UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 20092011

OR

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                      to                     

Commission File Number 000-30093

 

 

Websense, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware 51-0380839
(State or other jurisdiction of
incorporation or organization)
 (I.R.S. Employer
Identification Number)

10240 Sorrento Valley Road

San Diego, California 92121

858-320-8000

(Address of principal executive offices, zip code and telephone number)

 

 

Securities registered pursuant to section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common stock, $0.01 par value NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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 by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer  x Accelerated filer  ¨ Non-accelerated filer  ¨ Smaller reporting company  ¨
  (Do not check if a smaller reporting company) 

Indicate by check mark whether the registrant is a shell company (as defined in the Rule 12b-2 of the Act):    Yes  ¨    No  x

The aggregate market value of the voting stockCommon Stock held by non-affiliates of the registrant, as of June 30, 20092011 was approximately $787$919.7 million (based on the closing price for shares of the registrant’s Common Stock as reported by the Nasdaq Global SelectNASDAQ Stock Market for that date). Shares of Common Stock held by each officer, director and holder of 10% or more of the outstanding Common Stock have been excluded in that such persons may be deemed affiliates. The identification of 10% or greater stockholders as of June 30, 2011 is based on Schedule 13G and/or Schedule 13D reports publicly filed before June 30, 2011. Exclusion of shares held by any person should not be construed to indicate that such person possesses the power, direct or indirect, to direct or cause the direction of management or policies of the registrant, or that such person is controlled by or under common control with the registrant.

The number of shares outstanding of the registrant’s Common Stock, $.01$0.01 par value, as of February 12, 201015, 2012 was 43,276,718.37,692,408.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Definitive Proxy Statement to be delivered to stockholders in connection with the Annual Meeting of Stockholders to be held June 8, 2010May 31, 2012 are incorporated by reference into Part III.III of this report. Such Definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after the conclusionclose of the registrant’s fiscal year ended December 31, 2009.

Certain exhibits filed with the registrant’s prior registration statements, periodic reports on forms 8-K, forms 10-K and forms
10-Q are incorporated herein by reference into Part IV of this Report.2011.

 

 

 


Websense, Inc.

Form 10-K

For the Fiscal Year Ended December 31, 20092011

TABLE OF CONTENTS

 

      Page

Part I

    

Item 1.

  

Business

  12

Item 1A.

  

Risk Factors

  14

Item 1B.

  

Unresolved Staff Comments

  2830

Item 2.

  

Properties

  2830

Item 3.

  

Legal Proceedings

  2830

Item 4.

  

Submission of Matters to a Vote of Security HoldersMine Safety Disclosures

  2831

Part II

    

Item 5.

  

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

  2932

Item 6.

  

Selected Financial Data

  3034

Item 7.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  3135

Item 7A.

  

Quantitative and Qualitative Disclosures About Market Risk

  4552

Item 8.

  

Financial Statements and Supplementary Data

  4754

Item 9.

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

  7383

Item 9A.

  

Controls and Procedures

  7383

Item 9B.

  

Other Information

  7584

Part III

    

Item 10.

  

Directors, Executive Officers and Corporate Governance

  7686

Item 11.

  

Executive Compensation

  7686

Item 12.

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

  7686

Item 13.

  

Certain Relationships and Related Transactions, and Director Independence

  7787

Item 14.

  

Principal AccountantAccounting Fees and Services

  7787

Part IV

    

Item 15.

  

Exhibits, Financial Statements andStatement Schedules

  7888
  

Signatures

  8191


PART I

Forward-Looking Statements

This reportAnnual Report on Form 10-K may contain “forward-looking statements” within the meaning of the federal securities laws made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements, which represent our expectations or beliefs concerning various future events, may contain words such as “may,” “will,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates”“estimates,” or other words indicating future results. Such statements may include but are not limited to statements concerning the following:

 

anticipated trends in revenue;revenues and billings;

 

plans, strategies and objectives of management for future operations;

 

growth opportunities in domestic and international markets;

 

new and enhanced reliance on indirect channels of distribution;

 

anticipated product enhancements or releases;

 

customer acceptance and satisfaction with our products, services and fee structures;

 

expectations regarding competitive products and pricing;

risks associated with launching new product offerings;

 

changes in domestic and international market conditions;

 

risks associated with fluctuations in currency exchange rates;

 

the impact of macroeconomic conditions on our customers;

 

expected trends in operating and other expenses;

 

anticipated cash and intentions regarding usage of cash, including risks related to the required use of cash for debt servicing;cash;

 

risks related to compliance with the covenants in our senior secured credit facility;

risks associated with integrating acquired businesses and launching new product offerings;agreement;

 

changes in effective tax rates, tax laws and tax interpretations and statements related to tax audits;

 

risks related to changes in accounting interpretations;interpretations or accounting guidance;

 

the volatile and competitive nature of the Internet and security industries; and

 

the success of our marketing programs and brand development efforts.

These forward-looking statements are subject to risks and uncertainties, including those risks and uncertainties described herein under Part I, Item 1A “Risk Factors,” that could cause actual results to differ materially from those anticipated as of the date of this report. We assume no obligation to update any forward-looking statements to reflect events or circumstances arising after the date of this report.

Websense®, our corporate logo, TRITONTM, V-SeriesTM, V5000TM, V10000TM, X-SeriesTM, ThreatSeeker®, Security LabsTM, PreciseIDTM, SurfControl® and SurfControl RiskFilter® are trademarks of Websense. All other brand names or trademarks appearing in this report are the property of their respective holders.

In this report, “Websense,” the “Company,” “we,” “us” and “our” refer to Websense, Inc., and our wholly owned subsidiaries, unless the context otherwise provides.

2011 ANNUAL REPORT    1


Item 1.Item 1.Business

Overview

We are a leadingglobal provider of unified Web, email and data security solutions designed to protect an organization’s data and users from external and internal threats, including modern cyber-threats, advanced malware attacks, information leaks, legal liability and productivity loss. Our customers deploy our subscription software solutions on standard servers or other information technology (IT) security solutions,(“IT”) hardware, including real-time Web security (including malware detection and removal), data security, and email security solutions. Our solutions are available as software installed on standard server hardware, as software pre-installed onour optimized appliances, and as a software ascloud-based service (software-as-a-service or “SaaS”) offering, or in a service offering (SaaS).hybrid hardware/SaaS configuration. Our products and services are sold worldwide to enterprises,provide content security to enterprise customers, small and medium sized businesses (SMBs)(“SMBs”), public sector entities, and Internet service providers through a network of value addeddistributors, value-added resellers and original equipment manufacturer (OEM) arrangements.manufacturers (“OEMs”).

Organizations rely on the WebInternet and email to conduct business, and frequently sendingsend critical dataor confidential information outside their network boundaries.perimeters as part of their established business processes. Accelerating use of rich Web-based applications with real-time interaction, social Web sites with user-generated content, and the rise of cloud-based services, are increasing the volume and value of information transmitted across the Internet. At the same time, the cost and number of security breaches involving data loss has increased, and regulatory compliance requirements have become more stringent. These trends support the need for effectiveunified, organization-wide Web and email security integrated withsolutions that include data security capabilities.loss prevention capabilities and address the dynamic nature of both content and cyber-threats.

Over the past 15 years, Websense has evolved from a reseller of computernetwork security products to a leading developer and provider of IT security software solutions. Our first Web filteringcommercial software product was released in 1996 and preventedcontrolled employee access to inappropriate Web content.sites. Since then, we have focused on adaptingdeveloping our Web filtering and content classification capabilities to address changingchanges in the Internet use patternsand the external threat environment, including the rise of Web-based social and business applications and the growing incidence of Web-based criminal activity, as well as integratingsophisticated, targeted cyber-attacks designed to steal valuable information. In 2008, we introduced the first products under our TRITON security architecture, the Websense Web securitySecurity Gateway with dynamic content categorization and advanced malware protection, and the Websense Data Security Suite for monitoring and protecting an organization’s valuable data assets. Since then, we have extended the TRITON platform with the introduction of the Websense Email Security Gateway and the Websense TRITON Security Gateway (combined Web, email security and data security), incorporated our enterprise data loss prevention engine and policy controls in all three TRITON security solutions.gateways, added deployment options with the V10000, V5000 and X10G appliances and integrated SaaS capabilities. Our TRITON content security solutions utilize a common management and reporting console that unifies security policies and enforcement across an organization and reduces the total management burden on IT departments.

Today, our customersOur products use our solutions to protect their networksadvanced content classification, deep content inspection, and data from external Web- and email-based attacks and internal threats of data loss from employee errors, insecure business practices and malfeasance.

Our portfolio of Web security, data security and email and messaging security software allows organizationspolicy management technologies to:

dynamically categorize user generated and other dynamic Web 2.0 content;

 

prevent access to undesirable and dangerous elements on the Web, such asincluding Web sites that contain inappropriate content or sitespages that download viruses, spyware, keyloggers, hacking tools and an ever-increasing variety of malicious code, includingand Web 2.0 sites with user-generatedthat contain inappropriate content;

 

identify and remove malicious applicationsmalware from incoming Web traffic;content;

 

preventmanage the unauthorized use and loss of sensitive data, such as customer or employee information;

filter “spam” out of incoming email traffic;

filter viruses and other malicious attachments from email and instant messages;social Web sites;

 

manage the use of non-Web Internet traffic, such as peer-to-peer communications and instant messaging;

 

protect from spam and malware embedded in Web-based user-generated content; and

controlprevent misuse of an organization’s valuable computing resources, including unauthorized downloading of high-bandwidth content.content;

We derive

inspect the majoritycontent of our revenue from ourencrypted Web security and email security offerings and expect that a majority of our revenues will continuetraffic to come from these products for several years. The market forprevent data loss, prevention (DLP) solutions is still in the early phases of development,malware and therefore will only comprise a small percentage of our revenues in 2010 even though we anticipate sales growth in 2010.access to Web sites with inappropriate content;

2        2011 ANNUAL REPORT


filter spam, viruses and malicious attachments from incoming email and instant messages; and

protect against data loss by identifying and categorizing sensitive or confidential data and enforcing pre-determined policies regarding its use and transmission within and outside an organization.

We operate in one industry segment, as defined by U.S. generally accepted accounting principles.principles (“GAAP”).

We commenced operations in 1994 as NetPartners Internet Solutions, Inc., a reseller of computer security products. In 1999, we changed our name to Websense, Inc. to reflect the shift in our business focus to a developer of Web filtering solutions. Our principal offices are located at 10240 Sorrento Valley Road, San Diego, California 92121.

Industry Background

As part of their overall business strategies, manyMany organizations use the Internet as an integral part of their computing infrastructure, expanding their use of the Web to enable critical businessmission-critical applications that are accessed over their corporate networks.such as customer relationship management, accounting, employee benefits, collaborative research and development and more. Many employees also use their organization’s computing resources for recreational “Web surfing,“Web-surfing, social networking, peer-to-peer file sharing, downloading of high-bandwidth content, instant messaging and other personal matters. In recent years, the same activities that made employees efficient and productive—doing research over the Internet, sharing files and sending instant messages and emails to customers and co-workers—have also made IT infrastructures and valuable corporate data vulnerable to

external threats such as malicious code, spyware, viruses, trojan horses and phishing and pharming exploits. The modern Web is characterized by dynamic, user-generated content, rendering traditional security measures against these threats inadequate.

Additionally, asAs organizations create collaborative virtual networks with their customers, suppliers, technology partners and other stakeholders, they increase the amountvalue and volume of confidential and sensitive data that travels across these networks. The growing adoption of cloud-based applications andIT architectures, SaaS offerings, and mobile devices further blursobscures the boundaries of organizations’ networks and has acceleratedincreases the amount of data leaving an organization. Securing this sensitive data from loss duestored outside an organization’s network. Steady growth in business use of social networking sites, which are characterized by dynamic user-managed content that is vulnerable to inadequate business process controls, employee error and malfeasance,malware injection, increases exposure to cyber-threats. At the same time, cyber-attacks targeting data have increased in sophistication, as well as undetected data-stealing malicious code,scale and frequency. Securing confidential data in this environment has become a top priority for IT executives.executives, but the success of recent high-profile cyber-attacks demonstrates that traditional security solutions that are focused on network perimeters are ineffective.

To provide effective IT security in this environment,build a sound defense against modern threats, organizations must be able to manage who uses what information,implement security that monitors both inbound and outbound network traffic (Web pages, emails, and attached documents) for content, context and data, as well as where and how the information can be sent or shared.behavior of any embedded applications. Real-time analysis and dynamic categorization of internal data, Web content, Web sites,email content, and new threats isembedded applications are necessary to keep up with changingthe social Web, content, newly created internal information, and mutating threats.cyber-threats. Enforcement policies must be user, contentuser-, content- and destination awaredestination-aware to provide adequate protection without hindering established business processes.processes, and policies must extend across both the Web and email communication channels. As a result, we believe there is a significant opportunity for integrated real-time Web security, data security and emailIT security solutions that unify Web security, email security and data loss prevention technologies to continuously monitor Web, data and emailnetwork traffic and apply use policies based on deep content analysis and dynamic categorization.

Our Products and Services

Overview of our Solutions

Our products protectare designed to provide content security by protecting an organization’s data and users from threats tomodern cyber-threats and advanced malware attacks, information securityleaks, legal liability and productivity loss, and can be grouped into three categories:

Web filtering and Web security (URL filteringsolutions that protect against Web-based malware and real-time scanning of Web traffic), targeted cyber-attacks, and prevent access to inappropriate content;

2011 ANNUAL REPORT    3


email security solutions that filter spam, malicious links, inappropriate images and malware from inbound email; and

data security (our DLP offering),solutions that discover the location of sensitive data within the network, monitor and prevent the movement of sensitive data in outbound Web and email traffic and messaging security. at the desktop to enforce policies and prevent information leaks.

We released our first Web filtering software product in 1996 and have continually refined our Web filtering solution throughout the years to provide organizations the ability to restrict access to inappropriate Web content and to Web sites identified as security risks. Our Web filtering solution is highly scalable and utilizes the same database and classification technologies that can be found in our more advanced and integrated content security solutions. In 2007, we expanded our portfolio of software products to include email and data security offerings, establishing Websense as a leading provider of content security software solutions.

In April 2010, we integrated the management of our advanced Web, email and data security solutions on the TRITON management console to deliver unified visibility and policy management across Web, email and internal network communications. Collectively, these products allow IT administrators to protect against modern cyber-threats, targeted cyber-attacks, and information leaks, as well as mitigate the risks of legal liability and productivity loss associated with unmanaged Web use.

Our Web and email security productssoftware solutions are available installed on standard servers or other IT hardware, including pre-installed on a Websense-optimized appliance, as SaaS offerings, and in hybrid hardware/SaaS configurations. Our data security technologies are available as software installed on standard server hardware, as software installed on an optimized V-series appliance,functionality integrated within our TRITON Web and email security gateways and SaaS offerings, or as a SaaS offering. Our data security products are availablemay be implemented separately as server-based software or integrated on our Websoftware. All Websense security appliance. In April 2010, we plansolutions include several reporting modules to expandmeet the capabilitiesinformation needs of these products with the launch of our Triton™ single platformdifferent management console which will deliver unified content analysis and management. Collectively, these products provide customers with Essential Information Protection, allowing IT administrators to manage who uses what information, where it can go and how.groups.

We typically sell subscriptions to our software and SaaS products generally in 12, 24 or 36 month durations, based on the number of seats or devices to be managed. RevenuesOur TRITON content security solutions, including our TRITON security gateways, our data loss prevention products, SaaS offerings and related appliances, accounted for 54% of billings in 2011, compared with 40% in 2010 and 28% in 2009. Billings from sales of subscriptions to our legacy Web filtering solutions, including the Websense Web Filter and security solutions and related add-on productsWebsense Web Security Suite, accounted for 46% of billings in 2011 and the majority of billings in 2010 and 2009. We expect sales of our revenues in 2009, 2008TRITON solutions will be the primary driver of our billings and 2007.revenue growth for several years, while the percentage of our billings derived from our Web filtering products will continue to decline. Billings represent the amount of subscription contracts, OEM royalties and appliance sales billed to customers during the applicable period. See “Item 7 – Managements’ Discussion and Analysis of Financial Condition and Results of Operation” for further detail regarding our use of the billings measurement.

Web SecurityWebsense TRITON Solutions

Our TRITON security platform provides advanced content security by integrating our Web, email and data security solutions range from basic URL filtering that mitigatestechnologies in a single unified security architecture designed to reduce security risks, improve compliance, protect data, improve productivity and mitigate legal liability at a reduced overall cost of ownership. At the productivity losscore of the TRITON architecture is the Advanced Classification Engine (ACE), which scans inbound and legal exposure associated with unmanagedoutbound Web use, to our advanced network-based Web security that scans Weband email traffic and sites for malicious codeuses advanced analytics and contextual awareness to identify and classify security threats, sensitive internal data, and inappropriate content in real-time. Our Web security solutions and our TritonThe TRITON management console expected to be released in April 2010, will shareunifies policies and enforcement across an organization for Web, email and internal network traffic, creating a common code base to facilitate upgradesconsistent security profile and reduce our customers’reducing the overall cost of ownership.management.

Our WebTRITON content security solutions integrateinclude Web, email and combined security gateways with an organization’s network server, proxy server, switch, router or firewallwithout integrated data loss prevention, along with functionally equivalent SaaS solutions, Websense-optimized appliances for mid-sized and are designed to work in networks of virtually any sizeenterprise-class organizations, and configuration. stand-alone enterprise data security solutions.

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TRITON Web Security

Websense Web Security solutions can support organizations ranging in size from small businesses to very large organizations. We currently offer four separate deployment options andGateway is a hybrid solution:

integrated deployment on a separate serverWeb security solution that is tightly integrated with the network gateway platform to offer pass-through filtering to maximize stability, scalability and performance;

stand-alone deployment utilizing a network agent to deliver pass-by filtering capabilities in a network environment;

embedded deployment on an appliance that we sell to reduce hardware expense and enhance ease-of-use, particularly in remote locations;

as a SaaS deployment; and

as a hybrid combination of on-premise software and SaaS application managed from a single management console.

Ourcombines traditional Web filtering with dynamic content scanning and Web security solutions useclassification using our policy enforcement software in conjunction withACE Classification Engine. The ACE Classification Engine uses analytics generated by our databasesThreatSeeker Network, which scans billions of categorized Web sites, protocolsemails and malicious applicationsother content to give business managersidentify new threats. The analytics used by the ability to automate the enforcement of highly customized InternetACE Classification Engine detect and application use policies for different usersblock new and groups within the business. The software allows organizations to manage employees’ use of the Internet by filtering access to Web sitesuncategorized threats and Internet protocols while providing multiple options for identifying, analyzing and reporting on Internet activity and the risks associated with employee computing.

Ourinappropriate content. Additionally, our Websense® Security Labs technology populates our Web filteringmaster database of uniform record locators (“URLs”), protocols, applications and Web security databasesmalware using a proprietary process of automatic content assessment and classification, with manual verification. Our systems scan more than 180 million Web sites and 100 million emails daily for new Web-based and email-based threats. Additionally,verification as necessary. With our experience with the characteristics, behavior and reputations of malicious Web sites allows us to dynamically classify uncategorized sites and content, including user-generated content on the Internet (“Web 2.0 content”), and malicious applications as they are discovered.

Websense Web Filter. Websense Web Filter enables employers to proactively analyze, report and manage employee access to Web sites based on the content of the requested Web site. Our software application works in conjunction with a database of categorized Web sites to provide patented flexibility for managers when customizing, implementing and modifying Internet access policies for various groups, user types and individuals. A graphical interface enables business managers to define the categories of Web sites to which access will be managed. The filtering software examines each Internet access request, determines the category of the requested Web site and applies the policies that have been defined by the company. Some examples of management options include:

Allow: The request is allowed to proceed, because the organization has chosen not to restrict access to the category applicable to the Web site.

Block: The requested Web site is in a category that is not allowed to be accessed according to the organization’s policy in effect.

Time-based Quotas: Users are allowed a specified amount of personal Web surfing time within categories that are determined by the administrator. Once the user reaches his or her quota time, he or she is no longer able to access sites in those categories.

Continue with Exception Report: The user is reminded about the organization’s Internet usage policy, but can choose to access the requested Web site.

Time of Day: Filtering options can be managed by time of day. For example, access to shopping sites could be blocked during business hours and permitted at all other times.

The breadth and specificity of our Web site categorization provide flexibility in selecting which types of material should be allowed, blocked or reported. There are currently more than 90 categories in the basic Web filtering product.

Websense Web Security. Websense Web Security combines the functionality and database categories of the basic Websense Web Filter with additional security-specific categories as well as several additional services, including Real Time Security Updates, for a bundled price.

Security Categories.Security categories augment the basic Web filtering database categories with categories for spyware and phishing Web sites, as well as sites compromised with malicious code.

Beyond sites found to be hosting known and potential exploit code, these categories also include sites likely to contain little or no useful content, sites that camouflage their true nature or identity, and sites that employees can otherwise access to utilize hacking tools. We continually update our security-specific categories as new malicious or compromised Web sites are identified by our ThreatSeeker Network.

Real Time Security Updates.Real Time Security Updates allow subscribing organizations to receive database updates for Web-based and application-based threats in real time as they are identified and categorized by the Websense Security Labs. Websense Security Labs scans more than 180 million Web sites and 100 million emails every day to identify new Web-based and blended threats.

Websense Web Security Gateway.Websense Web Security Gateway, allows organizationscustomers can proactively discover and mitigate new security risks, block dangerous malware, prevent access to secure Web traffic effectivelyinappropriate content, and manage social networking use, while still enabling the use of Web-based tools and applications for business and other productive use.

Our Web Security Gateway can be deployed on standard servers or other IT hardware or on a Websense-optimized appliance. Websense Web Security Gateway analyzesAnywhere expands our Web Security Gateway product with the addition of our enterprise data security engine and hybrid SaaS deployment options, all managed from the TRITON management console. Integrated data security technology protects against data leaks via the Web by monitoring outbound Web traffic in real-time, categorizing new sites and dynamicenforcing customer-specific data security policies. Hybrid hardware and SaaS deployment allows IT administrators to implement policies across the organization, regardless of the location of the user or mobile device.

TRITON Email Security

Websense Email Security Gateway is an appliance-based gateway solution that scans outbound and inbound email traffic to perform content proactively discovering security risksfiltering and blocking dangerous malware, including user-generated content on the Internet and other Web 2.0 content. It also provides advanced analytics, including rules, signatures, heuristics and application behaviors, to detect and block proxy avoidance, hacking sites, adult content, botnets, keyloggers,policy enforcement within an organization. Our email software blocks threats such as spam, phishing attacks spyware, and viruses, and protects confidential data within email and attachments, providing compliance functionality and enterprise-grade data security, all managed from the TRITON management console. Integrated data security technology protects against data leaks via email by monitoring outbound email traffic, including attachments, and enforcing customer-specific data security policies. Our Email Security Gateway can be deployed on standard servers or other typesIT hardware or on a Websense-optimized appliance. Websense Email Security Gateway Anywhere expands our Email Security Gateway product with the addition of unsafe content.our hybrid SaaS deployment options. Hybrid hardware and SaaS deployment allows IT administrators to prefilter inbound email traffic in the cloud for malware and spam, and filter outbound emails for content and data loss prevention.

Websense Hosted Web Security.TRITON Cloud Security Websense Hosted Web Security is a

The SaaS offering that directs a customer’s Web site requests to a centralized server hosted by Websense “in the cloud” that provides Web malware protection and granular Web filtering withoutdeployment model eliminates the need for the customercustomers to maintain an on-site server-based solution. The SaaS deployment modelsolution and provides centralized policy management for any type of IT environment, including those companiesenvironments with remote locations, home offices, and mobile laptops. Hosteddevices. Websense cloud security provides real-time security scanning and content classification and is functionally equivalent to our server-based solutions. The services include advanced features such as clientless authentication for users, a lightweight endpoint client to prevent users from bypassing security controls. Our Web Securityand email SaaS solutions are managed from the TRITON management console in the cloud and can be deployed as a complete Web filtering and security solution or it can be layered with existing on-premise Web security to provide additional layers of Web malware protection.

Reporting and Analysis.All Websense Web filtering and security solutions, include several reporting modulesor layered with existing server-based Web and email security solutions to meetprovide additional protection from malware and undesirable content.

Websense Cloud Web Security. Websense Cloud Web Security directs customer Web traffic to our centralized servers and enforces the information needs of different management groups.same security and acceptable use policies to mobile and remote users that are applied to server-based users.

Websense Reporter is a batch-based reporting application that can generate tabularCloud Web Security Gateway. Websense Cloud Web Security Gateway combines traditional Web filtering with dynamic content scanning and graphical reportsclassification by our ACE Classification Engine, with in-the-cloud deployment to protect against both previously known and dynamically generate thousands of exploratory reports based on an organization’s historical Internet use. It analyzes information from Internet monitoring logs and builds visual charts in a variety of pre-set or customizable formats for easy distribution to and interpretation by managers.new unclassified threats. With Websense

 

2011 ANNUAL REPORT     

Websense Real-Time Analyzer utilizes the network agent in Websense Web Filter to monitor and analyze network traffic in real-time. This allows IT managers to identify potential risks and bandwidth bottlenecks associated with different types of network traffic.

5


Websense Explorer is a browser-based forensics and analytics reporting tool for non-technical business managers that enables them to drill down on Internet use data by risk class, user group, or individual.

V-Series Appliances

Our V-Series appliances, including our V10000 appliance which launched in 2009 and our V5000 appliance expected to be launched in 2010, are optimized hardware appliances for our software products offering a combination of performance and flexibility that simplifies deployment for our customers by consolidating multiple security functions in a single hardware platform. V-Series appliances significantly reduce deployment time and operational costs for WebsenseCloud Web Security Gateway, customers while meeting large enterprise scalability requirements. V-Series appliances also integrate with the Websense SaaS platformcan proactively discover and mitigate new security risks, block dangerous malware, prevent access to offer customers the flexibility to deployinappropriate content, and manage theirsocial networking use, while still enabling the use of Web-based tools and applications for business and other productive use.

Websense Cloud Email Security. Websense Cloud Email Security directs customer email traffic to our centralized servers. Incoming email traffic is scanned for spam, inappropriate content, security solutions howmalicious links and where theyembedded malware without the need it.

for a customer to install software on an on-premise server, eliminating undesirable content before it reaches a customer’s network. Our service will also encrypt emails containing sensitive data before forwarding such email to its destination.

Websense Data Security

Our DLP productsdata security solutions protect against the loss of confidential information and data due to internal threats, such as inadequate business process controls, employee error and malfeasance, and external threats, such as theft by undetected malicious code embedded in the network. WeIn addition to offering stand-alone data security solutions, we have integrated our data security policy controls with our Web and email security solutions to provide visibility into data use withinunder the network as well as visibility into the data’s destination when it leaves the network via email, instant messaging, peer-to-peer networking or download to external device.TRITON architecture. This integrated approach allows managers to set comprehensive internal and external data use policies that enable critical business processes while preventing unauthorized transmission of sensitive data loss through data transmission andvia email or the Web, or by download to devices utilizing the universal serial bus (“USB”) protocol or other exchange including email, Web, USB, and other channels.technologies.

Websense Data Security Suite.Websense Data Security Suite is an integrated DLPdata security solution that protects against data loss by identifying and categorizing sensitive or confidential data based on its characteristics, monitoring the movement of sensitive data throughout the network and enforcing pre-determined usage and movement policies. TheAdditionally, the Websense Data Security Suite leverages our knowledgecan be managed with the TRITON management console for an integrated content security solution that extends beyond the internal network. Customers can also purchase modules of high-risk Web sites to prevent the transfer of sensitive or confidentialWebsense Data Security Suite separately as they develop and deploy their data via email, Web, USB, and other channels.security policies.

The Websense Data Security Suite:

 

discovers and identifies data stored on a network-connected device (data-at-rest);

 

monitors and prevents sensitive data from unauthorized distribution in outgoing and internal communications, including transmission through traditional and Web-based email, instant messaging Internet (FTP and http)file and Web-based emailhypertext transfer protocols (data-in-motion);

 

automates enforcement of policies for data-in-motion to authorized recipients;

 

monitors and prevents unauthorized copying of highly sensitive files to USB drivesdevices and other portable media, or being printedprinting to hardcopy paper; and

 

audits and reports the distribution and use of confidential data against regulatory and internal security policy requirements.

Separate modules include:

Websense Data Discover. Websense Data Discover remotely scans specified network files, shared drives, databases, email servers, data repositories, and desktops to discover and classify confidential data. Data Discover enforces data protection policies by applying actions including encryption, file removal, file replacement, notification, auditing, logging, and custom scripts.

Websense Data Security Gateway. Websense Data Security Gateway offers network-based data loss protection, securing sensitive data from inadvertent or deliberate transmission outside the network. It monitors not only common network channels of communication such as Web and email, but also file transfer protocols, instant messaging, peer-to-peer communications, and other forms of communication for sensitive data.

6        2011 ANNUAL REPORT


Websense Data Endpoint. Websense Data Endpoint extends the visibility and control to client endpoints to identify what data is confidential, who is using the data, how it is being used and where the data is being transferred. Websense Data Endpoint enables organizations to enforce policies in the endpoint environment.

The Websense Data Security Suite includes built-in policy templates for easy, out-of-the-boxsimple policy creation and a sophisticated policy engine to address the most common compliance requirements for United States federal and state regulations, as well as industry regulations such as the Payment Card Industry Data Security Standard (PCI DSS) and Check 21 Act, Canada’s Personal Information Protection and Electronic Documents Act (PIPEDA), and international government and banking regulations for the European Union, United Kingdom, Israel, South Africa, Australia and Singapore. These templates are automatically updated as regulations change.

TRITON Combined Security Solutions

Websense TRITON Security Gateway. Websense TRITON Security Gateway combines the functionality of the Web and email security gateways into one consolidated gateway solution consisting of a unified platform, unified content analysis, and unified management capabilities. Security analytics powered by our ACE Classification Engine provides malware protection and data loss prevention. Websense TRITON Security Gateway is available on our appliances and in a hybrid deployment which combines our optimized appliance and our SaaS platform to extend security policies to remote offices, users and devices efficiently.

Websense TRITON Enterprise. Websense TRITON Enterprise provides security to organizations seeking a highly flexible, scalable, and effective solution designed to provide Web, email and data security across the enterprise, from the desktop to mobile users. Websense TRITON Enterprise includes the entire Websense TRITON solution portfolio, including Web and email security gateways with built-in data security, SaaS Web and email security offerings, and end-point data loss prevention.

Appliances

V-Series. Our V-Series appliances, including our V10000 and V5000 appliances are standard server platforms optimized for our security software products. They offer a combination of performance and flexibility that simplifies deployment of our solutions for our customers by consolidating multiple security functions in a single hardware platform. V-Series appliances significantly reduce deployment time and operational costs of the Websense TRITON Security Gateways, while meeting scalability requirements for small and mid-sized enterprises. V-Series appliances also integrate with our SaaS platform to offer customers the flexibility to combine server-based and cloud-based solutions to maximize effectiveness for all users and devices, regardless of location.

X-Series. Our X-Series appliances utilize a modular chassis architecture to deliver large enterprises a highly available and scalable system with the necessary real-time data-aware contextual defenses that defend against advanced malware and prevent data theft of intellectual property. X-Series appliances are interoperable with our V-Series appliances and can be synchronized with our SaaS platform to allow an organization to deploy security policies to off-site users and to connect remote offices. Our first X-Series appliance, the X10G, was introduced in the fourth quarter of 2011 and includes a 10 gigabit Ethernet interface and supports up to 16 blades and scales from 10,000 to 100,000 users per chassis.

Web Filtering Solutions

Our Web filtering solutions mitigate the productivity loss and legal exposure associated with unmanaged employee Web use and prevent access to Web sites identified as security risks. These solutions are deployed in conjunction with an organization’s network gateway platform (such as a proxy server or firewall) and manage employee Web use by applying pre-determined policies to Web content classified in more than 95 categories in

2011 ANNUAL REPORT    7


our master database. The policy management software provides multiple options for monitoring, analyzing and reporting on Internet activity and the risks associated with employee computing.

Websense DataWeb Filter

Websense Web Filter enables employers to proactively analyze, report and manage employee access to Web sites based on the content of the requested Web site. Our software application works in conjunction with network user directories and our database of categorized Web sites populated by our Security Labs technology and our Threatseeker Network to provide patented flexibility for managers when customizing, implementing and modifying Internet access policies for various groups, user types and individuals. A graphical user interface simplifies policy definition and implementation. Once policies have been established, the filtering software examines each Internet access request, determines the category of the requested Web site and applies the policies that have been defined by the customer. The breadth and specificity of our Web site categorization provide flexibility in selecting which types of material should be allowed, blocked or reported.

Websense Web Security Suite is available in four modules: Data Discover, Data Monitor, Data Protect

Websense Web Security Suite combines the functionality and Data Endpoint.database categories of the basic Websense Web Filter with additional security-specific categories, as well as several additional services, including Real Time Security Updates. Websense Web Security Suite enables organizations to manage acceptable use policies and block access to sites associated with spyware, phishing, keylogging and other threats. Additionally, advanced application and network protocol controls mitigate risks associated with social networking applications, peer-to-peer communications and instant messaging applications, among others.

 

  

Data DiscoverSecurity Categories. Websense Data Discover provides organizationsSecurity categories augment the basic Web filtering database categories with discoverycategories for spyware and classification of confidential information stored on network desktops, laptops,phishing Web sites, as well as sites compromised with malicious code. Beyond sites identified as hosting known and file servers. It includes digital fingerprinting technologypotential exploit code, these categories also include sites likely to identify virtually any type of data (e.g., customer data, intellectual propertycontain little or no useful content, sites that camouflage their true nature or identity, and other confidential data), and robust reporting and incident workflowsites that employees can access to manage data at rest. Websense Data Discover provides situational awareness of where confidential data is stored to assess whether it is at risk of leaking outside the organization, and helps manage compliance and risk.utilize hacking tools.

 

  

Data MonitorReal Time Security Updates. Websense Data Monitor provides enterprise-wide auditing of a broad array of communications channels, including the Web, email, network printing, and instant messaging. It includes over 800 built-in policy templates for regulatory compliance and corporate governance, as well as digital fingerprintingReal Time Security Updates use cloud-based technology to identify confidential data in motion.deliver security category updates as new Web and application-based threats are identified and categorized by Websense Data Monitor helps organizations audit business processes with an advanced policy framework that identifies who is sending what data where,Security Labs and how, providing actionable intelligence and a set of remediation tools to reduce risk of data leakage and manage compliance.

Data Protect. Websense Data Protect includes Websense Data Monitor, and supplements that with built-in, automated policy enforcement to secure how and where an organization’s data travels. Its policy framework maps data policies to business processes, and is based on real-time knowledge of the user, the data, the destination, and the channel. Websense Data Protect provides automated policy controls for data in use and data in motion, with real-time reporting for global regulatory compliance and corporate governance. With Websense Data Protect, organizations can utilize enforcement actions such as blocking, quarantining, forced encryption, and notification, in addition to incident management tools to prevent data leakage, improve business processes, and manage compliance and risk.our ThreatSeeker Network.

Data Endpoint. Websense Data Endpoint extends our DLP technology to the endpoint (the individual user device, suchWebsense Web Security Suite can be deployed on standard servers or other IT hardware, including Websense-optimized appliances, or as a desktop computer, laptop computer or mobile data device), including the ability to discover, monitor, and protect confidential data whether the user is on or off the network. It includes fingerprinting and over 800 policy templates for data identification and can prevent data loss even if the user is offline. The Websense Data Endpoint’s protection extends to mediums such as USB devices, local printing, instant messaging, and for such actions as copy/paste and print screen.

Email and Messaging Security

Our email and messaging security solutions include our on-premise and SaaS email filtering solutions to provide protection from spam and viruses, as well as basic inbound and outbound content filtering that enforces corporate governance policies. The information we compile through our ThreatSeeker Network is used to detect and stop unwanted emails that contain inappropriate and malicious URLs. Our email and messaging security solutions also allow organizations to manage confidential data and inappropriate content in outbound emails.

Websense Hosted Email Security. Websense Hosted Email Security is a SaaS offering that directs customer email traffic to a centralized server hosted by Websense “in the cloud” that filters email traffic withoutoffering. The SaaS deployment model eliminates the need for the customer to install software onmaintain an on-site server in order to protect against viruses, spam,server-based solution and phishing before they reach the customers’ network. Our service will also encrypt sensitive email before forwarding such email to its destination.provides centralized policy management for any type of IT environment, including environments with remote locations, home offices, and mobile devices.

Additional Websense Hosted Email Security can be deployed in one of four available modules, as a complete email filteringProducts and security solution or layered with existing on-premise email filtering security to create a hybrid solution that provides additional layers of anti-spam protection and content filtering.Services

Websense Email Security. Websense Email Security is a software-based gateway solution that filters outbound and inbound email traffic to perform content filtering and policy enforcement within an organization. Our email software blocks threats such as spam, phishing, and viruses, and protects confidential data within email and attachments, providing out-of-the-box compliance and basic DLP. Websense Email Security also increases management visibility through email usage monitoring and interactive drill-down reports.

SurfControl Products

Through our acquisition of SurfControl plc (“SurfControl”) in October 2007, we acquired certain legacy products for which we do not have long-term plans.

We continue to sell renewal subscriptions to SurfControl Web Filter and SurfControl Mobile Filter, and have enhanced these solutions by supplementing the SurfControl URL database with additional Web filtering and security coverage provided by Websense Security Labs and ThreatSeeker technology. We no longer accept new subscriptions to these products from customers. In addition, we continue to sell new and renewal subscriptions to SurfControl RiskFilter within China.

Additional Websense Services

 

8     

Standard Technical Support. Standard Support is included with every Websense subscription. It provides unlimited access to the Websense Knowledge Base, which includes product support related documentation, tutorials, articles and frequently asked questions, and MyWebsense, our secure Web portal, as well as phone and email access to technical support engineers during normal business hours.

Premium Technical Support. Premium Support augments Standard Support with 24/7 access to global support centers via a toll free support hotline, priority email support and targets one-hour response time for the highest severity issues.

    2011 ANNUAL REPORT


Additional Services

Mission Critical Support. Mission Critical Support combines all the benefits of Premium Support with superior technical response coordinated by a technical account manager. Mission Critical Support also includes architecture reviews, migration planning assistance, training recommendations, and periodic account reviews.

Standard Technical Support. Standard technical support is included with every software subscription and includes phone and email access to technical support engineers during normal business hours and unlimited access to My Websense, our secure Web portal, and the Websense Knowledgebase. The Knowledgebase includes constantly updated product-support related documentation, tutorials, articles and frequently asked questions, as well as on-line customer forums and technical and security alerts.

Professional Services.

Premium Technical Support. Premium technical support augments standard technical support with access to global support centers twenty-four hours a day and seven days per week, via a dedicated telephone number and priority email support. This service targets one-hour response times for the highest severity issues. Premium technical support is required for Websense Web Security Gateways and Websense Data Security Suite implementations.

Mission Critical Support. Mission Critical Support combines all the benefits of premium technical support with superior technical response coordinated by a dedicated account manager. Mission critical support also includes architecture reviews, migration planning assistance, training recommendations and periodic account reviews.

Professional Services. Websense Professional Services assists customers through consulting engagements staffed by Websense certified engineers who assess, plan, design and optimize Websense Web, email or data or email security solutions for the customers’ business environment.

Customers

Our customers range from companies with as few as 10 employees to members of the Global 1,000 and tolarge global organizations, government agencies and educational institutions.institutions in approximately 150 countries around the world. Ingram Micro, one of our broad-line distributor fordistributors in North America, accounted for approximately 30%28%, 31% and 23%30% of our revenuerevenues during 20092011, 2010 and 2008,2009, respectively. Ingram Micro sold subscriptions through approximately 1,4001,200 resellers in North America in 2009.2011.

Sales, Marketing and Distribution

Sales.Sales Our.Our sales strategy is to increase sales to new customers and increase subscription renewals, upgrades and other incremental business to existing customers by expanding our security offerings and increasing the number and productivity of the resellers and distributors thatwho sell our products. products to end-user customers worldwide.

We sell our products and services primarily through multi-tiered indirect channels.channels comprised of distributors and value-added resellers with substantial support from our internal sales team and sales engineers. For 20092011, 2010 and 2008,2009, indirect channel sales comprised over 90% of total billings and revenues. We expect that trend will continue in 2010 with the vastlarge majority of our revenue beingbillings and revenues will continue to be derived from sales through indirect channels, including distributors and value-added resellers. We also have several arrangements with OEMs that grant the OEM customers the right to incorporate our products into their products for resale to end users.

In North America, we use Ingram Micro and Arrow Enterprise Computing Solutions to distribute our products and provide credit facilities, marketing support and other services to regional and local value-added resellers thatwho sell to end-user customers. Our agreements with Ingram Micro and Arrow Enterprise Computing Solutions are not subject to any minimum sales obligations or obligations to market our products to existing customers. Both agreements are non-exclusive and either party to each agreement may terminate the agreement at any time without cause.

Internationally, we sell our products to end-users.

Wedistributors and resellers in approximately 130 countries, who in turn sell our products to customers in North America principally throughapproximately 150 countries. No international distributor accounted for more

2011 ANNUAL REPORT    9


than 10% of our revenues in 2011. In 2011, 2010 and 2009, we derived approximately 50% of our revenues from international sales. Revenues generated in the United Kingdom comprised approximately 11%, 13% and 14% of our total revenues during 2011, 2010 and 2009, respectively. See Note 4 to the consolidated financial statements for further explanation of our revenues based on geography. We believe international markets continue to represent a two-tier distribution system. We sell productssignificant growth opportunity and we are continuing to expand our distributorsinternational operations, particularly in selected countries in the European, Asia/Pacific and Latin American markets. Our continuing reliance on sales in international markets exposes us to risks inherent in foreign sales. See “Item 1A. Risk Factors—Sales to customers outside the United States have accounted for a significant portion of our distributors market, distribute and support our software through value added resellers. revenues, which exposes us to risks inherent in international sales.”

We also sell directly to resellers that specialize in security software.software through our Enterprise Alliance Partner program. These resellers work closely with a team of Websense territory managers and sales engineers to target potential customers and often build implementation services around our products, particularly our Data Security Suite offering.

Internationally, we sell our products through a multi-tiered distribution network of distributors and resellers in over 120 countries, who in turn sell our products to customers located in over 150 countries.advanced TRITON content security solutions.

Our channel sales efforts are coordinated worldwide through an internal sales team of approximately 250460 individuals located in our key markets. Our internal sales force focuses on new customer acquisitions,acquisition, strategic account management and lead generation for our channel partners. Certain customers, who are typically large organizations, from time to time require that we sell directly to them. We also have several arrangements with original equipment manufacturers (“OEMs”) that grant OEM customers the right to incorporate our products into the OEM’s products for resale to end-users.

In 2009, we generated 50% of our total revenue from customers outside of the United States. Revenue generated in the United Kingdom represented approximately 14% of our total revenue during 2009. See Note 5 of Notes to Consolidated Financial Statements for further explanation of our revenue based on geography. Our current international efforts are focused on expanding our indirect sales channels in Europe, Asia/Pacific and Latin America. Our continuing reliance on sales in international markets exposes us to risks attendant to foreign sales. See “Item 1A. Risk Factors—Sales to customers outside the United States have accounted for a significant portion of our revenue, which exposes us to risks inherent in international sales.”

Marketing.Marketing. Our marketing efforts are designed to increase recognition of Websense as a leading provider of integratedunified Web, filtering and security, DLP and email and messagingdata security solutions;solutions, raise awareness of the potential risks associated with unmanagedto employees and sensitive data from unprotected use of corporate computing resources and confidential data;the modern Web, and generate qualified sales leads for our channel partners. We provide potential customers and channel partners with free trials of our security software and appliances, typically for 30-day periods.

