
equipment, net (912) (346) (1,186) (413)
Proceeds from maturities of
marketable securities 25,170 14,925 41,376 41,572
Purchases of marketable
securities (21,032) (12,692) (37,539) (32,835)
-------- -------- -------- --------
Net cash provided by investing
activities 3,226 1,887 2,651 8,324
-------- -------- -------- --------

Financing activities:
Proceeds from stock option
exercises and issuances of
common stock under the
employee stock purchase plan 1,031 10 1,768 356
Change in restricted cash - - 600 -
-------- -------- -------- --------
Net cash provided by financing
activities 1,031 10 2,368 356
-------- -------- -------- --------

Net increase in cash and cash
equivalents 4,063 1,236 1,908 4,643
Cash and cash equivalents at
beginning of period 18,235 8,067 20,390 4,660
-------- -------- -------- --------
Cash and cash equivalents at
end of period $ 22,298 $ 9,303 $ 22,298 $ 9,303
======== ======== ======== ========