UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K/A10-K
(Amendment No. 1)
x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 20082011
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, 20082011 was approximately $677$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 15, 20092012 was 44,863,550.37,692,408.
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 16, 2009May 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, 2008.
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.
EXPLANATORY NOTE
On September 14, 2009, the audit committee of the board of directors of Websense, Inc. (the “Company,” sometimes referred to as “we”, “us” or “our”), upon the identification by and recommendation of management, concluded that the previously issued financial statements contained in our annual reports on Form 10-K for the years ended December 31, 2007 and 2008, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2008, June 30, 2008, September 30, 2008, March 31, 2009 and June 30, 2009 should no longer be relied upon because of errors in those financial statements, and that we would restate these financial statements to make the necessary accounting corrections.
This Amendment No. 1 on Form 10-K/A to our Annual Report on Form 10-K for the year ended December 31, 2008 is being filed to restate our consolidated financial statements for the years ended December 31, 2008 and 2007 (including restated financial information as of and for the interim periods contained therein) previously included in our Annual Report on Form 10-K for the year ended December 31, 2008 (the “Original Form 10-K”).
The restatement relates to an error in the method of recognizing royalty revenue relating to contracts with original equipment manufacturer (“OEM”) customers, who embed our software in their products for resale and provide services in the form of updates that primarily consist of database updates to our Web filtering products. All of these contracts were acquired in connection with the acquisition of SurfControl plc (“SurfControl”) in October 2007. The restatement also relates to an error in the income tax provision computation that resulted from a failure to eliminate a component of previously taxed income from our estimation of taxable income which caused our estimation of taxable profit to be overstated. The restated consolidated financial statements also include other adjustments that were identified but not previously recorded, as it had been determined that they were not material, either individually or in the aggregate. While none of these other adjustments were individually material, they are being made as part of the restatement process. See Notes 2 and 15 to the Company’s audited consolidated financial statements included in “Part II—Item 8. Financial Statements and Supplementary Data” of this report for additional information. The Company also has restated its unaudited consolidated financial statements as of and for the interim periods ended March 31, 2009 and June 30, 2009.
In connection with the restatement, management has assessed the effectiveness of our disclosure controls and procedures and has included revised disclosure in this Form 10-K/A under Item 9A of Part II, “Controls and Procedures.” Management identified material weaknesses in our internal control over financial reporting with respect to our misapplication of U.S. generally accepted accounting principles on revenue recognition for our OEM contracts which were acquired in connection with the acquisition of SurfControl in October 2007 and our error in our computation of our income tax benefit for the year ended December 31, 2008, as described under Item 9A of Part II in “Management’s Report on Internal Control over Financial Reporting (Restated).” Solely as a result of these material weaknesses, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were not effective at a reasonable assurance level as of December 31, 2008 and through the date of this filing. As of the date of this Form 10-K/A, we have adopted a revenue recognition methodology that management believes complies with the requirements of U.S. generally accepted accounting principles and we have corrected our computational mistake on our fiscal 2008 income tax benefit. Management has taken and is taking steps, as described under Item 9A of Part II in “Management’s Remediation Initiatives,” to remediate the material weaknesses in our internal control over financial reporting. We believe that, as a result of management’s in-depth review of its accounting processes, the utilization of external resources and the additional procedures management has implemented, there are no material inaccuracies or omissions of material fact in this Form 10-K/A and, to the best of our knowledge, we believe that the consolidated financial statements in this Form 10-K/A fairly present in all material aspects the financial condition, results of operations and cash flows of the Company in conformity with U.S. generally accepted accounting principles.
Except in the case of Item 1 of Part I, the Company has amended and restated in its entirety each item of the Original Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on February 27, 2009 (the “Original Filing Date”) that required a change to reflect this restatement and to include certain additional information. These items include Item 1A of Part I and Items 6, 7, 8 and 9A of Part II. The Company has
amended and restated the subsections of Item 1 of Part I entitled “Customers” and “Sales, Marketing and Distribution.” No other information included in the Original Form 10-K is amended hereby.