Our marketing activities are targeted toward business executives, including IT and information technologysystem security professionals, chief executives, upper level management and human resources personnel. We actively manage our public relations programs, communicating directly with technology professionals and the media in an effort to promote greater awareness of the growing problems caused by external threats,modern cyber-threats, such as advanced malware attacks, viruses, spyware, phishing, sites, and key logging,keylogging, as well as internal security threats such as the loss of confidential data and employee misuse of the Internet and other computing resources at work.

Our marketing initiatives include:

 

jointjointly marketing programs with our distributors to recruit additional value-added resellers and driveto increase awareness for Websense solutions with existing resellers;

 

advertising online and in high-technology trade magazines, management journals and other business orientedbusiness-oriented periodicals;

 

participationparticipating in and sponsorship of trade shows and industry events;

 

providing free subscriptions to security alerts from Websense Security Labs, which inform subscribers of newly identified security threats, such as phishing sites and sites infected with spyware and malicious code;threats;

 

hosting regional and internationalholding seminars, webinars, and training sessions for our sales organization and reseller partners, as well as customers and prospects;prospective customers;

 

conductingholding speaking engagements on topics of interest to our customers and prospects;prospective customers;

 

use ofutilizing our Web propertiessite and other social media outlets to communicate with our indirect sales channels,customers and provide product and company information to interested parties; and

 

providingdistributing materials about Websense and distributing soft and hard-copy materials on our company, products, solutions, technologies, partnerships and benefits.

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Ingram Micro.Through our joint marketing programs, our North American broad-line distributor, Ingram Micro, focuses its efforts on recruiting and servicing resellers focused on selling to the small and medium-sized business (“SMB”) segment, and on building awareness and demand within our existing North America channel partner base. Ingram Micro accounted for approximately 30% and 23% of our revenue during 2009 and 2008, respectively. Ingram Micro sold subscriptions through approximately 1,400 resellers in North America in 2009. Our agreement with Ingram Micro is not subject to any minimum sales obligations or obligations to market our products to its customers, the agreement is non-exclusive and either we or Ingram Micro can terminate the agreement at any time without cause.

Technology Integrations.WebsenseOur solutions integrate with a variety of solution vendorsnetwork and information technology platforms. OurIT platforms and our objective is for Websense productssecurity solutions to be available for virtuallyeffective in any network environment desired by a customer.

The table below lists many of our technology integration partners:

Web Security Integration Partners:Data Security Integration Partners:

•   3Com

•   Blue Coat Systems

•   ADTRAN

•   Check Point Software Technologies

•   ArcSight

•   Clearswift

•   Blue Coat Systems

•   FaceTime Communications

•   Celestix Networks

•   LogLogic

•   Check Point Software Technologies

•   PGP Corporation

•   Cisco Systems

•   PostX

•   Citrix Systems

•   Safend

•   CP Secure

•   Tumbleweed

•   Crossbeam Systems

•   Zix Corporation

•   IBM

•   Juniper Netscreen

•   Microsoft

•   Network Appliance

•   Network Engines

•   Network Intelligence

•   Novell

•   Open Service

•   Resilience

•   Riverbed

•   SonicWALL

•   Stratacache

•   Sun Microsystems

Customer Service, Training and Support

We believe that superior customer support is critical to retaining and expanding our customer base. Our technical support group provides dependable and timely resolution of customer technical inquiries and is available to customers by telephone, email and over the Web. We also proactively update customers on a variety of topics, including release dates of new products, and updates to existing products.products and other technical alerts. We monitor the performance of our technology and support on an ongoing basis and seek to enhance our performance levels.

Our training services group delivers education, training, certification and pre-sales support to our resellers and customers. We also offerIn 2010, we introduced the TRITON Solution Technical Enablement Program, an online and instructor-led training and certification program on Websense Web filtering and TRITON content security solutions, to enable our partners to deliver superior service and value to our customers and resellers to provide them with the knowledge and skills to successfully deploy, use and maintain our products.joint customers.

Research and Development

We maintain research and development facilities in San Diego and Los Gatos, California; Reading, England; Beijing, China and Ra’anana, Israel. Our research and development department is divided into several groups, which include content operations, security research, software development, quality and assurance, and documentation. Individuals in different locations are grouped along product lines and work as part of cross-disciplinary teams designed to provide a framework for defining and addressing the activities required to bring product concepts and development projects to market successfully. In the last three years ending December 31,2011, 2010 and 2009, 2008 and 2007, we have spent approximately $53$58 million, $53$54 million and $41$53 million, respectively, on research and development activities.

Competition

The marketmarkets for our productsTRITON content security solutions and legacy Web filtering solutions is fragmented, highly and increasingly competitive, quickly evolving and subject to rapid technological change. Increased competition and pricing pressures generally could result in reduced sales, reduced renewals and/or declining seat growthcounts from existing customers, reduced margins or failure of our products to achieve or maintain more widespread market acceptance. Competitors vary in size and in the scope and breadth of the products and services they offer. Our currentThe competitive environments in which we operate and the principal competitors include:within each environment are described below.

TRITON Solutions for Content Security

companiesWeb Security. Our principal competitors offering Web filtering and Web security software solutions include companies such as Microsoft, Symantec/Message Labs, McAfee (acquired by Intel), Symantec, Trend Micro, Check Point Software Technologies, Cisco Systems, Juniper Networks, Trend Micro, Google, BrightCloud, Cisco Systems/ScanSafe, Blue Coat Systems, Aladdin, FaceTime, St. BernardMicrosoft, Google, Webroot Software, SafeNet, Actiance, EdgeWave, FireEye, M86 Security/Finjan,Security, Clearswift, Sophos, Kaspersky Lab, AhnLab, IBM, Panda Security, F-Secure, Commtouch, CA Technologies, Juniper Networks, Black Box Network Services and Barracuda Networks.

Email Security.Our principal competitors offering messaging or email security solutions include companies such as McAfee, Symantec/Message Labs, Google, Cisco Systems, Barracuda Networks, Digital Arts and Computer Associates;

companies integrating Web filtering into specialized security appliances, such as Blue Coat Systems, Cisco Systems, McAfee, WatchGuard, Check Point Software, St. Bernard Software, Barracuda Networks, Juniper Networks,SonicWALL, Trend Micro, SonicWALL,Microsoft, Axway, Sophos, Network BoxProofpoint, Clearswift, Commtouch, Zix, WatchGuard Technologies, M86 Security, Webroot Software, EdgeWave, Zscaler and M86 Security/Finjan;Fortinet.

companiesData Security.Our principal competitors offering DLPdata loss prevention solutions include companies such as Symantec, Verdasys, Trustwave, EMC, McAfee, IBM, Trend Micro, Proofpoint, Palisade Systems, Computer Associates,CATechnologies, Raytheon, Intrusion, Fidelis Security Systems, GTB Technologies, Workshare, Check Point

2011 ANNUAL REPORT    11


Software Technologies and Code Green Networks;

companies offering messaging security, such as McAfee, Symantec/Message Labs, Google, Cisco Systems, Barracuda Networks, SonicWALL, Trend Micro, Axway/Tumbleweed, Sophos, Microsoft, Proofpoint, Clearswift and WatchGuard;

companies offering on-demand email and Web security services, such as Google, Symantec/Message Labs, McAfee, Webroot, St. Bernard Software, Purewire, BrightCloud, Zscaler, Trend Micro and Cisco Systems/ScanSafe;

companies offering desktop security solutions, such as Check Point Software Technologies, Cisco Systems, McAfee, Microsoft, Symantec, Computer Associates,CA Technologies, Sophos, Webroot Software, IBM and Trend Micro; andMicro.

Web Filtering Solutions

companiesOur principal competitors offering Web gatewayfiltering solutions, including through specialized security appliances, include companies such as Microsoft, Blue Coat Systems, Cisco Systems,McAfee, Symantec, Trend Micro, Check Point Software McAfeeTechnologies, Cisco Systems, Blue Coat Systems, Microsoft, Google, Webroot Software, SafeNet, Actiance, EdgeWave, FireEye, M86 Security, Clearswift, Sophos, Kaspersky Lab, AhnLab, IBM, Panda Security, F-Secure, Commtouch, CA Technologies, Palo Alto Networks, Fortinet, Barracuda Networks and Juniper Networks.SonicWALL.

We also face current and potential competition in Web filtering and Web security from vendors of Internet servers, operating systems and networking hardware, many of which now, or may in the future, develop and/or bundle Web filtering, Web security or other competitive products with their offerings.current products with no price increase to these current products. We compete against and expect increased competition from anti-virus software developers, firewall providers, traditional network management software developers, and Web management service providers. In the DLP market, we face competition from anti-virus software developers, email filtering and security vendors,providers and providers of other software-based compliance solutions.

We believe that the principal competitive factors affecting the markets for our products include, but are not limited to:

 

•    performance

  

•    innovation

•    quality

  

•    customer support

•    introduction of new products

  

•    frequency of upgrades and updates

•    brand name recognition and reputation

  

•    reductionlower cost of production costsownership

•    price

  

    integration and manageability of products

•    functionality

  

•    reputationthreat research

We believe that we compete effectively against our competitors in each of these areas. However, many of our current and potential competitors, such as Symantec, McAfee, Trend Micro, Cisco Systems, Check Point Software Technologies, Google and Microsoft, have significantly greater financial, technical, marketing or other resources. They may have

significantly greater name recognition, established marketing and channel relationships, both in the United States and internationally, better access to the SMB market, and access toenterprise customers, and a larger installed base of customers.users. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the functionality of their products to address customer needs.needs or may be acquired by a corporation with significantly greater resources. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share.

Intellectual Property Rights

Our intellectual property rights are important to our business. We rely on a combination of trademark, copyright, patent and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology and the Websense brand.brands. We generally distribute our products under subscription agreements that grant customers a right to use our products and receive daily database updates for a specified termtime period and contain terms and conditions prohibiting the unauthorized reproduction or transfer of our products. In addition, our policy is to enter into confidentiality and invention assignment agreements with all employees and consultants, and nondisclosure agreements with all other parties to whom we disclose confidential information. These protections, however, may not be adequate to protect our intellectual property rights.

We have registered our Websense trademark in the United States, Japan, the European Union, Canada, Australia, China, Switzerland, Norway, Mexico, Colombia, Argentina, Singapore, South Africa, Taiwan, Brazil,

12        2011 ANNUAL REPORT


Iceland, India, Morocco, Peru, SingaporeChile, Hong Kong, Jordan, New Zealand, Russia and Turkey. In addition, we have registrations for other Websense trademarks pending in several other countries. Effective trademark protection may not be available in every country where our products are available.

We seek to protect the source code of our products as trade secrets and as unpublished copyrighted works. We currently have 1933 patents issued in the United States, 2728 patents issued internationally, 4235 patent applications pending in the United States and 6488 pending international patent applications that seek to protect our proprietary database and certain Web filtering technologies, ThreatSeeker Web security technology, our ACE Classification Engine and DLPdata loss prevention and content distribution technology, including our PreciseID digital fingerprinting. No assurance can be given that any pending patent applications will result in issued patents. Our patents cover features of our product offerings that we believe help differentiate our products.

Employees

As of December 31, 2009,2011, we had 1,4521,502 employees worldwide, including 282265 in cost of revenue departments, 597615 in selling and marketing, 441502 in research and development and 132120 in administration. None of our employees are represented by a labor union, and we have never experienced a work stoppage. We believe that our relations with our employees are good.

Web Site Access to SECSecurities and Exchange Commission Filings

We maintain an Interneta Web site atwww.websense.com. The content of our Web site is not part of this report.Annual Report on Form 10-K. We make available, free of charge, through our Internet Web site our annual reportreports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended or the Exchange Act,(the “Exchange Act”), available free of charge on our Web site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.Securities and Exchange Commission (the “SEC”).

Executive Officers of the Registrant

Our executive officers and their ages as of February 15, 20102012 are as follows:

 

Name

  Age 

Position(s)

Gene Hodges

  5860  Chief Executive Officer

John McCormack

  5052  President

Douglas C. Wride

56Chief Operating Officer

Didier Guibal

  4750  Executive Vice President, Worldwide Sales

Arthur S. Locke IIIMichael A. Newman

  4642  Sr. Vice President, andInterim Chief Financial Officer,

Michael A. Newman

40Sr. Vice President, General Counsel, Chief Administrative Officer and Corporate Secretary

Gene Hodges has been the Chief Executive Officer of Websense since January 2006, and was Websense’s President from January 2006 to April 2007. He has been a Director of Websense since January 2006. Prior to joining Websense, Mr. Hodges served as President of McAfee, Inc., a security technology company subsequently acquired by Intel Corporation in 2011, from November 2001 to January 2006. Mr. Hodges served as President of the McAfee Product Group from January 2000 to November 2001. From2001, and from August 1998 to January 2000, he served as Vice President of Security Marketing. Mr. Hodges received a B.A. in Astronomy from Haverford College and completed the Harvard Advanced Management Program for business executives.

John McCormack has served as President of Websense since April 2009. Previously, Mr. McCormack served as Senior Vice President, Product Development of Websense from July 2006 to April 2009. From October 2005 until May 2006, Mr. McCormack was Vice President of Engineering for Symantec, Corporation, a publicly-traded security software company. Mr. McCormack joined Symantec through the acquisition of Sygate Technologies, Inc., a provider of network access software, where he was Senior Vice President of Product Development from May 2004 to October 2005. From 1997 to 2004, Mr. McCormack served in various capacities withfor Cisco Systems, Inc.,

2011 ANNUAL REPORT    13


a publicly-traded computer hardware and software company, most recently as General Manager of the Secure Managed Networks Business Unit. Mr. McCormack received his MastersMaster’s degree in Engineering Management from George Washington University and a B.S. in Computer Science from the University of New Hampshire.

Douglas C. Wride became Websense’s Chief Operating Officer in January 2009. Mr. Wride previously served as Websense’s President from April 2007 to April 2009 and as Chief Financial Officer from June 1999 until August 2007 and again from March 2009 to July 2009. From March 1997 to December 1998, Mr. Wride served as Chief Financial Officer of Artios, Inc., a provider of hardware and software design solutions to companies in the packaging industry. Mr. Wride also served as Chief Operating Officer of Artios from July 1997 to December 1998. Mr. Wride is a C.P.A. (inactive) and received his B.S. in Business/Accounting from the University of Southern California.

Didier Guibal has served as Websense’s Executive Vice President, Worldwide Sales, since July 2009. Mr. Guibal was previously President of Panda Security, a provider of IT security solutions from April 2008 to October 2008. From May 2000 to January 2007, Mr. Guibal was a Vice President of Sales at Rightnow Technologies, Inc., a publicly traded provider of SaaS enterprise solutions. From April 1996 to April 2000, Mr. Guibal was employed by McAfee, Inc., ultimately serving as Vice President of Sales-Americas. Mr. Guibal received a master’shis Master’s degree in business atBusiness from Sup de Co-Business School in Montpellier, France.

Arthur S. Locke III has served as Senior Vice President, Chief Financial Officer of Websense since July 2009. Mr. Locke was previously employed by MicroStrategy Incorporated, a publicly traded worldwide provider of business intelligence software and services, from January 2001 to March 2009, ultimately serving as Executive Vice President, Finance and Chief Financial Officer. Mr. Locke is a C.P.A. and received a Bachelor of Science in Business Administration (BSBA) in Accounting and Computer Systems from American University.

Michael A. Newman has served as Senior Vice President, General Counsel, Chief Administrative Officer and Corporate Secretary of Websense since August 2007,December 2010, after serving as Websense’s Senior Vice President, General Counsel and Corporate Secretary since August 2007. Mr. Newman has also served as Websense’s interim Chief Financial Officer since September 2011. Mr. Newman was previously Websense’s Vice President and General Counsel from September 2002 to August 2007. From April 1999 to September 2002, Mr. Newman served in the legal department of Gateway, Inc., a

publicly-traded PCpersonal computer manufacturer, and prior to that, Mr. Newman practiced as an attorney in the San Diego offices ofwith Cooley Godward, LLP and Latham & Watkins LLP, two of California’s leading law firms. Mr. Newman received his B.S. in Business Administration from Georgetown University, and a J.D. from Harvard Law School.

 

Item 1A.Item 1A.Risk Factors

YouIn addition to the other information in this report, including the important information in “Forward-Looking Statements,” you should carefully consider the following information in addition to other information in this report before you decide to purchaseevaluating our common stock.business and our prospects. The risks and uncertainties described below are those that we currently deem to be material and that we believe are specific to our company and our industry. In addition to these risks, our business may be subject to risks currently unknown to us. If any of these or other risks actually occur, our business, financial condition, results of operations, and cash flows may be adversely affected, the trading price of our common stock could decline, and you may lose all or part of your investment in Websense.

Recent volatilityOur future success depends on our ability to sell new, renewal and upgraded subscriptions to our security products.

We expect that a majority of our billings for 2012 will be derived from our TRITON content security solutions, including the TRITON security gateways, our data loss prevention products, SaaS offerings sold with or without appliances and related appliances. We also expect the percentage of our billings derived from our Web filtering products will decline in 2012 as many of our customers transition to our TRITON products or lower-priced products sold by our competitors. Our billings and revenue growth are dependent on sales of security products to new customers and to customers who upgrade products upon renewal, which must also offset declines in sales from the renewals of Web filtering subscriptions. We also depend upon enterprise customers for a substantial portion of our sales. If we cannot sufficiently increase our customer base with the addition of new customers and upgrade subscriptions for additional product offerings from existing customers or renew a sufficient number of customers, we will not be able to grow our business to meet expectations.

Subscriptions to our software and SaaS products generally have durations of 12, 24 or 36 months. Our billings and revenues depend upon maintaining a high rate of sales of renewal subscriptions and adding additional product offerings to existing customers as well as new customer sales. Our customers have no obligation to renew their subscriptions upon expiration, and if they renew, they may elect to renew for a shorter duration than the previous subscription period. As a result of macroeconomic conditions, our customers may

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elect to renew subscriptions for shorter durations and may reduce their subscribed products due to contractions of work forces of their respective organizations. This may require increasingly costly sales efforts targeting senior management and other management personnel associated with our customers’ Internet and security infrastructure. We may not be able to maintain or continue to generate increasing revenues from existing customers.

Volatility in the global economy and macroeconomic conditions may adversely impact our business, results of operations, financial condition or liquidity.

The global economy has been experiencingexperienced a period of unprecedented volatility characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from governments and regulatory agencies worldwide. We believe that financial distress and associated headcount reductions implemented by certain of our end user customers have caused these customers to choose shorter contract durations and/or reduce the number of seats under subscription and in some cases, have caused customers not to renew contracts at all. While the number of distressed customers appears to have stabilized, we expect this trend to continue until and unless there is a broad worldwide economic recovery and positive job growth. These trends, maymost recently in continental Europe, have negatively impactimpacted the duration and scope of contract renewals in certain countries or regions in the world and, in some cases, may resultresulted in customer losses. Our average contract duration may be volatile as we seek contract renewals without eroding our average contract price for our products and seek to sell subscriptions to our TRITON and gateway security products which may have longer durations and may depend on product mix. Credit markets may also adversely affect our resellers through whom our distributors distribute products and limit the credit value-added resellers may extend to their customers. The volatility of currency exchange rates can also significantly affect sales of our products denominated in foreign currencies. In addition, events in the global financial markets may make it difficult for us to access the credit markets or to obtain additional financing or refinancing, if needed, on satisfactory terms or at all.

Our future success depends on our ability to sell new, renewal and upgraded subscriptions toIf our security products.

Substantially all of our revenue for the fiscal year ended December 31, 2009 was derived from new and renewal subscriptions to our Web filtering and Web securitygateway products, and we expect that a significant majority of our sales for 2010 will continue to be derived from our Web filtering and Web security products, including our Web Security Gateway. We expect sales of our V-Series appliances, DLPdata loss prevention products, SaaS offerings and other products under development to comprise a relatively small portion of our overall sales in 2010, but represent a meaningful portion of our sales growth in 2010. If our products fail to meet the needs of our existing and target customers, or if they do not compare favorably in price, features and performance to competing products, our operating results and our business will be significantly impaired. If we cannot sufficiently increase our customer base with the addition of new customers and upgrade subscriptions for additional product offerings from existing customers or renew a sufficient number of customers, we will not be able to grow our business to meet expectations.

Subscriptions for our Web security, data security and email security products typically have durations of 12, 24 or 36 months. Our revenue depends upon maintaining a high rate of sales of renewal subscriptions and adding additional product offerings to existing customers as well as new customer sales. Our customers have no obligation to renew their subscriptions upon expiration, and if they renew, they may elect to renew for a shorter duration than the previous subscription period. As a result of macroeconomic conditions, our customers may elect to renew subscriptions for shorter durations and may reduce their subscribed products due to contractions of

work forces of their respective organizations. This may require increasingly costly sales efforts targeting senior management and other management personnel associated with our customers’ Internet and security infrastructure. We may not be able to maintain or continue to generate increasing revenue from existing customers.

Failure of our security products, including our security gateway products, DLP products, SaaS security solutions and our new V-series appliance platform,platforms are unable to achieve more widespread market acceptance our business will be seriously harm our business.harmed, particularly as Web filtering products continue to commoditize.

Our ability to generate revenue growth depends on our ability to continue to diversify our offerings by successfully developing, introducing and gaining customer acceptance of our new products and services, particularly our security gateway offerings.offerings as our Web filtering products have become more of a commodity. We now sell our next generation Web contentTRITON and gateway security products to address emerging Web 2.0 threats, Websense Web Security Gateway, as well as our V10000 applianceV-Series and X-Series appliances pre-loaded with our software. We also sell the Websense Data Security Suite, our DLPdata loss prevention offering, for the data security market, Websense HostedCloud Web Security and Websense HostedCloud Email Security, our SaaS offerings, and Websense Email Security, our email filtering solution. In April 2010, we will introduceWe offer our Tritonproducts with TRITON, our unified Web, email and data security architecture,solution, which combines our products into a single platform, and during 2010 we will also release our V5000 appliance.platform. We continue to develop and release products in accordance with our announced product roadmap. We may not be successful in achieving market acceptance of these or any new products that we develop and may be unsuccessful in obtaining incremental sales as a result. If our products fail to meet the needs of our existing and target customers, or if they do not compare favorably in price, features and performance to competing products, our operating results and our business will be significantly impaired. If we fail to continue to upgrade and diversify our products, we could lose revenuerevenues from renewal subscriptions for our Web filtering products as these products become more of a commodity.continue to suffer from commoditization.

Our V-seriesV-Series and X-Series appliance platformplatforms exposes us to risks inherent with the sale of hardware, to which we were not previously exposed as a software company.

With the launch of our V10000 applianceV-Series appliances in 2009, and the scheduled release of our V5000 appliance in 2010, we are nowbegan selling a productproducts that isare hardware-based and not solely software-based. Our V-series appliances are manufactured by a single third-party contract manufacturer, and a single third-party logistics company is providingprovides logistical services, including product configuration and shipping.

2011 ANNUAL REPORT    15


Our ability to deliver our V-series appliances to our customers could be delayed if we fail to effectively manage our third-party relationships or if our contract manufacturer or logistics provider experiences delays, disruptions or quality control problems in manufacturing, configuring or shipping the appliance.appliances. If our third-party providers fail for any reason to manufacture and deliver the V-series appliances with acceptable quality, in the required volumes, and in a cost-effective and timely manner, it could be costly to us, as well as disruptive to product shipments. In addition, supply disruptions or cost increases could increase our cost of goods sold and negatively impact our financial performance. If we are required to change our contract manufacturer and/or logistics provider, we may be unable to deliver our appliances to our customers on a timely basis which could result in loss of sales and existing or potential customers and could adversely affect our business and operating results. Our V-series appliance platformplatforms may also face greater obsolescence risks than our pure software products.

Our revenue isrevenues are derived almost entirely from sales through indirect channels and we depend upon these channels to create demand for our products.

Our revenue hasrevenues have been derived almost entirely from sales through multi-tiered indirect channels, including value-added resellers, distributors and OEM customers that sell our products to end-users,end users, providers of managed Internet services and other resellers. Although we rely upon these indirect channels of distribution, we also depend significantly upon our internal sales force to generate sales leads and sell products through the reseller network. Ingram Micro, one of our broad-line distributors in North America, accounted for approximately 28%, 31% and 30% of our revenuerevenues during the fiscal year ended December 31, 2009.years 2011, 2010 and 2009, respectively. Should Ingram Micro or any of our other distributors experience financial difficulties, difficulties in collecting their accounts receivable or otherwise delay or prevent our collection of accounts receivable from them, our revenuerevenues and cash flow would be adversely affected. Also, should our resellers be subject to credit limits or have financial difficulties that limit financing terms available to them, our revenuerevenues and cash flow could be adversely affected. Our indirect sales model involves a number of additional risks, including:

 

our resellers and distributors including Ingram Micro, are not subject to minimum sales requirements or any obligation to market our products to their customers;

we cannot control the level of effort our resellers and distributors expend or the extent to which any of them will be successful in marketing and selling our products;

 

we cannot assureensure that our channel partners will market and sell our newer product offerings such as our security-oriented offerings, our Web Security Gateway, our V-seriesV-Series and X-Series appliances, our DLPdata loss prevention and email offerings, our SaaS offerings or our SaaSTRITON content security solutions;

providers of networking hardware, OEM customers and other value-added resellers that incorporate our products into, or bundle our products with, their products may fail to provide, or restrict us from providing, adequate support services to end users of these integrated product offerings, harming our reputation and brand, or may decide to develop or sell competing products instead of our products;

 

our reseller and distributor agreements are generally nonexclusive and may be terminated at any time without cause; and

 

our resellers and distributors frequently market and distribute competing products and may, from time to time, place greater emphasis on the sale of these products due to pricing, promotions and other terms offered by our competitors.

Our ability to meaningfully increase the amount of our products sold through our sales channels also depends on our ability to adequately and efficiently support these channel partners with, among other things, appropriate financial incentives to encourage pre-sales investment and development of sales tools, such as sales training, technical training and product materials needed to support their customersexisting and prospects.prospective customers. The diversity and sophistication of our product offerings have required us to focus on additional sales and technical training, and we are making increased investments in this area. Additionally, we are continually evaluating the

16        2011 ANNUAL REPORT


changes to our internal ordering and partner management systems in order to effectively execute our two-tiermulti-tiered distribution strategy. Any failure to properly and efficiently support our sales channels will result in lost sales opportunities.

IfOur quarterly operating results fluctuate significantly and these fluctuations may cause our internal controls are not effective, currentstock price to fall.

Our quarterly operating results have varied significantly in the past, and potential stockholders could lose confidencewill likely vary in the future. Many of these variations come from macroeconomic and cyclical changes causing fluctuations in our financial reporting.

Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to conduct a comprehensive evaluation of their internal control over financial reporting. To comply with this statute, we are required to documentbillings, revenues, operating expenses and test our internal control over financial reporting; our management is required to assess and issue a report concerning our internal control over financial reporting; and our independent registered public accounting firm is required to attest to and reporttax provisions. Our billings depend in part on the effectivenessnumber of internal control over financial reporting.

Insubscriptions up for renewal each quarter and are affected by cyclical variations, with the fourth quarter generally being our annualstrongest quarter in billings, and quarterly reports (as amended)the first quarter generally being our lowest quarter for billings each fiscal year. Although a significant portion of our revenues in any quarter comes from previously deferred revenue, a meaningful portion of our revenues in any quarter depends on the periods from December 31, 2008 through September 30, 2009, we reported material weaknesses in our internal control over financial reporting which relatednumber, size and length of subscriptions to our revenue recognition under original equipment manufacturer (OEM) contracts and our computation of our income tax benefit for the year ended December 31, 2008. As describedproducts that are sold in “Part II—Item 9A. Controls and Procedures” of this report, we have taken a number of actions to remediate these material weaknesses, which include reviewing and designing enhancements to certain of our controls and processes relating to revenue recognition and the computation of the income tax provisionthat quarter as well as conducting additional trainingour appliance sales which are, following January 1, 2011, fully recognized in these areas. Based upon these remediation actions, management concluded that the material weaknesses described above have been remediated as of December 31, 2009.

Although we believequarter in which they are sold. In addition, we have taken appropriate actionsbecome increasingly dependent upon large orders which have a significant effect on our operating results during the quarter in which we receive them. The timing of such orders or the loss of an order is difficult to remediatepredict and sales expected in a quarter may not be completed until a subsequent quarter. The unpredictability of quarterly fluctuations is further increased by the material weaknesses we cannot assure youfact that we will not discover other material weaknessesa significant portion of our quarterly sales have historically been generated during the last month of each fiscal quarter, with many of the largest enterprise customers purchasing subscriptions to our products nearer to the end of the last month of each quarter.

Our operating expenses may increase in the future. The existencefuture if we expand our selling and marketing activities, increase our research and development efforts or hire additional personnel which could impact our margins. In addition, our operating expenses historically have fluctuated, and may continue to fluctuate in the future, as the result of onethe factors described below and elsewhere in this report:

changes in currency exchange rates impacting our international operating expenses;

timing of marketing expenses for activities such as trade shows and advertising campaigns;

quarterly variations in general and administrative expenses, such as recruiting expenses and professional services fees;

increased research and development costs prior to new or more material weaknesses could resultenhanced product launches; and

fluctuations in errorsexpenses associated with commissions paid on sales of subscriptions to our products which generally increase with billings growth in the short term because such expenses are recognized immediately upon sales of subscriptions while revenues are recognized ratably over the subscription term.

Consequently, these factors limit our financial statements,ability to accurately predict our results of operations and substantial costs and resourcesthe expectations of current or potential investors may not be required to rectify these or other internal control deficiencies.met. If we cannot produce reliable financial reports, investors could lose confidence in our reported financial information,this occurs, the market price of our common stock may decline.

Our worldwide income tax provisions and other tax accruals may be insufficient if any taxing authorities assume taxing positions that are contrary to our positions and those contrary positions are sustained.

Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for state, federal and international income taxes together with transaction taxes such as sales tax, value added tax and goods and services tax. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of intercompany arrangements to share revenues and costs. In such arrangements there are uncertainties about the amount and manner of such sharing, which could decline significantly,ultimately result in changes once the arrangements are reviewed by taxing authorities. Although we believe that our approach to determining the amount of such arrangements is consistent

2011 ANNUAL REPORT    17


with prevailing legislative interpretation, no assurance can be given that the final tax authority review of these matters will agree with our historical income tax provisions and other tax accruals. Such differences could have a material effect on our income tax provisions or benefits, or other tax accruals, in the period in which such determination is made, and consequently, on our results of operations for such period.

From time to time, we are also audited by various state, federal and tax authorities of other countries in which we operate. Generally, the tax years 2005 through 2010 could be subject to examination by U.S. federal and most state tax authorities. We are currently under examination by the respective tax authorities for tax years 2005 to 2009 in the United States and for 2006 to 2010 in Israel. We also have various other on-going audits in various stages of completion. No outcome for a particular audit can be determined with certainty prior to the conclusion of the audit and any appeals process.

As each audit progresses and is ultimately concluded, adjustments, if any, will be recorded in our financial statements from time to time in light of prevailing facts based on our and the taxing authority’s respective positions on any disputed matters. We provide for potential tax exposures by accruing for uncertain tax positions based on judgment and estimates including historical audit activity. If the reserves are insufficient or we are not able to establish a reserve under GAAP prior to completion or during the progression of any audits, there could be an adverse impact on our financial position and results of operations when an audit assessment is made. In addition, our external costs of contesting and settling any dispute with the tax authorities could be substantial and adversely impact our financial position and results of operation.

During the first quarter of 2010, we were informed by the U.S. Internal Revenue Service (“IRS”) that they had completed their audit for the tax years ended December 31, 2005 through December 31, 2007. Accordingly, the IRS issued us a 30-day letter which outlined all of their proposed audit adjustments and required us to either accept the proposed adjustments, subject to future litigation, or file a formal administrative protest contesting those proposed adjustments within 30 days. The proposed adjustments relate primarily to the cost sharing arrangement between Websense, Inc. and our businessIrish subsidiary, including the amount of cost sharing buy-in, as well as to our claim of research and financial conditiondevelopment tax credits and income tax deductions for equity compensation awarded to certain executive officers. The amount of additional tax proposed by the IRS totals approximately $19.0 million, of which $14.8 million relates to the amount of cost sharing buy-in, $2.5 million relates to research and development credits and $1.7 million relates to equity compensation awarded to certain executive officers. The total additional tax proposed excludes interest, penalties and state income taxes, each of which may be significant, and also excludes a potential reduction in tax on the Irish subsidiary. The proposed adjustments also do not include the future impact that changes in our cost sharing arrangement could have on our effective tax rate. We disagree with all of the proposed adjustments and have submitted a formal protest to the IRS for each matter. The IRS assigned our case to an IRS Appeals Officer and the appeals process commenced during the second quarter of 2011. In the third quarter of 2011, the IRS withdrew the proposed adjustment relating to equity compensation of $1.7 million, resulting in no additional tax liability. This reduced the amount of the additional tax proposed by the IRS for the tax years ended December 31, 2005 through December 31, 2007 to approximately $17.3 million. This amount excludes any interest, penalties or state income taxes, each of which may be significant, and represents approximately 56% of our net income for 2011 and approximately 23% of our cash and cash equivalents as of December 31, 2011. We intend to continue to defend our position on the remaining matters at the IRS Appeals Office, including through litigation if required. The timing of the ultimate resolution of these remaining matters cannot be reasonably estimated at this time and the appeals process is still ongoing as of the filing date of this Annual Report on Form 10K.

The IRS has identified and is aggressively pursuing cost sharing arrangements between related domestic and international subsidiaries, including the amount of the cost sharing buy-in, as a potential area for audit exposure for many companies. If this matter is litigated or the position proposed by the IRS is otherwise sustained, our results of operations for the periods when any additional tax liability is incurred could be harmed.materially and adversely affected particularly because we have not accrued for any potential liability relating to this matter based on GAAP. We also cannot predict what impact an adverse result could have on our future income tax rate, which could adversely impact our results of operations.

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Fluctuations in foreign currency exchange rates could materially affect our financial results.

A significant portion of our foreign subsidiaries’ operating expenses are incurred in foreign currencies so if the U.S. dollar weakens, our consolidated operating expenses would increase. Conversely, our operating expenses would be lower if the U.S. dollar strengthens. These currency changes have the opposite impact on our revenues from international sales. Should the U.S. dollar strengthen, our products may become more expensive for our international customers with subscription contracts denominated in U.S. dollars, and as a result, our results of operations and net cash flows from international operations may be adversely affected.

Changes in currency rates also impact our future revenues under subscription contracts that are not denominated in U.S. dollars as we bill certain international customers in Euros, British Pounds, Australian Dollars and Chinese Renminbi. Our revenue and deferred revenue for these currencies are recorded in U.S. dollars when the subscription begins based upon currency exchange rates in effect on the last day of the previous month before the subscription agreement is entered into. This accounting policy increases our risks associated with fluctuations in currency exchange rates since we cannot be assured of receiving the same U.S. dollar equivalent as when we bill exclusively in U.S. dollars. If there is a strong U.S. dollar at the time a subscription begins, we experience a reduction in subscription amounts as recorded in U.S. dollars relative to the foreign currency in which the subscription was priced to the customer. As a result, the strengthening of the U.S. dollar for current sales would reduce our future revenues from these contracts, even though these foreign currencies may strengthen during the term of these subscriptions. Because currency exchange rates remain volatile, our future revenues could be adversely affected by currency fluctuations.

We engage in currency hedging activities with the intent of limiting the risk of exchange rate fluctuations, but our foreign exchange hedging activities also involve inherent risks that could result in an unforeseen loss. If we fail to properly forecast our billings, expenses and currency exchange rates these hedging activities could have a negative impact.

We face increasing competition from much larger software and hardware companies, which places pressure on our pricing and which could prevent us from increasing revenue or returning to profitability.our revenues. In addition, as we increase our emphasis on our security-oriented products, we face competition from better-established security companies that have significantly greater resources.

The market for our products is intensely competitive and is likely to become even more so in the future. Our current principal Web filtering competitors frequently offer their products at a significantly lower price than our

products, which has resulted in pricing pressures on sales of our basic Web filtering products and email filtering products and potentially could result in the commoditization of products inthese products. We depend on our space. more advanced security solutions, such as our TRITON content security solutions, to replace and grow revenues from Web filtering subscriptions that are not renewed.

We also face current and potential competition from vendors of Internet servers, operating systems and networking hardware, many of which now, or may in the future, enhance, develop and/or bundle products to include functions that are currently provided primarily by network security software. If network security functions become standard features of computer hardware or of operating system software or other software, our products may become obsolete and unmarketable, particularly if the quality of these network security features is comparable to that of our products. Furthermore, even if the network security and/or management functions provided as standard features by hardware providers or operating systems or other software is more limited than that of our products, our customers might accept this limited functionality in lieu of purchasing additional software. Sales of our products would suffer materially if we were then unable to develop new Web filtering, security and data loss prevention products to further enhance operating systems or other competitive products with their current products with no price increasesoftware and to these currentreplace any obsolete products.

Increased competition may also cause price reductions or a loss of market share, either of which could have a material adverse effect on our business, results of operations and financial condition. If we are unable to

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maintain the current pricing on sales of our products or increase our pricing in the future, our results of operations could be negatively impacted. Even if our products provide greater functionality and are more effective than certain other competitive products, potential customers might accept this limited functionality. In addition, our own indirect sales channels may decide to develop or sell competing products instead of our products. Pricing pressures and increased competition generally could result in reduced sales, reduced margins or the failure of our products to achieve or maintain widespread market acceptance, any of which could have a material adverse effect on our business, results of operations and financial condition.

Our current The competitive environments in which we operate and the principal competitors include:within each environment are described below.

TRITON Solutions for Content Security

companiesWeb Security. Our principal competitors offering Web filtering and Web security software solutions include companies such as Microsoft, Symantec/Message Labs, McAfee (acquired by Intel), Symantec, Trend Micro, Check Point Software Technologies, Cisco Systems, Juniper Networks, Trend Micro, Google, BrightCloud, Cisco Systems/ScanSafe, Blue Coat Systems, Aladdin, FaceTime, St. BernardMicrosoft, Google, Webroot Software, SafeNet, Actiance, EdgeWave, FireEye, M86 Security/Finjan,Security, Clearswift, Sophos, Kaspersky Lab, AhnLab, IBM, Panda Security, F-Secure, Commtouch, CA Technologies, Juniper Networks, Black Box Network Services and Barracuda Networks.

Email Security.Our principal competitors offering messaging or email security solutions include companies such as McAfee, Symantec/Message Labs, Google, Cisco Systems, Barracuda Networks, Digital Arts and Computer Associates;

companies integrating Web filtering into specialized security appliances, such as Blue Coat Systems, Cisco Systems, McAfee, WatchGuard, Check Point Software, St. Bernard Software, Barracuda Networks, Juniper Networks,SonicWALL, Trend Micro, SonicWALL,Microsoft, Axway, Sophos, Network BoxProofpoint, Clearswift, Commtouch, Zix, WatchGuard Technologies, M86 Security, Webroot Software, EdgeWave, Zscaler and M86 Security/Finjan;Fortinet.

companiesData Security.Our principal competitors offering DLPdata loss prevention solutions include companies such as Symantec, Verdasys, Trustwave, EMC, McAfee, IBM, Trend Micro, Proofpoint, Palisade Systems, Computer Associates,CA Technologies, Raytheon, Intrusion, Fidelis Security Systems, GTB Technologies, Workshare, Check Point Software Technologies and Code Green Networks;

companies offering messaging security, such as McAfee, Symantec/Message Labs, Google, Cisco Systems, Barracuda Networks, SonicWALL, Trend Micro, Axway/Tumbleweed, Sophos, Microsoft, Proofpoint, Clearswift and WatchGuard;

companies offering on-demand email and Web security services, such as Google, Symantec/Message Labs, McAfee, Webroot, St. Bernard Software, Purewire, BrightCloud, Zscaler, Trend Micro and Cisco Systems/ScanSafe;

companies offering desktop security solutions, such as Check Point Software Technologies, Cisco Systems, McAfee, Microsoft, Symantec, Computer Associates,CA Technologies, Sophos, Webroot Software, IBM and Trend Micro; andMicro.

Web Filtering Solutions

companiesOur principal competitors offering Web gatewayfiltering solutions, including through specialized security appliances, include companies such as Microsoft, Blue Coat Systems, Cisco Systems,McAfee, Symantec, Trend Micro, Check Point Software McAfeeTechnologies, Cisco Systems, Blue Coat Systems, Microsoft, Google, Webroot Software, SafeNet, Actiance, EdgeWave, FireEye, M86 Security, Clearswift, Sophos, Kaspersky Lab, AhnLab, IBM, Panda Security, F-Secure, Commtouch, CA Technologies, Palo Alto Networks, Fortinet, Barracuda Networks and Juniper Networks.SonicWALL.

As we develop and market our products with an increasing security-oriented emphasis, we also face growing competition from security solutions providers. Many of our competitors within the Web security market, such as Symantec, McAfee, Trend Micro, Cisco Systems, Check Point Software Technologies, Google and Microsoft enjoy substantial competitive advantages, including:

 

greater name recognition and larger marketing budgets and resources;

 

established marketing relationships and access to larger customer bases; and

 

substantially greater financial, technical and other resources.

As a result, we may be unable to gain sufficient traction as a provider of Webadvanced content security solutions, and our competitors may be able to respond more quickly and effectively than we can to new or emerging technologies

and changes in customer requirements, or devote greater resources to the development, marketing, promotion and sale of their products than we can. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the functionality and market acceptance of their products. products or may be acquired by a corporation with significantly greater resources.

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In addition, our competitors may be able to replicate our products, make more attractive offers to existing and potential employees and strategic partners, develop new products or enhance existing products and services more quickly. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, many of our competitors made recent acquisitions in some of our product areas, and, we expect competition to increase as a result of this industry consolidation. Through an acquisition, a competitor could bundle separate products to include functions that are currently provided primarily by our Web, email and data security solutions and sell the combined product at a lower cost thanwhich could essentially include, at no additional cost, the functionality of our stand-alone solutions. For all of the foregoing reasons, we may not be able to compete successfully against our current and future competitors.

The covenants in our senior secured credit facility restrict our financial and operational flexibility, including our ability to complete additional acquisitions and invest in new business opportunities.

In connection with our acquisition of SurfControl in October 2007,2010, we announced that we had entered into ana senior credit facility (the “2010 Credit Agreement” or the “2010 Credit Facility”) and used the initial proceeds to repay our term loan and retire the 2007 amended and restated senior secured credit facility entered into in October 2007 (the “2007 Credit Agreement” or the “2007 Credit Facility”). The 2010 Credit Agreement contains affirmative and negative covenants, including an obligation to provide financing formaintain a substantial portion of the acquisition purchase price. Our senior secured credit facility contains covenants that restrict, among other things,certain consolidated leverage ratio and consolidated interest coverage ratio and restrictions on our ability to borrow money, to incur liens, to enter into mergers and acquisitions, to make particular types ofdispositions, to pay cash dividends or repurchase capital stock, and to make investments, including investments in our subsidiaries, make other restricted payments, pay down subordinated debt, swap or sell assets, merge or consolidate or make acquisitions.subject to certain exceptions. An event of default under our senior secured credit facilitythe 2010 Credit Agreement could allow the lenders to declare all amounts outstanding with respect to the senior secured credit facilityagreement to be immediately due and payable. As collateral for the loan, we pledgedThe 2010 Credit Agreement is secured by substantially all of our consolidated assets, and theincluding pledges of stock of somecertain of our subsidiaries (subject to limitations with respect toin the case of foreign subsidiaries) to secure the debt underand by secured guarantees by our senior secured credit facility.domestic subsidiaries. If the amountsamount outstanding under the senior secured credit facility were2010 Credit Agreement is accelerated, the lenders could proceed against those consolidated assets and the stock of our subsidiaries.stock. Any event of default, therefore, could have a material adverse effect on our business. Our senior secured credit facilityThe 2010 Credit Agreement also requires us to maintain specified financial ratios. Our ability to meet these financial ratios can be affected by events beyond our control, and we cannot assureensure that we will meet those ratios.

The amount of our debt outstanding may prevent us from taking actions we would otherwise consider in our best interest.

In October 2007, we borrowed $210 million under the Senior Credit Agreement and $87 million remained outstanding as of December 31, 2009. As a result, we are incurring interest expense for the amounts we borrowed under the senior secured term loan, and our income from our cash, cash equivalents and marketable securities has declined as we used a significant portion of our cash and marketable securities to fund a portion of the acquisition cost and have continued to use cash from operations to pay down debt and repurchase our common stock. This debt and the limitations our senior secured credit facility impose on us could have important consequences, including:

it may be difficult for us to satisfy our obligations under the senior secured credit facility;

we will have to use much of our cash flow for scheduled debt service rather than for potential investments;

we may be less able to obtain other debt financing in the future;

we could be less able to take advantage of significant business opportunities, including acquisitions or divestitures, as a result of debt covenants;

our vulnerability to general adverse economic and industry conditions could be increased; and

we could be at a competitive disadvantage to competitors with less debt.

Our international operations involve risks that could increase our expenses, adversely affect our operating results and require increased time and attention of our management.

We have significant operations outside of the United States, including research and development, sales and customer support. We have engineering operations in Reading, England; Beijing, China and Ra’anana, Israel.

We plan to continue to expand our international operations, but such expansion is contingent upon the financial performance of our existing international operations as well as our identification of growth opportunities. Our international operations are subject to risks in addition to those faced by our domestic operations, including:

 

difficulties associated with managing a distributed organization located on multiple continents in greatly varying time zones;

 

potential loss of proprietary information due to misappropriation or foreign laws that may be less protective of our intellectual property rights;

 

requirements of foreign laws and other governmental controls, including trade and labor restrictions and related laws that reduce the flexibility of our business operations;

 

potential failures of our foreign employees or partners to comply with U.S. and foreign laws, including antitrust laws, trade regulations and anti-bribery and corruption laws;

political unrest, war or terrorism, particularly in areas in which we have facilities;

 

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difficulties in staffing, managing, and operating our international operations, including difficulties related to administering our stock plans in some foreign countries;

 

difficulties in coordinating the activities of our geographically dispersed and culturally diverse operations;

seasonal reductions in business activity in the summer months in Europe and in other periods in other countries;

 

restrictions on our ability to repatriate cash from our international subsidiaries or to exchange cash in international subsidiaries into cash available for use in the United States; and

 

costs and delays associated with developing software in multiple languages.

Sales to customers outside the United States have accounted for a significant portion of our revenue,revenues, which exposes us to risks inherent in international sales.

We market and sell our products outside the United States through value-added resellers, distributors and other resellers. International sales represented approximately 50% of our total revenuerevenues generated during the fiscal year ended December 31, 2009 compared with 46% of our total revenue during the fiscal year ended December 31, 2008.years 2011, 2010 and 2009. As a key component of our business strategy to generate new business sales, we intend to continue to expand our international sales, but success cannot be assured. In addition to the risks associated with our domestic sales, our international sales are subject to the following risks:

 

our ability to adapt to sales and marketing practices and customer requirements in different cultures;

 

our ability to successfully localize software products for a significant number of international markets;

laws in foreign countries may not adequately protect our intellectual property rights;

 

the significant presence of some of our competitors in some international markets;

 

laws and business practices favoring local competitors;

 

dependence on foreign distributors and their sales channels;

 

longer payment cycles for sales in foreign countries and difficulties in collecting accounts receivable;

 

compliance with multiple, conflicting and changing governmental laws and regulations, including tax laws and regulations and consumer protection and privacy laws; and

 

regional economic and political conditions, including civil unrest and adverse economic conditions in emerging markets with significant growth potential.

These factors could have a material adverse effect on our international sales. Any reduction in international sales, or our failure to further develop our international distribution channels, could have a material adverse effect on our business, results of operations and financial condition.

Fluctuations in foreign currency exchange ratesSecurity threats to our IT infrastructure could materiallyexpose us to liability, and damage our reputation and business.

It is essential to our business strategy that our technology and network infrastructure remain secure and is perceived by our customers, distributors and resellers to be secure. Despite security measures, however, any network infrastructure may be vulnerable to cyber-attacks by hackers and other security threats. As a provider of security solutions designed to provide content security by protecting an organization’s data and users, we may face cyber-attacks that attempt to penetrate our network security, including our data centers, to sabotage or otherwise disable our products and services, misappropriate our or our customers’ proprietary information, which may include personally identifiable information, or cause interruptions of our internal systems and services. If successful, any of these attacks could negatively affect our financial results.

A significant portionreputation as a provider of security solutions, damage our foreign subsidiaries’ operating expenses are incurred in foreign currencies so if the U.S. dollar weakens,network infrastructure and our consolidated operating expenses would increase. Should the U.S. dollar strengthen,ability to deploy our products may become more expensive forand services, harm our internationalrelationship with customers with subscription contracts denominated in U.S. dollars, and as a result, our results of operations and net cash flows from international operations may be adversely affected, especially if the trend continues of international sales growing as a percentage of our total sales. Changes in currency rates also impact our future revenue under subscription contracts that are not denominated in U.S. dollars as we bill certain international customers in Euros, British Pounds, Australian Dollars, Chinese Renminbiaffected and Japanese Yen. Our revenue and deferred revenue for these currencies are recorded in U.S. dollars when the subscription is signed based upon currency exchange rates in effect on the last day of the previous month before the subscription agreement is signed. This increases our risks associated with fluctuations in currency exchange rates since we cannot be assured of receiving the same U.S. dollar equivalent as when we bill exclusively in U.S. dollars. During the first three quarters of 2009, dueexpose us to the strengthening of the U.S. dollar, we experienced a reduction in subscription amounts as recorded in U.S. dollars relative to the foreign currency in which the subscription was priced to the customer. As a result, the strengthening of the U.S. dollar for current sales has reduced our future revenue from these contracts, even though these foreign currencies may strengthen during the term of these subscriptions. This trend reversed itself during the fourth quarter of 2009 but currency exchange rates remain volatile and our future revenue could be adversely affected by currency fluctuations. We engage in currency hedging activities with the intent of limiting the risk of exchange rate fluctuations, but our foreign exchange hedging activities also involve inherent risks that could result in an unforeseen loss. If we fail to properly forecast our billings, expenses and currency exchange rates these hedging activities could have a negative impact.financial liability.

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We may not be able to develop acceptable new products or enhancements to our existing products at a rate required by our rapidly changing market.

Our future success depends on our ability to develop new products or enhancements to our existing products that keep pace with rapid technological developments and that address the changing needs of our customers. Although our products are designed to operate with a variety of network hardware and software platforms, we will need to continuously modify and enhance our products to keep pace with changes in Internet-related hardware, software, communication, browser and database technologies. We may not be successful in either developing such products or introducing them to the market in a timely fashion. In addition, uncertainties about the timing and nature of new network platforms or technologies, or modifications to existing platforms or technologies could increase our research and development expenses. The failure of our products to operate effectively with the existing and future network platforms and technologies will limit or reduce the market for our products, result in customer dissatisfaction and seriously harm our business, results of operations and financial condition.

Because our products primarily manage access to URLs and executable files included in our databases, if our databases do not contain a meaningful portion of relevant content, the effectiveness of our Web filtering products will be significantly diminished. Any failure of our databases to keep pace with the rapid growth and technological change of the Internet, such as the increasing amount of multimedia content on the Internet that is not easily classified, will impair the market acceptance of our products.

We rely upon a combination of automated filtering technology and human review to categorize URLs and executable files in our proprietary databases. Our customers may not agree with our determinations that particular URLs and executable files should be included or not included in specific categories of our databases.

In addition, it is possible that our filtering processes may place objectionable or security risk material in categories that are generally unrestricted by our users’ Internet and computer access policies, which could result in such material not being blocked from the network. Any errors in categorization could result in customer dissatisfaction and harm our reputation. Any failure to effectively categorize and filter URLs and executable files according to our customers’ expectations could impair the growth of our business. Our databases and database technologies may not be able to keep pace with the growth in the number of URLs and executable files, especially the growing amount of content utilizing foreign languages and the increasing sophistication of malicious code and the delivery mechanisms associated with spyware, phishing and other hazards associated with the Internet. The success of our dynamic Web categorization capabilities may be critical to our customers’ long term acceptance of our products.

We may spend significant time and money on research and development to design and developenhance our TritonTRITON management console, V-series appliances, content gateway products, DLPdata loss prevention products and our SaaS security products.offerings. If these products fail to achieve broad market acceptance in our target markets, we may be unable to generate significant revenuerevenues from our research and development efforts. As a result, our business, results of operations and financial condition would be adversely impacted.

Because our products primarily manage access to URLs and executable files included in our databases, if our databases do not contain a meaningful portion of relevant content, the effectiveness of our Web filtering products will be significantly diminished. Any failure of our databases to keep pace with the rapid growth and technological change of the Internet, such as the increasing amount of multimedia content on the Internet that is not easily classified, will impair the market acceptance of our products.

If we fail to maintain adequate operations infrastructure, we may experience disruptions of our SaaS offerings.

Any disruption to our technology infrastructure or the Internet could harm our operations and our reputation among our customers. Our technology and network infrastructure is extensive and complex, and could result in inefficiencies or operational failures. These potential inefficiencies or operational failures could diminish the quality of our products, services, and user experience, resulting in damage to our reputation and loss of current and potential subscribers, and could harm our operating results and financial condition. Any disruption to our computer systems could adversely impact the performance of our SaaS offerings and hybrid service offerings, our customer service, our delivery of products or our operations and result in increased costs and lost opportunities for business.

2011 ANNUAL REPORT    23


Failure of our products to work properly or misuse of our products could impact sales, increase costs, and create risks of potential negative publicity and legal liability.

Our products are complex, are deployed in a wide variety of network environments and manage content in a dramatically changing Web 2.0 world. Our products may have errors or defects that users identify after deployment, which could harm our reputation and our business. In addition, products as complex as ours frequently contain undetected errors when first introduced or when new versions or enhancements are released. We have from time to time found errors in versions of our products, and we expect to find such errors in the future. Because customers rely on our products to manage employee behavior to protect against security risks and prevent the loss of sensitive data, including confidential and proprietary information, any significant defects or errors in our products may result in negative publicity or legal claims. For example, an actual or perceived breach of network or computer security at one of our customers, regardless of whether the breach is attributable to our products, could adversely affect the market’s perception of our security products. Moreover, any actual security breach could result in product liability and related claims. Our subscription agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims, however, it is possible, that such provisions may not be effective under the laws of certain jurisdictions, particularly in circumstances involving subscriptions without signed agreements from our customers.

In addition to the risks above, parties whose Web sites or executable files are placed in security-risk categories or other categories with negative connotations may seek redress against us for falsely labeling them or for interfering with their business. The occurrence of errors could adversely affect sales of our products, divert the attention of engineering personnel from our product development efforts and cause significant customer relations or legal problems.

Our products may also be misused or abused by customers or non-customer third parties who obtain access to our products. These situations may arise where an organization uses our products in a manner that impacts their end users’ or employees’ privacy or where our products are misappropriated to censor private access to the Internet. Any of these situations could result in negative press coverage and negatively affect our reputation.

Third parties claiming that we infringe their proprietary rights could cause us to incur significant legal expenses that reduce our operating margins and/or prevent us from selling our products.

The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of patent infringement or other violations of intellectual property rights. As we expand our product offerings in the data loss and security area where larger companies with large patent portfolios compete, the possibility of an intellectual property claim against us grows. We may receive claims that we have infringed the intellectual property rights of others, including claims regarding patents, copyrights and trademarks. For example, on July 12, 2010, Finjan, Inc. filed a complaint entitled Finjan, Inc. v. McAfee, Inc., Symantec Corp., Webroot Software, Inc., Websense, Inc. and Sophos, Inc. in the United States District Court for the District of Delaware. The complaint alleges that our Web filtering and Web Security Gateway products infringe a patent owned by Finjan and seeks damages and injunctive relief. Any such claim, including Finjan’s claim, with or without merit, could result in costly litigation and distract management from day-to-day operations and may result in us deciding to enter into license agreements to avoid ongoing patent litigation costs. If we are not successful in defending such claims, we could be required to stop selling our products, redesign our products, pay monetary amounts as damages, enter into royalty or licensing arrangements, or satisfy indemnification obligations that we have with some of our customers. Such arrangements may cause our operating margins to decline.

The amount of our debt outstanding may prevent us from taking actions we would otherwise consider in our best interest.

In October 2010, we announced that we had entered into the 2010 Credit Agreement and that we used the initial proceeds to repay the term loan and retire the 2007 Credit Facility. Under the 2010 Credit Agreement, we

24        2011 ANNUAL REPORT


can borrow up to $120 million and use proceeds to fund share repurchases or other corporate purposes. We may increase the maximum aggregate commitment under the 2010 Credit Agreement to $200 million if certain conditions are satisfied, including that we are not in default under the 2010 Credit Agreement at the time of the increase and that we obtain the commitment of the lenders participating in the increase. If we should need to increase the aggregate commitment, it may not be possible to satisfy these conditions. The limitations the 2010 Credit Agreement imposes on us could have important consequences, including the following:

it may be difficult for us to satisfy our obligations under the 2010 Credit Agreement;

we may be less able to obtain other debt financing in the future;

we could be less able to take advantage of significant business opportunities, including acquisitions or divestitures, as a result of debt covenants under the 2010 Credit Agreement;

our vulnerability to general adverse economic and industry conditions could be increased;

we could be at a competitive disadvantage to competitors with less debt; and

we may be unable to continue to repurchase our securities due to certain financial covenants set forth in the 2010 Credit Agreement.

We face risks related to customer outsourcing to system integrators.

Some of our customers have outsourced the management of their information technologyIT departments to large system integrators. If this trend continues, our established customer relationships could be disrupted and our products could be displaced by alternative system and network protection solutions offered by system integrators. Significant product displacements could impact our revenuerevenues and have a material adverse effect on our business.

Other vendors may include products similar to ours in their hardware or software and render our products obsolete.

In the future, vendors of hardware and of operating system software or other software may continue to enhance their products or bundle separate products to include functions that are currently provided primarily by network security software. If network security functions become standard features of computer hardware or of operating system software or other software, our products may become obsolete and unmarketable, particularly if the quality of these network security features is comparable to that of our products. Furthermore, even if the network security and/or management functions provided as standard features by hardware providers or operating systems or other software is more limited than that of our products, our customers might accept this limited functionality in lieu of purchasing additional software. Sales of our products would suffer materially if we were then unable to develop new Web filtering, security and DLP products to further enhance operating systems or other software and to replace any obsolete products.

Our worldwide income tax provisions and other tax accruals may be insufficient if any taxing authorities assume taxing positions that are contrary to our positions and those contrary positions are sustained.

Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for state, federal and international income taxes together with transaction taxes such as sales tax, VAT and GST. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of intercompany arrangements to share revenue and costs. In such arrangements there are uncertainties about the amount and manner of such sharing, which could ultimately result in changes once the arrangements are reviewed by taxing authorities. Although we believe that our approach to determining the amount of such arrangements is consistent with prevailing legislative interpretation, no assurance can be given that the final tax authority review of these matters will agree with our historical income tax provisions and other tax accruals. Such differences could have a material effect on our income tax provisions or benefits, or other tax accruals, in the period in which such determination is made, and consequently, on our results of operations for such period.

From time to time, we are also audited by various state, federal and tax authorities of other countries in which we operate. Generally, the tax years 2005 through 2008 could be subject to examination by U.S. federal and most state tax authorities. In significant foreign jurisdictions, tax years 2004 through 2008 could be subject to examination by the respective tax authorities. We are currently under examination by the respective tax authorities for tax years 2005 to 2007 in the United States, for 2006 to 2007 in the United Kingdom and for 2006 to 2008 in Israel. Our audits are in various stages of completion; however, no outcome for a particular audit can be determined with certainty prior to the conclusion of the audit and any appeals process.

As each audit progresses and is ultimately concluded, adjustments, if any, will be recorded in our financial statements from time to time in light of prevailing facts based on our and the taxing authority’s respective positions on any disputed matters. We provide for potential tax exposures by accruing for uncertain tax positions based on judgment and estimates including historical audit activity. If the reserves are insufficient or we are not able to establish a reserve under GAAP prior to completion or during the progression of any audits, there could be an adverse impact on our financial position and results of operations when an audit assessment is made. In addition, our external costs of contesting and settling any dispute with the tax authorities could be substantial and adversely impact our financial position and results of operation.

During the fourth quarter of 2009, the U.S. Internal Revenue Service (the “IRS”) issued Notices of Proposed Adjustment related to the cost sharing arrangement between our U.S. parent company and our Irish subsidiary, including the amount of cost sharing buy-in, as well as with respect to our claim of research and development tax credits and income tax deductions for equity compensation awarded to certain executive officers. The amount of additional tax proposed by the IRS totals approximately $17.7 million, of which $13.5 million relates to the amount of cost sharing buy-in, $2.5 million relates to research and development credits and $1.7 million relates to equity compensation awarded to certain executive officers. The total additional tax proposed excludes interest, penalties and state income taxes, each of which may be significant, and a potential reduction in tax on the Irish subsidiary. The proposed adjustments also do not include the future impact that changes in our cost sharing arrangement could have on our effective tax rate.

We believe the IRS’s positions with respect to the proposed adjustments to our cost sharing arrangements, including the amount of cost sharing buy-in, our research and development tax credits, and our deductions for equity compensation are inconsistent with applicable tax law, and that we have meritorious defenses to our positions. Accordingly, we are vigorously defending our positions, including as necessary and appropriate, utilizing our rights to appeal as well as other legal remedies. While we believe the IRS’s asserted positions on these matters are not supported by applicable law, we may be required to make additional payments in order to resolve these matters.

In particular, the IRS has identified and is aggressively pursuing cost sharing arrangements between domestic and international subsidiaries, including the amount of the buy-in, as a potential area for audit exposure for many companies. If this matter is litigated and the position proposed by the IRS were sustained, our results of operations for periods when any new liability is incurred would be materially and adversely affected. We also cannot predict what impact an adverse result could have on our future income tax rate, which could adversely impact our results of operations.

Any failure to protect our proprietary technology would negatively impact our business.

Intellectual property is critical to our success, and we rely upon patent, trademark, copyright and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology and our Websense brands. We rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. While we require employees, collaborators and consultants to enter into confidentiality agreements and include provisions in our subscription agreements with customers that prohibit the unauthorized reproduction or transfer of our products, we cannot assure that these agreements will not be breached or that we will have adequate remedies for any breach.

We rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable and protect the source code of our products as trade secrets and as unpublished copyrighted works. We may not be able to adequately protect our trade secrets or other proprietary information in the event of any unauthorized use or disclosure, or the lawful development by others of such information. Any unauthorized disclosure of our source code or other trade secrets could result in the loss of future trade secret protection for those items. Additionally, any intentional disruption and/or the unauthorized use or publication of our trade secrets and other confidential business information, via theft or a cyber-attack, could adversely affect our competitive position, reputation, brands and future sales of our products.

We have registered our trademarks in severalvarious countries and have registrations for the Websense trademark pending in several other countries. Effective trademark protection may not be available in every country where our products are available. Furthermore, any of our trademarks may be challenged by others or invalidated through administrative process or litigation.

We currently have 1933 patents issued in the United States and 2728 patents issued internationally, and we may be unable to obtain further patent protection in the future. We have other pending patent applications in the United States and in other countries. We cannot ensure that:

 

we were the first to makeconceive the inventions covered by each of our pending patent applications;

 

2011 ANNUAL REPORT    25


we were the first to file patent applications for these inventions;

 

any of our pending patent applications are not obvious or anticipated such that they will not result in issued patents;

 

others will not independently develop similar or alternative technologies or duplicate any of our technologies;

any patents issued to us will provide us with any competitive advantages or will not be challenged by third parties;

 

we will develop additional proprietary technologies that are patentable; or

 

the patents of others will not have a negative effect on our ability to do business.

Our patents and claims in pending patent applications cover features or technology used in certain of our products but do not cover all of the technology utilized in any such product or preclude our competitors from offering competing products. Furthermore, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and can change over time. Effective patent, trademark, copyright and trade secret protection may not be available to us in every country in which our products are available. The laws of some foreign countries may not be as protective of intellectual property rights as U.S. laws, and mechanisms for enforcement of intellectual property rights may be inadequate. As a result our means of protecting our proprietary technology and brands may not be adequate. Furthermore, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property, including the misappropriation or misuse of the content of our proprietary databases of URLs and executable files, and our ability to police that misappropriation or infringement is uncertain, particularly in countries outside of the United States. Any such infringement or misappropriation could have a material adverse effect on our business, results of operations and financial condition.

Third parties claiming that we infringe their proprietary rights could cause us to incur significant legal expenses that reduce our operating margins and/or prevent us from selling our products.

The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of patent infringement or other violations of intellectual property rights. As we expand our product offerings in the data loss and security area where larger companies with large patent portfolios compete, the possibility of an intellectual property claim against us grows. We may receive claims that we have infringed the intellectual property rights of others, including claims regarding patents, copyrights and trademarks. Any such claim, with or without merit, could result in costly litigation and distract management from day-to-day operations and may result in us deciding to enter into license agreements to avoid ongoing patent litigation costs. If we are not successful in defending such claims, we could be required to stop selling or redesign our products, pay monetary amounts as damages, enter into royalty or licensing arrangements, or satisfy indemnification obligations that we have with some of our customers. Such arrangements may cause operating margins to decline.

Because we recognize revenuerevenues from subscriptions for our software products ratably over the term of the subscription, downturns in software subscription sales may not be immediately reflected in our revenue.revenues.

Substantially allMost of our revenue comesrevenues come from the sale of subscriptions to our software products, including our SaaS offerings. Upon execution of a subscription agreement or receipt of royalty reports from OEM customers, we invoice our customers for the full term of the subscription agreement or for the period covered by the royalty report from OEM customers. We then recognize revenue from customers daily over the terms of their subscription agreements, or performance period under the OEM contract, as applicable, which, in the case of subscriptions, typically have durations of 12, 24 or 36 months. As a result,Even though new revenue recognition rules require us to recognize revenue from hardware sales in the current period that the sale is concluded, a majority of the revenuerevenues we report in each quarter iswill continue to be derived from deferred revenue from subscription agreements and OEM contracts entered into and paid for during previous quarters. Because of this financial model, the revenuerevenues we report in any quarter or series of quarters may mask significant downturns in sales and the market acceptance of our products, before these downturns are reflected by declining revenues.

Acquired companies or technologies can be difficult to integrate, disrupt our business, dilute stockholder value and adversely affect our operating results.

We may acquire additional companies, services and technologies in the future as part of our efforts to expand and diversify our business. Although we review the records of companies or businesses we are interested

in acquiring, even an in-depth review may not reveal existing or potential problems or permit us to become familiar enough with a business to assess fully its capabilities and deficiencies. Integration of acquired companies may disrupt or slow the momentum of the activities of our business. As a result, if we fail to properly evaluate, execute and integrate future acquisitions, our business and prospects may be seriously harmed.

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Acquisitions involve numerous risks, including:

 

difficulties in integrating operations, technologies, services and personnel of the acquired company;

 

potential loss of customers and OEM relationships of the acquired company;

 

diversion of financial and management resources from existing operations and core businesses;

 

risk of enteringrisks associated with entrance into new markets;

 

potential loss of key employees of the acquired company;

 

integrating personnel with diverse business and cultural backgrounds;

 

preserving the development, distribution, marketing and other important relationships of the companies;

 

assumption ofassuming liabilities of the acquired company, including debt and litigation;

 

inability to generate sufficient revenuerevenues from newly acquired products and/or cost savings needed to offset acquisition related costs; and

 

the continued use by acquired companies of accounting policies that differ from GAAP, such as policies related to the timing of revenue recognition.GAAP.

Acquisitions may also cause us to:

 

issue equity securities that would dilute our current stockholders’ percentage ownership;

 

assume certain liabilities, including liabilities that were not detected at the time of the acquisition;

 

incur additional debt, such as the debt we incurred to partially fund the acquisition of SurfControl;debt;

 

make large and immediate one-time write-offs for restructuring and other related expenses;

 

become subject to intellectual property or other litigation; and

 

create goodwill and other intangible assets that could result in significant impairment charges and/or amortization expense.

Our quarterly operating results may fluctuate significantly, and these fluctuations may cause our stock price to fall.

Our quarterly operating results have varied significantly in the past, and will likely vary in the future primarily as the result of fluctuations in our billings, operating expenses and tax provisions. Although a significant portion of our revenue in any quarter comes from previously deferred revenue, a meaningful portion of our revenue in any quarter depends on the number, size and length of subscriptions to our products that are sold in that quarter. The unpredictability of quarterly fluctuations is increased by the fact that a significant portion of our quarterly sales have historically been generated during the last month of each fiscal quarter, with many of the largest enterprise customers purchasing subscriptions to our products nearer to the end of the last month of each quarter.

We expect that our operating expenses will increase in the future as we expand our selling and marketing activities, increase our research and development efforts and potentially hire additional personnel which could impact our margins. In addition, our operating expenses historically have fluctuated, and may continue to fluctuate in the future, as the result of the factors described below and elsewhere in this annual report:

changes in currency exchange rates impacting our international operating expenses;

timing of marketing expenses for activities such as trade shows and advertising campaigns;

quarterly variations in general and administrative expenses, such as recruiting expenses and professional services fees;

increased research and development costs prior to new or enhanced product launches; and

timing of expenses associated with commissions paid on sales of subscriptions to our products.

Consequently, our results of operations may not meet the expectations of current or potential investors. If this occurs, the price of our common stock may decline.

The market price of our common stock is likely to be highly volatile and subject to wide fluctuations.

The market price of our common stock has been and likely will continue to be highly volatile and could be subject to wide fluctuations in response to a number of factors that are beyond our control, including:

 

deteriorating or fluctuating world economic conditions;

 

announcements of technological innovations or new products or services by our competitors;

 

demand for our products, including fluctuations in subscription renewals;

 

changes in the pricing policies of our competitors; and

 

changes in government regulations.

In addition, the market price of our common stock could be subject to wide fluctuations in response to:

 

announcements of technological innovations or new products or services by us;

 

changes in our pricing policies; and

 

quarterly variations in our revenues and operating expenses.

Further, the stock market has experienced significant price and volume fluctuations that have particularly affected the market price of the stock of many Internet-related companies, and that often have been unrelated or disproportionate to the operating performance of these companies. A number of publicly traded Internet-related companies have current market prices below their initial public offering prices. Market fluctuations such as these may

2011 ANNUAL REPORT    27


seriously harm the market price of our common stock. In the past, securities class action suits have been filed following periods of market volatility in the price of a company’s securities. If such an action were instituted, we would incur substantial costs and a diversion of management attention and resources, which would seriously harm our business, results of operations and financial condition.

We are dependent on our management team, and the loss of any key member of this team may prevent us from implementing our business plan in a timely manner.

Our success depends largely upon the continued services of our executive officers and other key management personnel and our ability to recruit new personnel to executive and key management positions. For example, we are in the process of recruiting a new Chief Financial Officer to assume this position from our General Counsel, Chief Administrative Officer and Corporate Secretary, Michael A. Newman, who is currently also serving as our interim Chief Financial Officer. We are also substantially dependent on the continued service of our existing engineering personnel because of the complexity of our products and technologies. We do not have employment agreements with a majority of our executive officers, key management or development personnel and, therefore, they could terminatethat would prevent them from terminating their employment with us at any time without penalty.time. We do not maintain key person life insurance policies on any of our employees. The loss of one or more of our key employees could seriously harm our business, results of operations and financial condition. In such an event we may be unable to recruit personnel to replace these individuals in a timely manner, or at all, on acceptable terms.

Because competition for our target employees is intense, we may not be able to attract and retain the highly skilled employees we need to support our planned growth.

To execute our growth plan, we must attract and retain highly qualified personnel. Competition for these personnel is intense especially for engineers with high levels of experience in designing and developing software

and Internet-related products. Wewe may not be successful in attracting and retaining qualified personnel. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. In order to attract and retain personnel in a competitive marketplace, we believe that we must provide a competitive compensation package, including cash and equity-based compensation. The volatility of our stock price and our results of operations may from time to time adversely affect our ability to recruit or retain employees. Many of the companies with which we compete for experienced personnel have greater resources than we have. If we fail to attract new personnel or retain and motivate our current personnel, our revenues may be negatively impacted and our business and future growth prospects could be severely harmed.

If our internal controls are not effective, current and potential stockholders could lose confidence in our financial reporting.

Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to conduct a comprehensive evaluation of their internal control over financial reporting. To comply with this statute, we are required to document and test our internal control over financial reporting; our management is required to assess and issue a report concerning our internal control over financial reporting; and our independent registered public accounting firm is required to attest to and report on the effectiveness of internal control over financial reporting.

In our annual and quarterly reports (as amended) for the periods from December 31, 2008 through September 30, 2009, we reported material weaknesses in our internal control over financial reporting which related to our revenue recognition under OEM contracts and our computation of our income tax benefit for the year ended December 31, 2008. We took a number of actions to remediate these material weaknesses. As a result of an error in identifying a variance in our deferred tax assets in the fourth quarter of 2010, we reassessed the effectiveness of our disclosure controls and procedures for the year ended December 31, 2009 and the period from January 1, 2010 through September 30, 2010 and concluded that we continued to have a material weakness in the internal controls over the computation of our income tax provision. In the fourth quarter of 2010, we took additional remediation measures and concluded that the material weakness described above had been remediated as of December 31, 2010.

28        2011 ANNUAL REPORT


Although we believe we have taken appropriate actions to remediate the material weaknesses, we cannot assure you that we will not discover other material weaknesses applicable to both future and past reporting periods. The existence of one or more material weaknesses could result in errors in our financial statements, and substantial costs and resources may be required to rectify these or other internal control deficiencies. If we cannot produce reliable financial reports, investors could lose confidence in our reported financial information, the market price of our common stock could decline significantly, and our business and financial condition could be harmed.

The restatement of our historical financial statements may affect stockholder confidence, may consume a significant amount of our time and resources and may have a material adverse effect on our business and stock price.

We restated our consolidated financial statements and related disclosures for fiscal years ended December 31, 2009, 2008 and 2007. We cannot be certain that the measures we have taken since we completed the restatement process will ensure that restatements will not occur in the future. A restatement may affect investor confidence in the accuracy of our financial disclosures and may result in a decline in stock price and stockholder lawsuits related to the restatement. We cannot guarantee that we will not be affected in this way.

The restatement process was also highly time and resource-intensive and involved substantial attention from management and significant legal and accounting costs. Although we have now completed the restatement, we cannot guarantee that we will not receive inquiries from the SEC or the NASDAQ Stock Market, Inc. (“NASDAQ”) regarding our restated financial statements or matters relating thereto.

Any future inquiries from the SEC or NASDAQ as a result of the restatement of our historical financial statements will, regardless of the outcome, likely consume a significant amount of our resources in addition to those resources already consumed in connection with the restatement itself.

Compliance with regulation ofregulations relating to corporate governance, accounting principles and public disclosure may result in additional expenses.

Compliance with laws, regulations and standards relating to corporate governance, accounting principles and public disclosure, including the Sarbanes-Oxley Act of 2002, regulationsDodd-Frank Wall Street Reform and Consumer Protection Act, and NASDAQ listing rules, have caused us to incur higher compliance costs and we expect to continue to incur higher compliance costs as a result of our increased global reach and obligation to ensure compliance with these laws as well as local laws in the jurisdictions where we do business. These laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity and, as a result, their application in practice may evolve over time. Further guidance by regulatory and governing bodies can result in continuing uncertainty regarding compliance matters and higher costs related to the ongoing revisions to accounting, disclosure and governance practices. Our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.

If we cannot effectively manage our internal growth, our business revenues, results of operations and prospects may suffer.

If we fail to manage our internal growth in a manner that minimizes strains on our resources, we could experience disruptions in our operations that could negatively affect our revenue,revenues, billings and results of operations. We are pursuing a strategy of organic growth through implementation of two-tier distribution, international expansion, introduction of new products, leveraging our two-tier distribution channels and expansion of our product sales to the SMB segment.international expansion. Each of these initiatives requires an investment of our

2011 ANNUAL REPORT    29


financial and employee resources and involves risks that may result in a lower return on our investments than we expect. These initiatives also may limit the opportunities we pursue or investments we would otherwise make, which may in turn impact our prospects.

It may be difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.

Some provisions of our amended and restated certificate of incorporation and amended and restated bylaws, as well as some provisions of Delaware law, may discourage, delay or prevent third parties from acquiring us, even if doing so would be beneficial to our stockholders. For example, our amended and restated certificate of incorporation provides that stockholders may not fill board vacancies, call stockholder meetings or act by written consent. Our amended and restated bylaws provide that stockholders may not fill board of director vacancies and further provide that advance written notice is required prior to stockholder proposals. Each of these provisions makes it more difficult for stockholders to obtain control of our board of directors or initiate actions that are opposed by the then current board.board of directors. Additionally, we have authorized preferred stock that is undesignated, making it possible for the board of directors to issue up to 5,000,000 shares of preferred stock with voting or other rights and preferences that could impede the success of any attempted change of control. Delaware law also could make it more difficult for a third party to acquire us. Section 203 of the Delaware General Corporation Law has an anti-takeover effect with respect to transactions not approved in advance by our board of directors, including discouraging attempts that might result in a premium over the market price of the shares of common stock held by our stockholders.

Our senior secured credit facility alsoborrowings under the 2010 Credit Facility accelerates and becomes payable in full upon a change of control, which is defined generally as a person or group acquiring 35% of our voting securities or a proxy contest that results in changing a majority of our Boardboard of Directors.directors. These consequences may discourage third parties from attempting to acquire us.

We do not intend to pay dividends.

We have not declared or paid any cash dividends on our common stock since we have been a publicly traded company. We currently intend to retain any future cash flows from operations to fund growth, pay down our senior secured term loanthe 2010 Credit Facility and repurchase shares of our common stock, and therefore do not expect to pay any cash dividends in the foreseeable future. Moreover, we are not permitted to pay cash dividends under the terms of our senior secured credit facility.the 2010 Credit Facility.

 

Item 1B.Item 1B.Unresolved Staff Comments

None.

 

Item 2.Item 2.Properties

Our corporate headquarters and principal offices are located at a 122,000 square foot facility we lease in San Diego, California, where we have leased approximately 105,000 square feet as of December 31, 2009. ThisCalifornia. The lease expires in December 2013, withhowever, we have an option to extend the lease for an additional five years. Our international headquarters and offices are located in Dublin, Ireland. We lease additional office space in Los Gatos, California; Reading, and Congleton, England; Ra’anana, Israel; Sydney, Australia and Shanghai, Guangzhou and Beijing, China andChina. We also have executive suite arrangements on monthly or annual arrangements,terms, depending on the local market, relating to office space in the United Kingdom, Brazil, Dubai, France, Germany, Hong Kong, India, Italy, Japan, Singapore, Spain, Sweden, the Netherlands Turkey and Dallas, Texas.Turkey.

 

Item 3.Item 3.Legal Proceedings

On July 12, 2010, Finjan, Inc. filed a complaint entitled Finjan, Inc. v. McAfee, Inc., Symantec Corp., Webroot Software, Inc., Websense, Inc. and Sophos, Inc. in the United States District Court for the District of Delaware. The complaint alleges that the Company’s making, using, importing, selling and/or offering for sale

30        2011 ANNUAL REPORT


Websense Web Filter, Websense Web Security and Websense Web Security Gateway infringes U.S. Patent No. 6,092,194 (“194 Patent”). Finjan, Inc. seeks an injunction from further infringement of the 194 Patent and damages. A hearing on the construction of the claims in the 194 Patent was held on January 30, 2012 and the court has not issued a ruling as of the filing date of this Annual Report on Form 10-K. The parties are currently engaged in discovery. We deny infringing any valid claims of the 194 Patent and intend to vigorously defend the lawsuit.

We are involved in various other legal actions in the normal course of business. Based on current information, including consultation with our lawyers, we believe we have adequately reserved fornot accrued any ultimate liability that may result from these actions such that any liability would not materially affectof our consolidated financial positions, results of operations or cash flows.pending legal actions. Our evaluation of the likely impact of these actions could change in the future, we may determine that we are required to accrue for potential liabilities in one or more legal actions and unfavorable outcomes and/or defense costs, depending upon the amount and timing, could have a material adverse effect on our results of operations or cash flows in a future period. If we later determine that we are required to accrue for potential liabilities resulting from any of these legal actions, it is reasonably possible that the ultimate liability for these matters will be greater than the amount for which we have accrued at that time.

 

Item 4.Submission of Matters to a Vote of Security HoldersMine Safety Disclosures

There were no matters submitted to a vote of the security holders during the fourth quarter of the fiscal year-ended December 31, 2009.Not applicable.

2011 ANNUAL REPORT    31


Part II

 

Item 5.Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Market Information

Our common stock is traded on the NASDAQ Global Select Market (“Nasdaq”) under the symbol “WBSN.” The following table sets forth the range of high and low closing sale prices on Nasdaq offor our common stock for the periods indicated, as reported by Nasdaq.the NASDAQ Global Select Market. Such quotations represent inter-dealer prices without retail markup, markdownmarkups, markdowns or commission and may not necessarily represent actual transactions.commissions.

 

  Years Ended December 31,  Years Ended December 31, 
  2009  2008  2011   2010 
  High  Low  High  Low  High   Low   High   Low 

First Quarter

  $16.14  $9.77  $20.50  $16.06  $23.23    $19.16    $24.29    $17.46  

Second Quarter

   19.45   12.41   20.29   16.84   26.02     22.56     24.96     18.90  

Third Quarter

   18.09   14.64   23.99   16.83   27.82     17.08     21.38     17.73  

Fourth Quarter

   18.27   15.53   21.26   13.84   19.77     15.63     22.39     17.18  

To date, we have neither declared nor paid any cash dividends on our common stock. We currently intend to retain all future cash flows from operations, if any, for use in the operation and development of our business, and for debt repayment and stock repurchases and, therefore, do not expect to declare or pay any cash dividends on our common stock in the foreseeable future. Moreover, we are not permitted to pay cash dividends under the terms of the 2010 Credit Agreement, subject to certain exceptions.

Holders

As of February 12, 2010,15, 2012, there were approximately 7,00016 holders of record of our common stock. See Item 12—“Security Ownershipstock and we estimate that there were approximately 6,700 beneficial owners of Certain Beneficial Owners and Management and Related Stockholder Matters” for information regarding our equity compensation plans.common stock that hold our shares in “street name” through brokerage firms, banks, dealers or similar organizations.

Issuer Purchases of Equity Securities

In April 2003, we announced that our Board of Directors authorized a stock repurchase program of up to 4 million shares of our common stock. In August 2005, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 8 million shares. In July 2006, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 12 million shares. In January 2008, we adopted a 10b5-1 plan that provides for quarterlyThe following table sets forth information about purchases of our common stock in open market transactions. In January 2010, Websense’s Board of Directors increased the size of its stock repurchase program by an additional 4 million shares, for a total program size of up to 16 million shares. We repurchased 2,284,915 shares in 2009, bringing the total number of shares repurchased as part of our stock repurchase program to 11,534,024.

The following table represents our purchases of equity securities during the fourth quarter of fiscal year 2009:ended December 31, 2011:

 

Month

  Number of
Shares
Purchased
During Month
  Average Price
Paid Per Share
  Cumulative
Number of Shares
Purchased as Part
of Publicly
Announced Plan
  Maximum Number of
Shares that May Be
Purchased Under the
Plan
 

October 2009

  169,100  $17.32  10,987,748  1,012,252  

November 2009

  265,725  $16.08  11,253,473  746,527  

December 2009

  280,551  $17.04  11,534,024  465,976  

Total

  715,376  $16.75  11,534,024  465,976

Month

  Number of
Shares
Purchased
During Month(1)
   Average Price
Paid Per Share
   Cumulative
Number of Shares
Purchased as Part
of Publicly
Announced Plan(2)
   Number of Shares
that May Be
Purchased Under the
Plan(2)
 

October 1—October 31, 2011

   425,300    $17.75     19,449,830     4,550,170  

November 1—November 30, 2011

   433,700    $17.90     19,883,530     4,116,470  

December 1—December 31, 2011

   528,291    $18.31     20,411,821     3,588,179  

Total

   1,387,291    $18.01     20,411,821     3,588,179  

 

*(1)All share purchases were made in open market transactions under our 10b5-1 stock repurchase plans.
(2)

In April 2003, we announced that our board of directors authorized a stock repurchase program of up to four million shares of our common stock. In August 2005, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to eight million shares. In July 2006, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to 12 million shares. In January 2010, we announced that our Boardboard of Directorsdirectors increased the maximumsize of the stock repurchase program by an additional four million shares, for a total program size of up to 16 million shares. In October 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional eight million shares, for a total program size of up to 24 million shares. The stock repurchase

32        2011 ANNUAL REPORT


program does not have an expiration date, does not require us to purchase a specific number of shares thatand may be purchasedmodified, suspended or terminated at any time by our board of directors. In connection with the stock repurchase program, we adopted two 10b5-1 stock repurchase plans (the “2009 Repurchase Plans”) in August 2009. The 2009 Repurchase Plans initially provided for purchases of up to an aggregate of $7.5 million of our common stock per calendar quarter in open market transactions beginning in October 2009. In November 2010, we increased the value of shares to be repurchased under the Plan2009 Repurchase Plans from an aggregate of $7.5 million to $25 million per calendar quarter effective as of January 1, 2011. In October 2011, we decreased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $25 million to $20 million per calendar quarter effective as of January 1, 2012. The 2009 Repurchase Plans will expire on November 15, 2012, unless they are further extended by amendment. Depending on market conditions and other factors, including compliance with covenants in the 2010 Credit Agreement, purchases by our agents under the 2009 Repurchase Plans may be suspended at any time, or from time to time. We repurchased an additional 4 million shares.aggregate of 4,787,302 shares in 2011. The remaining number of shares authorized for repurchase under our stock repurchase program as of December 31, 2011 was 3,588,179.

2011 ANNUAL REPORT    33


Item 6.Selected Financial Data

You should readThe following table summarizes certain historical financial information at the following selected financial datadates and for the periods indicated prepared in conjunctionaccordance with our financial statements and related notes and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this annual report. We derived theGAAP. The consolidated statement of operations data for each of the years ended December 31, 2009, 20082011, 2010 and 20072009, and the consolidated balance sheet data as of December 31, 20092011 and 20082010, have been derived from our consolidated financial statements audited by Ernst & Young LLP, an independent registered public accounting firm, which appearincluded elsewhere in this report. We derived theAnnual Report on Form 10-K. The consolidated statement of operations data for each of the years ended December 31, 20062008 and 20052007 and the consolidated balance sheet data as of December 31, 2009, 2008 and 2007 2006 and 2005have been derived from our financial statements audited by Ernst & Young LLP, an independent registered public accounting firm,not included herein. The selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto, which are not included elsewhere in this annual report. Certain amounts in the selected financial data below have been reclassified to conform to the 2009 presentation.Annual Report on Form 10-K. Our historical results are not necessarily indicative of operating results to be expected in the future.

 

  Years Ended December 31,  Years Ended December 31, 
  2009 2008 2007 2006  2005  2011 2010 2009 2008 2007 
  (In thousands, except for per share data)  (In thousands, except for per share data) 

Statement of Operations Data:

             

Revenues

  $313,713   $288,274   $210,307   $178,814  $148,636

Cost of revenues

   50,806    48,160    29,140    15,274   10,642

Revenues:

      

Software and service

  $325,373   $320,544   $311,476   $288,274   $210,307  

Appliance

   38,810    12,218    2,237    0    0  
                 

 

  

 

  

 

  

 

  

 

 

Gross margin

   262,907    240,114    181,167    163,540   137,994

Total revenues

   364,183    332,762    313,713    288,274    210,307  

Cost of revenues:

      

Software and service

   41,563    45,681    48,653    48,160    29,140  

Appliance

   18,056    7,409    2,153    0    0  
  

 

  

 

  

 

  

 

  

 

 

Total cost of revenues

   59,619    53,090    50,806    48,160    29,140  
  

 

  

 

  

 

  

 

  

 

 

Gross profit

   304,564    279,672    262,907    240,114    181,167  

Operating expenses:

             

Selling and marketing

   166,910    175,365    126,247    80,135   55,288   161,039    157,758    166,910    175,365    126,247  

Research and development

   52,643    53,274    40,913    22,663   16,277   58,247    54,325    52,643    53,274    40,913  

General and administrative

   40,295    45,343    32,708    21,279   11,729   40,863    36,779    40,295    45,343    32,708  
                 

 

  

 

  

 

  

 

  

 

 

Total operating expenses

   259,848    273,982    199,868    124,077   83,294   260,149    248,862    259,848    273,982    199,868  
                 

 

  

 

  

 

  

 

  

 

 

Income (loss) from operations

   3,059    (33,868  (18,701  39,463   54,700   44,415    30,810    3,059    (33,868  (18,701

Interest expense

   (7,084  (13,134  (4,308  —     —     (1,635  (3,715  (7,084  (13,134  (4,308

Other income, net

   384    739    9,461    11,287   5,411

Other income (expense), net

   1,239    (834  384    739    9,461  
                 

 

  

 

  

 

  

 

  

 

 

(Loss) income before income taxes

   (3,641  (46,263  (13,548  50,750   60,111

Income (loss) before income taxes

   44,019    26,261    (3,641  (46,263  (13,548

Provision (benefit) for income taxes

   7,056    (19,484  2,933    18,657   21,343   13,025    7,609    7,056    (19,484  8,748  
                 

 

  

 

  

 

  

 

  

 

 

Net (loss) income

  $(10,697 $(26,779 $(16,481 $32,093  $38,768

Net income (loss)

  $30,994   $18,652   $(10,697 $(26,779 $(22,296
                 

 

  

 

  

 

  

 

  

 

 

Net (loss) income per share:

       

Basic

  $(0.24 $(0.59 $(0.37 $0.69  $0.82

Diluted

  $(0.24 $(0.59 $(0.37 $0.68  $0.79

Net income (loss) per share:

      

Basic net income (loss) per share

  $0.78   $0.44   $(0.24 $(0.59 $(0.49

Diluted net income (loss) per share

  $0.76   $0.43   $(0.24 $(0.59 $(0.49

Weighted average shares—basic

   44,262    45,190    45,107    46,494   47,491   39,711    42,409    44,262    45,190    45,107  

Weighted average shares—diluted

   44,262    45,190    45,107    47,116   49,196   40,739    43,438    44,262    45,190    45,107  
  As of December 31, 
  2011 2010 2009 2008 2007 
  (In thousands) 

Balance Sheet Data:

      

Cash and cash equivalents (including restricted cash) and marketable securities

  $76,829   $78,080   $83,296   $66,811   $87,733  

Total assets

   634,438    661,943    695,846    718,848    774,924  

Deferred revenue

   393,034    394,304    380,112    341,784    288,043  

Long term liabilities

   232,493    229,744    233,929    261,965    322,829  

Total stockholders’ equity

   99,745    131,663    156,915    170,845    186,622  

 

   As of December 31,
   2009  2008  2007  2006  2005
   (In thousands)

Balance Sheet Data:

          

Cash and cash equivalents (including restricted cash) and marketable securities

  $83,296  $66,811  $87,733  $326,905  $320,389

Total assets

   701,661   724,663   780,739   424,257   403,675

Deferred revenue

   380,112   341,784   288,043   220,343   179,925

Long-term liabilities

   232,641   261,965   322,829   71,804   60,807

Total stockholders’ equity

   162,730   176,660   192,437   180,725   205,811

34        2011 ANNUAL REPORT


Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with theour consolidated financial statements and related notes containedincluded elsewhere in this report. See “Item 1A—RiskAnnual Report on Form 10-K. The following discussion contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed here. Factors that might cause such a difference include, but are not limited to, those discussed below and elsewhere, including under Part I, Item 1A “Risk Factors” above regarding certain factors knownof this Annual Report on Form 10-K. The cautionary statements made in this Annual Report on Form 10-K should be read as applying to us that could cause reported financial information not to be necessarily indicative of future results.all related forward-looking statements wherever they appear in this Annual Report on Form 10-K.

Overview

We are a leadingglobal provider of information technology (IT)unified Web, email and data security solutions designed to protect an organization’s data and users from external and internal threats, including Web security (includingmodern cyber-threats, advanced malware detectionattacks, information leaks, legal liability and removal), data security, and email security solutions.productivity loss. Our solutions are available ascustomers deploy our subscription software installedsolutions on standard serverservers or other IT hardware, as software pre-installed onincluding our optimized appliances, andas a software-as-a-service (SaaS) offering.SaaS offering, or in a hybrid hardware/SaaS configuration. Our products and services are sold worldwide to enterprises, small and medium sized businesses (SMBs),provide content security to enterprise customers, SMBs, public sector entities, and Internet service providers through a network of value addeddistributors, value-added resellers and original equipment manufacturer (OEM) arrangements.OEMs. Our portfolio of URL filtering, real-time Web security, data loss prevention (DLP)products use our advanced content classification, deep content inspection, and email anti-spam and security software allows organizationspolicy enforcement technologies to:

dynamically categorize user generated and other dynamic Web 2.0 content;

 

prevent access to undesirable and dangerous elements on the Web, such asincluding Web sites that contain inappropriate content or sitespages that download viruses, spyware, keyloggers, hacking tools and an ever-increasing variety of malicious code, includingand Web 2.0 sites with user-generatedthat contain inappropriate content;

 

identify and remove malicious applicationsmalware from incoming Web traffic;content;

 

preventmanage the unauthorized use and loss of sensitive data, such as customer or employee information;

filter “spam” out of incoming email traffic;

filter viruses and other malicious attachments from email and instant messages;social Web sites;

 

manage the use of non-Web Internet traffic, such as peer-to-peer communications and instant messaging;

 

protect from spam and malware embedded in Web-based user-generated content; and

controlprevent misuse of an organization’s valuable computing resources, including unauthorized downloading of high-bandwidth content.content;

inspect the content of encrypted Web traffic to prevent data loss, malware and access to Web sites with inappropriate content;

filter spam, viruses and malicious attachments from incoming email and instant messages; and

protect against data loss by identifying and categorizing sensitive or confidential data and enforcing pre-determined policies regarding its use and transmission within and outside the organization.

Since we commenced operations in 1994, Websense has evolved from a reseller of computernetwork security products to a leading developer and provider of IT security software solutions, including Web security, URL filtering, DLP, email, anti-spam and messaging security solutions. Our first Web filteringcommercial software product was released in 1996 and preventedcontrolled employee access to inappropriate Web content.sites. Since then, we have focused on adaptingdeveloping our Web filtering and content classification capabilities to address changingthe Internet use patternsand the external threat environment, including the rise of Web-based social and business applications and the growing incidence of Web-based criminal activity, as well as integrating Web security with email security and data security solutions.sophisticated, targeted cyber-attacks designed to steal valuable information.

During 2009, weWe derived approximately 50% of our revenuerevenues from international sales compared with 46% for 2008,during 2011, 2010 and 2009, with the United Kingdom comprising approximately 14%11%, 13% and approximately 15%14% of our total revenue inrevenues during 2011, 2010 and 2009, and 2008, respectively. We believe international markets continue to represent a significant growth opportunity and we are continuing to expand our international operations, particularly in selected countries in the European, Asia/Pacific and Latin American markets.

2011 ANNUAL REPORT    35


We utilize a two-tiermulti-tiered distribution strategy in North America toglobally and sell our products with an objective of increasing the number of value-added resellers selling our products and further extending our reach into the SMB market segment. Our distribution strategy outside North America also relies on a multi-tiered system ofthrough indirect distributors and value-added resellers.reseller channels. Sales through indirect channels currently account for more than 90%approximately 95% of our revenue. Sales torevenues. In North America, we use Ingram Micro our broad-line distributor who sellsand Arrow Enterprise Computing Solutions to distribute our products and provide credit facilities, marketing support and other services to regional and local value-added resellers who sell to end-user customers. Ingram Micro accounted for approximately 28%, 31% and 30% of our revenues during 2011, 2010 and 2009, respectively, and distributed our products to approximately 1,200 resellers in North America through approximately 1,400 resellers, accounted for approximately 30% of our revenue in 2009 and 23% of our revenue

in 2008.2011. We also have several arrangements with OEMs that grant the OEM customersthem the right to incorporate our products and services into the OEM’stheir products for resale to end-users.end users.

We sell subscriptions to our software and SaaS products, generally in 12, 24 or 36 month contract durations, based on the number of seats or devices managed. As described elsewhere in this report, we recognize revenuerevenues from subscriptions to our products, including our appliancessoftware and our add-on modules,SaaS products on a daily straight-line basis, commencing on the day the term of the subscription begins, over the term of the subscription agreement. We recognize revenuerevenues associated with OEM contracts ratably over the contractual period for which we are obligated to provide our services. We generally recognize the operating expenses related to these sales as they are incurred. These operating expenses include sales commissions, which are based on the total amount of the subscription contractagreement and are fully expensed in the period the product and/or software activation key isare delivered. Our operating expenses, including cost of revenues, in 2009 decreased2011 increased as compared to 2008with 2010, primarily due to increased cost of revenues from the immediate recognition of appliance cost of sales as a result of the adoption of the new revenue recognition accounting standards in January 2011 and our increased headcount, partially offset by a reduction in the amortization of acquired intangible assets of approximately $10.8 million and to a lesser extent the elimination of the majority of the restructuring and integration costs related to the SurfControl acquisition and theoverall favorable movement of currency exchange rates. These cost reductions were only partially offset

Billings represent the amount of subscription contracts, OEM royalties and appliance sales billed to customers during the applicable period. Any excess of billings booked in 2009 bya period compared with revenue recognized in that same period results in an increase in deferred revenue at the end of the period compared with the beginning of the period. Our primarily subscription-based business model operates such that subscription billings are recorded initially to our expanded sellingbalance sheet as deferred revenue and marketing efforts, continued product research and development and investments in administrative infrastructurethen recognized to support subscription sales that we will recognizeour income statement as revenue ratably over the subscription term or, in subsequentthe case of OEM arrangements, over the contractual obligation period. Our billings are not a numerical measure that can be calculated in accordance with GAAP. We provide this measurement (net of distributor marketing payments, channel rebates and adjustments to the allowance for doubtful accounts) in reporting financial performance because this measurement provides a consistent basis for understanding our sales activities each period. We believe the billings measurement is useful because the GAAP measurements of revenue and deferred revenue in the current period include subscription contracts commenced in prior periods.

Billings to end-user customers increased 7% year-over-year to $359.4 million in 2011 compared with $336.3 million in 2010. Billings from OEM arrangements declined from $10.7 million in 2010 to $3.5 million in 2011. Our total billings, including our OEM business, grew 5% from $347.0 million in 2010 to $362.9 million in 2011.

Billings from our TRITON content security solutions accounted for 53% of total billings in 2011 and grew 42% year-over-year from $135.4 million in 2010 to $192.4 million in 2011, whereas billings from our non-TRITON solution products declined from $211.6 million in 2010 to $170.5 million in 2011, reflecting migration of existing customers to our more advanced TRITON security solutions, as well as decreased seats and shorter contract duration from customers experiencing financial distress and customer loss to lower priced competitive solutions. Our TRITON solutions include our TRITON family of security gateways for Web, email and data security (including appliances), our standalone data security suite and our cloud-based security solutions. Our non-TRITON solutions include our legacy Web filtering products, such as our Websense Web Filter, Web Security Suite, server-based e-mail security and related hardware. Our appliance billings increased from $20.5 million in 2010 to $28.6 million in 2011. We expect the proportion of billings from our TRITON solutions to continue to increase as a percentage of total billings in 2012.

36        2011 ANNUAL REPORT


Billings from incremental sales, which includes product purchases by new customers and purchase of additional products or upgrades by existing customers, increased from $97.7 million in 2010 to $103.1 million in 2011, which was driven by increased sales of our TRITON solution products.

Our international billings to end-user customers represented $188.3 million, or 52% of our total billings, for 2011 compared with $172.8 million, or 50% of total billings, for 2010.

The average annual value of each subscription sold during 2011 was approximately $10,900 compared with approximately $9,300 during 2010, reflecting increased sales of our TRITON security solutions, including our TRITON security gateways and related appliances, our data loss prevention products and SaaS offerings to larger enterprise customers. Our average contract duration increased from 23.5 months for 2010 to 23.7 months for 2011, with approximately 50% of our billings in 12 month contracts, 7% in 24 month contracts and 43% in contracts with durations of 36 months or more. In addition, the number of transactions valued at over $100,000 increased 11% year-over-year, from 508 transactions in 2010 to 563 transactions in 2011.

We expect our billings to grow in 2012 relative to 2011 billings as existing Web and email filtering customers migrate to our TRITON solutions, existing TRITON customers expand their commitment with additional TRITON functionality and new customers adopt our TRITON solutions. Our billings depend in part on the number of subscriptions up for renewal each quarter and are affected by cyclical variations, with the fourth quarter generally being our strongest quarter in billings, and the first quarter generally being our lowest quarter in billings each fiscal year. As a trend, the percentage of billings from subscriptions to our TRITON content security solutions, including those pre-installed on appliances, is increasing and the percentage of billings from our legacy Web filtering products is declining.

During 2010, we completed a global restructuring of our international distribution operations. The restructuring became effective in January 2011, and we anticipate that it will reduce the complexity and compliance risks associated with our global distribution activities. We expect that the restructuring will also reduce our GAAP effective tax rate relative to the GAAP effective tax rate that would have applied absent the restructuring because we expect to reduce our taxable income in certain foreign jurisdictions with high tax rates and expect to increase our taxable income in a foreign jurisdiction with a lower tax rate where we streamlined and consolidated the ownership of our intellectual property and distribution rights. The restructuring did not materially impact our U.S. business operations or the relative amount of taxable income in the U.S. versus outside the U.S. While we anticipate that our GAAP effective tax rate will be lower than it would have been without the restructuring, we cannot predict whether the GAAP effective tax rate in any particular period will be less than the GAAP effective tax rate in the immediately preceding prior period or in the comparable period of the prior fiscal year. The actual impact of the restructuring on our GAAP effective tax rate is highly dependent on our future results of operations, including the jurisdictions where our revenue is generated.

In October 2007, we closed our acquisition of SurfControl and as a result incurred an operatinga net loss under GAAP during the fourth quarter of 2007 and for the fiscal years 2007, 2008 and 2008.2009. Similar to Websense, SurfControl sold products primarily under subscriptions whereby revenues were recorded ratably over the term of the agreement. Under purchase accounting, we wrote off $101.1 million of the deferred revenue of SurfControl, leaving a balance of $19.7 million. This adjustment reflected the fair value of the post-contract technical support services that is recognized daily in accordance with our revenue recognition policy. In connection with the acquisition, we incurred restructuring costs primarily in connection with reducing SurfControl headcount and eliminating redundant facilities. As of the acquisition date, we also immediately started to incur the expenses of operating the SurfControl operations as well as recording the amortization of the acquired intangibles. Given our deferred revenue as of December 31, 2009, our subscriptions up for renewal in 2010 for which we will recognize a portion of the total billing as revenue and the elimination of many of the non-recurring acquisition related expenses, we currently expect to report income from operations for fiscal year 2010.

Critical Accounting Policies and Estimates

Critical accounting policies are those that may have a material impact on our financial statements and also require management to exercise significant judgment due to a high degree of uncertainty at the time the estimate is made. Our senior management has discussed the development and selection of our accounting policies, related

2011 ANNUAL REPORT    37


accounting estimates and disclosures with the Audit Committeeaudit committee of our Boardboard of Directors.directors. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition. When a purchase decision is made forThe majority of our revenues are derived from software and SaaS products including our appliance products, customers enter intosold on a subscription agreement, whichbasis. A subscription is generally 12, 24 or 36 months in duration and for a fixed number of seats or devices. Other services such as upgrades/enhancementsseats. We recognize revenues for the software and standard post-contractSaaS subscriptions, including any related technical support services are sold together with our product subscription and provided throughout the subscription term. We recognize revenueprofessional services, on a daily straight-line basis, including our appliance product revenue, commencing on the date the term of the subscription begins, and continuing over the term of the subscription agreement, provided the fee is fixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred and collectability is reasonably assured. Upon entering into a subscription arrangement for a fixed or determinable fee, we electronically deliver software access codes to users and in the case of our appliance product we ship the product with our software pre-installed on the product, and then promptly invoice customers for the full amount of their order.subscriptions. Payment is due for the full term of the subscription, generally within 30 to 60 days of the invoice. Weinvoice date.

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove from the scope of industry-specific software revenue recognition guidance any tangible products containing software components and non-software components that operate together to deliver the product’s essential functionality. In addition, the FASB amended the accounting standards for certain multiple element revenue arrangements to:

record amounts billedprovide updated guidance on whether multiple elements exist, how the elements in an arrangement should be separated, and how the arrangement consideration should be allocated to customersthe separate elements; and

require an entity to allocate arrangement consideration to each element based on a selling price hierarchy, where the selling price for an element is based on vendor-specific objective evidence (“VSOE”), if available; third-party evidence (“TPE”), if available and VSOE is not available; or the best estimate of selling price (“BESP”), if neither VSOE nor TPE is available.

We adopted the amended standards as of January 1, 2011 on a prospective basis for transactions entered into or materially modified after December 31, 2010.

A portion of our revenues are generated from the sale of appliances, which are standard server platforms optimized for our software products. These appliances contain software components, such as operating systems, that operate together with the hardware platform to provide the essential functionality of the appliance. Based on the amended accounting standards, when sold in excessa multiple element arrangement that includes software deliverables, our hardware appliances are considered non-software deliverables and are no longer accounted for under the industry-specific software revenue recognition guidance. When appliance orders are taken, we ship the product, invoice the customer and recognize revenues when title/risk of recognizableloss passes to the buyer (typically upon delivery to a common carrier) and the other criteria of revenue recognition are met. The revenues recognized are based upon BESP, as outlined further below.

For transactions entered into prior to the adoption of the amended revenue standards on January 1, 2011, all elements in a multiple element arrangement containing software were treated as a single unit of accounting as we did not have adequate support for VSOE of undelivered elements. As a result, we deferred revenue on our balance sheet. Whenmultiple element arrangements until only the post-contract customer support (database updates and technical support) or other services not essential to the functionality of the software remained undelivered. At that point, the revenue was amortized over the remaining life of the software subscription or estimated delivery term of the services, whichever was longer.

For transactions entered into subsequent to the adoption of the amended revenue recognition standards that are multiple element arrangements, we enter into a subscription agreement that is denominatedallocate the arrangement fee to the software-related elements and paid in a currency other than U.S. dollars, we record the subscription billing and deferred revenue in U.S. dollarsnon-software-related elements based upon the currency exchange rate in effectrelative selling price of such element. When applying the relative

38        2011 ANNUAL REPORT


selling price method, we determine the selling price for each element using BESP, because VSOE and TPE are not available. The revenues allocated to the software-related elements are recognized based on the last dayindustry-specific software revenue recognition guidance that remains unchanged. The revenues allocated to the non-software-related elements are recognized based on the nature of the previous month beforeelement provided the subscription agreementfee is effective. Changesfixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred and collectability is reasonably assured. The manner in currency rates relativewhich we account for multiple element arrangements that contain only software and software-related elements remains unchanged.

We determine BESP for an individual element within a multiple element revenue arrangement using the same methods utilized to determine the selling price of an element sold on a standalone basis. We estimate the selling price by considering internal factors such as historical pricing practices and gross margin objectives. Consideration is also given to market conditions such as competitor pricing strategies, customer demands and geography. As there is a significant amount of judgment when determining BESP, we regularly review all of our assumptions and inputs around BESP and maintain internal controls over the establishment and updates of these estimates.

During 2011, we recognized $38.8 million in revenues from appliance sales, of which $27.4 million represented the immediate recognition of revenue upon shipment and the remaining $11.4 million represented primarily the ratable recognition of deferred revenue from appliance sales recorded prior to the U.S. dollar mayadoption of the amended revenue recognition rules. In 2012 we expect to recognize revenues of $5.9 million from appliance sales made prior to 2011 that are recorded in deferred revenue as of December 31, 2011. Had we not adopted the amended revenue recognition rules, the amount of revenues recognized from appliance sales would have a significantbeen approximately $20.6 million for 2011. The new accounting guidance for revenue recognition is expected to continue to affect total revenues in future periods, although the impact on the revenue that wetiming and pattern of revenues will recognize undervary depending on the nature and volume of new or materially modified contracts that are denominated in currencies other than U.S. dollars.any given period.

For our OEM contracts, we grant our OEM customers the right to incorporate our products into theirthe OEMs’ products or services for resale to end users. The OEM customer generally pays us a royalty fee for each resale of our product to an end user of a subscription to our product over a specified period of time. We recognize revenuerevenues associated with the OEM contracts ratably over the contractual period for which we are obligated to provide our services.services to the OEM. The timing oftime period over which we recognize revenue associated with OEM contracts is determined by the OEM revenue recognitioncontractual obligation period and will vary for each OEM depending on the information available, such as underlying end userend-user subscription periods, to determineperiods. To the contractual obligation period.extent we provide any custom software and engineering services in connection with an OEM arrangement, we defer recognition of all revenue until acceptance of the custom software.

We record distributor marketing payments and channel rebates as an offset to revenue.revenues, unless we receive an identifiable benefit in exchange for the consideration and we can estimate the fair value of the benefit received. We recognize distributor marketing payments as an offset to revenue asrevenues in the period the marketing service is provided. Weprovided and we recognize channel rebates as an offset to revenuerevenues generally on a straight-line basis over the term of the underlying subscription agreement.sale.

Income Taxes. We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves for tax contingencies are established when we believe that certain positions might be challenged despite our belief that our tax return positions are consistent with prevailing law and practice. We adjust these reserves in light of changing facts and circumstances, such as the outcome of tax audits. The provision for income taxes includes the impact of these reserves and changes to the reserves that are considered appropriate.

2011 ANNUAL REPORT    39


Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the extent we believe it is more-likely-than-not that all or a portion of the deferred tax assets will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience and expectations of future taxable income by taxing jurisdiction, the carry-forward periods available for tax reporting purposes, and other relevant factors.

We use a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which require periodic adjustments and which may not accurately anticipate actual outcomes.

During the first quarter of 2010, we were informed by the IRS that they had completed their audit for the tax years ended December 31, 2005 through December 31, 2007. Accordingly, the IRS issued us a 30-day letter which outlined all of their proposed audit adjustments and required us to either accept the proposed adjustments, subject to future litigation, or file a formal administrative protest contesting those proposed adjustments within 30 days. The proposed adjustments relate primarily to the cost sharing arrangement between Websense, Inc. and our Irish subsidiary, including the amount of cost sharing buy-in, as well as to our claim of research and development tax credits and income tax deductions for equity compensation awarded to certain executive officers. The amount of additional tax proposed by the IRS totals approximately $19.0 million, of which $14.8 million relates to the amount of cost sharing buy-in, $2.5 million relates to research and development credits and $1.7 million relates to equity compensation awarded to certain executive officers. The total additional tax proposed excludes interest, penalties and state income taxes, each of which may be significant, and also excludes a potential reduction in tax on the Irish subsidiary. The proposed adjustments also do not include the future impact that changes in our cost sharing arrangement could have on our effective tax rate. We disagree with all of the proposed adjustments and have submitted a formal protest to the IRS for each matter. The IRS assigned our case to an IRS Appeals Officer and the appeals process commenced during the second quarter of 2011. In the third quarter of 2011, the IRS withdrew the proposed adjustment relating to equity compensation of $1.7 million, resulting in no additional tax liability. This reduced the amount of the additional tax proposed by the IRS for the tax years ended December 31, 2005 through December 31, 2007 to approximately $17.3 million. We intend to continue to defend our position on the remaining matters at the IRS Appeals Office, including through litigation if required. The timing of the ultimate resolution of these remaining matters cannot be reasonably estimated at this time and the appeals process is still ongoing as of the date of this report, February 23, 2012.

Acquisitions, Goodwill and Other Intangible Assets. We account for acquired businesses using the acquisition method of accounting, in accordance with U.S. GAAP accounting rules for business combinations, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of net assets acquired is recorded as goodwill. The fair value of intangible assets, including acquired technology and customer relationships, is based on significant judgments made by management. The valuations and useful life assumptions are based on information available near the acquisition date and are based on expectations and assumptions that are considered reasonable by management. In our assessment of the fair value of identifiable intangible assets acquired in the PortAuthority and SurfControl acquisitions, management used valuation techniques and made various assumptions. Our analysis and financial projections were based on management’s prospective operating plans and the historical performance of the acquired businesses. We engaged third party valuation firms to assist management in the following:

developing an understanding of the economic and competitive environment for the industry in which we and the acquired companies participate;

identifying the intangible assets acquired;

reviewing the acquisition agreements and other relevant documents made available;

interviewing our employees, including the employees of the acquired companies, regarding the history and nature of the acquisition, historical and expected financial performance, product lifecycles and roadmap, and other factors deemed relevant to the valuation;

performing additional market research and analysis deemed relevant to the valuation analysis;

estimating the fair values and recommending useful lives of the acquired intangible assets; and

preparing a narrative report detailing methods and assumptions used in the valuation of the intangible assets.

All work performed by the outside valuation firms was discussed and reviewed in detail by management to determine the estimated fair values of the intangible assets. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed, as well as asset lives, can materially impact our results of operations.

We review goodwill that has an indefinite useful life for impairment at least annually in our fourth fiscal quarter, or more frequently if an event occurs indicating the potential for impairment. We amortize the cost of

identified intangible assets using amortization methods that reflect the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up. We review intangible assets that have finite useful lives when an event occurs indicating the potential for impairment. We review for impairment by facts or circumstances, either external or internal, indicating that we may not recover the carrying value of the asset. We measure impairment losses related to long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values. We measure fair value generally based on the estimated future cash flows.flows generated by the asset. Our analysis is based on available information and on assumptions and projections that we consider to be reasonable and supportable. If necessary, we perform subsequent calculations to measure the amount of the impairment loss based on the excess of the carrying value over the fair value of the impaired assets.

40        2011 ANNUAL REPORT


Share-Based CompensationCompensation.. We account for share-based compensation under the fair value method. Share-based compensation expense related to stock options and employee stock purchase plan share grants is recorded based on the fair value of the award on its grant date which wedate. We estimate the fair value using the Black-Scholes valuation model. Share-based compensation expense related to restricted stock unit awards is calculated based on the market price of our common stock on the date of grant.

Performance based restricted stock units have performance based vesting components that vest only if performance criteria are met for each respective performance period. If the performance criteria are not met for a performance period, then the related performance awards that would have vested are forfeited. Certain performance criteria allow for different vested amounts based on the level of achievement of the performance criteria. Once the performance based vesting criteria is met, the awards are then subject to time based vesting. Fair value has been measured on the grant date and is recognized over the expected vesting period, provided we determine it is probable that the performance criteria will be met.

At December 31, 2009,2011, there was $46.2$39.5 million of total unrecognized compensation cost related to share-based compensation arrangements granted under all equity compensation plans (excluding tax effects). That total unrecognized compensation cost will be adjusted for estimated forfeitures as well as for future changes in estimated forfeitures. We expect to recognize that cost over a weighted average period of approximately 2.21.9 years.

We estimate the fair value of options granted using the Black-Scholes option valuation model and the assumptions described below. We estimate the expected term of options granted based on the history of grants and exercises in our option database. We estimate the volatility of our common stock at the date of grant based on both the historical volatility as well as the implied volatility of publicly traded options onfor our common stock. We base the risk-free interest rate that is used in the Black-Scholes option valuation model on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with equivalent remaining terms. We have never paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes option valuation model. We amortize the fair value ratably over the vesting period of the awards, which is typically four years.awards. We use historical data to estimate pre-vesting option forfeitures and record share-based expense only for those awards that are expected to vest. We may elect to use different assumptions under the Black-Scholes option valuation model in the future or select a different option valuation model altogether, which could materially affect our net income or loss and net income or loss per shareresults of operations in the future.

We determine the fair value of share-based payment awards on the date of grant using an option-pricing model that is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because our employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion the existing valuation models may not provide an accurate measure of the fair value of our employee stock options. Although the fair value of employee stock options is determined using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Income Taxes.We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves for tax contingencies are established when we

believe that certain positions might be challenged despite our belief that our tax return positions are consistent with prevailing law and practice. We adjust these reserves in light of changing facts and circumstances, such as the outcome of tax audits. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate.

Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience and expectations of future taxable income by taxing jurisdiction, the carry-forward periods available to us for tax reporting purposes, and other relevant factors.

We use a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which require periodic adjustments and which may not accurately anticipate actual outcomes.

During the fourth quarter of 2009, the U.S. Internal Revenue Service (the “IRS”) issued Notices of Proposed Adjustment related to the cost sharing arrangement between our U.S. parent company and our Irish subsidiary, including the amount of the cost sharing buy-in, as well as with respect to our claim of research and development tax credits and our income tax deductions for equity compensation awarded to certain executive officers. The amount of additional tax proposed by the IRS totals approximately $17.7 million, of which $13.5 million relates to the amount of the cost sharing buy-in, $2.5 million relates to research and development credits and $1.7 million relates to equity compensation awarded to certain executive officers. The total additional tax proposed excludes interest, penalties and state income taxes, each of which may be significant, and a potential reduction in tax on the Irish subsidiary. The proposed adjustments also do not include the future impact that changes in our cost sharing arrangement could have on our effective tax rate. As each audit progresses and is ultimately concluded, adjustments, if any, will be recorded in our financial statements from time to time in light of prevailing facts based on our and the taxing authority’s respective positions on any disputed matters.

We believe the IRS’s positions with respect to the proposed adjustments to our cost sharing arrangements, including the amount of cost sharing buy-in, our research and development tax credits, and our deductions for equity compensation are inconsistent with applicable tax law, and that we have meritorious defenses to our positions. Accordingly, we are vigorously defending our positions, including as necessary and appropriate, utilizing our rights to appeal as well as other legal remedies. While we believe the IRS’s asserted positions on these matters are not supported by applicable law, we may be required to make additional payments in order to resolve these matters.

In particular, the IRS has identified and is aggressively pursuing cost sharing arrangements between domestic and international subsidiaries, including the amount of the buy-in, as a potential area for audit exposure for many companies. If this matter is litigated and the position proposed by the IRS were sustained, our results of operations for periods when any new liability is incurred would be materially and adversely affected. We also cannot predict what impact an adverse result could have on our future income tax rate, which could adversely impact our results of operations.

Allowance for Doubtful Accounts and Other Loss Contingencies.We maintain an allowance for doubtful accounts for estimated losses resulting from the inability or unwillingness of our customers to pay their invoices. We establish this allowance using estimates that we make based on factors such as the composition of the accounts receivable aging, historical bad debts, changes in payment patterns, changes to customer creditworthiness, current economic trends and other facts and circumstances of our existing customers. If the

financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make

2011 ANNUAL REPORT    41


payments, additional allowances may be required. Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires significant judgment by management based on the facts and circumstances of each matter.

Results of Operations

The following table summarizes our operating results as a percentage of total revenues for each of the periods shown.

 

   Years Ended December 31, 
   2009  2008  2007 

Revenues

  100 100 100

Cost of revenues

  16   17   14  
          

Gross margin

  84   83   86  

Operating expenses:

    

Selling and marketing

  53   61   60  

Research and development

  17   18   19  

General and administrative

  13   16   16  
          

Total operating expenses

  83   95   95  
          

Income (loss) from operations

  1   (12 (9

Interest expense

  (2 (4 (2

Other income, net

  —     —     4  
          

Loss before income taxes

  (1 (16 (7

Provision (benefit) for income taxes

  2   (7 1  
          

Net (loss) income

  (3)%  (9)%  (8)% 
          
   Years Ended December 31, 
   2011  2010  2009 

Revenues:

    

Software and service

   89  96  99

Appliance

   11    4    1  
  

 

 

  

 

 

  

 

 

 

Total revenues

   100  100  100

Cost of revenues:

    

Software and service

   11    14    15  

Appliance

   5    2    1  
  

 

 

  

 

 

  

 

 

 

Total cost of revenues

   16    16    16  
  

 

 

  

 

 

  

 

 

 

Gross profit

   84    84    84  

Operating expenses:

    

Selling and marketing

   44    48    53  

Research and development

   16    16    17  

General and administrative

   11    11    13  
  

 

 

  

 

 

  

 

 

 

Total operating expenses

   71    75    83  
  

 

 

  

 

 

  

 

 

 

Income from operations

   13    9    1  

Interest expense

   (1  (1  (2

Other income (expense), net

   0    0    0  
  

 

 

  

 

 

  

 

 

 

Income (loss) before income taxes

   12    8    (1

Provision for income taxes

   4    2    2  
  

 

 

  

 

 

  

 

 

 

Net income (loss)

   8  6  (3%) 
  

 

 

  

 

 

  

 

 

 

Year ended December 31, 20092011 compared with the year ended December 31, 20082010

Revenues

RevenuesSoftware and service revenues. Software and service revenues increased to $313.7$325.4 million in 20092011 from $288.3$320.6 million in 2008. The increase was a result primarily2010. Because we recognize software and service revenues ratably over the term of increasedthe subscription, growth in software and service revenues reflect changes in current deferred revenue from new, renewed and upgraded product subscriptions including SaaS security products, DLP products and OEM contract revenue from 2008 to 2009at the beginning of the period compared with the prior period, as well as the revenue from our Websense Web Security Gatewaychange in current period billings. The increase in 2011 software and V10000 appliance sales that commencedservice revenues compared with 2010 was primarily the result of increased incremental billings to new customers and upgrades to existing customers, as well as higher OEM revenues in 2009. Revenue from products sold2011 as compared with 2010. Software and service revenues generated in the United States accounted for $155.8$163.0 million, or 50%45% of 2009 revenue2011 revenues, compared to $155.7with $158.5 million, or 54%47% in 2008. Revenue from products sold2010. Software and service revenues generated internationally accounted for $157.9$162.4 million, or 50%44% of 2009 revenue2011 revenues, compared to $132.6with $162.1 million, or 46%49%, in 2008.2010. We had current deferred revenue relating to software and service revenues of $239.0$244.6 million as of December 31, 2009,2011, compared to $223.9with $240.5 million as of December 31, 2008. 2010, and we had total deferred revenue relating to software and service revenues of $383.3 million as of December 31, 2011, compared with $374.3 million as of December 31, 2010.

42        2011 ANNUAL REPORT


We expect our 2010 revenuesoftware and service revenues in 2012 to increase over 2009 revenue levelsexceed our software and service revenues in 2011 due to the level ofincrease in current deferred revenue that will be recognized as revenue, during 2010, subscriptions that are scheduled for renewal in 2010 that are expected to be renewed and upgraded, and expected new business during 2010 for which a ratable portion of revenuesome revenues will be recognized during 2010.2012. These trends are anticipated to be partially offset by an expected decline in revenue from OEM arrangements. Our revenue in 2010 may besoftware and service revenues are impacted by the average duration of contracts for renewal and new subscriptions,billed, the timing of sales of renewal and new subscriptions, the average annual contract value and per seat price, the volume of OEM revenue activity and the effect of currency exchange rates impactingon new and renewal subscriptions in international markets.

Appliance revenues. Appliance revenues increased to $38.8 million in 2011 from $12.2 million in 2010. The increase was primarily a result of increased appliance sales in 2011 and our adoption of new revenue recognition rules (as more fully described in Note 1 to the consolidated financial statements) starting January 1, 2011 under which revenues from sales of appliances are generally recognized when sold. Accordingly, $11.4 million of the revenue recognized in 2011, represented primarily the ratable recognition of deferred revenue for sales of appliances recorded prior to the adoption of the amended revenue recognition rules, and the remaining $27.4 million represented revenues from sales of appliances sold in 2011. As of December 31, 2011, we had $8.6 million of remaining deferred revenue for sales recorded prior to the adoption of the amended revenue recognition rules. Appliance revenues generated in the United States accounted for $19.4 million, or 5% of 2011 revenues, compared with $6.8 million, or 2% of revenues, in 2010. Appliance revenues generated internationally accounted for $19.4 million, or 5% of 2011 revenues, compared with $5.4 million, or 2% of revenues, in 2010.

For 2012, we expect our appliance revenues to decrease in both absolute dollars and as a percentage of total revenues as compared with 2011 primarily as a result of the decline in deferred revenue to be recognized in 2012 from appliance sales recorded prior to January 1, 2011, which is expected to offset projected increases in appliance sales in 2012. For 2012, we expect to recognize $5.9 million of deferred revenue for appliance sales recorded prior to January 1, 2011.

Cost of Revenues

CostSoftware and service cost of revenues.Software and service cost of revenues consists of the costs of Web content review, amortization of acquired technology, technical support and infrastructure costs associated with maintaining our databases and costs associated with providing our SaaS security products, amortizationofferings. Software and service cost of

acquired technology and the amortized costs of acquiring and configuring our V10000 appliance. Cost of revenue increased revenues decreased to $50.8$41.6 million in 20092011 from $48.2$45.7 million in 2008.2010. The $2.6$4.1 million increasedecrease was primarily consisted of $0.5 million of increaseddue to decreased amortization of acquired technology of $6.0 million and decreased allocated costs of $0.7 million, offset by increased personnel costs of $2.1 million. Amortization of acquired technology was $3.0 million in 2011 compared with $9.0 million in 2010. The decrease of $6.0 million in amortization of acquired technology from 2010 to 2011 was primarily due to certain acquired technology being fully amortized in 2010. As of December 31, 2011, the acquisitionsremaining acquired technology is being amortized over a remaining weighted average period of 3.2 years. We expect to incur $2.3 million in amortization expense of acquired technology during 2012. Our full-time employee headcount in the latter partcost of 2008, $1.1 million relatedrevenues departments decreased from an average of 266 employees during 2010 to increased personnel costs,an average of 261 employees during 2011, and $1.7 million relatedis expected to sales of our appliance products, offset by a reductionremain relatively flat in our allocated costs of $1.0 million.2012. We allocate the costs for human resources, employee benefits, payroll taxes, information technology,IT, facilities and fixed asset depreciation to each of our functional areas based on headcount data. Our headcount in cost of revenue departments increased from an average of 225 during 2008 to an average of 258 during 2009 and is expected to remain relatively flat in 2010. As of December 31, 2009, the acquired technology is being amortized over a remaining weighted average period of 2.5 years. We expect to record $9.0 million in amortization expense of acquired technology in 2010 based on our existing acquired technology assets as of December 31, 2009. Our cost of revenues for appliances will increase as a result of the appliances being sold for a full fiscal year and will increase as sales of appliances increase. In addition, we expect cost of revenue to increase to support the growth and maintenance of our databases and costs associated with providing our SaaS security services as well as the technical support needs of our customers. As a percentage of revenue,software and service revenues, software and service cost of revenue decreased to 16% during 2009 from 17% in 2008 primarily due to reduced allocated costs as a result of the completion of SurfControl related integration activities during 2008. revenues was 13% for 2011, compared with 14% for 2010.

We expect thatsoftware and service cost of revenuerevenues will increase in absolute dollars in 20102012 due to higher expected software and service billings, but remain approximately constant as a percentage of revenue will remain approximatelysoftware and service revenues in 2012 as compared with 2011.

Appliance cost of revenues.Appliance cost of revenues consists of the same for 2010 compared to 2009.

Gross Margin

Gross margincosts associated with the sale of our appliance products, primarily the cost of the hardware platform and software installation costs. Appliance cost of revenues increased to $262.9$18.1 million in 20092011, from $240.1$7.4 million in 2008. The2010. As described in the Appliance Revenues

2011 ANNUAL REPORT    43


section above, the $10.7 million increase was primarily due to increased revenue.appliance sales in 2011 and our adoption of revenue recognition rules under which the related costs are generally recognized when the appliances are sold. In appliance cost of revenues for 2011, we recognized $5.2 million of the ratable cost of appliances sold prior to 2011 that were recognized in revenues in 2011 and the remaining $12.9 million represents costs of appliances sold in 2011. As a percentage of revenue, gross margin increasedappliance revenues, appliance cost of revenues decreased to 84%47% in 20092011 from 83%61% in 2008 primarily2010.

We expect appliance cost of revenues will decrease in absolute dollars in 2012 as compared with 2011 due to the decreasedecline in deferred costs to be recognized in 2012 from appliance sales recorded prior to January 1, 2011. This decline is expected to be offset by projected increases in appliance sales in 2012. During 2012, we expect to recognize $2.6 million in deferred cost of revenues related to sales recorded prior to January 1, 2011.

Gross Profit

Gross profit increased to $304.6 million in 2011 from $279.7 million in 2010, primarily as a result of increased revenues. As a percentage of revenue described in the preceding Cost of Revenues section.total revenues, our gross profit was 84% for both 2011 and 2010. We expect that gross margin,profit as a percentage of revenue will remain in excess of 80% of revenue for 2010.2012.

Operating Expenses

Selling and marketing.marketing. Selling and marketing expenses consist primarily of salaries, commissions and benefits related to personnel engaged in selling, marketing and customer support functions, including costs related to public relations, advertising, promotions and travel, amortization of acquired customer relationships as well asand other allocated costs. Selling and marketing expenses decreaseddo not include payments to $166.9channel partners for marketing services and rebates as those are recorded as an offset to revenue. Selling and marketing expenses increased to $161.0 million, or 44% of revenues, in 20092011 from $175.4$157.8 million, or 48% of revenues, in 2008.2010. The decrease$3.2 million increase in total selling and marketing expenses was primarily due to an $11.1 million reduction in amortization of acquired customer relationships from the acquisition of SurfControl in October 2007 and a $1.4 million decrease in allocated costs offset by increased personnel costs of $6.1$6.2 million asresulting from higher average head count and costs associated with changes to our internal sales team during 2011 and increased allocated costs of $1.7 million, partially offset by a reduction in the amortization of acquired intangible assets (customer relationships) of $4.9 million. Our headcount in sales and marketing increased from an average of 533583 employees during 20082010 to an average of 594608 employees during 2009.2011. Headcount is expected to be relatively flatincrease slightly in 2010. As of December 31, 2009, the acquired customer relationships intangible assets are being amortized over a remaining weighted average period of approximately 5.4 years. Operating expenses in 2009 were reduced compared to 2008 as a result of strengthening U.S. currency exchange rates relative to the foreign currencies in which certain of our international expenses were incurred. 2012.

We expect overall selling and marketing expenses to decreaseincrease in absolute dollars in 2012 as compared with 2011 primarily due to additional sales and marketing personnel to support our expanding selling and marketing efforts worldwide and increased sales commission expenses from higher expected billings, partially offset by a reduction of amortization of acquired intangible assets, compared with 2011, from the SurfControl acquisition. We expect selling and marketing expenses as a percentage of revenuerevenues will remain relatively constant in 2010 primarily due2012 compared with 2011. If our 2012 billings exceed expectations, our sales commission expenses can be expected to exceed our expectations and result in higher than expected selling and marketing expenses in 2012. Because commission expenses are recognized in the period incurred, while a decreasesubstantial portion of revenues are recognized in future periods, if our 2012 billings exceed expectations, our selling and marketing expenses as a percentage of revenues could increase in 2012 compared with 2011. Based on the existing sales and marketing related intangible assets as of December 31, 2011, we expect amortization of sales and marketing related acquired intangibles of $6.0 million for 2012, which would be a reduction of approximately $8.7$6.6 million of amortization of acquired intangibles from the SurfControl acquisition.2011. Fluctuations in foreign currencies may also impact our expenses in 2010, and the amount of sales commissions recognized during the year can vary based on the sales volume for our product subscriptions. We expect amortization of selling and marketing related acquired intangibles of $17.5 millionexpenses in 2010 based on our existing acquired intangible assets as of December 31, 2009 from the SurfControl and PortAuthority acquisitions.2012.

Research and development.development. Research and development expenses consist primarily of salaries and benefits for software developers and allocated costs. Research and development expenses decreasedincreased to $52.6$58.2 million, or 16% of revenues, in 20092011 from $53.3$54.3 million, or 16% of revenues, in 2008.2010. The decreaseincrease of $0.7$3.9 million in research and development expenses was primarily due to a reduction in allocated costs of $0.8 million offset by increased personnel costs of $0.1$2.4 million and increased allocated costs of $1.5 million.

Although our headcount increased in research and development from an average of 353

44        2011 ANNUAL REPORT


454 employees during 20082010 to an average of 411490 employees during 2009, the majority of whom were employed in foreign jurisdictions,2011, the impact of the higher headcount was significantly offsetpartially mitigated by an increase in the favorable movement in currency exchange rates in 2009 compared to 2008 and our increased hiringnumber of employees in relatively low cost foreign locations.

We expect research and development expenses to increase in absolute dollars andin 2012 as a percentage of revenue in 2010compared with 2011 due to ouran expanded base of product offerings and the full year impact of hiring of personnelincreased average headcount compared with 2011 to support our existingcontinued enhancements and new products.product developments. Fluctuations in foreign currencies may also impact our research and development expenses in 2010.2012. We are managing the increase in our absolute research and development expenses by operating research and development facilities in multiple international locations, including a facilityfacilities in Beijing, China and Ra’anana, Israel, that have lower costs than our operations in the United States. We also have research and development facilities in Los Gatos and San Diego, California and Reading, England. We expect that research and development expenses as a percentage of revenues will remain relatively flat in 2012 compared with 2011.

General and administrative. General and administrative expenses consist primarily of salaries, benefits and related expenses for our executive, finance and administrative personnel, third partythird-party professional servicesservice fees and allocated costs. General and administrative expenses increased to $40.9 million, or 11% of revenues, in 2011 from $36.8 million, or 11% of revenues, in 2010. The $4.1 million increase in general and administrative expenses was primarily due to an increase in third-party professional service fees, which were largely related to the global restructuring of our international distribution operations, and increased personnel costs. Our headcount remained consistent in general and administrative departments with an average of 120 employees during 2010 to an average of 121 employees during 2011.

We expect general and administrative expenses to remain relatively constant in absolute dollars and as a percentage of revenue in 2012 compared with 2011.

Interest Expense

Interest expense decreased to $1.6 million in 2011 compared with $3.7 million in 2010. The decrease was partially due to a lower average outstanding loan balance on our secured loan of $67.8 million during 2011, compared with an average loan balance of $73.0 million during 2010. In addition, the effective interest rate was lower in 2011 compared with 2010 primarily due to the expiration of an unfavorable fixed rate swap agreement which expired on September 30, 2010 and more favorable interest rate terms under our 2010 Credit Facility. Also included in the interest expense is amortization of deferred financing fees of $0.2 million and $1.0 million for 2011 and 2010, respectively, that were capitalized as part of the 2010 Credit Facility and 2007 Credit Facility, as applicable.

Our weighted average interest rate was 2.0% in 2011 and is expected to increase to 3.1% for 2012 as a result of an interest rate swap becoming effective on December 30, 2011. Our interest expense is expected to increase in 2012 as compared with 2011 due to a higher weighted average interest rate. See “Liquidity and Capital Resources” for a description of the 2010 Credit Agreement.

Other Income (Expense), Net

Other income increased to $1.2 million in 2011, compared with other expense of $0.8 million in 2010, reflecting foreign exchange related net gains of $1.0 million in 2011 compared with net losses of $1.3 million in 2010 as a result of movements in the currency exchange rates during 2011 and 2010.

We expect our net other income in 2012 will be less than 2011 levels because 2011 included these foreign exchange related net gains which are expected to be non-recurring.

Provision for Income Taxes

In 2011, we recognized an income tax expense of $13.0 million compared with an income tax expense of $7.6 million for 2010. The annual effective income tax rate for 2011 was 29.6 % compared with 29.0% for 2010.

2011 ANNUAL REPORT    45


For 2011, the effective tax rate variance from the U.S. federal statutory rate was primarily attributable to a net tax benefit recognized for the year of approximately $5.5 million offset partially by the unfavorable impact of foreign withholding taxes and non-deductible share-based compensation expense. Approximately $2.8 million of the net tax benefit recognized for the year resulted from our global distribution restructuring which was completed during 2010 and became effective in January 2011. This amount relates primarily to the non-recurring tax effect from the transfer of customer relationship intangible assets and the related deferred tax liabilities from a higher tax rate jurisdiction to a lower tax rate jurisdiction. This entire tax benefit was recorded in the first quarter of 2011 upon completion of our global distribution restructuring and is not expected to recur. The remaining net tax benefit recognized for the year of approximately $2.7 million relates to the reversal of previously established reserves for uncertain tax positions due to the settlement of a tax inquiry in the United Kingdom in the fourth quarter of 2011. This entire net tax benefit was recorded in the fourth quarter of 2011, the period in which the settlement occurred, and is not expected to recur. For 2010, the effective tax rate variance from the U.S. federal statutory rate was primarily related to earnings recognized in lower tax jurisdictions, and the reduction of a valuation allowance related to net operating losses for one of our subsidiaries in the United Kingdom, partially offset by the write-down of a deferred tax asset relating to the net operating losses in the United Kingdom.

Our effective tax rate may change in future periods due to differences in the composition of taxable income between domestic and international operations along with the potential changes or interpretations in tax rules and legislation, or corresponding accounting rules. Effective January 2011, we completed a global restructuring of our international distribution operations, which we anticipate will reduce the complexity and compliance risks associated with our global distribution activities. We expect that the restructuring will also reduce our GAAP effective tax rate relative to the GAAP effective tax rate that would have applied absent the restructuring because we expect to reduce our taxable income in certain foreign jurisdictions having high tax rates and expect to increase our taxable income in a foreign jurisdiction with a lower tax rate where we streamlined and consolidated the ownership of our intellectual property and distribution rights. The restructuring did not materially impact our U.S. business operations or the relative amount of taxable income in the U.S. versus outside the U.S. While we anticipate that our GAAP effective tax rate will be lower than it would have been without the global distribution restructuring, we cannot predict whether the GAAP effective tax rate in any particular period will be less than the GAAP effective tax rate in the immediately preceding prior period or in the comparable period of the prior fiscal year. The actual impact of the restructuring on our GAAP effective tax rate is highly dependent on our future results of operations, including the jurisdictions where our revenue is generated.

We assess, on a quarterly basis, the ultimate realization of our deferred income tax assets. Realization of deferred income tax assets is dependent upon taxable income in prior carryback years, estimates of future taxable income, tax planning strategies and reversals of existing taxable temporary differences. Based on our assessment of these items for the fiscal year ended December 31, 2011, specifically the expected reversal of existing taxable temporary differences and a history of generating taxable income in applicable tax jurisdictions, we believe that it is more-likely-than-not that we will fully realize the balance of the deferred tax assets currently reflected on our consolidated balance sheets.

Year ended December 31, 2010 compared with the year ended December 31, 2009

Revenues

Revenues increased to $332.8 million in 2010 from $313.7 million in 2009. The increase was primarily a result of incremental sales, which include new customers and upgrades to existing customers, including increased sales of our Web Security and Web Security Gateway products pre-installed on appliances from 2009 to 2010. Revenue from products sold in the United States accounted for $165.3 million, or 50% of 2010 revenue, compared with $155.8 million, or 50% of 2009 revenue. Revenue from products sold internationally accounted for $167.5 million, or 50% of 2010 revenue, compared with $157.9 million, or 50% of 2009 revenue. We had current deferred revenue (which is revenue we expect to realize within the next twelve months) of $251.9 million

46        2011 ANNUAL REPORT


as of December 31, 2010, compared with $239.0 million as of December 31, 2009, and we had total deferred revenue of $394.3 million as of December 31, 2010, compared with $380.1 million as of December 31, 2009.

Cost of Revenues

Cost of revenues increased to $53.1 million in 2010 from $50.8 million in 2009. The $2.3 million increase was primarily due to increased cost of sales related to our Websense appliances of $5.0 million, increased personnel costs of $0.5 million and increased allocated costs of $0.7 million, offset by decreased amortization of acquired technology of $3.9 million. Amortization of acquired technology was $9.0 million in 2010 compared with $12.9 million in 2009. The decrease of $3.9 million in amortization of acquired technology was primarily due to certain acquired technology being fully amortized in 2009. Our full-time employee headcount in cost of revenue departments increased from an average of 258 employees during 2009 to an average of 266 employees during 2010.

Gross Profit

Gross profit increased to $279.7 million in 2010 from $262.9 million in 2009. The increase was primarily due to increased revenue as described in the preceding Revenues section. As a percentage of revenue, gross profit was 84% for both 2010 and 2009.

Operating Expenses

Selling and marketing. Selling and marketing expenses decreased to $157.8 million in 2010 from $166.9 million in 2009. The decrease in selling and marketing expenses was primarily due to an $8.8 million reduction in amortization of acquired customer relationships from the acquisition of SurfControl in October 2007 and a $1.3 million decrease in allocated costs, offset by increased personnel costs of $1.0 million resulting from changes to our internal sales team during 2010. Our headcount in sales and marketing decreased slightly from an average of 594 during 2009 to an average of 583 during 2010.

Research and development. Research and development expenses increased to $54.3 million in 2010 from $52.6 million in 2009. The increase of $1.7 million in research and development expenses was primarily due to increased personnel costs of $2.4 million offset by a reduction in allocated costs of $0.9 million. Although our headcount increased in research and development from an average of 411 during 2009 to an average of 454 during 2010, the impact of the higher headcount was partially mitigated by the favorable movement in currency exchange rates in 2010 compared with 2009 and the majority of our increased number of employees were in relatively low cost foreign locations.

General and administrative. General and administrative expenses decreased to $36.8 million in 2010 from $40.3 million in 2009 from $45.3 million in 2008.2009. The $5.0$3.5 million decrease in general and administrative expenses was primarily due to a reduction in personnel costs and allocated costs of $1.5 million and a reduction in professional service fees of $2.8 million primarily related to the completion of SurfControl related integration activities during 2008. Although ourcosts. Our headcount increaseddecreased in general and administrative departments from an average of 112127 during 20082009 to an average of 127120 during 2009, the impact was offset by the favorable movement in currency exchange rates and the mix of headcount in 2009 compared to 2008. We expect general and administrative expenses to increase in absolute dollars, but decline as a percentage of revenue in 2010 due to the expected increase in revenue.2010.

Interest Expense

Interest expense represents the interest incurred on our senior secured credit facility that we utilizeddecreased to pay for a portion of the SurfControl purchase price$3.7 million in October 2007. Interest expense decreased to2010 compared with $7.1 million in 2009 compared to $13.1 million in 2008.2009. The decrease was primarily due to a lower average outstanding loan balance on our senior secured termunder the respective 2007 Credit Agreement and 2010 Credit Agreement, of $73 million during 2010 compared with an average loan balance of $106 million during 2009, comparedas well as lower interest rates due to the reduction in the notional amount of principal subject to an average loan balance of $154 million during 2008 and lower interest rates.unfavorable fixed rate swap agreement that expired in September 2010. Also included in the interest expense is amortization of deferred financing fees of $1.0 million and $1.2 million for 2010 and $2.4 million for 2009, and 2008, respectively, that were capitalized as part of the senior secured credit facility.respective 2007 Credit Agreement and 2010 Credit Agreement. During October 2010 we used the initial proceeds from the 2010 Credit Agreement to repay the term loan and retire the 2007

2011 ANNUAL REPORT    47


Credit Agreement. In connection with the pay-off of the term loan, we wrote off approximately $0.4 million of unamortized deferred financing costs. We made principal payments on the senior secured credit facilitydebt outstanding under the respective 2007 Credit Agreement and 2010 Credit Agreement that reduced the outstanding balance from $125 million as of December 31, 2008 to $87 million as of December 31, 2009.2009 to $67 million as of December 31, 2010. As a result of reductionsmore favorable terms in the LIBOR interest rate and improvements in our leverage ratio,2010 Credit Agreement, our weighted average interest rate decreased from 5.7% at December 31, 2008in 2009 to 3.9% as of December 31, 2009. The amount of interest expense will fluctuate due to changes in the outstanding principal balance, changes in LIBOR and changes in our applicable spread to LIBOR based upon improvements in our leverage ratio in accordance with our senior secured credit facility agreement. We expect interest expense to decline in 2010 compared to 2009 due to the anticipated lower average outstanding principal amount under the senior secured credit facility, the expected lower marginal interest rate from the reduction in the notional amount of principal subject to the fixed rate swap agreement, and the expiration of the swap agreement on September 30, 2010. Fluctuations in LIBOR could impact our marginal interest rate. See “Liquidity and Capital Resources” for a description of our senior secured credit facility.

Other (Expense) Income, Net

NetOther (expense) income, net went from a net other income decreased toof $0.4 million in 2009 from $0.7to a net other expense of $0.8 million in 2008.2010. The decreasechange was due primarily to lower interest rates on our balancesforeign exchange related net losses of cash and cash equivalents and marketable securities during 2009 as compared to 2008. During 2009, we also used $38$1.3 million to make principal payments on our senior secured credit facility and approximately $34.2 million for stock repurchases, reducing our cash balances. We expect to continue to generate significant cash flow from our operations and expect to continue to use a substantial portion of cash generated to pay down debt and fund stock repurchases. Due to a lower interest rate environment we expect our net other income in 2010 will be consistentcompared with or less thannet gains of $0.1 million in 2009 levels.due to movements in the currency exchange rates during 2010 and 2009.

Provision for Income Taxes

In 2009,2010, we recognized an income tax provision of $7.1$7.6 million compared towith an income tax benefitprovision of $19.5$7.1 million for 2008.2009. The annual effective income tax rate for 20092010 was 29.0% compared with 193.8% comparedfor 2009. The 2010 effective tax rate variance from the statutory rate primarily related to (42.1)%earnings recognized in lower tax jurisdictions, and the reduction of a valuation allowance related to net operating losses for 2008.one of our subsidiaries in the United Kingdom, partially offset by the write-down of a deferred tax asset relating to the net operating losses in the United Kingdom. The 2009 effective tax rate variance from the statutory rate was primarily related to an increase in reserves for uncertain tax positions and an increase in valuation allowance related to net operating losses for one of our subsidiaries in the United Kingdom, partially offset by income generated in low tax jurisdictions. The 2008 effective tax rate variance from the statutory rate was primarily related to losses generated in a low tax jurisdiction (Ireland) and the establishment of a valuation allowance related to net operating losses for one of our subsidiaries in the United Kingdom offset by release of a valuation allowance related to net operating losses in the United States.

Our effective tax rate may change in future periods due to the composition of taxable income between domestic and international operations, the magnitude of our tax-exempt income, any future acquisitions and any future changes or interpretations in tax rules and legislation, or corresponding accounting rules.

Year ended December 31, 2008 compared with the year ended December 31, 2007

Revenues

Revenues increased to $288.3 million in 2008 from $210.3 million in 2007. The increase was a result primarily of additional customer seats in new, renewed and upgraded subscriptions (including an increase of $54.5 million from new or renewed SurfControl seat subscriptions, an increase of $3.6 million of SurfControl OEM revenue and an increase of $5.0 million of revenue recognized from the deferred revenue acquired from SurfControl in October 2007) from 2007 to 2008. Revenue from DLP products initially acquired from PortAuthority contributed $4.6 million for 2008 compared to $2.1 million for 2007. The number of seats under subscription increased from 42.1 million as of December 31, 2007 to 43.9 million as of December 31, 2008. Revenue from products sold in the United States accounted for $155.7 million or 54% of 2008 revenue compared to $123.4 million or 59% in 2007. Revenue from products sold internationally accounted for $132.6 million or 46% of 2008 revenue compared to $86.9 million or 41% in 2007. We had current deferred revenue of $223.9 million as of December 31, 2008, compared to $191.0 million as of December 31, 2007.

Cost of Revenues

Cost of revenue increased to $48.2 million in 2008 from $29.1 million in 2007. The $19.1 million increase primarily consisted of $7.2 million of increased amortization of acquired technology primarily due to the acquisition of SurfControl in October 2007, $3.7 million related to increased personnel costs in our technical support and database groups, including the increased headcount attributable to the acquisition of SurfControl, $2.9 million related to the SaaS operations we acquired from SurfControl and $3.7 million related to increased allocated costs. We allocated the costs for human resources, employee benefits, payroll taxes, information technology, facilities and fixed asset depreciation to each of our functional areas based on headcount data. Our headcount in cost of revenue departments increased from an average of 179 during 2007 to an average of 225 during 2008. As of December 31, 2008, the acquired technology was amortized over a remaining weighted average period of 2.5 years. As a percentage of revenue, cost of revenue increased to 17% during 2008 from 14% in 2007.

Gross Margin

Gross margin increased to $240.1 million in 2008 from $181.2 million in 2007. The increase was primarily due to increased revenue. As a percentage of revenue, gross margin decreased to 83% in 2008 from 86% in 2007 primarily due to the increased costs described in the preceding Cost of Revenues section.

Operating Expenses

Selling and marketing.Selling and marketing expenses increased to $175.4 million in 2008 from $126.2 million in 2007. Approximately $24.2 million of the increase was due to the amortization of acquired customer relationships which resulted from the acquisition of SurfControl in October 2007. As of December 31, 2008, the acquired customer relationships intangible assets were amortized over a remaining weighted average period of approximately 5.6 years. In addition to the amortization of acquired intangible assets, the increase in selling and marketing expenses was due to increased personnel costs of $17.6 million, including new personnel added to support increased sales following the SurfControl acquisition in October 2007, and $5.7 million of increased allocated costs. Our headcount in sales and marketing increased from an average of 425 during 2007 to an average of 533 during 2008. Operating expenses in 2008 were reduced by strengthening U.S. currency exchange rates relative to the foreign currencies in which certain of our international expenses were incurred.

Research and development. Research and development expenses increased to $53.3 million in 2008 from $40.9 million in 2007. The increase of $12.4 million in research and development expenses was primarily due to $7.2 million of increased personnel cost, including adding new employees due to the SurfControl acquisition in October 2007, and increased hiring to support the release of our Web content gateway, DLP endpoint module and enhancements to our other products, as well as to support our expanding list of technology partners and $4.9 million of increased allocated costs. Our headcount increased in research and development from an average of 230 during 2007 to an average of 353 during 2008. Included in research and development for 2007 was $1.3 million of in-process research and development related to our PortAuthority acquisition in January 2007.

General and administrative.General and administrative expenses increased to $45.3 million in 2008 from $32.7 million in 2007. The $12.6 million increase in general and administrative expenses was primarily due to $5.4 million of increased personnel costs needed to support our growing operations, including the acquisition of SurfControl in October 2007, $4.9 million of increased professional services primarily related to SurfControl integration activities and $2.3 million of increased allocated costs. Our headcount increased in general and administrative departments from an average of 80 during 2007 to an average of 112 during 2008. During 2008, we incurred $2.9 million in non-recurring acquisition related general and administrative expenses, including professional services, integration travel and allocated excess facility expenses.

Interest Expense

Interest expense increased to $13.1 million in 2008 compared to $4.3 million in 2007. The increase was primarily due to the senior secured credit facility being outstanding for only one quarter in 2007 compared to the full year in 2008. Also included in the interest expense is amortization of deferred financing fees of $2.4 million and $763,000 for 2008 and 2007, respectively that were capitalized as part of the senior secured credit facility. We made prepayments on the senior secured credit facility that reduced the outstanding balance from $190 million as of December 31, 2007 to $125 million as of December 31, 2008. As a result of reductions in the LIBOR interest rate and improvements in our leverage ratio, our weighted average interest rate decreased from 7.3% at December 31, 2007 to 5.7% as of December 31, 2008.

Other Income, Net

Net other income decreased to $0.7 million in 2008 from $9.5 million in 2007. The decrease was due primarily to reduced cash, cash equivalents and marketable securities balances from which we generate interest income as a result of our use of an aggregate of $272 million to fund the acquisitions of SurfControl in October 2007 and PortAuthority in January 2007 and related transaction costs. During 2008, we also used $65 million to make prepayments of principal on our senior secured credit facility and approximately $20 million for stock repurchases reducing our cash balances. The decline in net other income was also due to lower interest rates realized on our balances of cash and cash equivalents and marketable securities as well as foreign exchange losses due to unfavorable movements in foreign exchange rates during 2008 as compared with 2007.

Provision for Income Taxes

In 2008, we recognized an income tax benefit of $19.5 million compared to an income tax expense of $2.9 million for 2007. The annual effective income tax rate for 2008 was (42.1)% compared to 21.6% for 2007. The 2008 effective tax rate variance from the statutory rate was primarily related to losses generated in a low tax jurisdiction (Ireland) and the establishment of a valuation allowance related to net operating losses for one of our subsidiaries in the United Kingdom offset by release of a valuation allowance related to net operating losses in the United States. In 2007 the annual effective tax rate variance from the statutory rate was primarily attributed to certain post-acquisition net operating losses related to SurfControl’s U.S. operations for which no tax benefit was recorded due to the uncertainty of the future utilization of these losses.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on revenue recognition that will become effective for Websense beginning January 1,June 2011, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangementsthe presentation of other comprehensive income within the financial statements that will become effective for the Company beginning January 1, 2012, with multiple deliverables that are outsideearlier adoption permitted. The guidance provides an option to registrants to present total comprehensive income, the scopecomponents of net income and the components of other comprehensive income in a single continuous statement or two separate but consecutive statements. The guidance eliminates the option to present other comprehensive income components as part of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimateconsolidated statement of stockholders’ equity. We do not believe that adoption of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. We are currently evaluating both the timing and thewill have a significant impact of the pending adoption of these standards on our consolidated financial statements.position, results of operations or cash flows.

Liquidity and Capital Resources

As of December 31, 2009,2011, we had cash and cash equivalents (including restricted cash and cash equivalents) of approximately $83.3$76.2 million and retained earnings of $28.4$72.2 million. As of December 31, 2008,2010, we had cash and cash equivalents (including restricted cash and cash equivalents) of $66.8$77.4 million and retained earnings of $39.1$41.3 million. During 2009, we used our cash to pay down $38Of the $76.2 million of principal oncash and cash equivalents held as of December 31, 2011, $31.9 million was held by our senior secured term loanforeign subsidiaries, and an additional approximately $34 millionwe plan to indefinitely reinvest the undistributed foreign earnings into our foreign operations. During 2011, we primarily used cash and cash equivalents in excess of our cash to repurchase our common stock.required for operations and for stock repurchases totaling $98.7 million.

Net cash provided by operating activities was $94.8$79.2 million in 20092011, compared with $65.8$90.1 million in 2008.2010. The $29.0$10.9 million increasedecrease in cash provided by operating activitiesflow from operations in 20092011 compared with 2010 was primarily athe result of ourhigher cash collections increasing by approximately $14.0 million due principally to improved accounts receivable collection performanceoperating expenses resulting from higher headcount costs, third-party professional fees and increased sales resulting from new, renewed and upgraded subscriptions including sales of new products, decreased cash expenses of approximately $10.8 million principally associated with decreased interest payments as a result of a lower average outstanding loan balance and lower effective interest rates during 2009 and reduced cash tax payments, as well as a decrease in the settlement of liabilities of approximately $3.7 million in 2009 compared to 2008 which included many non-recurring SurfControl related obligations and a litigation settlement.payments. Our operating cash flow is significantly influenced by salesthe timing of new and renewal subscriptions, accounts receivable collections and cash operating expenses. A decrease in sales of new and/or renewal subscriptions or accounts receivable collections, willor an increase in our cash expenses, would negatively impact our operating cash flow. We expect to continue to generate significant cash flow from operations in 2010.

48        2011 ANNUAL REPORT


Net cash used in investing activities was $10.0$9.9 million in 20092011, compared with net cash provided by investing activities of $10.1$9.5 million in 2008.2010. The $20.1$0.4 million changeincrease in net cash used in investing activities was primarily a resultdue to acquisition of an increase of net maturities over purchases of marketable securities of approximately $19.8 millionintangible assets (acquired technology) during 2008.2011.

Net cash used in financing activities was $66.5$70.4 million in 20092011, compared with $76.2$85.6 million in 2008.2010. In 2011, the Company used approximately $98.7 million to repurchase its common stock which was offset primarily by $16.7 million in proceeds from the exercise of stock options and net borrowings of $6.0 million under the 2010 Credit Agreement. The $9.7$15.2 million decrease in net cash used in financing activities in 2009 was primarily due to reduceda reduction in net principal payments of $27.0 million onmade under the senior secured term loanCompany’s credit facilities during 2011 compared with 2010, partially offset by increased purchases of treasury stock of approximately $14.2 million in 20092011 compared to 2008.

During the fourth quarter of 2009, the U.S. Internal Revenue Service (the “IRS”) issued Notices of Proposed Adjustment related to the cost sharing arrangement between our U.S. parent company and our Irish subsidiary, including the amount of cost sharing buy-in, as well as with respect to our claim of research and development tax credits and our income tax deductions for equity compensation awarded to certain executive officers. The amount of additional tax proposed by the IRS totals approximately $17.7 million, of which $13.5 million relates to the amount of cost sharing buy-in, $2.5 million relates to research and development credits and $1.7 million relates to equity compensation awarded to certain executive officers. The total additional tax proposed excludes interest, penalties and state income taxes, each of which may be significant, and a potential reduction in tax on the Irish subsidiary. The proposed adjustments also do not include the future impact that changes in our cost sharing arrangement could have on our effective tax rate. As each audit progresses and is ultimately concluded, adjustments, if any, will be recorded in our financial statements from time to time in light of prevailing facts based on our and the taxing authority’s respective positions on any disputed matters. These adjustments may include the use of cash to pay taxes relating to the disputed matters.2010.

In connection with the acquisition of SurfControl in October 2007,2010, we entered into an amendedthe 2010 Credit Agreement and restated senior credit agreement (the “Seniorused the proceeds to repay the term loan under the 2007 Credit Agreement”).Agreement and retired the 2007 Credit Facility. The $225 million senior2010 Credit Agreement provides for a secured revolving credit facility consiststhat matures on October 29, 2015 with an initial maximum aggregate commitment of a five year $210$120 million, senior secured term loan andincluding a $15 million revolvingsublimit for issuances of letters of credit facility. The senior secured term loanand $5 million sublimit for swing line loans. We may increase the maximum aggregate commitment under the 2010 Credit Agreement up to $200 million if certain conditions are satisfied, including that we are not in default under the 2010 Credit Agreement at the time of the increase and that we obtain the commitment of the lenders participating in the increase. Loans under the 2010 Credit Agreement are designated at our election as either base rate or Eurodollar rate loans. Base rate loans bear interest at a rate equal to (i) the highest of (a) the federal funds rate plus 0.5%, (b) the Eurodollar rate plus 1.00% and (c) Bank of America’s prime rate, plus (ii) a margin set forth below. Eurodollar rate loans bear interest at a rate equal to (i) the Eurodollar rate plus (ii) a margin set forth below. As of December 31, 2011, the total amount outstanding under the 2010 Credit Facility was fully funded on October 11, 2007,$73 million and the revolving line of credit remains unused. Through December 31, 2009, we have made principal payments totaling $123 million onweighted average interest rate was 3.1%.

The applicable margins are determined by reference to our senior secured term loan, reducingleverage ratio, as set forth in the outstanding balance to $87 million. The senior secured credit facilitytable below:

Consolidated Leverage Ratio

     Eurodollar
Rate
Loans
  Base
Rate

Loans
 

<1.25:1.0

    1.75  0.75

³1.25:1.0

    2.00  1.00

Indebtedness under the 2010 Credit Agreement is secured by substantially all of our assets, including pledges of stock of somecertain of our subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by ourits domestic subsidiaries. The senior secured term loan bears interest at a spread above LIBOR with the spread determined based upon our total leverage ratio, as defined in the Senior Credit Agreement. Based on the total leverage ratio throughout 2009, the spread on the senior secured term loan was LIBOR plus 225 basis points per annum and the fee for the unused portion of the revolving credit facility was 25 basis points per annum. The weighted average interest rate on the senior secured term loan at December 31, 2009 was 3.9%. The Senior2010 Credit Agreement contains financialaffirmative and negative covenants, including an obligation to maintain a certain consolidated leverage ratio and a consolidated interest coverage ratio as well as affirmative and negative covenants. Among the negative covenants are restrictions on our ability to borrow money, including restrictionsto incur liens, to enter into mergers and acquisitions, to make dispositions, to pay cash dividends or repurchase capital stock, and to make investments, subject to certain exceptions. The 2010 Credit Agreement does not require us to use excess cash to pay down debt.

The 2010 Credit Agreement provides for acceleration of our obligations thereunder upon certain events of default. The events of default include, without limitation, failure to pay loan amounts when due, any material inaccuracy in our representations and warranties, failure to observe covenants, defaults on (a)any other indebtedness, entering bankruptcy, existence of a judgment or decree against us or our subsidiaries involving an aggregate liability of $10 million or more, the incurrencesecurity interest or guarantee ceasing to be in full force and effect, any person becoming the beneficial owner of more than $15 million of new debt, including capital leases (subject to certain exceptions), (b) the incurrence of more than $7.5 million in letters of credit, (c) the incurrence of more than $50 to $75 million of new debt, depending on our leverage ratio, to finance future acquisitions or (d) the assumption of more than $15 million of new debt in connection with acquisitions.

The Senior Credit Agreement provides that we must maintain hedge agreements so that at least 50% of the aggregate principal amount of the senior secured credit facility is subject to fixed interest rate protection for a period of not less than 2.5 years from the initial funding date. On October 11, 2007 in conjunction with the funding of the senior secured credit facility, we entered into an interest rate swap agreement to pay a fixed rate of interest (4.85% per annum) and receive a floating rate interest payment (based on three month LIBOR) on an equivalent amount. The notional amount of the swap agreement was $27 million on December 31, 2009 and it amortizes each quarter down to $11 million on June 30, 2010. In addition, on October 11, 2007 we entered into an interest rate cap agreement to limit the maximum interest rate on a portion35% of our senior secured term loanoutstanding common stock, or our board of directors ceasing to 6.5% per annum. The amountconsist of principal subject toa majority of Continuing Directors (as defined in the cap agreement was $64.9 million at December 31, 2009 and increases to $74.3 million on June 30, 2010. Both the interest rate swap and cap expire on September 30, 2010.2010 Credit Agreement).

2011 ANNUAL REPORT    49


Obligations and commitments.The following table summarizes our contractual payment obligations and commitments as of December 31, 20092011 (in thousands):

 

  Payment Obligations by Year  Payment Obligations by Year 
  2010  2011  2012  2013  2014  Thereafter  Total  2012   2013   2014   2015   2016   Thereafter   Total 

Senior secured term loan:

              

Scheduled principal payments

  $12,429  $14,914  $59,657  $—    $—    $—    $87,000

2010 Credit Agreement:

              

Contractual principal payments

  $0    $0    $0    $73,000    $0    $0    $73,000  

Estimated interest and fees

   2,820   1,844   1,042   —     —     —     5,706   2,419     2,406     2,406     1,991     0     0     9,222  

Operating leases

   6,125   4,864   4,613   4,491   816   520   21,429   6,616     6,403     2,203     792     0     0     16,014  

Other commitments

   364   187   68   10   —     —     629   3,144     2,196     1,469     0     0     0     6,809  
                       

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Total

  $21,738  $21,809  $65,380  $4,501  $816  $520  $114,764  $12,179    $11,005    $6,078    $75,783    $0    $0    $105,045  
                       

 

   

 

   

 

   

 

   

 

   

 

   

 

 

Obligations under our Seniorthe 2010 Credit Agreement represent the future minimum principal debt payments due under the senior secured term loan.this facility. Estimated interest and fees expected to be incurred on the senior secured term loan2010 Credit Facility are based on known rates and scheduled principal payments, as well as the interest rate swap agreement, as of December 31, 20092011 (see Note 76 to the auditedconsolidated financial statements).

We lease our facilities under operating lease agreements that expire at various dates through 2015. Over 40%Approximately 35% of our operating lease commitments are related to our corporate headquarters lease in San Diego which extends through December 2013. Our corporate headquarters lease includeshas escalating rent payments from 20092011 to 2013. The San Diego lease expires in December 2013, however, we have an option to extend the lease for an additional five years. The rent expense related to our worldwide office space leases are generally recorded monthly on a straight-line basis in accordance with GAAP.

Other commitments represent minimumAs of December 31, 2011, we had contractual commitmentscommitment obligations for inbound software licenses, equipment maintenance, royalty agreements and automobile leases.leases in the following amounts: $3.1 million for 2012, $2.2 million for 2013 and $1.5 million for 2014.

In addition, due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at December 31, 2009,2011, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities. Therefore, $14.2$10.1 million of gross unrecognized tax benefits (as more fully described in Note 1110 to the auditedconsolidated financial statements) have been excluded from the contractual payment obligations table above.

In April 2003, we announced that our board of directors authorized a stock repurchase program of up to four million shares of our common stock. In August 2005, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to eight million shares. In July 2006, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to 12 million shares. In January 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to 16 million shares. In October 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional eight million shares, for a total program size of up to 24 million shares. The stock repurchase program does not have an expiration date, does not require us to purchase a specific number of shares and may be modified, suspended or terminated at any time by our board of directors.

In connection with the stock repurchase program, we adopted the 2009 Repurchase Plans in August 2009. The 2009 Repurchase Plans initially provided for purchases of up to an aggregate of $7.5 million of our common stock per calendar quarter in open market transactions beginning in October 2009. In November 2010, we increased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $7.5 million to $25 million per calendar quarter, effective as of January 1, 2011. In October 2011, we decreased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $25 million to

50        2011 ANNUAL REPORT


Off-Balance Sheet Arrangements.$20 million per calendar quarter effective as of January 1, 2012. Repurchases are made on the open market at prevailing market prices in accordance with timing conditions set forth in the 2009 Repurchase Plans. Depending on market conditions and other factors, including compliance with covenants in the 2010 Credit Agreement, purchases by our agents under the 2009 Repurchase Plans may be suspended at any time, or from time to time. The 2009 Repurchase Plans will expire on November 15, 2012, unless they are further extended by amendment. During 2011, we repurchased 4,787,302 shares of our common stock for an aggregate of approximately $100.0 million at an average price of $20.89 per share. As of December 31, 20092011, we had repurchased a total of 20,411,821 shares of our common stock under this stock repurchase program, for an aggregate of $409.8 million at an average price of $20.08 per share. The 2010 Credit Agreement permits us to repurchase our securities so long as we are not in default under the 2010 Credit Agreement, have complied with all of our financial covenants, and 2008,have liquidity of at least $20 million; provided, however, if, after giving effect to any repurchase, our leverage ratio is greater than 1.75:1, such repurchase cannot exceed $10.0 million in the aggregate in any fiscal year. As of December 31, 2011, there are 3,588,179 shares available for purchase under the plan and we intend to continue repurchasing shares during 2012.

We believe that our cash and cash equivalents balances, accounts receivable, revolving credit balances and our ongoing cash flow from operations will be sufficient to satisfy our cash requirements, including our capital expenditures, debt repayment obligations and stock repurchases, if any, for at least the next 12 months. During 2011, we borrowed a net total of $6.0 million on our secured loan and repurchased approximately $100.0 million of our common stock. Our cash requirements may increase for reasons we do not currently foresee or we may make acquisitions as part of our growth strategy that increase our cash requirements. We may elect to borrow under the 2010 Credit Agreement, raise funds for these purposes or reduce our cost of capital through capital markets transactions or debt or private equity transactions as appropriate. We intend to continue to invest our cash in excess of current operating and capital requirements in interest-bearing, investment-grade money market funds.

Off-Balance Sheet Arrangements

As of December 31, 2011 and 2010, we did not have any relationships with unconsolidated entities or financial partners, such asincluding entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

Share Repurchase Program.In 2003, we announced that our Board of Directors authorized a stock repurchase program of up to 4 million shares of our common stock. In 2005, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 8 million shares. In 2006, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 12 million shares. On January 31, 2010, our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 16 million shares. Repurchases may be made from time to time on the open market at prevailing market prices. In January 2008, we adopted a 10b5-1 plan that provides for quarterly purchases of our common stock in open market transactions. Depending on market conditions and other factors, purchases by our agent under this program may be commenced or suspended at any time, or from time to time, without prior notice to us. During 2009, we repurchased 2,284,915 shares of our common stock for an aggregate of approximately $34.5 million at an average price of $15.08 per share through both our 10b5-1 repurchase plan and through open market purchases. As of December 31, 2009, we had

2011 ANNUAL REPORT    51

cumulatively repurchased 11,534,024 shares of our common stock under this program for an aggregate of $224.9 million at an average price of $19.50 per share. On February 5, 2010, we amended our Senior Credit Agreement to increase our capacity to repurchase shares of our common stock. Under the terms of the Senior Credit Agreement, we are restricted from repurchasing our common stock for an aggregate purchase price that exceeds 50% of the aggregate amount of our consolidated net income, as defined in our Senior Credit Agreement, during the period from the effective date of the facility through the most recent quarter end for which we have filed quarterly financial statements. Based on our February 5, 2010 amendment, we can repurchase up to $42.2 million of our common stock under our Senior Credit Agreement as of December 31, 2009, excluding shares we had repurchased through December 31, 2009. We intend to purchase shares during the remainder of 2010.

Prospective Capital Needs.We believe that our cash and cash equivalents balances, accounts receivable balances, revolving credit balances and our ongoing cash flow from operations will be sufficient to satisfy our cash requirements, including our capital expenditures, debt repayment obligations and stock repurchases, if any, for at least the next 12 months. During 2009, we made principal payments on our senior secured term loan of $38 million and repurchased $34.5 million of our common stock. Our cash requirements may increase for reasons we do not currently foresee or we may make acquisitions as part of our growth strategy that increase our cash requirements. We may elect to raise funds for these purposes through capital markets transactions or debt or private equity transactions as appropriate. We intend to continue to invest our cash in excess of current operating and capital requirements in interest-bearing, investment-grade money market funds.


Item 7A.Quantitative and Qualitative Disclosures About Market Risk

Our market risk exposures are related to our cash and cash equivalents and senior secured term loan.the 2010 Credit Facility. We invest our excess cash in highly liquid short-term investments such as money market funds. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and the interest expense incurred on our senior secured term loan and therefore impact our cash flows and results of operations.

We are exposed to changes in interest rates primarily from our money market funds and from our borrowings at variable rates under our variable rate senior secured term loan used inthe 2010 Credit Facility. In connection with the acquisition of SurfControl in October 2007. Our Senior2010 Credit Agreement provides that we must maintain hedge agreements so that at least 50%entered into an interest rate swap agreement to pay a fixed rate of interest (1.778% per annum) and receive a floating rate interest payment (based on the aggregatethree-month LIBOR) on a principal amount of the senior secured term loan is subject to fixed interest rate protection for a period of not less than 2.5 years from the date of the initial funding of the loan.$50 million. The $50 million swap agreement became effective on December 30, 2011 and expires on October 29, 2015.

A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would materially affect our interest expense. However, the impact of this type of adverse movement would be partially mitigated by our interest rate swap and cap agreements.agreement that became effective on December 30, 2011. Based on our outstanding senior secured term loanrevolving credit balance at December 31, 20092011 and taking into consideration our interest rate swap and cap,agreement, our interest expense would increase on a pre-tax basis by approximately $567,000$0.2 million during 2010the next 12 months if there were a 100 basis point adverse move in the interest rate yield curve.curve occurred.

A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive investments at December 31, 2009.2011. Changes in interest rates over time will, however, affect our interest income.

Foreign Currency Exchange Rate Risk

We sell our products through a distribution network in approximately 130 countries, and we bill certain international customers in Euros, British Pounds, Australian Dollars and Chinese Renminbi. Additionally, a significant portion of our foreign subsidiaries’ operating expenses are incurred in foreign currencies. As a result, our financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we sell our products.

To mitigate the effect of changes in currency exchange rates, we utilize foreign currency forward contracts and zero-cost collar contracts to hedge foreign currency market exposures of underlying assets, liabilities and expenses. We bill certain international customers in Euros, British Pounds, Australian Dollars, Chinese Renminbi and Japanese Yen. We also keep working funds necessary to facilitate the short-term operations of our subsidiaries in the local currencies in which they do business. As exchange rate fluctuations can significantly vary our sales and expense results when converted to U.S. dollars, our objective is to reduce the risk to earnings and cash flows associated with changes in currency exchange rates. We do not use foreign currency contracts for speculative or trading purposes.

Notional and fair values of our hedging positions at December 31, 20092011 and 20082010 are presented in the table below (in thousands):

 

   December 31, 2009  December 31, 2008
   Notional
Value
Local
Currency
  Notional
Value
USD
  Fair Value
USD
  Notional
Value
Local
Currency
  Notional
Value
USD
  Fair Value
USD

Fair Value Hedges

            

Euro

  8,000  $11,647  $11,465  13,000  $16,820  $18,128

British Pound

  500   807   808  5,500   8,196   7,973

Australian Dollar

  600   518   539  —     —     —  
                    

Total

    $12,972  $12,812    $25,016  $26,101
                    

Cash Flow Hedges

            

Israeli Shekel

  —    $—    $—    950  $251  $254
   December 31, 2011   December 31, 2010 

Fair Value Hedges

  Notional
Value
Local
Currency
   Notional
Value
USD
   Fair Value
USD
   Notional
Value
Local
Currency
   Notional
Value
USD
   Fair Value
USD
 

Euro

   11,000    $14,909    $14,266     8,550    $11,405    $11,449  

British Pound

   0     0     0     1,250     1,938     1,958  

The approximate $5.2$3.5 million notional decreaseincrease in our Euro hedgedhedge position at December 31, 20092011 compared towith December 31, 2008 is2010 was primarily a result of an increase in natural hedges anddue to the occurrence of more timing differences in when assets were acquired and/or liabilities

52        2011 ANNUAL REPORT


incurred. All of the Euro hedging contracts in place on December 31, 2009 will2011 are scheduled to be settled before April 2010.June 2012. For 20082011 and 2009,2010, less than 15% and 20%, respectively, of our total billings were denominated in the Euro. We do not expect Euro billings to represent moreless than 20%15% of our total billings during 2010.2012.

The approximate $7.4$1.9 million notional decrease in our British Pound hedgedhedge position at December 31, 20092011 compared towith December 31, 2008 is primarily the result of an increase in natural hedges and the occurrence of more timing differences in when assets were acquired or liabilities incurred. All of the2010 was due to having no British Pound hedging contracts in place as of December 31, 2009 will be settled before March 2010.2011. For 20082011 and 2009,2010, less than 15% of our total billings were denominated in the British Pound. We do not expect British Pound billings to represent moreless than 15% of our total billings during 2010.2012.

We began hedging ourhad no Australian Dollar position during fiscal 2009 primarily to hedge against our Australian Dollar denominated net monetary assets as we had changed the functional currency designation for our Australian subsidiary at the beginning of 2009. All of the Australian Dollaror Chinese Renminbi hedging contracts in place as of December 31, 2009 will be settled before March2011 or 2010. For 2008 and 2009, less than 5%

A significant portion of our total billings wereforeign subsidiaries’ operating expenses are incurred in foreign currencies so if the U.S. dollar weakens, our consolidated operating expenses would increase. Should the U.S. dollar strengthen, our products may become more expensive for our international customers with subscription contracts denominated in U.S. dollars. Changes in currency rates also impact our future revenues under subscription contracts that are not denominated in U.S. dollars. Our revenues and deferred revenue for these foreign currencies are recorded in U.S. dollars when the Australian Dollar.subscription is entered into based upon currency exchange rates in effect on the last day of the previous month before the subscription agreement is entered into. We expect Australian Dollar billings to represent less than 5% of our total billings during 2010.

The approximate $0.3 million notional decreaseengage in our Israeli Shekel hedge position at December 31, 2009 compared to December 31, 2008 was primarily due to a general reduction of ourcurrency hedging activities forwith the Israeli Shekel towardsintent of limiting the endrisk of 2009.

Givenexchange rate fluctuations, but our foreign exchange position, a 10% change in foreign exchange rates upon which these foreign exchange contracts are based wouldhedging activities also involve inherent risks that could result in exchange gains and losses. In all material aspects, these exchange gains and losses would be fully offset by exchange gains and losses on the underlying net monetary exposures for which the contracts are designated as hedges. We do not expect material exchange rate gains and losses from unhedged foreign currency exposures.an unforeseen loss.

2011 ANNUAL REPORT    53


Item 8.Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Websense, Inc.

We have audited the accompanying consolidated balance sheets of Websense, Inc. as of December 31, 20092011 and 20082010 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009.2011. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Websense, Inc. at December 31, 20092011 and 2008,2010, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2009,2011, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

As discussed in Note 1 to the consolidated financial statements, Websense changed its method of accounting for revenue recognition effective January 1, 2011.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Websense, Inc.’s internal control over financial reporting as of December 31, 2009,2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 201023, 2012 expressed an unqualified opinion thereon.

/s/ ERNST & YOUNG LLP

San Diego, California

February 25, 201023, 2012

54        2011 ANNUAL REPORT


Websense, Inc.

Websense, Inc.

Consolidated Balance Sheets

(In thousands, except par value amounts)

 

  December 31,   December 31, 
  2009 2008   2011 2010 

Assets

      

Current assets:

      

Cash and cash equivalents

  $82,862   $64,096    $76,201   $77,390  

Cash and cash equivalents—restricted

   267    2,500     0    256  

Accounts receivable, net of allowance for doubtful accounts of $1,802 and $1,752 at December 31, 2009 and 2008

   82,529    82,099  

Income tax receivable

   11,446    10,927  

Accounts receivable, net of allowance for doubtful accounts of $979 and $1,156 at December 31, 2011 and 2010

   80,147    82,182  

Income tax receivable / prepaid income tax

   738    2,760  

Current portion of deferred income taxes

   36,538    34,198     30,021    36,191  

Other current assets

   11,461    9,029     13,793    14,708  
         

 

  

 

 

Total current assets

   225,103    202,849     200,900    213,487  

Cash and cash equivalents—restricted, less current portion

   167    215     628    434  

Property and equipment, net

   16,494    14,312     16,832    16,944  

Intangible assets, net

   67,563    106,493     26,412    41,078  

Goodwill

   372,445    372,624     372,445    372,445  

Deferred income taxes, less current portion

   11,795    24,237     8,599    6,352  

Deposits and other assets

   8,094    3,933     8,622    11,203  
         

 

  

 

 

Total assets

  $701,661   $724,663    $634,438   $661,943  
         

 

  

 

 

Liabilities and stockholders’ equity

      

Current liabilities:

      

Accounts payable

  $5,135   $2,719    $9,026   $6,858  

Accrued compensation and related benefits

   21,953    19,129     22,770    22,168  

Other accrued expenses

   21,253    27,946     16,534    18,704  

Current portion of income taxes payable

   1,938    7,135     3,187    549  

Current portion of senior secured term loan

   12,429    4,112  

Current portion of deferred tax liability

   4,572    1,053     86    367  

Current portion of deferred revenue

   239,010    223,944     250,597    251,890  
         

 

  

 

 

Total current liabilities

   306,290    286,038     302,200    300,536  

Other long term liabilities

   10    2,616     2,600    2,388  

Income taxes payable, less current portion

   15,988    10,098     11,955    16,065  

Senior secured term loan, less current portion

   74,571    120,888  

Secured loan, less current portion

   73,000    67,000  

Deferred tax liability, less current portion

   970    10,523     2,501    1,877  

Deferred revenue, less current portion

   141,102    117,840     142,437    142,414  
         

 

  

 

 

Total liabilities

   538,931    548,003     534,693    530,280  

Stockholders’ equity:

      

Common stock—$0.01 par value; 100,000 shares authorized; 43,410 and 45,048 shares issued and outstanding at December 31, 2009 and 2008

   529    522  

Common stock—$0.01 par value; 100,000 shares authorized; 38,048 and 41,001 shares issued and outstanding at December 31, 2011 and 2010

   568    548  

Additional paid-in capital

   330,451    300,050     415,573    373,229  

Treasury stock, at cost

   (194,672  (159,842   (385,544  (282,570

Retained earnings

   28,416    39,113     72,247    41,253  

Accumulated other comprehensive loss

   (1,994  (3,183   (3,099  (797
         

 

  

 

 

Total stockholders’ equity

   162,730    176,660     99,745    131,663  
         

 

  

 

 

Total liabilities and stockholders’ equity

  $701,661   $724,663    $634,438   $661,943  
         

 

  

 

 

See accompanying notes.notes to consolidated financial statements

2011 ANNUAL REPORT    55


Websense, Inc.

Websense, Inc.

Consolidated Statements of Operations

(In thousands, except per share amounts)

 

   Years Ended December 31, 
   2009  2008  2007 

Revenues

  $313,713   $288,274   $210,307  

Cost of revenues

   50,806    48,160    29,140  
             

Gross margin

   262,907    240,114    181,167  

Operating expenses:

    

Selling and marketing

   166,910    175,365    126,247  

Research and development

   52,643    53,274    40,913  

General and administrative

   40,295    45,343    32,708  
             

Total operating expenses

   259,848    273,982    199,868  
             

Income (loss) from operations

   3,059    (33,868  (18,701

Interest expense

   (7,084  (13,134  (4,308

Other income, net

   384    739    9,461  
             

Loss before income taxes

   (3,641  (46,263  (13,548

Provision (benefit) for income taxes

   7,056    (19,484  2,933  
             

Net loss

  $(10,697 $(26,779 $(16,481
             

Net loss per share:

    

Basic and diluted net loss per share

  $(0.24 $(0.59 $(0.37

Weighted average shares—basic and diluted

   44,262    45,190    45,107  
   Years Ended December 31, 
   2011  2010  2009 

Revenues:

    

Software and service

  $325,373   $320,544   $311,476  

Appliance

   38,810    12,218    2,237  
  

 

 

  

 

 

  

 

 

 

Total revenues

   364,183    332,762    313,713  

Cost of revenues:

    

Software and service

   41,563    45,681    48,653  

Appliance

   18,056    7,409    2,153  
  

 

 

  

 

 

  

 

 

 

Total cost of revenues

   59,619    53,090    50,806  
  

 

 

  

 

 

  

 

 

 

Gross profit

   304,564    279,672    262,907  

Operating expenses:

    

Selling and marketing

   161,039    157,758    166,910  

Research and development

   58,247    54,325    52,643  

General and administrative

   40,863    36,779    40,295  
  

 

 

  

 

 

  

 

 

 

Total operating expenses

   260,149    248,862    259,848  
  

 

 

  

 

 

  

 

 

 

Income from operations

   44,415    30,810    3,059  

Interest expense

   (1,635  (3,715  (7,084

Other income (expense), net

   1,239    (834  384  
  

 

 

  

 

 

  

 

 

 

Income (loss) before income taxes

   44,019    26,261    (3,641

Provision for income taxes

   13,025    7,609    7,056  
  

 

 

  

 

 

  

 

 

 

Net income (loss)

  $30,994   $18,652   $(10,697
  

 

 

  

 

 

  

 

 

 

Net income (loss) per share:

    

Basic net income (loss) per share

  $0.78   $0.44   $(0.24

Diluted net income (loss) per share

  $0.76   $0.43   $(0.24

Weighted average shares—basic

   39,711    42,409    44,262  

Weighted average shares—diluted

   40,739    43,438    44,262  

See accompanying notes.notes to consolidated financial statements

56        2011 ANNUAL REPORT


Websense, Inc.

Websense, Inc.

Consolidated Statements of Stockholders’ Equity

(In thousands)

 

  Common stock  Additional
paid-in capital
  Treasury
stock
  Retained
earnings
  Accumulated other
comprehensive

loss
  Total
stockholders’

equity
            Accumulated  other
comprehensive
loss
  Total
stockholders’
equity
 
  Shares Amount    Common stock Additional
paid-in capital
  Treasury
stock
  Retained
earnings
  

Balance at January 1, 2007

  44,785   $509  $236,443   $(139,744 $82,373   $(90 $179,491  

Issuance of common stock upon exercise of options

  339    4   3,256    —      —      —      3,260  

Issuance of common stock for ESPP purchase

  240    2   4,315    —      —      —      4,317  

Issuance of common stock from restricted stock units, net

  30    —     —      (48  —      —      (48

Share-based compensation expense

  —      —     22,076    —      —      —      22,076  

Excess tax benefit of share-based compensation

  —      —     1,052    —      —      —      1,052  

Components of comprehensive loss:

         

Net loss

  —      —     —      —      (16,481  —      (16,481

Net change in unrealized gain on marketable securities, net of tax

  —      —     —      —      —      81    81  

Net change in unrealized loss on derivative contracts, net of tax

  —      —     —      —      —      (989  (989

Translation adjustments

  —      —     —      —      —      (322  (322
            Shares Amount Additional
paid-in capital
  Treasury
stock
  Retained
earnings
  Accumulated  other
comprehensive
loss
 Total
stockholders’
equity
 

Comprehensive loss

          (17,711
                      

Balance at December 31, 2007

  45,394    515   267,142    (139,792  65,892    (1,320  192,437  

Issuance of common stock upon exercise of options

  356    4   4,307    —      —      —      4,311  

Issuance of common stock for ESPP purchase

  347    3   5,318    —      —      —      5,321  

Issuance of common stock from restricted stock units, net

  30    —     —      (52  —      —      (52

Share-based compensation expense

  —      —     24,089    —      —      —      24,089  

Tax shortfall from share-based compensation

  —      —     (806  —      —      —      (806

Purchase of treasury stock

  (1,079  —     —      (19,998  —      —      (19,998

Components of comprehensive loss:

         

Net loss

  —      —     —      —      (26,779  —      (26,779

Net change in unrealized loss on derivative contracts, net of tax

  —      —     —      —      —      (560  (560

Translation adjustments

  —      —     —      —      —      (1,303  (1,303
           

Comprehensive loss

          (28,642
                      

Balance at December 31, 2008

  45,048    522   300,050    (159,842  39,113    (3,183  176,660  

Balance at January 1, 2009

  45,048   $522   $300,050   $(159,842 $33,298   $(3,183 $170,845  

Issuance of common stock upon exercise of options

  205    3   2,430    —      —      —      2,433    205    3    2,430    0    0    0    2,433  

Issuance of common stock for ESPP purchase

  378    4   5,428    —      —      —      5,432    378    4    5,428    0    0    0    5,432  

Issuance of common stock from restricted stock units, net

  64    —     —      (330  —      —      (330  64    0    0    (330  0    0    (330

Share-based compensation expense

  —      —     24,765    —      —      —      24,765    0    0    24,765    0    0    0    24,765  

Tax shortfall from share-based compensation

  —      —     (2,222  —      —      —      (2,222  0    0    (2,222  0    0    0    (2,222

Purchase of treasury stock

  (2,285  —     —      (34,500  —      —      (34,500  (2,285  0    0    (34,500  0    0    (34,500

Components of comprehensive loss:

                

Net loss

  —      —     —      —      (10,697  —      (10,697  0    0    0    0    (10,697  0    (10,697

Net change in unrealized loss on derivative contracts, net of tax

  —      —     —      —      —      1,189    1,189    0    0    0    0    0    1,189    1,189  
                  

 

 

Comprehensive loss

          (9,508        (9,508
                       

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at December 31, 2009

  43,410   $529  $330,451   $(194,672 $28,416   $(1,994 $162,730    43,410    529    330,451    (194,672  22,601    (1,994  156,915  

Issuance of common stock upon exercise of options

  973    10    15,982    0    0    0    15,992  

Issuance of common stock for ESPP purchase

  440    5    5,986    0    0    0    5,991  

Issuance of common stock from restricted stock units, net

  268    4    0    (2,900  0    0    (2,896

Share-based compensation expense

  0    0    22,565    0    0    0    22,565  

Tax shortfall from share-based compensation

  0    0    (1,755  0    0    0    (1,755

Purchase of treasury stock

  (4,090  0    0    (84,998  0    0    (84,998

Components of comprehensive income:

       

Net income

  0    0    0    0    18,652    0    18,652  

Net change in unrealized gain on derivative contracts, net of tax

  0    0    0    0    0    1,197    1,197  
                             

 

 

Comprehensive income

        19,849  
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at December 31, 2010

  41,001    548    373,229    (282,570  41,253    (797  131,663  

Issuance of common stock upon exercise of options

  1,026    10    16,890    0    0    0    16,900  

Issuance of common stock for ESPP purchase

  473    5    6,609    0    0    0    6,614  

Issuance of common stock from restricted stock units, net

  335    5    0    (2,984  0    0    (2,979

Share-based compensation expense

  0    0    18,976    0    0    0    18,976  

Tax shortfall from share-based compensation

  0    0    (131  0    0    0    (131

Purchase of treasury stock

  (4,787  0    0    (99,990  0    0    (99,990

Components of comprehensive income:

       

Net income

  0    0    0    0    30,994    0    30,994  

Net change in unrealized loss on derivative contracts, net of tax

  0    0    0    0    0    (1,764  (1,764

Translation adjustments

  0    0    0    0    0    (538  (538
       

 

 

Comprehensive income

        28,692  
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

Balance at December 31, 2011

  38,048   $568   $415,573   $(385,544 $72,247   $(3,099 $99,745  
 

 

  

 

  

 

  

 

  

 

  

 

  

 

 

See accompanying notes.notes to consolidated financial statements

2011 ANNUAL REPORT    57


Websense, Inc.

Websense, Inc.

Consolidated Statements of Cash Flows

(In thousands)

 

  Years ended December 31,   Years Ended December 31, 
  2009 2008 2007   2011 2010 2009 

Operating activities:

        

Net loss

  $(10,697 $(26,779 $(16,481

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Net income (loss)

  $30,994   $18,652   $(10,697

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

Depreciation and amortization

   51,184    62,994    28,604     26,286    37,873    51,374  

Share-based compensation

   24,765    24,089    22,076     18,976    22,565    24,765  

Deferred income taxes

   3,271    (28,229  (14,882   5,423    (264  (586

Unrealized loss (gain) on foreign exchange

   512    (632  543     (137  490    512  

Tax shortfall (windfall) from share-based compensation

   2,222    806    (1,052

Changes in operating assets and liabilities, net of effects from purchases of PortAuthority and SurfControl:

    

Excess tax benefit from share-based compensation

   (2,596  (1,552  (208

Changes in operating assets and liabilities:

    

Accounts receivable

   (535  (3,765  (6,744   957    1,712    (535

Other assets

   (10,902  (8,271  (5,160   2,251    (5,121  (10,256

Accounts payable

   2,659    (1,111  (1,181   1,667    2,346    2,659  

Accrued compensation and related benefits

   3,102    (5,718  1,088     449    (274  3,431  

Other liabilities

   (7,749  (2,584  (5,658   (4,161  (2,246  (7,785

Deferred revenue

   38,329    54,465    47,664     (1,246  14,191    38,329  

Income taxes payable

   (1,360  546    4,717  

Income taxes payable and receivable/prepaid

   328    1,747    1,852  
            

 

  

 

  

 

 

Net cash provided by operating activities

   94,801    65,811    53,534     79,191    90,119    92,855  
            

 

  

 

  

 

 

Investing activities:

        

Change in restricted cash and cash equivalents

   2,347    (1,240  (261   31    (199  2,347  

Purchase of property and equipment

   (12,013  (7,911  (5,866   (9,117  (9,259  (12,167

Purchase of intangible assets

   (320  (2,061  —       (765  0    (320

Cash refunded from (paid to acquire) PortAuthority, net of cash acquired

   —      147    (81,988

Cash paid to acquire SurfControl, net of cash acquired

   —      —      (395,062

Cash received from sale of CyberPatrol assets

   —      1,400    —    

Net cash paid for option contracts on SurfControl acquisition

   —      —      (443

Purchases of marketable securities

   —      (20,160  (506,913

Maturities of marketable securities

   —      39,963    730,595  
            

 

  

 

  

 

 

Net cash (used in) provided by investing activities

   (9,986  10,138    (259,938

Net cash used in investing activities

   (9,851  (9,458  (10,140
            

 

  

 

  

 

 

Financing activities:

        

Borrowings under senior secured term loan

   —      —      210,000  

Principal payments on senior secured term loan

   (38,000  (65,000  (20,000

Cash paid for deferred financings fees under senior secured term loan

   —      —      (5,444

Repayment of PortAuthority loan

   —      —      (4,214

Proceeds from secured loan

   87,000    5,000    0  

Principal payments on secured loan

   (81,000  (25,000  (38,000

Principal payments on capital lease obligation

   (569  (532  0  

Cash paid for deferred financings fees under secured loan

   (35  (864  0  

Proceeds from exercise of stock options

   2,433    4,311    3,260     16,719    15,992    2,433  

Proceeds from issuance of common stock for stock purchase plan

   5,432    5,321    4,317  

Tax (shortfall) windfall from share-based compensation

   (2,222  (806  1,052  

Proceeds from issuance of common stock for employee stock purchase plan

   6,614    5,991    5,432  

Excess tax benefit from share-based compensation

   2,596    1,552    208  

Tax payments related to restricted stock unit issuances

   (2,979  (2,896  (329

Purchase of treasury stock

   (34,158  (19,998  —       (98,712  (84,854  (34,158
            

 

  

 

  

 

 

Net cash (used in) provided by financing activities

   (66,515  (76,172  188,971  

Net cash used in financing activities

   (70,366  (85,611  (64,414
            

 

  

 

  

 

 

Effect of exchange rate changes on cash and cash equivalents

   466    (1,771  —       (163  (522  465  

Increase (decrease) in cash and cash equivalents

   18,766    (1,994  (17,433

(Decrease) increase in cash and cash equivalents

   (1,189  (5,472  18,766  

Cash and cash equivalents at beginning of year

   64,096    66,090    83,523     77,390    82,862    64,096  
            

 

  

 

  

 

 

Cash and cash equivalents at end of year

  $82,862   $64,096   $66,090    $76,201   $77,390   $82,862  
            

 

  

 

  

 

 

Supplemental disclosures of cash flow information:

    

Income taxes paid

  $9,899   $13,066   $15,994  

Cash paid during the period for:

    

Income taxes paid, net of refunds

  $8,597   $6,792   $9,899  

Interest paid

  $5,867   $10,778   $3,526    $1,421   $3,571   $5,867  

Increase in other accrued expenses for purchase of treasury stock

  $342   $—     $—    

Non-cash investing and financing activities:

    

Change in operating assets and liabilities for unsettled purchase of treasury stock and exercise of stock options

  $1,097   $144   $342  

Capital lease obligation incurred for a software license arrangement

  $0   $1,688   $0  

See accompanying notes.notes to consolidated financial statements

58        2011 ANNUAL REPORT


Websense, Inc.

Notes to Consolidated Financial Statements

December 31, 2009

 

1.Summary of Significant Accounting Policies

Description of Business

Websense, Inc. (“Websense” or the “Company”) commenced operations in 1994. Websense is a global provider of information technologyunified Web, email and data content security solutions designed to protect an organization’s data and users from external and internal threats, including Web security (includingmodern cyber-threats, advanced malware detectionattacks, information leaks, legal liability and removal), URL filtering, data loss prevention, and email anti-spam and security solutions.productivity loss. The Company’s products are availableCompany provides its solutions to its customers as software installed on standard serverservers or other information technology hardware, as software pre-installed onincluding the Company’s optimized appliances, and as a software ascloud-based service (software-as-a-service or “SaaS”) offering, or in a service (“SaaS”) offering.hybrid hardware/SaaS configuration. The Company’s products and services are sold worldwide to provide content security to enterprise customers, use its products to protect their networkssmall and data from external Webmedium sized businesses, public sector entities, and email-based attacksInternet service providers through a network of distributors, value-added resellers and internal threats of data loss from employee errors, insecure business practices and malfeasance.original equipment manufacturers (“OEMs”).

Subsequent EventsReclassifications

The Company has evaluated subsequent events through February 25, 2010, the date of issuance of the audited consolidated financial statements. During this period the Company did not have any material subsequent events, other than those disclosed in Note 10 to these consolidated financial statementsCertain prior year amounts relating to the increasebreakout of appliance revenues and appliance cost of revenues in the Company’s capacityconsolidated statement of operations have been reclassified to repurchase shares of its common stock.conform to the current year presentation.

Use of Estimates

The preparation of the consolidated financial statements in conformity with generally accepted accounting principles (“GAAP”) in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries in Australia, Austria, Brazil, Canada, China, France, Germany, India, Ireland, Israel, Italy, Japan, Mauritius, the Netherlands, the United Kingdom and the United States. Significant intercompany accounts and transactions have been eliminated in consolidation.

The functional currencyFunctional Currency Designations

As of December 31, 2010, the Company’s foreigninternational subsidiaries ishad the U.S. dollar as their functional currencies. In connection with the subsidiaries are generally considered direct and integral components or extensionscompletion of a global restructuring of the Company’s operations. international distribution operations during 2010 that became effective at the beginning of 2011, the Company reassessed the functional currency designation of each of its subsidiaries and determined that a change in functional currency from the U.S. dollar to the respective local currency for certain of its subsidiaries was appropriate as the primary economic environment in which these entities operate changed as a result of the restructuring. The change in functional currency designation was made prospectively effective as of the beginning of fiscal 2011 and the adjustment from translating these subsidiaries’ financial statements from the local currency to the U.S. dollar was recorded as a separate component of accumulated other comprehensive income. Foreign currency translation adjustments generally reflect the translation of the balance sheet at period end exchange rates and the income statement at an average exchange rate in effect during the respective period. As a result of the change in functional currency, the Company recorded a cumulative translation adjustment of approximately ($0.3 million), which is included in the consolidated balance sheet.

2011 ANNUAL REPORT    59


The Company recorded foreign currency transaction gains (losses) of $119,000,$1.0 million, ($888,000)1.3 million) and $453,000$0.1 million for the years ended December 31, 2009, 20082011, 2010 and 2007,2009, respectively, which are included in “Otherother income net”(expense), net on its consolidated statements of operations.

Revenue Recognition

The Company sells itsmajority of the Company’s revenues are derived from software and SaaS products including its appliance products,sold on a subscription basis. A subscription is generally 12, 24 or 36 months in duration and for a fixed number of seats or devices.seats. The Company recognizes revenuerevenues for the software and SaaS subscriptions, including any related technical support and professional services, on a daily straight-line basis, including its appliance product revenue, commencing withon the daydate the term of the subscription begins, and continuing over the term of the subscription agreement, provided the fee is fixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred and collectability is reasonably assured. Upon entering into a subscription arrangement for a fixed or determinable fee, the Company electronically delivers software access codes to users, and in the case of our appliance product the Company ships the

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

product with its software pre-installed on the product,customers and then promptly invoices customers for the full amount of their subscriptions. Payment is due for the full term of the subscription, generally within 30 to 60 days of invoicing.the invoice date.

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove from the scope of industry-specific software revenue recognition guidance any tangible products containing software components and non-software components that operate together to deliver the product’s essential functionality. In addition, the FASB amended the accounting standards for certain multiple element revenue arrangements to:

provide updated guidance on whether multiple elements exist, how the elements in an arrangement should be separated, and how the arrangement consideration should be allocated to the separate elements; and

require an entity to allocate arrangement consideration to each element based on a selling price hierarchy, where the selling price for an element is based on vendor-specific objective evidence (“VSOE”), if available; third-party evidence (“TPE”), if available and VSOE is not available; or the best estimate of selling price (“BESP”), if neither VSOE nor TPE is available.

The Company adopted the amended standards as of January 1, 2011 on a prospective basis for transactions entered into or materially modified after December 31, 2010.

A portion of the Company’s revenues are generated from the sale of appliances, which are standard servers optimized for the Company’s software products. These appliances contain software components, such as operating systems, that operate together with the hardware platform to provide the essential functionality of the appliance. Based on the amended accounting standards, when sold in a multiple element arrangement that includes software deliverables, the Company’s hardware appliances are considered non-software deliverables and are no longer accounted for under the industry-specific software revenue recognition guidance. When appliance orders are taken, the Company ships the product, invoices the customer and recognizes revenues when title/risk of loss passes to the buyer (typically upon delivery to a common carrier) and the other criteria of revenue recognition are met. The revenues recognized are based upon BESP, as outlined further below.

For transactions entered into prior to the adoption of the amended revenue standards on January 1, 2011, all elements in a multiple element arrangement containing software were treated as a single unit of accounting as the Company did not have adequate support for VSOE of undelivered elements. As a result, the Company deferred revenue on its multiple element arrangements until only the post-contract customer support (database updates and technical support) or other services not essential to the functionality of the software remained undelivered. At that point, the revenues were amortized over the remaining life of the software subscription or estimated delivery term of the services, whichever was longer.

60        2011 ANNUAL REPORT


For transactions entered into subsequent to the adoption of the amended revenue recognition standards that are multiple element arrangements, the Company allocates the arrangement fee to the software-related elements and the non-software-related elements based upon the relative selling price of such element. When applying the relative selling price method, the Company determines the selling price for each element using BESP, because VSOE and TPE are not available. The revenues allocated to the software-related elements are recognized based on the industry-specific software revenue recognition guidance that remains unchanged. The revenues allocated to the non-software-related elements are recognized based on the nature of the element provided the fee is fixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred and collectability is reasonably assured. The manner in which the Company accounts for multiple element arrangements that contain only software and software-related elements remains unchanged.

The Company determines BESP for an individual element within a multiple element revenue arrangement using the same methods utilized to determine the selling price of an element sold on a standalone basis. The Company estimates the selling price by considering internal factors such as historical pricing practices and gross margin objectives. Consideration is also given to market conditions such as competitor pricing strategies, customer demands and geography. The Company regularly reviews BESP and maintains internal controls over the establishment and updates of these estimates.

During 2011, the Company recognized $38.8 million in revenues from appliance sales, of which $27.4 million represented the immediate recognition of revenue upon shipment and the remaining $11.4 million represented primarily the ratable recognition of deferred revenue from appliance sales recorded prior to the adoption of the amended revenue recognition rules. The Company expects to recognize revenues of $5.9 million during 2012 from appliance sales made prior to 2011 that are recorded in deferred revenue as of December 31, 2011. Had the Company not adopted the amended revenue recognition rules, the amount of revenues recognized from appliance sales would have been approximately $20.6 million for 2011. The Company recognized $18.1 million in cost of revenues from appliance sales, of which $5.2 million represented the ratable recognition of deferred cost of revenues from appliance sales recorded prior to the adoption of the amended revenue recognition rules and $12.9 of immediate recognition of cost of revenues upon shipment. The Company expects to recognize costs of revenues of $2.6 million during 2012 from appliance sales made prior to 2011 that are recorded in deferred cost of revenues as of December 31, 2011. Had the Company not adopted the amended revenue recognition rules, the amount of cost of revenues recognized from appliance sales would have been approximately $11.1 million for 2011. The new accounting guidance for revenue recognition is expected to continue to affect total revenues in future periods, although the impact on the timing and pattern of revenues will vary depending on the nature and volume of new or materially modified contracts in any given period.

For the Company’s original equipment manufacturer (“OEM”)OEM contracts, the Company grants its OEM customers the right to incorporate the Company’s products into the OEMs’ products for resale to end users. The OEM customer pays the Company a royalty fee for each resale of a subscription to the Company’s product to an end user over a specified period of time. The Company recognizes revenuerevenues associated with the OEM contracts ratably over the contractual period for which the Company is obligated to provide its services to the OEM. These services consist of software updates, technical support and database updates to the Company’s Web filtering products.

The Company records amounts billed to customers in excess of recognizable revenue as deferred revenue in the accompanying consolidated balance sheets. The Company amortizes deferred revenues over the term of the subscription agreement commencing with the day the agreement is signed and all other revenue recognition requirements have been met.

The Company records distributor marketing payments and channel rebates as an offset to revenue,revenues, unless the Companyit receives an identifiable benefit in exchange for the consideration and the Companyit can estimate the fair value of the benefit received. The Company recognizes distributor marketing payments as an offset to revenuerevenues in the period the marketing service is provided. The Companyprovided and it recognizes channel rebates as an offset to revenuerevenues on a straight-line basis over the term of the corresponding subscription agreement. During 2009, 20082011, 2010 and 2007,2009, the Company recordedoffset revenue for distributor marketing payments of $2.7$3.1 million, $2.4$3.1 million and $2.1$2.7 million, respectively, and recorded channel rebates of $3.8 million, $3.5 million and $3.2 million, $2.7 million and $1.1 million, respectively.

2011 ANNUAL REPORT    61


Cash and Cash Equivalents (including restricted cash and cash equivalents)

The Company considers all highly liquid investments with a maturity of ninety days or less when purchased to be cash equivalents. The Company generally invests its excess cash in interest-bearing, investment-grade money market funds with strong credit ratings. Such investments are made in accordance with the Company’s investment policy, which establishes guidelines relative to diversification and maturities designed to maintain safety and liquidity. These guidelines are periodically reviewed and modified if necessary to take advantage of trends in yields and interest rates. The Company has not experienced any losses on its cash and cash equivalents. As of December 31, 2009,2011, the Company’s restricted cash relates to certain lease guarantees in international locations.

Interest on Cash and Cash Equivalents

The Company’s interest on cash and cash equivalents, included as a component of other income (expense), net in the Company’s consolidated statements of operations, was $0.2 million $1.6 million and $8.5 million for each of the years ended December 31, 2009, 20082011, 2010 and 2007, respectively.2009.

Acquisitions, Goodwill and Other Intangible Assets

The Company accounts for acquired businesses using the acquisition method of accounting, in accordance with GAAP accounting rules for business combinations, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of net assets acquired is recorded as goodwill. The Company reviews goodwill that has an indefinite useful life for impairment at least annually in the Company’sits fourth fiscal quarter, or more frequently if an event occurs indicating the potential for impairment. Intangible assets with finite lives are carried at cost less accumulated amortization. The Company amortizes the

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

cost of identified intangible assets using amortization methods that reflect the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up. The Company reviews intangible assets for impairment whenever eventsby facts or changes in circumstances, indicateeither external or internal, indicating that the Company may not recover the carrying value may not be recoverable. Ifof the asset. The Company measures impairment losses related to long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values. The Company measures fair value ofgenerally based on the estimated future undiscounted cash flows generated by the asset. Its analysis is less thanbased on available information and on assumptions and projections that the carryingCompany considers to be reasonable and supportable. If necessary, the Company performs subsequent calculations to measure the amount of an asset, the Company records an impairment loss based on the excess of the carrying amountvalue over the fair value of the asset.impaired assets. No impairment losses were recorded in 2009, 20082011, 2010 or 2007.2009.

Fair Value of Financial Instruments

The carrying value of cash and cash equivalents (including restricted cash and cash equivalents), accounts receivable, accounts payable, accrued liabilities and income tax receivable and payables approximate their fair values.

Deferred Financing Costs

In connection with the senior secured credit facility, theThe Company capitalized approximately $5.4 million ofcapitalizes deferred financing costs incurred in connection with its credit agreements and is amortizingamortizes those costs over the respective term of the senior secured credit facilityagreements. Deferred financing costs included in other current assets (current portion) and making proportionate amortization adjustments for paymentsdeposits and other assets (long term portion) on the consolidated balance sheets were $0.9 million and $1.2 million as of principal.December 31, 2011 and 2010, respectively.

Derivatives

The Company uses derivativesderivative financial instruments to manage foreign currency risk relating to foreign exchange rates, and to manage interest rate risk andrelating to the Company’s variable rate secured loan. The Company does not use these instruments for speculative or trading purposes. The Company’s objective is to

62        2011 ANNUAL REPORT


reduce the risk to earnings and cash flows associated with changes in foreign currency exchange rates and changes in interest rates. Derivative instruments are recognized as either assets or liabilities in the accompanying financial statements and are measured at fair value. Gains and losses resulting from changes in the fair values of those derivative instruments are recorded to earnings or other comprehensive income (loss) depending on the use of the derivative instrument and whether it qualifies for hedge accounting.

The Company utilizes Euro and British Pound and Australian Dollar foreign currency forward contracts to hedge anticipated foreign currency denominated net monetary assets. All such contracts entered into were designated as fair value hedges and were not required to be tested for effectiveness as hedge accounting was not elected. The net gains (losses) related to the contracts designated as fair value hedges are included in other income (expense), net, in the accompanying consolidated statements of operations and amounted to approximately $170,000, $(1,266,000)$0.9 million, $0.4 million and $(346,000)$0.2 million for 2009, 20082011, 2010 and 2007,2009, respectively. All of the fair value hedging contracts in place as of December 31, 20092011 will be settled before April 2010.

The Company utilizes Israeli Shekel zero-cost collar and forward contracts to hedge anticipated operating expenses. All such contracts entered into were designated as cash flow hedges and were considered effective. None of the contracts were terminated prior to settlement. Net realized gains (losses) of approximately $150,000, $(32,000) and zero related to the contracts designated as cash flow hedges during 2009, 2008 and 2007 are included in the respective operating categories for which the Company hedges its Israeli Shekel expenditures.June 2012. There were no Israeli Shekeloutstanding British Pound hedging contracts in place as of December 31, 2009.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

2011.

Notional and fair values of the Company’s hedging positions at December 31, 20092011 and 20082010 are presented in the table below (in thousands):

 

   December 31, 2009  December 31, 2008
   Notional
Value
Local
Currency
  Notional
Value
USD
  Fair Value
USD
  Notional
Value
Local
Currency
  Notional
Value
USD
  Fair Value
USD

Fair Value Hedges

            

Euro

  8,000  $11,647  $11,465  13,000  $16,820  $18,128

British Pound

  500   807   808  5,500   8,196   7,973

Australian Dollar

  600   518   539  —     —     —  
                    

Total

    $12,972  $12,812    $25,016  $26,101
                    

Cash Flow Hedges

            

Israeli Shekel

  —    $—    $—    950  $251  $254
   December 31, 2011   December 31, 2010 

Fair Value Hedges

  Notional
Value
Local
Currency
   Notional
Value
USD
   Fair Value
USD
   Notional
Value
Local
Currency
   Notional
Value
USD
   Fair Value
USD
 

Euro

   11,000    $14,909    $14,266     8,550    $11,405    $11,449  

British Pound

   0     0     0     1,250     1,938     1,958  

The Company’s Senior Credit Agreement provides thatIn connection with the Company must maintain hedge agreements so that at least 50% of the aggregate principal amount of the2007 amended and restated senior secured credit facility is subject to fixed interest rate protection for a period of not less than 2.5 years from the initial funding date. Onentered into in October 11, 2007 in conjunction with the funding of the senior secured credit facility,(the “2007 Credit Agreement”), the Company entered into an interest rate swap agreement to pay a fixed rate of interest (4.85% per annum) and receive a floating rate interest payment (based on three month LIBOR) on an equivalent amount. The initial principal amount of the swap agreement was $105 million on October 11, 2007 and it amortizes each quarter down to $11 million on June 30, 2010. In addition, on October 11, 2007 the Company entered intoas well as an interest rate cap agreement to limit the maximum interest rate on a portion of its senior secured credit facility to 6.5% per annum. The amount of principal protected by this cap agreement increases from $5 million at December 31, 2007 to $74.3 million on June 30, 2010. Both the interest rate swap agreement and interest rate cap expireagreement expired on September 30, 2010. In connection with the senior credit facility entered into in October 2010 (the “2010 Credit Agreement”), the Company entered into an interest rate swap agreement to pay a fixed rate of interest (1.778% per annum) and receive a floating rate interest payment (based on the three-month LIBOR) on a principal amount of $50 million. The $50 million swap agreement became effective on December 30, 2011 and expires on October 29, 2015. The interest rate swap was designated as a cash flow hedge. Under hedge accounting, the effective portion of the derivative fair value gains or losses is deferred in accumulated other comprehensive loss.

Concentration of Credit Risk

The Company sells its products to customers primarily in the United States, Canada, Europe, Asia, Australia and Latin America (See Note 5)4). The Company maintains a reserve for potential credit losses and historically such losses have been within management’s estimates. TheOne of the Company’s broad-line distributordistributors in North America, Ingram Micro, accounted for approximately 30%28%, 23%31% and 12%30% of the Company’s revenuerevenues during 2011, 2010 and 2009, 2008 and 2007, respectively.

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability or unwillingness of the Company’s customers to pay their invoices. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

2011 ANNUAL REPORT    63


Inventory

Inventory, which consists primarily of finished goodsappliance hardware held at the Company’s fulfillment partner locations, is stated at lower of cost or market. Cost is computed using standard cost, which approximates actual cost on a first in, first out basis. Inventory balances are included in other current assets on the accompanying consolidated balance sheets and were $1.7$2.2 million and $36,000$2.1 million at December 31, 20092011 and 2008,2010, respectively.

Deferred CostsCost of RevenueRevenues

Deferred cost of revenues consists of the costs of Web content review, amortization of acquired technology, costs associated with revenues on our appliance products, technical support and infrastructure costs associated with maintaining our databases and costs associated with providing our SaaS offerings. As described in the Revenues section above, our cost of revenues were impacted by the adoption of new revenue recognition rules under which the related costs are generally recognized when the appliances are sold. Deferred costs of revenue, which consist primarily of direct costs of materials that are associated with product and subscription revenues deferred over a service period, are included in theother current assets (current portion) and deposits and other assets line item(long term portion) on the

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

consolidated balance sheets were $4.4 million and $9.1 million as of December 31, 2009

accompanying consolidated balance sheets. The Company recognizes such deferred costs ratably as revenue is recognized. At December 31, 20092011 and 2008, the Company’s deferred costs of revenue were $4.8 million and $0.3 million,2010, respectively.

Shipping and Handling

The Company’s policy for shipping and handling is to classify the costs as a component of costs of revenues.

Property and Equipment

Property and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives, ranging from three to seven years. Depreciation and amortization of leasehold improvements are computed using the shorter of the remaining lease term or the economic life.

Computer Software Costs

Computer software development costs for the development of specific computer software products are capitalized, when significant, after establishment of technological feasibility and marketability. There have been no such costs capitalized to date as the costs incurred during the period between technological feasibility to general release have not been significant.

Advertising Expenses

Advertising costs are expensed as incurred. Total advertising costs for each of the years ended December 31, 2011, 2010 and 2009 2008were $6.1 million, $6.0 million and 2007 were $6.6 million, $7.8 million and $7.8 million, respectively.

64        2011 ANNUAL REPORT


Share-Based Compensation

Share-based compensation expense (excluding tax effects) was recorded in the following expense categories of the consolidated statements of operations.

 

  Years Ended December 31,  Years Ended December 31, 
  2009  2008  2007  2011   2010   2009 

Share-based compensation in:

            

Cost of revenue

  $1,381  $1,318  $1,500  $1,097    $1,270    $1,381  
           

 

   

 

   

 

 

Total share-based compensation in cost of revenue

   1,381   1,318   1,500   1,097     1,270     1,381  

Selling and marketing

   7,964   8,957   8,886   5,893     7,160     7,964  

Research and development

   5,206   4,734   4,099   3,827     5,285     5,206  

General and administrative

   10,214   9,080   7,591   8,159     8,850     10,214  
           

 

   

 

   

 

 

Total share-based compensation in operating expenses

   23,384   22,771   20,576   17,879     21,295     23,384  
           

 

   

 

   

 

 

Total share-based compensation

  $24,765  $24,089  $22,076  $18,976    $22,565    $24,765  
           

 

   

 

   

 

 

At December 31, 2009,2011, there was $46.2$39.5 million of total unrecognized compensation cost related to share-based compensation arrangements granted under all equity compensation plans (excluding tax effects). That total unrecognized compensation cost will be adjusted for estimated forfeitures as well as for future changes in estimated forfeitures. The Company expects to recognize that cost over a weighted average period of approximately 2.21.9 years.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

The Company estimates the fair value of options granted using the Black-Scholes option valuation model and the assumptions shown in the tables below. The Company estimates the expected term of options granted based on the history of grants and exercises in the Company’s option database. The Company estimates the volatility of its common stock at the date of grant based on both the historical volatility as well as the implied volatility of publicly traded options on its common stock. The Company bases the risk-free interest rate that is used in the Black-Scholes option valuation model on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with equivalent remaining terms. The Company has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends in the foreseeable future. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model. The Company amortizes the fair value ratably over the vesting period of the awards, which is typically four years.awards. The Company uses historical data to estimate pre-vesting option forfeitures and records share-based expense only for those awards that are expected to vest.

The Company used the following assumptions to estimate the fair value of stock options granted for each of the years ended December 31, 2009, 20082011, 2010 and 2007:2009:

 

  Years Ended December 31,   Years Ended December 31, 
      2009         2008         2007       2011 2010 2009 

Average expected life (years)

  3.1   3.0   3.1     3.4    3.4    3.1  

Average expected volatility factor

  45.4 35.3 35.2   42.1  42.4  45.4

Average risk-free interest rate

  1.4 2.5 4.5   1.1  1.4  1.4

Average expected dividend yield

  —     —     —       0    0    0  

2011 ANNUAL REPORT    65


The Company used the following assumptions to estimate the fair value of the semi-annual employee stock purchase plan share grants during the years ended December 31, 2009, 20082011, 2010 and 2007:2009:

 

  Years Ended December 31,   Years Ended December 31, 
      2009         2008         2007       2011 2010 2009 

Average expected life (years)

  1.3   1.3   1.3     1.3    1.3    1.3  

Average expected volatility factor

  48.8 50.7 34.4   44.4  41.7  48.8

Average risk-free interest rate

  0.7 1.6 4.3   0.2  0.4  0.7

Average expected dividend yield

  —     —     —       0    0    0  

The Company’s determination of fair value of share-based payment awards on the date of grant using an option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards, and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because the Company’s employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management’s opinion, the existing valuation models may not provide an accurate measure of the fair value of the Company’s employee stock options. Although the fair value of employee stock options is determined using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Share-based compensation expense related to restricted stock unit awards is calculated based on the market price of the Company’s common stock on the date of grant and is recognized ratably over the vesting period of the awards.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

Performance based restricted stock units have performance based vesting components that vest only if performance criteria are met for each respective performance period. If the performance criteria are not met for a performance period, then the related performance awards that would have vested are forfeited. Certain performance criteria allow for different vested amounts based on the level of achievement of the performance criteria. Fair value has been measured on the grant date and is recognized over the expected vesting period, provided we determine it is probable that the performance criteria will be met.

Comprehensive Income (Loss) Income

Comprehensive income (loss) is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources. NetThe components of comprehensive income (loss) and other comprehensive income (loss), including foreign currency translation adjustments and unrealized gains and losses on investments and certain derivative contracts, are reported, net of their related tax effect, to arrive at comprehensive income (loss).were as follows (in thousands):

 

   Years Ended December 31, 
   2009  2008  2007 

Net loss

  $(10,697 $(26,779 $(16,481

Net change in unrealized gain on marketable securities, net of tax

   —      —      81  

Net change in unrealized gain on derivative contracts, net of tax of $796, $(376) and $(665), respectively

   1,189    (560  (989

Translation adjustment

   —      (1,303  (322
             

Comprehensive loss

  $(9,508 $(28,642 $(17,711
             
   Years Ended December 31, 
   2011  2010   2009 

Net income (loss)

  $30,994   $18,652    $(10,697

Net change in unrealized (loss) gain on derivative contracts

   (1,764  1,197     1,189  

Translation adjustment

   (538  0     0  
  

 

 

  

 

 

   

 

 

 

Comprehensive income (loss)

  $28,692   $19,849    $(9,508
  

 

 

  

 

 

   

 

 

 

66        2011 ANNUAL REPORT


The accumulated unrealized derivative loss,(losses) gains, net of tax, on the Company’s derivative contracts included in “Accumulatedaccumulated other comprehensive loss”loss were as follows (in thousands):

 

  Years Ended December 31,   Years Ended December 31, 
  2009 2008 2007   2011 2010 2009 

Beginning balance

  $(1,558 $(998 $(9  $828   $(369 $(1,558

Net change during the period

   1,189    (560  (989   (1,764  1,197    1,189  
            

 

  

 

  

 

 

Ending balance

  $(369 $(1,558 $(998

Ending balance, net of tax of $624, $552 and $246, respectively

   $ (936 $828    $ (369
            

 

  

 

  

 

 

Accumulated Other Comprehensive Loss

Accumulated other comprehensive loss on the Company’s consolidated balance sheet consisted of the following (in thousands):

 

   December 31, 
   2009  2008 

Unrealized gain on fair value of foreign currency contracts

  $—     $3  

Unrealized loss on interest rate swap and cap

   (369  (1,561

Translation adjustment

   (1,625  (1,625
         
  $(1,994 $(3,183
         
   December 31, 
   2011  2010 

Unrealized (loss) gain on interest rate derivatives, net of tax

  $(936 $828  

Translation adjustments

   (2,163  (1,625
  

 

 

  

 

 

 
  $(3,099 $(797
  

 

 

  

 

 

 

Net Income Per Share

Basic net income per share (“EPS”) is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per shareEPS is computed by dividing the net income for the period by the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares for all periods presented consist of dilutive stock options, and restricted stock units. Dilutive securities include both dilutive stock options and dilutive restricted stock units and dilutive employee stock purchase plan grants. Dilutive stock options, dilutive restricted stock units, dilutive performance based restricted stock units and dilutive employee stock purchase plan grants are calculated based on the average share price for each fiscal period using the treasury stock method.

If, however, the Company reports a net loss, diluted EPS is computed in the same manner as basic EPS.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

Potentially dilutive securities totaling 4,466,000 and 5,519,000 weighted average shares for 2011 and 2010, respectively, were excluded from the diluted EPS calculation because of their anti-dilutive effect. As the Company reported a net loss in 2009, 2008 and 2007, basic and diluted net loss per share were the same. Potentially dilutive securities outstanding were not included in the computation of diluted net loss per share for 2009 because to do so would have been anti-dilutive.

2011 ANNUAL REPORT    67


The following is a reconciliation of the numerator and denominator used in calculating basic EPS to the numerator and denominator used in calculating diluted EPS for all periods presented.

   Net (Loss)
Income
(Numerator)
  Shares
(Denominator)
   Per Share
Amount
 
   (In thousands, except per share amounts) 

For the Years Ended:

     

December 31, 2011:

     

Basic EPS

  $30,994    39,711    $0.78  

Effect of dilutive securities

   0    1,028     (0.02
  

 

 

  

 

 

   

 

 

 

Diluted EPS

  $30,994    40,739    $0.76  
  

 

 

  

 

 

   

 

 

 

December 31, 2010:

     

Basic EPS

  $18,652    42,409    $0.44  

Effect of dilutive securities

   0    1,029     (0.01
  

 

 

  

 

 

   

 

 

 

Diluted EPS

  $18,652    43,438    $0.43  
  

 

 

  

 

 

   

 

 

 

December 31, 2009:

     

Basic EPS

  $(10,697  44,262    $(0.24

Effect of dilutive securities

   0    0     0  
  

 

 

  

 

 

   

 

 

 

Diluted EPS

  $(10,697  44,262    $(0.24
  

 

 

  

 

 

   

 

 

 

Income Taxes

The Company applies the liability method of accounting for income taxes. Under the liability method, deferred taxes are determined based on the temporary differences between the financial statement and tax basis of assets and liabilities using tax rates expected to be in effect during the years in which the basis differences reverse. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized.

The Company uses a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company considers many factors when evaluating and estimating its tax positions and tax benefits, which require periodic adjustments and which may not accurately anticipate actual outcomes. The Company recognizes potential accrued interest and penalties related to unrecognized tax benefits as income tax expense.

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability or unwillingness of the Company’s customers to pay their invoices. If the financial condition of the Company’s customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required.

Recently Issued Accounting Standards

In October 2009,June 2011, the Financial Accounting Standards Board (“FASB”)FASB issued authoritative guidance on revenue recognitionthe presentation of other comprehensive income within the financial statements that will become effective for the Company beginning January 1, 2011,2012, with earlier adoption permitted. UnderThe guidance provides an option to registrants to present total comprehensive income, the newcomponents of net income and the components of other comprehensive income in a single continuous statement or two separate but consecutive statements. The guidance on arrangements that include software elements, tangible products that have softwareeliminates the option to present other comprehensive income components that are essential to the functionalityas part of the tangible product will no longer be within the scopeconsolidated statement of stockholders’ equity. The Company does not believe that adoption of the software revenue recognition guidance and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally,have a significant impact on the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scopeCompany’s financial position, results of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidenceoperations or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. The Company is currently evaluating both the timing and the impact of the pending adoption of these standards on its consolidated financial statements.cash flows.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

 

68        2011 ANNUAL REPORT


2.Property and Equipment

Property and equipment consisted of the following (in thousands):

 

  Estimated

Useful Lives

  December 31,   Estimated
Useful  Lives
   December 31, 
  2009 2008    2011 2010 

Computer hardware and software

  3 years  $42,962   $37,906     3 years    $45,783   $40,020  

Leasehold improvements, office furniture and equipment

  3-7 years   9,174    6,634     3-7 years     13,124    11,904  
             

 

  

 

 
     52,136    44,540       58,907    51,924  

Accumulated depreciation

     (35,642  (30,228     (42,075  (34,980
             

 

  

 

 
    $16,494   $14,312      $16,832   $16,944  
             

 

  

 

 

Depreciation expense, including amortization of assets recorded under capital leases, for 2011, 2010 and 2009 2008was $10.4 million, $10.3 million and 2007 was $10.7 million, $10.8respectively.

Included in property and equipment is a capital lease obligation for a software license arrangement that had an original cost of $1.7 million and $5.9net book value of approximately $0.6 million and $1.2 million as of December 31, 2011 and 2010, respectively.

 

3.Acquisitions

SurfControl

In October 2007, the Company completed the acquisition of SurfControl, a U.K.-based provider of Web and email security solutions for approximately $460.9 million. The purchase price was allocated as follows: $157.8 million to amortizable intangible assets, $0.4 million to net tangible liabilities assumed and the remaining $303.5 million to goodwill. In connection with the acquisition, management approved plans to exit certain SurfControl facilities. During 2009, the Company made a lease termination payment to exit the last remaining vacated SurfControl facility. As a result, the Company has no remaining accrued facility exit costs as of December 31, 2009 as show below (in thousands):

   Balance at
December 31,
2008
  Cash
Payments
  Charged to
Expense
  Adjustments  Balance at
December 31,
2009

Facility exit costs

  $2,243  $(2,097 $33  $(179 $—  

The adjustment of $179,000 to eliminate the unused accrued facility exit costs was recorded as a reduction to goodwill.

PortAuthority

In January 2007, the Company completed the acquisition of PortAuthority Technologies, Inc. (“PortAuthority”), a provider of data loss prevention technology, for approximately $90.3 million in cash. The purchase price was allocated as follows: $14.7 million to amortizable intangible assets, $1.3 million to in-process research and development, $54,000 to net tangible liabilities assumed and the remaining $74.4 million to goodwill.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

4.Intangible Assets

Intangible assets subject to amortization consisted of the following as of December 31, 20092011 (in thousands):

 

  Remaining
Weighted Average Life
(in years)
  Cost  Accumulated
Amortization
 Net  Remaining
Weighted Average
Life (in years)
  Cost   Accumulated
Amortization
 Net 

Technology

  2.5  $32,598  $(17,706 $14,892  3.2  $15,157    $(11,255 $3,902  

Customer relationships

  5.4   129,200   (76,733  52,467  4.8   69,200     (46,690  22,510  

Trade name

  2.0   510   (306  204
               

 

   

 

  

 

 

Total

  4.8  $162,308  $(94,745 $67,563  4.6  $84,357    $(57,945 $26,412  
               

 

   

 

  

 

 

Intangible assets subject to amortization consisted of the following as of December 31, 2010 (in thousands):

   Remaining
Weighted Average
Life (in years)
  Cost   Accumulated
Amortization
  Net 

Technology

  2.7  $16,347    $(10,418 $5,929  

Customer relationships

  5.0   126,200     (91,153  35,047  

Trade name

  1.0   510     (408  102  
    

 

 

   

 

 

  

 

 

 

Total

  4.7  $143,057    $(101,979 $41,078  
    

 

 

   

 

 

  

 

 

 

Amortization expense of intangible assets for 2011, 2010 and 2009 2008 and 2007 was $39.3$15.7 million, $49.9$26.5 million and $20.6$39.3 million, respectively. As of December 31, 2009,2011, remaining amortization expense is expected to be as follows (in thousands):

 

Years Ending December 31,

    

2010

  $26,484

2011

   15,550

2012

   8,329  $8,473  

2013

   5,577   5,720  

2014

   4,545   4,689  

2015

   3,862  

2016

   3,668  

Thereafter

   7,078   0  
     

 

 

Total expected amortization expense

  $67,563  $26,412  
     

 

 

 

2011 ANNUAL REPORT    69


5.4.Geographic Information

The Company operates under one operating segment, which focuses on being a global provider of unified Web, email and data security solutions. The Company’s chief operating decision makers allocate resources and make decisions based on financial data consistent with the presentation in the accompanying consolidated financial statements.

The following illustrates revenues attributed to customers located in the Company’s country of domicile (the United States) and those attributed to foreign customers (in thousands):

 

  Years Ended December 31,  Years Ended December 31, 
  2009  2008  2007  2011   2010   2009 

United States

  $155,837  $155,720  $123,445  $182,402    $165,272    $155,837  

Europe, Middle East and Africa

   108,290   91,182   59,166   117,971     113,721     108,290  

Asia/Pacific

   22,684   18,556   10,745   31,903     25,785     22,684  

Canada and Latin America

   26,902   22,816   16,951   31,907     27,984     26,902  
           

 

   

 

   

 

 
  $313,713  $288,274  $210,307  $364,183    $332,762    $313,713  
           

 

   

 

   

 

 

The United Kingdom represented $45.2$40.5 million, $43.2$42.9 million and $22.5$45.2 million of total revenue for the fiscal years ended2011, 2010 and 2009, 2008 and 2007, respectively. No other foreign country represented more than 5% of total revenue.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

The net carrying valuevalues of the Company’s property and equipment assets are located in the following geographic areas (in thousands):

 

  December 31,  December 31, 
  2009  2008  2011   2010 

United States

  $8,474  $8,724  $9,421    $9,311  

China

   2,697   1,112   2,879     2,643  

United Kingdom

   2,615   3,168   1,366     1,731  

Ireland

   1,863   193   1,579     1,845  

Other

   845   1,115   1,587     1,414  
        

 

   

 

 
  $16,494  $14,312  $16,832    $16,944  
        

 

   

 

 

 

6.5.Deferred Revenue

The Company expects to recognize revenue related to contractual arrangements in existence as of December 31, 20092011 as follows (in thousands):

 

Years Ending December 31,

  

2010

  $239,010

2011

   92,963

2012

   40,254

2013 and thereafter

   7,885
    
  $380,112
    

Years Ending December 31,

  

2012

  $250,597  

2013

   93,058  

2014

   40,664  

2015

   6,511  

2016 and thereafter

   2,204  
  

 

 

 
  $393,034  
  

 

 

 

 

7.6.Senior Secured Credit Facility

In connection with the acquisition of SurfControl in October 2007, the Company entered into an amended and restated senior credit agreement (the “Seniorthe 2007 Credit Agreement”).Agreement. The $225 million senior secured credit facility consistsconsisted of a five year $210 million senior secured term loan and a $15 million revolving credit facility. The senior secured

70        2011 ANNUAL REPORT


In October 2010, the Company entered into the 2010 Credit Agreement and used the proceeds to repay the term loan was fully fundedunder the 2007 Credit Agreement and retired the 2007 Credit Agreement. The 2010 Credit Agreement provides for a secured revolving credit facility that matures on October 11, 2007,29, 2015 with an initial maximum aggregate commitment of $120 million, including a $15 million sublimit for issuances of letters of credit and $5 million sublimit for swing line loans. The Company will borrow and make repayments under the revolving linecredit facility depending on its liquidity position. During 2011, the Company borrowed $87.0 million and made repayments of $81.0 million under its revolving credit remains unused. Atfacility. The Company may increase the maximum aggregate commitment under the 2010 Credit Agreement up to $200 million if certain conditions are satisfied, including that it is not in default under the 2010 Credit Agreement at the time of the increase and that it obtains the commitment of the lenders participating in the increase. Loans under the 2010 Credit Agreement are designated at the Company’s election as either base rate or Eurodollar rate loans. Base rate loans bear interest at a rate equal to (i) the highest of (a) the federal funds rate plus 0.5%, (b) the Eurodollar rate plus 1.00%, and (c) Bank of America’s prime rate plus (ii) a margin set forth below. Eurodollar rate loans bear interest at a rate equal to (i) the Eurodollar rate, plus (ii) a margin set forth below. For the year ended December 31, 2009,2011, the outstanding balanceCompany’s weighted average interest rate was 2.0%.

The applicable margins are determined by reference to the Company’s leverage ratio, as set forth in the table below:

Consolidated Leverage Ratio

     Eurodollar
Rate
Loans
  Base
Rate

Loans
 

<1.25:1.0

    1.75  0.75

³1.25:1.0

    2.00  1.00

For each commercial Letter of Credit, the Company must pay a fee equal to 0.125% per annum times the daily amount available to be drawn under such Letter of Credit and, for each standby Letter of Credit, the Company must pay a fee equal to the applicable margin for Eurodollar rate loans times the daily amount available to be drawn under such Letter of Credit. A quarterly commitment fee is payable to the lenders in an amount equal to 0.25% of the unused portion of the credit facility.

Indebtedness under the senior secured term loan was $87 million as a result of the Company making optional prepayments as well as required principal payments. The senior secured credit facility2010 Credit Agreement is secured by substantially all of the Company’s assets, of the Company, including pledges of stock of somecertain of its subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by the Company’sits domestic subsidiaries. The senior secured term loan bears2010 Credit Agreement contains affirmative and negative covenants, including an obligation to maintain a certain consolidated leverage ratio and consolidated interest at a spread above LIBOR with the spread determined based uponcoverage ratio and restrictions on the Company’s total leverage ratio, asability to borrow money, to incur liens, to enter into mergers and acquisitions, to make dispositions, to pay cash dividends or repurchase capital stock, and to make investments, subject to certain exceptions. The 2010 Credit Agreement does not require the Company to use excess cash to pay down debt.

The 2010 Credit Agreement provides for acceleration of the Company’s obligations thereunder upon certain events of default. The events of default include, without limitation, failure to pay loan amounts when due, any material inaccuracy in the Company’s representations and warranties, failure to observe covenants, defaults on any other indebtedness, entering bankruptcy, existence of a judgment or decree against the Company or its subsidiaries involving an aggregate liability of $10 million or more, the security interest or guarantee ceasing to be in full force and effect, any person becoming the beneficial owner of more than 35% of the Company’s outstanding common stock, or the Company’s board of directors ceasing to consist of a majority of Continuing Directors (as defined in the Senior2010 Credit Agreement.Agreement).

The secured revolving credit facility under the 2010 Credit Agreement is included in the line item secured loan on the Company’s consolidated balance sheets and had a balance of $73 million and $67 million as of December 31, 2011 and 2010, respectively. As of December 31, 2011, future remaining minimum principal payments under the secured loan will be due in October 2015 when the revolving credit facility matures. The unused portion of the revolving credit facility requires a fee per annum, also based upon the Company’s total leverage ratio. Based on the total leverage ratio throughout 2009, the spread on the senior secured term loan was LIBOR plus 225 basis points per annum and the fee for the unused portion of the revolving credit facility was 25 basis points per annum. The weighted average interest rate on the senior secured term loan at December 31, 2009 was 3.9%. The Senior Credit Agreement contains financial covenants, including a consolidated leverage ratio and a consolidated interest coverage ratio, as well as affirmative and negative covenants. Among the negative covenants are restrictions on the Company’s ability to borrow money, including restrictions on (a) the incurrence of more than $15 million of new debt, including capital leases (subject to certain exceptions), (b) the incurrence of more than $7.5 million in letters of credit, (c) the incurrence of more than $50 to $75 million of new debt,

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

depending on the Company’s leverage ratio, to finance future acquisitions or (d) the assumption of more than $15 million of new debt in connection with acquisitions. Also, the Company is not permitted to pay cash dividends under the terms of the Senior Credit Agreement.

As of December 31, 2009, future remaining minimum principal payments under the senior secured term loan will be as follows (in thousands):2011 was $47 million.

 

Years Ending December 31,

  

2010

  $12,429

2011

   14,914

2012

   59,657
    

Total

  $87,000
    
2011 ANNUAL REPORT    71

8.    Fair Value Measurements and Derivatives


7.Fair Value Measurements and Derivatives

Fair Value Measurements on a Recurring Basis

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. The Company’s assessment of the significance of a particular input to the fair value measurements requires judgment, and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.

The following table presents the values of balance sheet accounts measured at fair value on a recurring basis as of December 31, 2011 (in thousands):

   Level 1(1)   Level 2(2)   Level 3(3)   Total 

Assets:

        

Cash equivalents—money market funds

  $1,558    $0    $          0    $1,558  

Foreign currency forward contracts not designated as hedges

   0     643     0     643  

Liabilities:

        

Interest rate swap

   0     1,561     0     1,561  

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis as of December 31, 20092010 (in thousands):

 

  Level 1(1)  Level 2(2)  Level 3(3)  Total  Level 1(1)   Level 2(2)   Level 3(3)   Total 

Assets:

                

Cash equivalents—money market funds

  $13,197    $0    $          0    $13,197  

Interest rate swap

   0     1,379     0     1,379  

Liabilities:

        

Foreign currency forward contracts not designated as hedges

  $—    $160  $—    $160   0     64     0     64  

Liabilities:

        

Interest rate swaps

  $—    $616  $—    $616

 

(1)—quoted prices in active markets for identical assets or liabilities

(2)—observable inputs other than quoted prices in active markets for identical assets andor liabilities

(3)—no observable pricing inputs in the market

Included in deposits and other assets and in other accrued expenses in the consolidated balance sheet as of December 31, 20092011 are derivative contracts, comprised of an interest rate swaps as well asswap contract and foreign currency forward contracts that are valued using models based on readily observable market parameters for all substantial terms of the Company’s derivative contracts and thus are classified within Level 2.

The effects of derivative instruments on the Company’s financial statements were as follows as of December 31, 20092011 and 2010 and for each of the yearyears ended December 31, 2011, 2010 and 2009 (in thousands):. There was no ineffective portion nor was any amount excluded from effectiveness testing during any of the periods presented below.

 

   Fair Value of Derivative Instruments 
   December 31, 2009 
   Balance Sheet Location  Fair Value 

Foreign exchange contracts not designated as cash flow hedges

  Other assets  $160  

Interest rate swap contracts designated as cash flow hedges

  Other accrued expenses   (616
       

Total derivatives

    $(456
       

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009
      Fair Value of Derivative Instruments 
      December 31, 
   

Balance Sheet Location

  2011  2010 

Interest rate contracts designated as cash flow hedges

  

(Other accrued expenses) / other assets

  $(407 $1,379  
  

(Other long term liabilities)

   (1,154  0  

Currency forward contracts not designated as hedges

  

Other assets / (other accrued expenses)

   643    (64
    

 

 

  

 

 

 

Total derivatives

    $(918 $1,315  
    

 

 

  

 

 

 

 

72        2011 ANNUAL REPORT

Effects of Derivative Instruments on Income and Other Comprehensive Income (OCI) (in thousands):


 

Derivatives in Cash Flow
Hedging Relationships

  Amount of Gain (Loss)
Recognized in
Accumulated OCI on
Derivative (Effective
Portion)
  Amount and Location of Gain
(Loss) Reclassified from
Accumulated OCI into Income
(Effective Portion)
  

Amount and Location of Gain
(Loss) Recognized in Income on
Derivative (Ineffective Portion and
Amount Excluded from
Effectiveness Testing)

  Year Ended
December 31, 2009
  Year Ended
        December 31, 2009        
  Year Ended
December 31, 2009

Interest rate cap contract

  $(3 $—     Interest expense  $—    Interest expense

Interest rate swap contracts

   1,992    (2,319 Interest expense   —    Interest expense

Foreign exchange contracts

   (4  150   Research and
development
   —    Research and
development
                

Total

  $1,985   $(2,169   $—    
                

Amount of Gain (Loss)
Recognized in Accumulated OCI on
Derivatives (Effective Portion)

  Location and Amount of Gain (Loss)
Reclassified from Accumulated OCI into
Income (Effective Portion)
 

Derivatives in Cash

Flow Hedging

Relationships

  Year Ended December 31,  Derivatives in Cash
Flow Hedging
Relationships
  Year Ended
December 31,
 
   2011  2010   2009     2011   2010  2009 

Interest rate contracts

  $(2,940 $1,991    $1,989   Interest expense  $0    $(625 $(2,319

Currency contracts

   0    0     (4 R&D   0     14    150  
  

 

 

  

 

 

   

 

 

    

 

 

   

 

 

  

 

 

 

Total

  $(2,940 $1,991    $1,985     $0    $(611 $(2,169
  

 

 

  

 

 

   

 

 

    

 

 

   

 

 

  

 

 

 

 

  

Location and Amount of Gain
Recognized in Income on Derivatives

 
  Amount and Location of Gain (Loss)
Recognized in Income on Derivatives
     Year Ended
December 31,
 

Derivatives Not Designated as Hedges

  Year Ended December 31, 2009     2011   2010   2009 

Foreign currency forward contracts

  $170  Other income, net

Currency forward contracts

  Other income, net  $860    $443    $170  

Fair Value Measurements on a Nonrecurring Basis

During 2009, the Company did not re-measure any nonfinancial assets and liabilities measured at fair value on a nonrecurring basis (e.g., goodwill, intangible assets, property and equipment and nonfinancial assets and liabilities initially measured at fair value in a business combination). As of December 31, 2009,2011, the Company’s senior secured term loan, with a carrying value of $87.0$73.0 million, had an estimated fair value of $76.2$73.1 million which the Company determined using a discounted cash flow model with a discount rate of 7.95%2.3% which represents the Company’s estimated incremental borrowing rate.

 

9.8.Commitments and Contingencies

The Company leases its facilities and certain equipment under non-cancelable operating leases, which expire at various dates through 2015. The facilities’ leases contain renewal options and are subject to cost increases. Future minimum annual payments under non-cancelable operating leases at December 31, 20092011 are as follows (in thousands):

 

  Operating
Leases
  Operating
Leases
 

Years Ending December 31,

      

2010

  $6,125

2011

   4,864

2012

   4,613  $6,616  

2013

   4,491   6,403  

2014

   816   2,203  

Thereafter

   520

2015

   792  

2016 and thereafter

   0  
     

 

 

Total

  $16,014  
  $21,429  

 

 
   

Rent expense totaled $7.2$7.1 million, $7.9$7.1 million and $6.6$7.2 million for the years ended December 31, 2009, 20082011, 2010 and 2007,2009, respectively. Rent expense is generally recognized on a straight-line basis over the term of the respective leases.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

As of December 31, 2009,2011, the Company has contractual commitment obligations for the purchase ofinbound software licenses, equipment maintenance, royalty agreements and automobile leases in the following amounts: $364,000 for 2010, $187,000 for 2011, $68,000$3.1 million for 2012, $2.2 million for 2013 and $10,000$1.5 million for 2013.2014.

The Company provides indemnifications of varying scope and size to certain customers against claims of intellectual property infringement made by third parties arising from the use of its products. The Company evaluates estimated losses for such indemnifications and considers such factors as the degree of probability of an unfavorable outcome and the ability to make a reasonable estimate of the amount of loss. To date, the Company has not encountered material costs as a result of such obligations and has not accrued any liabilities related to such indemnifications in its financial statements.

2011 ANNUAL REPORT    73


Litigation

On July 12, 2010, Finjan, Inc. filed a complaint entitled Finjan, Inc. v. McAfee, Inc., Symantec Corp., Webroot Software, Inc., Websense, Inc. and Sophos, Inc. in the United States District Court for the District of Delaware. The complaint alleges that the Company’s making, using, importing, selling and/or offering for sale Websense Web Filter, Websense Web Security and Websense Web Security Gateway infringes U.S. Patent No. 6,092,194 (“194 Patent”). Finjan, Inc. seeks an injunction from further infringement of the 194 Patent and damages. A hearing on the construction of the claims in the 194 Patent was held on January 30, 2012 and the court has not issued a ruling as of the filing date of this Annual Report on Form 10-K. The parties are currently engaged in discovery. The Company denies infringing any valid claims of the 194 Patent and intends to vigorously defend the lawsuit.

The Company is involved in various other legal actions in the normal course of business. Based on current information, including consultation with its lawyers, the Company’s attorneys, management believes itCompany has adequately reserved fornot accrued any ultimate liability that may result from these actions such that any liability would not materially affectof its consolidated financial position, results of operations or cash flows. Management’spending legal actions. The Company’s evaluation of the likely impact of these actions could change in the future, the Company may determine that it is required to accrue for potential liabilities in one or more legal actions and unfavorable outcomes and/or defense costs, depending upon the amount and timing, could have a material adverse effect on the Company’sits results of operations or cash flows in a future period. If we later determine that we are required to accrue for potential liabilities resulting from any of these legal actions, it is reasonably possible that the ultimate liability for these matters will be greater than the amount for which we have accrued at that time.

 

10.9.Stockholders’ Equity

Stock PlansShare-Based Compensation

Employee Stock Purchase Plan

Beginning with the 2001 calendar year and ending with (and including) the calendar year 2010, the Company’s Amended and Restated 2000 Employee Stock Purchase Plan (the “Purchase Plan”) providesprovided for automatic annual increases in the number of shares reserved for issuance thereunder equal to the lesser of (i) 1% of the Company’s outstanding shares on the last trading day in December of the immediately preceding calendar year immediately preceding or (ii) 750,000 shares. The Purchase Plan is intended to qualify as an employee stock purchase plan within the meaning of Section 423 of the Internal Revenue Code.Code of 1986, as amended. Under the Purchase Plan, the Boardboard of Directorsdirectors may authorize participation by eligible employees, including officers, in periodic offerings following commencement of the Purchase Plan. Shares issued and available for issuance are as follows:

 

Shares reserved for issuance at December 31, 2006

1,483,241

Shares reserved for issuance during 2007 based on the automatic increase in shares authorized

447,845

Shares issued during 2007

(239,921

Shares reserved for issuance at December 31, 2007

1,691,165

Shares reserved for issuance during 2008 based on the automatic increase in shares authorized

453,936

Shares issued during 2008

(347,523

Shares reserved for issuance at December 31, 2008

 1,797,578  

Shares reserved for issuance during 2009 based on the automatic increase in shares authorized

  450,484  

Shares issued during 2009

  (377,619
  

 

Shares reserved for issuance at December 31, 2009

  1,870,443

Shares reserved for issuance during 2010 based on the automatic increase in shares authorized

434,099

Shares issued during 2010

(440,255

Shares reserved for issuance at December 31, 2010

1,864,287

Shares issued during 2011

(473,206

Shares reserved for issuance at December 31, 2011

1,391,081  
  

 

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

Unless otherwise determined by the Board or precluded by laws of foreign jurisdictions, employees are eligible to participate in the Purchase Plan provided they are employed for at least 20 hours per week and are customarily employed for at least five months per calendar year. Employees who participate in an offering may

74        2011 ANNUAL REPORT


have up to 15% of their earnings withheld pursuant to the Purchase Plan. The amount withheld is then used to purchase shares of common stock on specified dates. The price of common stock purchased pursuant to the Purchase Plan will be equal to 85% of the lower of the fair market value of the common stock at the commencement date of each offering period or the relevant purchase date. Employees may end their participation in the offering at any time during the offering period, and participation ends automatically on termination of employment.

Employee Stock Plans

In June 2009, the stockholders of the Company approved the Company’s 2009 Equity Incentive Plan (the “2009 Plan”) as a successor to and continuation of the Company’s Amended and Restated 2000 Stock Incentive Plan and the Company’s 2007 Stock Incentive Assumption Plan (the(collectively, the “Prior Plans”). All outstanding stock awards under the Prior Plans continue to be subject to the terms and conditions as set forth in the agreements evidencing such awards. The 2009 Plan provides for the grant of awards to the Company’s employees, directors and consultants. The 2009 Plan provides for the grant of the following awards: incentive stock options, non-statutory stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance stock awards, performance cash awards and other stock awards. The aggregate number of shares of Common Stock that may be issued pursuant to the 2009 Plan is not to exceed 17,500,442 shares (the “Share Reserve”); however, if any shares of common stock issued pursuant to a stock award are forfeited back to the Company, then the shares that are forfeited become available for issuance under the 2009 Plan. The stock issuable under the 2009 Plan are shares of authorized but unissued or reacquired Common Stock, including shares repurchased by the Company on the open market or otherwise. Stock options are generally exercisable for a period of seven years from the date of grant and generally vest 25% one year from the date of grant and ratably each month thereafter for a period of 36 months. The exercise price of stock options generally must not be not less than the fair market value on the date of grant. Restricted stock units are subject to vesting and the holders of the restricted stock units are entitled to delivery of the underlying common stock on the applicable vesting date. The restricted stock units generally vest 25% one year from the date of grant with semi-annual vesting thereafter for a period of 36 months. The Company also grants restricted stock units with performance-based vesting schedules to certain of its officers. To date, only non-statutory stock options and restricted stock units have been granted under the Prior Plans and 2009 Plan. Through December 31, 2009,2011, the Company granted 1,534,9283,450,482 restricted stock units of which 153,1081,047,984 have vested and been issued and 178,417856,773 have been forfeited. The remaining 1,203,4031,545,725 restricted stock units have a weighted average grant date fair value of $14.30$19.54 per share, a weighted average remaining contractual term of 1.51.3 years and an aggregate intrinsic value of $21.0$28.9 million as December 31, 2009.2011.

During 2008, the Company granted a total of 44,000 restricted stock unit awards with performance vesting to certain of its officers under the Prior Plans. The performance criteria were based on the Company’s achievement of combined annual billings and operating income objectives for 2008 set by the Company’s Board of Directors. As a result of the Company achieving the performance requirements, 50% of the restricted stock units vested on February 5, 2010 and the remaining 50% will vest on February 5, 2011. During 2009, the Company granted a total of 74,000 restricted stock unit awards with performance based vesting schedules to certain of its officers under the Prior Plans. The performance criteria were based on the Company’s achievement of combined annual billings and operating income objectives for 2009 set by the Company’s Boardboard of Directors.directors. As a result of the Company not achieving the performance requirements in 2009, none of these restricted stock units will vest.

Websense, Inc.

Notes During 2010, the Company granted a total of 126,750 restricted stock unit awards with performance based vesting schedules to Consolidated Financial Statements (Continued)certain of its officers under the 2009 Plan. The performance criteria were based on the Company’s achievement of annual billings objectives for 2010 set by the Company’s board of directors. As a result of the Company not achieving the performance requirements in 2010, none of these restricted stock units will vest. During 2011, the Company granted a total of 121,000 restricted stock unit awards with performance based vesting schedules to certain of its officers under the 2009 Plan, assuming a target level for each award. The performance criteria were based on the Company’s achievement of annual billings objectives for 2011 set by the Company’s board of directors. As a result of the Company achieving certain performance objectives in 2011, 86,268 total shares of restricted stock units are subject to vest as follows: 50% of the restricted stock will vest on February 10, 2013 and the remaining 50% will vest on February 10, 2014. These restricted units are subject to vest only if the officer is continuously employed through each vesting date.

December 31, 2009

 

2011 ANNUAL REPORT    75


The following table summarizes the Company’s restricted stock unit activity for fiscal years 2007, 20082009, 2010 and 2009:2011:

 

  Number of
Shares
 Weighted
Average
Fair Value

Balance at December 31, 2006

  120,000   $29.40

Released

  (32,333  23.22
     

Balance at December 31, 2007

  87,667    29.70

Granted

  291,770    17.60

Released

  (33,000  17.69

Canceled

  (10,750  16.81
       Number of
Shares
 Weighted
Average
Fair Value
 

Balance at December 31, 2008

  335,687    19.73   335,687   $19.73  

Granted

  1,123,158    13.05   1,123,158    13.05  

Released

  (87,775  14.61   (87,775  14.61  

Canceled

  (167,667  13.06   (167,667  13.06  
       

 

  

Balance at December 31, 2009

  1,203,403    14.30   1,203,403    14.30  

Granted

   904,682    19.90  

Released

   (417,065  19.45  

Canceled

   (342,873  17.52  
       

 

  

Balance at December 31, 2010

   1,348,147    17.03  

Granted

   1,010,872    21.15  

Released

   (477,811  20.97  

Canceled

   (335,483  17.97  
  

 

  

Balance at December 31, 2011

   1,545,725    19.54  
  

 

  

The following table summarizes the Company’s stock option activity for fiscal years 2007, 20082009, 2010 and 2009:2011:

 

  Number of
Shares
 Weighted
Average
Exercise
Price

Balance at December 31, 2006

  7,038,259   22.61

Granted

  3,229,009   21.51

Exercised

  (339,368 9.60

Canceled

  (841,114 23.58
     

Balance at December 31, 2007

  9,086,786   22.62

Granted

  2,718,725   19.12

Exercised

  (356,084 12.11

Canceled

  (1,018,327 22.44
       Number of
Shares
 Weighted
Average
Exercise
price
 

Balance at December 31, 2008

  10,431,100   22.08   10,431,100   $22.08  

Granted

  802,259   14.74   802,259    14.74  

Exercised

  (204,818 11.88   (204,818  11.88  

Canceled

  (1,252,863 20.88   (1,252,863  20.88  
       

 

  

Balance at December 31, 2009

  9,775,678   21.85   9,775,678    21.85  

Granted

   316,000    20.27  

Exercised

   (973,047  16.43  

Canceled

   (1,237,877  22.25  
       

 

  

Balance at December 31, 2010

   7,880,754    22.39  

Granted

   66,000    23.99  

Exercised

   (1,026,023  16.47  

Canceled

   (819,245  23.51  
  

 

  

Balance at December 31, 2011

   6,101,486    23.25  
  

 

  

The weighted average fair value of stock options granted during the years ended December 31, 2011, 2010 and 2009 2008was $7.54, $6.49 and 2007 was $4.85 $5.15 and $6.71 per share, respectively, based on the grant date fair value of the stock options.

The total intrinsic value of stock options exercised during the years ended December 31, 2011, 2010 and 2009 2008 and 2007 was $1.2$7.2 million, $3.0$5.2 million and $4.1$1.2 million, respectively.

The total fair value of stock options vested during the years ended December 31, 2011, 2010 and 2009 2008 and 2007 was $9.7$4.3 million, $13.1$8.1 million and $13.8$13.4 million, respectively.

76        2011 ANNUAL REPORT

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009


The following table summarizes all stock options outstanding and exercisable by price range as of December 31, 2009:2011:

 

   Options Outstanding  Options Exercisable

Range of Exercise Prices

  Number of
Shares
  Weighted
Average
Remaining
Contractual Life
in Years
  Weighted
Average
Exercise Price
  Number of
Shares
  Weighted
Average
Exercise
Price

$  1.07 – $18.38

  2,196,177  4.5  $14.10  1,209,888  $13.19

$18.40 – $20.14

  2,020,886  4.5   19.14  1,168,534   19.21

$20.50 – $23.46

  1,986,302  4.2   21.93  1,344,244   21.98

$23.60 – $27.70

  1,961,192  3.1   24.83  1,610,950   24.97

$27.74 – $99.96

  1,611,121  4.2   32.06  1,230,956   32.01
            
  9,775,678  4.1   21.85  6,564,572   22.48
            
   Options Outstanding   Options Exercisable 

Range of Exercise Prices

  Number of
Shares
   Weighted
Average
Remaining
Contractual Life
in Years
  Weighted
Average
Exercise Price
   Number of
Shares
   Weighted
Average
Exercise
Price
 

$  1.07 – $18.74

   1,565,040    3.5  $16.79     1,306,669    $16.89  

$18.75 – $21.77

   1,385,235    2.7   20.47     1,317,939     20.51  

$21.81 – $24.21

   1,221,336    2.9   23.41     1,107,495     23.45  

$24.26 – $39.91

   633,460    1.1   26.34     633,460     26.34  

$32.24 – $99.96

   1,296,415    2.4   32.34     1,238,081     32.34  
  

 

 

       

 

 

   
   6,101,486    2.7   23.25     5,603,644     23.52  
  

 

 

       

 

 

   

The Company defines in-the-money stock options at December 31, 20092011 as stock options that had exercise prices that were lower than $18.73, the $17.46 market price of the Company’s common stock at that date. As of December 31, 2009,2011, the weighted-average remaining contractual term of options outstanding is 4.12.7 years and the weighted-average remaining contractual term of options currently exercisable is 3.62.6 years. The aggregate intrinsic value of all exercisable and non-exercisable stock options outstanding and in-the-money at December 31, 20092011 was $7.7$3.0 million. The aggregate intrinsic value of only exercisable stock options outstanding and in-the-money at December 31, 20092011 was $5.4$2.4 million. There were 1,703,5351,181,540 stock options in-the-money at December 31, 2009,2011, of which 935,803969,008 stock options were exercisable.

Shares Reserved for Future Issuance

The following shares of common stock are reserved for future issuance as of December 31, 2009:2011:

 

Stock options and restricted stock units:

  

Granted and outstanding

  10,979,0817,647,211

Reserved for future grants

  6,322,8895,628,409

Employee Stock Purchase Plan:

  

Reserved for future issuance

  1,870,4431,391,081
  

 

Total

  19,172,41314,666,701
  

 

Treasury Stock

The Company repurchased shares of its common stock under its stock repurchase program during the fiscal year ended December 31, 2011 as follows:

In April 2003, the Company announced that its BoardCompany’s board of Directorsdirectors authorized a stock repurchase program of up to 4four million shares of its common stock. In August 2005, the Company announced that its BoardCompany’s board of Directorsdirectors increased the size of the stock repurchase program by an additional 4four million shares, for a total program size of up to 8eight million shares. In July 2006, the Company announced that its BoardCompany’s board of Directorsdirectors increased the size of the stock repurchase program by an additional 4four million shares, for a total program size of up to 12 million shares. In January 2008, the Company adopted a 10b5-1 plan that provides for quarterly purchases of2010, the Company’s common stock in open market transactions. In January 2010, the Boardboard of Directorsdirectors increased the size of the stock repurchase program by an additional 4four million shares, for a total program size of up to 16 million shares.

In October 2010, the Company’s board of directors increased the size of the stock repurchase program by an additional eight million shares, for a total program size of up to 24 million shares. The stock repurchase program does not have an expiration date, does not require the Company to purchase a specific number of shares and may be modified, suspended or terminated at any time by the Company’s board of directors.

Websense, Inc.In connection with the stock repurchase program, the Company adopted two 10b5-1 stock repurchase plans (the “2009 Repurchase Plans”) in August 2009. The 2009 Repurchase Plans initially provided for purchases of up

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

 

2011 ANNUAL REPORT    77


to an aggregate of $7.5 million of the Company’s common stock per calendar quarter in open market transactions beginning in October 2009. In November 2010, the Company increased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $7.5 million to $25 million per calendar quarter effective as of January 1, 2011. In October 2011, the Company decreased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $25 million to $20 million per calendar quarter effective as of January 1, 2012. Depending on market conditions and other factors, including compliance with covenants in the Company’s senior secured credit facility,2010 Credit Agreement, purchases by the Company’s agentagents under this programthe 2009 Repurchase Plans may commence or be suspended at any time, or from time to time, without prior notice to the Company.time. During 2009,2011, the Company repurchased 2,284,915an aggregate of 4,787,302 shares of its common stock for an aggregate of approximately $34.5$100.0 million at an average price of $15.08$20.89 per share. As of December 31, 2009,2011, the Company had repurchased a total of 11,534,02420,411,821 shares of its common stock under these programsthe stock repurchase program, for an aggregate of $224.9$409.8 million at an average price of $19.50$20.08 per share. On February 5,The 2010 Credit Agreement permits the Company amendedto repurchase its securities so long as it is not in default under the Senior2010 Credit Agreement, in orderhas complied with all of its financial covenants, and has liquidity of at least $20 million; provided, however, if, after giving effect to increase its capacity toany repurchase, shares of common stock. Under the terms of the Senior Credit Agreement, the CompanyCompany’s leverage ratio is restricted from repurchasing its common stock for an aggregate purchase price that exceeds 50% ofgreater than 1.75:1, such repurchase cannot exceed $10 million in the aggregate amount of its consolidated net income, as defined in the Senior Credit Agreement, during the period from the effective date of the facility through the most recent quarter end for which the Company has filed quarterly financial statements. Based on the February 5, 2010 amendment, the Company can repurchase up to $42.2 million of its common stock under the Senior Credit Agreement as of December 31, 2009, excluding amounts repurchased by the Company prior to December 31, 2009.any fiscal year.

 

11.10.Income Taxes

For financial reporting purposes, lossincome (loss) before income taxes includes the following components:

 

  Years Ended December 31,   Years Ended December 31, 
  2009 2008 2007   2011   2010   2009 
  (In thousands)   (in thousands) 

(Loss) income before income taxes

    

Income (loss) before income taxes

      

United States

  $2,922   $(27,407 $(3,906  $26,674    $16,820    $2,922  

Foreign

   (6,563  (18,856  (9,642   17,345     9,441     (6,563
            

 

   

 

   

 

 

Total

  $(3,641 $(46,263 $(13,548  $44,019    $26,261    $(3,641
            

 

   

 

   

 

 

The provision (benefit) for income taxes is as follows:

 

   Years Ended December 31, 
   2009  2008  2007 
   (In thousands) 

Current

    

Federal

  $(247 $(1,105 $7,840  

Foreign

   5,443    13,331    5,943  

State

   2,519    (2,316  3,628  
             
   7,715    9,910    17,411  

Deferred

    

Federal

   5,612    (13,577  (6,100

Foreign

   (7,192  (12,380  (6,623

State

   921    (3,437  (1,755
             
   (659  (29,394  (14,478
             

Provision (benefit) for income taxes

  $7,056   $(19,484 $2,933  
             

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009
   Years Ended December 31, 
   2011  2010  2009 
   (in thousands) 

Current

    

Federal

  $2,882   $3,251   $(247

Foreign

   4,606    4,099    5,443  

State

   528    2,286    2,519  
  

 

 

  

 

 

  

 

 

 
   8,016    9,636    7,715  

Deferred

    

Federal

   6,596    1,288    5,612  

Foreign

   (1,863  (3,881  (7,192

State

   276    566    921  
  

 

 

  

 

 

  

 

 

 
   5,009    (2,027  (659
  

 

 

  

 

 

  

 

 

 

Provision for income taxes

  $13,025   $7,609   $7,056  
  

 

 

  

 

 

  

 

 

 

 

78        2011 ANNUAL REPORT


The reconciliation of income tax computed at the federal statutory rate to the provision (benefit) for income taxes is as follows:

 

  Years Ended December 31,   Years Ended December 31, 
  2009 2008 2007   2011 2010 2009 
  (In thousands)   (in thousands) 

Statutory rate

  $(1,274 $(16,192 $(4,742  $15,407   $9,200   $(1,274

Foreign tax

   (1,505  4,350    674     480    (4,436  (1,505

State tax

   2,690    (5,641  1,112     1,421    2,632    2,690  

Valuation allowance

   2,428    (1,986  4,822  

Credits

   —      (432  (680   (1,648  (1,307  0  

Tax-exempt interest

   —      348    (651

Share-based compensation

   1,498    304    2,323     1,297    1,777    1,498  

Uncertain tax positions

   2,530    (453  (669   (3,260  (1,386  2,530  

Other

   689    218    744     (672  1,129    3,117  
            

 

  

 

  

 

 

Provision (benefit) for income taxes

  $7,056   $(19,484 $2,933  

Provision for income taxes

  $13,025   $7,609   $7,056  
            

 

  

 

  

 

 

Significant components of the Company’s deferred tax assets are as follows:

 

  Years Ended December 31,   December 31, 
        2009             2008               2011             2010       
  (In thousands)   (in thousands) 

Deferred tax assets:

      

Deferred revenue

  $34,859   $40,757    $29,112   $37,019  

Share-based compensation

   21,266    16,436     18,983    20,045  

State tax

   40    498     78    183  

Reserves and accruals not currently deductible

   5,384    11,686     4,693    4,534  

Net operating losses

   13,423    17,678     1,885    4,383  

Tax credits

   657    920     897    503  

Other

   1,210    2,630     825    794  
         

 

  

 

 

Gross deferred tax assets

   76,839    90,605     56,473    67,461  

Valuation allowance for deferred tax assets

   (5,329  (5,049   (2,227  (1,816
         

 

  

 

 

Deferred tax assets, net

   71,510    85,556     54,246    65,645  

Deferred tax liabilities:

      

Basis difference in intangibles

   (26,655  (36,303   (15,591  (20,074

Other

   (2,064  (2,394   (2,622  (5,272
         

 

  

 

 

Net deferred taxes

  $42,791   $46,859    $36,033   $40,299  
         

 

  

 

 

A valuation allowance is required when it is more likely than not that all or a portion of a deferred tax asset will not be realized. The Company has previously established a full valuation allowance against acquired net operating loss and foreign tax credit carryforwards in jurisdictions, primarily the United States federal and state, in which it is more likely than not that such carryforwards will not be utilized in the foreseeable future. The net change in the total valuation allowance for the year ended December 31, 2011 was an increase of $0.4 million.

Periodically, management reassesses the need for a valuation allowance. Realization of deferred income tax assets is dependent upon taxable income in prior carryback years, estimates of future taxable income, tax planning strategies and reversals of existing taxable temporary differences. Based on the Company’s assessment of these items during 2009,2011, specifically the expected reversal of existing taxable temporary differences and a history of generating taxable income in applicable tax jurisdictions, the Company determined that it wasis more likely than not that the balance of its net deferred tax assets wouldwill be fully utilized. During 2009, the increase in valuation allowance related primarily to net operating losses of foreign subsidiaries.

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

realized.

As of December 31, 2009,2011, the Company had net operating loss carryforwards for federal, state, United Kingdom, Australia, Austria, Brazil, France and China net operating loss carryforwards of approximately $16.4$2.9 million, $35.6$21.4 million, $18.0 million, $1.0 million, $0.4$0.2 million, $0.8 million, $1.4 million, and $0.5$0.2 million, respectively. A portion of the U.S. federal and state net operating losses are subject to annual limitations due to changes in ownership. If not utilized, the federal net operating loss

2011 ANNUAL REPORT    79


carryforward will begin to expire in 2027, the state net operating loss carryforwardcarryforwards will begincontinue to expire in 20142012, and the China net operating loss carryforward will expire in 2013. The net operating loss carryforwards in the United Kingdom, Australia, Austria, France and Brazil have no expiration date.

As of December 31, 2009,2011, the Company had approximately $40.9$36.8 million of undistributed earnings related to its foreign subsidiaries. Management believes that these earnings will be indefinitely reinvested in foreign jurisdictions; accordingly, the Company has not provided for U.S. federal income taxes related to these earnings. However, upon distribution of these earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes and withholding taxes payable to the various foreign countries. Due to the complex nature of U.S. and foreign tax laws, it is not practicable for the Company to estimate the amount of the unrecognized deferred tax liability as a result of a distributionassociated with the unremitted earnings of its foreign subsidiaries’ earnings.subsidiaries.

The Company operates under a qualified tax incentive in China, which is in effect through 2012. The tax holiday is conditional upon the Company’s meeting certain employment, investment or qualified project criteria. The tax incentive decreased the Company’s taxes in China by approximately $0.2 million, $0.1 million and $0.5 million for 2011, 2010 and 2009, respectively.

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

 

 Years Ended December 31,   Years Ended December 31, 
       2009             2008             2007         2011 2010 2009 
 (In thousands)   (in thousands) 

Balance at beginning of year

 $8,772   $12,338   $9,707    $13,878   $14,225   $8,772  

Additions for tax positions related to the current year

  2,578    705    1,892     461    703    2,578  

Additions for tax positions of prior years

  5,050    1,515    2,243     227    833    5,050  

Reductions for tax positions related to prior years

  (8  (3,979  (145   (75  (630  (8

Reductions for settlements

  (1,325  (65  —       (4,399  (1,253  (1,325

Reductions for lapse of statute of limitations for assessment of taxes

  (842  (1,742  (1,359   0    0    (842
           

 

  

 

  

 

 

Balance at end of year

 $14,225   $8,772   $12,338    $10,092   $13,878   $14,225  
           

 

  

 

  

 

 

Included in the balance of unrecognized tax benefits as of December 31, 20092011 and 20082010, are $10.5$7.0 million and $8.1$9.7 million, respectively, of tax benefits that, if recognized, would affect the Company’s effective tax rate and $1.0 million and $0.7$1.0 million, respectively as of both dates, of tax benefits that, if recognized, would increase additional paid-in capital. The Company also accrued potentialgross penalties and interest of $0.4 million, $0.5$0.4 million and $0.6$0.4 million related to these uncertain tax positions during 2009, 20082011, 2010 and 2007,2009, respectively, and in total, as of December 31, 20092011 and 2008,2010, the Company has recorded a liability for potentialgross penalties and interest of $1.8$2.2 million and $1.3$2.1 million, respectively. Based on the current status of the IRS auditThe Company classifies interest and the related extension of the statutes of limitations, it is not reasonably possiblepenalties relating to estimate a range by which the Company’s unrecognized tax benefits mayas part of its provision for income taxes. As of December 31, 2011, the Company estimates that the liability for uncertain tax positions could change up to $0.3 million within the next twelve months.months due to the expiration of certain statutes of limitation and from potential settlement of examinations with tax authorities.

During the fourth quarter of 2011, the Company reached a settlement agreement with the tax authorities in the United Kingdom concerning various tax matters relating to tax years 2005 through 2008. As a result of this settlement agreement, the Company reversed previously established reserves for uncertain tax positions which resulted in a net tax benefit of approximately $2.7 million. The entire net tax benefit was recorded in the fourth quarter of 2011, the period in which the settlement agreement was reached, and is not expected to recur.

The Company and its subsidiaries file tax returns which are routinely examined by tax authorities in the U.S. and in various state and foreign jurisdictions. The Company is currently under examination by the respective tax authorities for tax years 2005 to 20072009 in the United States for 2006 to 2007 in the United Kingdom and for 2006 to 20082010 in Israel. The Company has various other on-goingongoing audits in various stages of completion. In general, the tax years 2005 through 20082010 could be subject to examination by U.S. federal and most state tax authorities. In significant foreign jurisdictions such

80        2011 ANNUAL REPORT


as Australia, China, Ireland, Israel and the United Kingdom, the statute of limitations for tax years 20042006 through 20082010 are still open and these years could be subject to examinationexamined by the respective tax authorities.

During the fourthfirst quarter of 2009,2010, the U.S. Internal Revenue Service (the “IRS”)Company was informed by the IRS that they had completed their audit for the tax years ended December 31, 2005 through December 31, 2007. Accordingly, the IRS issued Noticesthe Company a 30-day letter which outlined all of Proposed Adjustment relatedtheir proposed audit adjustments and required the Company to either accept the proposed adjustments, subject to future litigation, or file a formal administrative protest contesting those proposed adjustments within 30 days. The proposed adjustments relate primarily to the cost sharing arrangement between our U.S. parent companyWebsense, Inc. and ourits Irish subsidiary, including the amount of cost sharing buy-in, as well as with respect to the Company’s claim of research and development tax credits and income tax deductions for equity compensation awarded to certain executive

Websense, Inc.

Notes to Consolidated Financial Statements (Continued)

December 31, 2009

officers. The amount of additional tax proposed by the IRS totals approximately $17.7$19.0 million, of which $13.5$14.8 million relates to the amount of cost sharing buy-in, $2.5 million relates to research and development credits and $1.7 million relates to equity compensation awarded to certain executive officers. The total additional tax proposed excludes interest, penalties and state income taxes, each of which may be significant, and also excludes a potential reduction in tax on the Irish subsidiary. The proposed adjustments also do not include the future impact that changes in the Company’s cost sharing arrangement could have on the Company’s effective tax rate. AsThe Company disagrees with all of the proposed adjustments and has submitted a formal protest to the IRS for each audit progresses and is ultimately concluded, adjustments, if any, will be appropriately recorded inmatter. The IRS assigned the Company’s financial statements from timecase to timean IRS Appeals Officer and the appeals process commenced during the second quarter of 2011. In the third quarter of 2011, the IRS withdrew the proposed adjustment relating to equity compensation of $1.7 million, resulting in lightno additional tax liability. This reduced the amount of prevailing facts basedthe additional tax proposed by the IRS for the tax years ended December 31, 2005 through December 31, 2007 to approximately $17.3 million. The Company intends to continue to defend its position on the Company’sremaining matters at the IRS Appeals Office, including through litigation if required. The timing of the ultimate resolution of these remaining matters cannot be reasonably estimated at this time and the taxing authority’s respective positions on any disputed matters.appeals process is still ongoing as of the date of this report, February 23, 2012.

 

12.11.Employee Retirement Plans

The Company has a 401(k) defined contribution retirement plan (the “401(k) Plan”) covering substantially all U.S. employees. The 401(k) Plan provides for voluntary employee contributions from 1% to 50% of annual compensation, as defined, and provides for a discretionary employer matching contribution of 25% for each employee deferral contribution made during the plan year, up to 6% of the participant’s compensation. The Company also has defined contribution plans in certain foreign subsidiary locations in which the majority of employees in those locations participate. The amount of employer expenses, including the employer contributions to the 401(k) Plan and foreign subsidiaries’ plans during the years ended December 31, 2011, 2010 and 2009 2008 and 2007 were $1.4$2.7 million, $1.5$1.3 million and $0.9$1.4 million, respectively.

 

13.12.Summarized Quarterly Data (Unaudited)

The following tables present the Company’s unaudited quarterly consolidated statement of operations data for 20092011 and 2008.2010.

 

   1st Quarter  2nd Quarter  3rd Quarter  4th Quarter 
   (In thousands, except per share data) 

2009

     

Revenues

  $77,567   $77,837   $78,601   $79,708  

Gross margin

   65,736    65,438    65,432    66,301  

Income (loss) from operations

   1,836    1,391    1,263    (1,431

Loss before income taxes

   (19  (284  (253  (3,085

Net (loss) income

  $(1,087 $3,335   $(1,925 $(11,020

Basic (loss) income per share(1)

  $(0.02 $0.08   $(0.04 $(0.25

Diluted (loss) income per share(1)

  $(0.02 $0.07   $(0.04 $(0.25
   1st Quarter  2nd Quarter  3rd Quarter  4th Quarter 
   (In thousands, except per share data) 

2008

     

Revenues

  $65,120   $70,262   $74,884   $78,008  

Gross margin

   53,241    58,578    62,589    65,706  

Loss from operations

   (16,046  (10,969  (4,325  (2,528

Loss before income taxes

   (20,557  (12,929  (7,438  (5,339

Net loss

  $(6,701 $(9,611 $(4,813 $(5,654

Basic and diluted loss per share(1)

  $(0.15 $(0.21 $(0.11 $(0.13
   1st Quarter   2nd Quarter   3rd Quarter   4th Quarter 
   (In thousands, except per share data) 

2011

        

Revenues

  $88,634    $90,705    $92,111    $92,733  

Gross profit

   73,971     75,613     77,212     77,768  

Income from operations

   7,792     9,527     13,714     13,382  

Income before income taxes

   8,830     9,022     13,544     12,623  

Net income

  $8,121    $4,380    $8,118    $10,375  

Basic income per share(1)

  $0.20    $0.11    $0.21    $0.27  

Diluted income per share(1)

  $0.20    $0.11    $0.20    $0.27  

2011 ANNUAL REPORT    81


   1st Quarter   2nd Quarter   3rd Quarter   4th Quarter 
   (In thousands, except per share data) 

2010

        

Revenues

  $79,770    $81,870    $84,748    $86,374  

Gross profit

   67,619     68,910     71,185     71,958  

Income from operations

   3,669     7,066     12,410     7,665  

Income before income taxes

   1,780     6,022     11,560     6,899  

Net income

  $835    $3,120    $5,781    $8,916  

Basic income per share(1)

  $0.02    $0.07    $0.14    $0.22  

Diluted income per share(1)

  $0.02    $0.07    $0.13    $0.21  

 

(1)Basic and diluted net income (loss) per share computations for each quarter are independent and may not add up to the net income (loss) per share computation for the respective year. See Note 1 of Notes to the Consolidated Financial Statementsconsolidated financial statements for an explanation of the determination of basic and diluted net income (loss) per share.

82        2011 ANNUAL REPORT


Item 9.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.None.

 

Item 9A.Controls and Procedures

(a)EvaluationConclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a—15(e) and 15d—15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”))Act) that are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is (a) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange CommissionSEC and (b) accumulated and communicated to management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure.

Management, with participation As of the end of the period covered by our CEO and CFO, has designed our disclosure controls and procedures to provide reasonable assurance of achieving desired objectives. As required by SEC Rule 13a-15(b), in connection with filing this Annual Report on Form 10-K, management conductedwe carried out an evaluation, under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness of theand design and operation of our disclosure controls and procedures, as such term is defined under Rulein Rules 13a-15(e) promulgatedand 15d-15(e) under the Exchange Act, as of December 31, 2009, the end of the period covered by this report.Act. Based on thatthis evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

Remediation of Material Weaknesses

In our annual report for the year ended December 31, 2008 and our quarterly reports for the periods from January 1, 2009 through September 30, 2009, we reported the following material weaknesses in our internal control over financial reporting:

There were deficiencies in our internal controls over the application of software revenue recognition accounting rules as it applies to the recording of our royalty revenue pursuant to arrangements with our OEM customers. These OEM contracts were acquired in our acquisition of SurfControl in October 2007 and contain multiple elements which require us to provide services over various contractual periods. Specifically, our failure to properly review the acquired OEM contracts caused us to not detect that our method of accounting for the royalty revenue upon being invoiced was not in conformity with generally accepted accounting principles.

There were also deficiencies in our internal controls over the computation of our income tax benefit for the year ended December 31, 2008. Specifically, our failure to properly reconcile the separate pre-tax bases in the individual subsidiary income tax provision calculations to the consolidated pre-tax earnings, together with the incorrect treatment of a valuation allowance in the tax reconciliation, caused us to not detect that a component of previously taxed income had not been eliminated in computing the tax provision.

We took the following actions to remediate these material weaknesses:

We performed a detailed review of all of our OEM contracts and implemented increased internal controls surrounding our review of contracts with our customers, including implementing a process to review each OEM contract to determine the maximum period of our performance obligations.

We implemented a detailed revenue recognition checklist that is required to be completed for all significant revenue contracts and is required to have various levels of review and approval depending on established dollar thresholds.

We implemented new annual controls requiring a tax executive to review and approve (1) the reconciliation between the separate pre-tax US GAAP income by subsidiary, as used for the purpose of

preparing the tax provision in the annual financial statements, to the consolidated total pre-tax US GAAP income and (2) the rollforward of the valuation allowance in the income tax rate reconciliation.

We have formed an internal audit function that reports jointly to the Audit Committee of the Board of Directors and our Chief Financial Officer.

During the quarter ended December 31, 2009, management tested the design and operating effectiveness of the newly implemented controls and concluded that the material weaknesses described above have been remediated as of December 31, 2009.2011.

Management’s Report on Internal Control over Financial Reporting

(b)Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP. Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records, that in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with GAAP, and that receipts and expenditures of the Company are being made only in accordance with authorizations of our management and directors, and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Under the supervision and with the participation of our management, including our CEO and CFO, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2009.2011. The framework on which such evaluation was based is contained in the report entitled “Internal Control—Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Report”). Based on our evaluation under the criteria set forth in the COSO Report, our management concluded our internal control over financial reporting was effective as of December 31, 2009.2011.

The effectiveness of our internal control over financial reporting as of December 31, 20092011 has been audited and attested to by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report on our internal control over financial reporting which is included herein.

Changes in Internal Control over Financial Reporting

An evaluation was also performed under the supervision and with the participation of our management, including our CEO and CFO, of any change in our internal control over financial reporting that occurred during

 

(c)Changes in Internal Control over Financial Reporting
2011 ANNUAL REPORT    83

Other than actions described in subsection (a) titled “Remediation of Material Weaknesses,” there were no


our last fiscal quarter. That evaluation did not identify any changes in our internal control over financial reporting during the fiscal quarter ended December 31, 20092011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Websense, Inc.

We have audited Websense, Inc.’s internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Websense, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Websense, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of Websense, Inc. as of December 31, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2009 of Websense, Inc. and our report dated February 25, 2010 expressed an unqualified opinion thereon.

/s/ ERNST & YOUNG LLP

San Diego, California

February 25, 2010

 

Item 9B.Other Information

None.

84        2011 ANNUAL REPORT


Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Websense, Inc.

We have audited Websense, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Websense, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Websense, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying consolidated balance sheets of Websense, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2011 of Websense, Inc. and our report dated February 23, 2012 expressed an unqualified opinion thereon.

/s/ ERNST & YOUNG LLP

San Diego, California

February 23, 2012

2011 ANNUAL REPORT    85


PART III

 

Item 10.Directors, Executive Officers and Corporate Governance

(a) Directors. Information concerning our directors is incorporated by reference from the section captionedProposal 1: Election of Directors”contained in our Proxy Statement related to the Annual Meeting of Stockholders to be held on June 8, 2010.May 31, 2012.

(b) Executive Officers. Information concerning our executive officers is set forth under the section captioned“Executive Officers”Officers of the Registrant” in Part I of this report.

(c) Compliance with Section 16(a) of the Exchange Act. Information concerning compliance with Section 16(a) of the Exchange Act is incorporated by reference from the section captioned“Section 16(a) Beneficial Ownership Reporting Compliance” contained in our Proxy Statement related to the Annual Meeting of Stockholders to be held on June 8, 2010.May 31, 2012.

(d) The Company has adopted aCode of Business Conduct which, together with the policies referred to therein, is applicable to all directors, officers and employees of the Company. In addition, the Company has adopted aCode of Ethics for the Chief Executive Officer, Senior Financial Officers and All Finance, AccountingTax and TaxAccounting Department Personnel (“Code of EthicsEthics”). TheCode of Business Conduct and theCode of Ethics cover all areas of professional conduct, including conflicts of interest, disclosure obligations, insider trading and confidential information, as well as compliance with all laws, rules and regulations applicable to our business. The Company encourages all employees, officers and directors to promptly report any violations of any of the Company’s policies. In the event that an amendment to, or a waiver from, a provision of theCode of Business Conduct orCode of Ethics that applies to any of our directors or executive officers is necessary, the Company intends to post such information on its Web site. A copy of ourCode of Business Conduct and ourCode of Ethics can be obtained from our Web site free of charge atwww.websense.com.

(e) Audit Committee. Information concerning the audit committee of our Boardboard of Directorsdirectors and our designated “audit committee financial experts” is incorporated by reference from the section captioned “Audit Committee” contained in our Proxy Statement related to the Annual Meeting of Stockholders to be held on June 8, 2010.May 31, 2012.

 

Item 11.Executive Compensation

The information required by Item 11 of Form 10-K is incorporated by reference from the information contained in the sectionsections captioned“Compensation of Executive Officers” and“Compensation of Directors”in our Proxy Statement related to the Annual Meeting of Stockholders to be held on June 8, 2010.May 31, 2012.

 

Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by Item 12 of Form 10-K concerning security ownership of certain beneficial owners and management is incorporated by reference from the information contained in the section captioned“Security Ownership of Certain Beneficial Owners and Management” in our Proxy Statement related to the Annual Meeting of Stockholders to be held on June 8, 2010.May 31, 2012.

86        2011 ANNUAL REPORT


The following table provides information as of December 31, 20092011 with respect to the shares of the Company’s common stock that may be issued under the Company’s existing equity compensation plans:

 

Plan Category

  Number of securities
to be issued upon
exercise of outstanding
options, warrants and
rights
  Weighted-
average
exercise price
of outstanding
options,
warrants and
rights
  Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities subject to
outstanding options,
warrants  and rights)
   Number of securities
to be issued upon
exercise of outstanding
options, warrants and
rights
   Weighted-
average
exercise price
of outstanding
options,
warrants and
rights
   Number of securities
remaining available for
future issuance  under
equity compensation
plans (excluding
securities subject to
outstanding options,
warrants and rights)
 

Equity compensation plans approved by security holders(1)

  10,968,447  $21.69  8,193,332(3)    7,646,377    $22.50     7,019,490(3) 

Equity compensation plans not approved by security holders(2)

  10,634  $6.74  —       834    $11.50     0  
           

 

     

 

 

Total

  10,979,081  $21.68  8,193,332     7,647,211    $22.50     7,019,490  
           

 

     

 

 

 

(1)Consists solely of the 2009 Equity Incentive Plan.
(2)Consists of 354,000 stock option grants made to certain new employees in 2002 in order to induce them to commence employment with the Company, of which 10,634834 shares under options are outstanding. The outstanding stock options have substantially the same terms as stock options issued under the 2009 Equity Incentive Plan and have a weighted average exercise price of $6.74$11.50 per share.
(3)Consists of shares available for future issuance under the 2009 Equity Incentive Plan. As of December 31, 2009,2011, an aggregate of 1,870,4431,391,081 shares of Common Stock were available for issuance under the Employee Stock Purchase Plan and 6,322,8895,628,409 shares of Common Stock were available for issuance under the 2009 Equity Incentive Plan.

 

Item 13.Certain Relationships and Related Transactions and Director Independence

The information required by Item 13 of Form 10-K is incorporated by reference from the information contained in the section captioned“Transactions with Related Persons” in the Company’s Proxy Statement related to the Annual Meeting of Stockholders to be held on June 8, 2010.May 31, 2012.

 

Item 14.Principal AccountantAccounting Fees and Services

The information required by Item 14 of Form 10-K is incorporated by reference from the information contained in the section captionedProposal 2: Ratification of Selection of Independent Registered Public Accounting Firm” in the Company’s Proxy Statement related to the Annual Meeting of Stockholders to be held on June 8, 2010.May 31, 2012.

2011 ANNUAL REPORT    87


PART IV

 

Item 15.Exhibits, Financial Statements andStatement Schedules

 

(a)The following documents are filed as part of this report:

 

1.      The following consolidated financial statements of Websense, Inc. are filed as part of this report under Item 8—8–Financial Statements and Supplementary Data:

  

Consolidated balance sheets—December 31, 20092011 and 20082010

  4855

Consolidated statements of operations—Years ended December 31, 2009, 20082011, 2010 and 20072009

  4956

Consolidated statements of stockholders’ equity—Years ended December  31, 2009, 20082011, 2010 and 20072009

  5057

Consolidated statements of cash flows—Years ended December 31, 2009, 20082011, 2010 and 20072009

  5158

Notes to consolidated financial statements—December 31, 20092011

  5259

2.      Financial schedules required to be filed by Item 8 of this form:report:

  

Schedule II Valuation and Qualifying Accounts

  8292

Schedules not listed above have been omitted because they are not applicable, not required, or the information required to be set forth therein is included in the consolidated financial statements or notes thereto.

 

 3.Exhibits

 

Exhibit Number

  

Description of Document

    3.1(1)

  Amended and Restated Certificate of Incorporation

    3.2(1)

  Amended and Restated Bylaws

    4.1(2)

  Specimen Stock Certificate of Websense, Inc.

  10.1(2)10.1(13)*

  EmploymentDouglas Wride Retirement Agreement, by and between Websense, Inc. and Douglas C. Wride, dated June 11, 1999January 31, 2011

  10.2(3)*

Amendment to Employment Agreement by and between Websense, Inc. and Douglas C. Wride, dated January 24, 2006

  10.3(4)10.2(4)*

  Employment Agreement by and between Websense, Inc. and Gene Hodges, dated January 9, 2006

  10.4(5)10.3(5)*

  EmploymentSeparation Agreement, dated September 6, 2011, by and between Websense, Inc. and Arthur S. Locke III dated July 28, 2009

  10.5(6)10.4(6)*

  Employment Agreement by and between Websense, Inc. and John McCormack, dated July 5, 2006

  10.6*10.5(14)*

  Employment Agreement by and between Websense, Inc. and Didier Guibal, dated July 14, 2009

  10.7(1)10.6(1)*

  2009 Equity Incentive Plan

  10.8(1)10.7(1)*

  Form of Stock Option Agreement under the 2009 Equity Incentive Plan

  10.9(1)10.8(1)*

  Form of Restricted Stock Unit Award Agreement under the 2009 Equity Incentive Plan

  10.10(1)10.9(1)*

  Form of Non-Discretionary Stock Option Agreement under the 2009 Equity Incentive Plan and Form of Early Exercise Stock Purchase Agreement under the 2009 Equity Incentive Plan

  10.11(1)10.10(1)*

  Form of Non-Discretionary Restricted Stock Unit Award Agreement under the 2009 Equity Incentive Plan

  10.11(12)*

2000 Amended and Restated Employee Stock Purchase Plan

  10.12(16)

Form of Indemnification Agreement between Websense, Inc. and its directors

88        2011 ANNUAL REPORT


Exhibit Number

  

Description of Document

    10.12(5)*

2000 Amended and Restated Employee Stock Purchase Plan

  10.13(2)

Form of Indemnification Agreement between Websense, Inc. and its directors

  10.14(2)10.13(16)

  Form of Indemnification Agreement between Websense, Inc. and its officers

    10.15(7)10.14(7)

  Lease Agreement between Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated April 19, 2002; 2002

    10.15(7)

First Amendment to Lease between Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated October 1, 2002; 2002

    10.16(7)

Second Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated April 30, 2003

    10.16(8)10.17(8)

  Third Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated July 30, 2004

    10.17(3)10.18(3)

  Fourth Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated March 24, 2005

    10.18(9)10.19(9)

  Fifth Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated December 21, 2006

    10.19(9)10.20(9)

  Sixth Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated January 30, 2007

    10.20(9)10.21(9)

  Seventh Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated February 12, 2007

    10.21(10)10.22(10)

  $225,000,000 Amended and Restated Senior Credit Agreement, dated October 11, 2007, amongEighth Amendment to Lease between Websense, Inc. as borrower, the lenders from time to time parties thereto, Morgan Stanley Senior Funding, Inc. as sole lead arranger and sole bookrunner, Morgan Stanley Senior Funding, Inc. as senior administrative agent, Bank of America, N.A., as syndication agent, Key Bank National Association, JP Morgan Chase Bank and Citibank, N.A., as co-documentation agents, Morgan Stanley Senior Funding, Inc. as senior administrative agent, and Morgan Stanley & Co. Incorporated, as senior collateral agent for the benefit of the secured parties.Creekside Property Holdings LLC, dated June 24, 2010

    10.22(11)10.23(11)

  First Amendment, dated as of December 28, 2007, to the Senior Credit Agreement, dated as of October 11, 2007,22, 2010, among Websense, Inc., a Delaware corporation, the lenders from time to time parties thereto, Morgan Stanley Senior Funding,PortAuthority Technologies, Inc., as senior administrative agent,Karabunga, Inc., Bank of America N.A., as syndication agent, Key Bank National Association, JP Morgan Chase Bank, N.A. and Citibank, N.A., as codocumentation agents and Morgan Stanley & Co., as senior collateral agent.the other Lenders (as defined therein)

    10.23

Second Amendment, dated as of June 10, 2008, to the Senior Credit Agreement, dated as of October 11, 2007, and amended on December 28, 2007, among Websense, Inc., a Delaware corporation, the Guarantors identified on the signature pages hereto, the lenders identified on the signature pages hereto and Bank of America, N.A., as Senior Administrative Agent.

  10.24

Third Amendment, dated as of February 5, 2010, to the Senior Credit Agreement, dated as of October 11, 2007, and amended on December 28, 2007 and June 10, 2008, among Websense, Inc., a Delaware corporation, the Guarantors identified on the signature pages hereto, the lenders identified on the signature pages hereto and Bank of America, N.A., as Senior Administrative Agent.

  10.25(12)

Distribution Agreement by and between Websense, Inc. and Ingram Micro Inc., dated August 3, 2006.

  10.26(13)10.24(17)*

  Officer Change in Control Severance Benefit Plan

    10.27(13)10.25(17)*

  Form of Severance Plan Participation Agreement for Tier One Officers

Exhibit Number

Description of Document

  10.28(13)    10.26(17)*

  Form of Severance Plan Participation Agreement for Tier Two Officers

    10.29(13)10.27(17)*

  Form of Severance Plan Participation Agreement for Tier Three Officers

    10.30(14)10.28(13)*

  20102011 Management Bonus Program

    10.31(14)10.29(13)*

  20102011 EVP of Worldwide Sales Bonus Program

    10.32*10.30(14)*

  Board of Directors Compensation Plan

    10.31(15)*

2012 Management Bonus Program

    10.32(15)*

2012 EVP of Worldwide Sales Bonus Program

    21.1

  Subsidiaries of the Registrant

    23.1

  Consent of Independent Registered Public Accounting Firm

    31.1

  Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)

    31.2

  Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)

2011 ANNUAL REPORT    89


Exhibit Number

Description of Document

    32.1

  Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) and 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code

    32.2

  Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) and 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code

  101.INS

XBRL Instance Document

  101.SCH

XBRL Taxonomy Extension Schema Document

  101.CA

XBRL Taxonomy Extension Calculation Linkbase Document

  101.DEF

XBRL Taxonomy Extension Definition Document

  101.LAB

XBRL Taxonomy Label Linkbase Document

  101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document

 

*Indicates management contract or compensatory plan or arrangement.
(1)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on June 19, 2009.2009 and incorporated herein by reference.
(2)Filed as an exhibit to our Registration Statement on Form S-1 filed with the SEC on March 23, 2000 (Commission File No. 333-95619) and incorporated herein by reference.
(3)Filed as an exhibit to our Annual Report on Form 10-K for the period ended December 31, 2005 filed with the SEC on March 3, 2006 and incorporated herein by reference.
(4)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on January 11, 2006 and incorporated herein by reference.
(5)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on July 28, 2009September 6, 2011 and incorporated herein by reference.
(6)Filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended March 31, 2008 filed with the SEC on May 9, 2008 and incorporated herein by reference.
(7)Filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended June 30, 2003 filed with the SEC on August 13, 2003 and incorporated herein by reference.
(8)Filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended September 30, 2004 filed with the SEC on November 5, 2004 and incorporated herein by reference.
(9)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on February 22, 2007 and incorporated herein by reference.
(10)Filed as an exhibit to our Current Report on Form 8-K10-Q for the period ended June 30, 2010 filed with the SEC on October 17, 2007August 6, 2010 and incorporated herein by reference.
(11)Filed as an exhibit to our Current Report on Form 10-K for8-K filed with the period ended December 31, 2007 filedSEC on February 28, 2008October 26, 2010 and incorporated herein by reference.
(12)Filed as an exhibit to our Annual Report on Form 10-Q10-K for the period ended MarchDecember 31, 20092010 filed with the SEC on May 7, 2009February 10, 2011 and incorporated herein by reference.
(13)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on July 23, 2008February 1, 2011 and incorporated herein by reference.
(14)Filed as an exhibit to our Annual Report on Form 10-K for the period ended December 31, 2009 filed with the SEC on February 25, 2010.
(15)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on February 24, 2010January 31, 2012 and incorporated herein by reference.
(16)Filed as an exhibit to our Registration Statement on Form S-1 filed with the SEC on March 3, 2000 (Commission File No. 333-95619) and incorporated herein by reference.
(17)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on July 23, 2008 and incorporated herein by reference.

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K have a Commission File No. of 000-30093.

90        2011 ANNUAL REPORT


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities 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.

 

WEBSENSE,INC.
Date: February 23, 2012By: /s/    ARTHURS/    MICHAEL S. LA. NOCKEEWMAN         III        
 Arthur S. Locke IIIMichael A. Newman
 Chief Financial Officer

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

Signature

  

Title

 

Date

/s/    GENE HODGES      

Gene Hodges

  Director, Chief Executive Officer (principal executive officer) February 25, 201023, 2012

/s/    AMRTHURICHAEL S. LA. NOCKEEWMAN         III        

Arthur S. Locke IIIMichael A. Newman

  Sr. Vice President and Chief Financial Officer (principal financial and accounting officer) February 25, 201023, 2012

/s/    JOHN B. CARRINGTON        

John B. Carrington

  Chairman of the Board February 25, 201023, 2012

/s/    MARK ST.CLARE        

Mark St.Clare

  Director February 25, 201023, 2012

/s/    BRUCE T. COLEMAN        

Bruce T. Coleman

  Director February 25, 201023, 2012

/s/    JOHN SCHAEFER        

John Schaefer

  Director February 25, 201023, 2012

/s/    GARY E. SUTTON        

Gary E. Sutton

  Director February 25, 201023, 2012

/s/    PETER WALLER        

Peter Waller

  Director February 25, 2010__, 2012

2011 ANNUAL REPORT    91


Schedule II—VALUATION AND QUALIFYING ACCOUNTS

WEBSENSE, INC.

(Inin thousands)

 

A

 B C D E  B   C D E 

Description

 Balance at Beginning
of Period
 Additions Deductions—Describe  Balance at End
of Period
  Balance at
Beginning
of Period
   Additions Deductions-
Describe
  Balance at End
of Period
 
 Charged to Costs
and Expenses
 Charged to Other
Accounts—Describe
    Charged to Costs
and Expenses
   Charged to Other
Accounts-Describe
 

YEAR ENDED
DECEMBER 31, 2007

     

Reserves and allowances deducted from asset accounts:

     

Allowance for doubtful accounts

 $1,425 —   $1,356(2)  $650(1)  $2,131

YEAR ENDED
DECEMBER 31, 2008

     

Reserves and allowances deducted from asset accounts:

     

Allowance for doubtful accounts

 $2,131 —   $—     $379(1)  $1,752

YEAR ENDED
DECEMBER 31, 2009

             

Reserves and allowances deducted from asset accounts:

             

Allowance for doubtful accounts

 $1,752 —   $250(2)  $200(1)  $1,802  $1,752     0    $250(2)  $200(1)  $1,802  

YEAR ENDED DECEMBER 31, 2010

        

Reserves and allowances deducted from asset accounts:

        

Allowance for doubtful accounts

  $1,802     0     0   $646(3)  $1,156  

YEAR ENDED DECEMBER 31, 2011

        

Reserves and allowances deducted from asset accounts:

        

Allowance for doubtful accounts

  $1,156     0     0   $177(4)  $979  

 

(1)Uncollectible accounts written off, net of recoveries.
(2)Amount represents reserve recorded as a reduction of deferred revenue and represents customer balances deemed uncollectible. The reserve is amortized as a reduction of revenue over the average life of all subscriptions.
(3)The deductions of $646,000 in the year ended December 31, 2010 consisted of the reversal of reserves of $600,000 and $46,000 of uncollectible accounts written off.
(4)The deductions of $177,000 in the year ended December 31, 2011 consisted of the reversal of reserves of $100,000, $78,000 of uncollectible accounts written off, less $1,000 in translation adjustments.

92        2011 ANNUAL REPORT


EXHIBIT INDEX

 

Exhibit Number

  

Description of Document

3.1(1)

  Amended and Restated Certificate of Incorporation

3.2(1)

  Amended and Restated Bylaws

4.1(2)

  Specimen Stock Certificate of Websense, Inc.

10.1(2)10.1(13)*

  EmploymentDouglas Wride Retirement Agreement, by and between Websense, Inc. and Douglas C. Wride, dated June 11, 1999January 31, 2011

10.2(3)*

Amendment to Employment Agreement by and between Websense, Inc. and Douglas C. Wride, dated January 24, 2006

10.3(4)10.2(4)*

  Employment Agreement by and between Websense, Inc. and Gene Hodges, dated January 9, 2006

10.4(5)10.3(5)*

  EmploymentSeparation Agreement, dated September 6, 2011, by and between Websense, Inc. and Arthur S. Locke III dated July 28, 2009

10.5(6)10.4(6)*

  Employment Agreement by and between Websense, Inc. and John McCormack, dated July 5, 2006

10.6*     10.5(14)*

  Employment Agreement by and between Websense, Inc. and Didier Guibal, dated July 14, 2009

10.7(1)10.6(1)*

  2009 Equity Incentive Plan

10.8(1)10.7(1)*

  Form of Stock Option Agreement under the 2009 Equity Incentive Plan

10.9(1)10.8(1)*

  Form of Restricted Stock Unit Award Agreement under the 2009 Equity Incentive Plan

10.10(1)10.9(1)*

  Form of Non-Discretionary Stock Option Agreement under the 2009 Equity Incentive Plan and Form of Early Exercise Stock Purchase Agreement under the 2009 Equity Incentive Plan

10.11(1)10.10(1)*

  Form of Non-Discretionary Restricted Stock Unit Award Agreement under the 2009 Equity Incentive Plan

10.12(5)10.11(12)*

  2000 Amended and Restated Employee Stock Purchase Plan

10.13(2)10.12(16)

  Form of Indemnification Agreement between Websense, Inc. and its directors

10.14(2)10.13(16)

  Form of Indemnification Agreement between Websense, Inc. and its officers

10.15(7)10.14(7)

  Lease Agreement between Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated April 19, 2002; 2002

10.15(7)

First Amendment to Lease between Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated October 1, 2002; 2002

10.16(7)

Second Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated April 30, 2003

10.16(8)10.17(8)

  Third Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated July 30, 2004

10.17(3)10.18(3)

  Fourth Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated March 24, 2005

10.18(9)10.19(9)

  Fifth Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated December 21, 2006

10.19(9)10.20(9)

  Sixth Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated January 30, 2007

10.20(9)10.21(9)

  Seventh Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated February 12, 2007

10.22(10)

Eighth Amendment to Lease between Websense, Inc. and Creekside Property Holdings LLC, dated June 24, 2010

10.23(11)

Credit Agreement, dated October 22, 2010, among Websense, Inc., PortAuthority Technologies, Inc., Karabunga, Inc., Bank of America N.A. and the other Lenders (as defined therein)


Exhibit Number

  

Description of Document

10.21(10)

$225,000,000 Amended and Restated Senior Credit Agreement, dated October 11, 2007, among Websense, Inc. as borrower, the lenders from time to time parties thereto, Morgan Stanley Senior Funding, Inc. as sole lead arranger and sole bookrunner, Morgan Stanley Senior Funding, Inc. as senior administrative agent, Bank of America, N.A., as syndication agent, Key Bank National Association, JP Morgan Chase Bank and Citibank, N.A., as co-documentation agents, Morgan Stanley Senior Funding, Inc. as senior administrative agent, and Morgan Stanley & Co. Incorporated, as senior collateral agent for the benefit of the secured parties.

10.22(11)

First Amendment, dated as of December 28, 2007, to the Senior Credit Agreement, dated as of October 11, 2007, among Websense, Inc., a Delaware corporation, the lenders from time to time parties thereto, Morgan Stanley Senior Funding, Inc., as senior administrative agent, Bank of America, N.A., as syndication agent, Key Bank National Association, JP Morgan Chase Bank, N.A. and Citibank, N.A., as codocumentation agents and Morgan Stanley & Co., as senior collateral agent.

10.23         

Second Amendment, dated as of June 10, 2008, to the Senior Credit Agreement, dated as of October 11, 2007, and amended on December 28, 2007, among Websense, Inc., a Delaware corporation, the Guarantors identified on the signature pages hereto, the lenders identified on the signature pages hereto and Bank of America, N.A., as Senior Administrative Agent.

10.24         

Third Amendment, dated as of February 5, 2010, to the Senior Credit Agreement, dated as of October 11, 2007, and amended on December 28, 2007 and June 10, 2008, among Websense, Inc., a Delaware corporation, the Guarantors identified on the signature pages hereto, the lenders identified on the signature pages hereto and Bank of America, N.A., as Senior Administrative Agent.

10.25(12)  

Distribution Agreement by and between Websense, Inc. and Ingram Micro Inc., dated August 3, 2006.

10.26(13)10.24(17)*

  Officer Change in Control Severance Benefit Plan

10.27(13)10.25(17)*

  Form of Severance Plan Participation Agreement for Tier One Officers

10.28(13)10.26(17)*

  Form of Severance Plan Participation Agreement for Tier Two Officers

10.29(13)10.27(17)*

  Form of Severance Plan Participation Agreement for Tier Three Officers

10.30(14)10.28(13)*

  20102011 Management Bonus Program

10.31(14)10.29(13)*

  20102011 EVP of Worldwide Sales Bonus Program

10.32*       10.30(14)*

  Board of Directors Compensation Plan

10.31(15)*

2012 Management Bonus Program

10.32(15)*

2012 EVP of Worldwide Sales Bonus Program

21.1

  Subsidiaries of the Registrant

23.1

  Consent of Independent Registered Public Accounting Firm

31.1

  Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)

31.2

  Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a)

32.1

  Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) and 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code

32.2

  Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) and 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code

101.INS

XBRL Instance Document

101.SCH

XBRL Taxonomy Extension Schema Document

101.CAL

XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF

XBRL Taxonomy Extension Definition Document

101.LAB

XBRL Taxonomy Label Linkbase Document

101.PRE

XBRL Taxonomy Extension Presentation Linkbase Document

 

*Indicates management contract or compensatory plan or arrangement.


(1)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on June 19, 2009.2009 and incorporated herein by reference.
(2)Filed as an exhibit to our Registration Statement on Form S-1andS-1 filed with the SEC on March 23, 2000 (Commission File No. 333-95619) and incorporated herein by reference.
(3)Filed as an exhibit to our Annual Report on Form 10-K for the period ended December 31, 2005 filed with the SEC on March 3, 2006 and incorporated herein by reference.
(4)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on January 11, 2006 and incorporated herein by reference.
(5)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on July 28, 2009September 6, 2011 and incorporated herein by reference.
(6)Filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended March 31, 2008 filed with the SEC on May 9, 2008 and incorporated herein by reference.
(7)Filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended June 30, 2003 filed with the SEC on August 13, 2003 and incorporated herein by reference.
(8)Filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended September 30, 2004 filed with the SEC on November 5, 2004 and incorporated herein by reference.
(9)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on February 22, 2007 and incorporated herein by reference.
(10)Filed as an exhibit to our Current Report on Form 8-K10-Q for the period ended June 30, 2010 filed with the SEC on October 17, 2007August 6, 2010 and incorporated herein by reference.


(11)Filed as an exhibit to our Current Report on Form 10-K for8-K filed with the period ended December 31, 2007 filedSEC on February 28, 2008October 26, 2010 and incorporated herein by reference.
(12)Filed as an exhibit to our Annual Report on Form 10-Q10-K for the period ended MarchDecember 31, 20092010 filed with the SEC on May 7, 2009February 10, 2011 and incorporated herein by reference.
(13)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on February 1, 2011 and incorporated herein by reference.
(14)Filed as an exhibit to our Annual Report on Form 10-K for the period ended December 31, 2009 filed with the SEC on February 25, 2010.
(15)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on January 31, 2012 and incorporated herein by reference.
(16)Filed as an exhibit to our Registration Statement on Form S-1 filed with the SEC on March 3, 2000 (Commission File No. 333-95619) and incorporated herein by reference.
(17)Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on July 23, 2008 and incorporated herein by reference.
(14)Filed as an exhibit to our Form 8-K filed on February24, 2010 and incorporated herein by reference.

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K have a Commission File No. of 000-30093.