Pursuant to Rule 12b-15 under the Securities Exchange Act of 1934, as amended, this Amendment contains only the items and exhibits to the Original Form 10-K that are being amended and restated, and those unaffected items or exhibits are not included herein. Except as stated above, this Amendment speaks only as of the Original Filing Date, and this filing has not been updated to reflect any events occurring after the Original Filing Date or to modify or update disclosures affected by other subsequent events. In particular, forward-looking statements included in this Amendment represent management’s views as of the Original Filing Date. Such forward-looking statements should not be assumed to be accurate as of any future date. This Amendment should be read in conjunction with the Company’s other filings made with the SEC subsequent to the Original Filing Date, together with any amendments to those filings.
Item 15 of Part IV of this Form 10-K/A has been amended to contain the currently-dated certifications from our principal executive officer and principal financial officer, as required by Section 302 and 906 of the Sarbanes-Oxley Act of 2002. Ernst & Young LLP has dual dated their reports on the consolidated financial statements and internal control over financial reporting to the board of directors and stockholders with regard to the effects on the consolidated financial statements of the restatement as described in Note 2 of the consolidated financial statements and the material weaknesses described previously and updated their consent to the date of this filing.
Websense, Inc.
Form 10-K/A
(Amendment No. 1)10-K
For the Fiscal Year Ended December 31, 20082011
Page | ||||||
Part I | ||||||
Item 1. | ||||||
2 | ||||||
Item 1A. | 14 | |||||
Item 1B. | 30 | |||||
Item 2. | 30 | |||||
Item 3. | 30 | |||||
Item 4. | 31 | |||||
Part II | ||||||
Item 5. | 32 | |||||
Item 6. | ||||||
34 | ||||||
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 35 | ||||
Item 7A. | 52 | |||||
Item 8. | 54 | |||||
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure | 83 | ||||
Item 9A. | 83 | |||||
Item 9B. | 84 | |||||
Part III | ||||||
Item 10. | 86 | |||||
Item 11. | 86 | |||||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 86 | ||||
Item 13. | Certain Relationships and Related Transactions, and Director Independence | 87 | ||||
Item 14. | 87 | |||||
Part IV | ||||||
Item 15. | ||||||
88 | ||||||
91 |
PART I
Forward-Looking Statements
This reportAnnual Report on Form 10-K/A10-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 enhancedreliance on indirect channels of distribution;
anticipated product enhancements or releases;
customer acceptance and satisfaction with our products;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;
risks associatedrelated to compliance with integrating acquired businesses and launching new product offerings;the covenants in our credit agreement;
changes in effective tax rates;rates, laws and interpretations and statements related to tax audits;
risks related to changes in accounting interpretations or accounting guidance;
the volatile and competitive nature of the Internet and security industries; and
anticipated product enhancements or releases.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. | Business |
Overview
We are a global 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”) hardware, including our optimized appliances, as a cloud-based service (software-as-a-service or “SaaS”) offering, or in a hybrid hardware/SaaS configuration. Our products and services are sold worldwide to provide content security to enterprise customers, small and medium sized businesses (“SMBs”), public sector entities, and Internet service providers through a network of distributors, value-added resellers and original equipment manufacturers (“OEMs”).
Organizations rely on the Internet and email to conduct business, and frequently send critical or confidential information outside their network 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 unified, organization-wide Web and email security solutions that include data loss prevention capabilities and address the dynamic nature of both content and cyber-threats.
Websense has evolved from a reseller of network security products to a leading developer and provider of IT security software solutions. Our first commercial software product was released in 1996 and controlled employee access to inappropriate Web sites. Since then, we have focused on developing our Web filtering and content classification capabilities to address changes in the Internet and the external threat environment, including the rise of Web-based social and business applications and the growing incidence of sophisticated, targeted cyber-attacks designed to steal valuable information. In 2008, we introduced the first products under our TRITON security architecture, the Websense Web Security 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 and data security), incorporated our enterprise data loss prevention engine and policy controls in all three TRITON security 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.
Our products use our advanced content classification, deep content inspection, and policy management technologies to:
prevent access to undesirable and dangerous elements on the Web, including Web pages that download viruses, spyware, keyloggers, hacking tools and an ever-increasing variety of malicious code, and Web sites that contain inappropriate content;
identify and remove malware from incoming Web content;
manage the use of social Web sites;
manage the use of non-Web Internet traffic, such as peer-to-peer communications and instant messaging;
prevent misuse of computing resources, including unauthorized downloading of high-bandwidth content;
inspect the content of encrypted Web traffic to prevent data loss, malware and access to Web sites with inappropriate content;
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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 (“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
Many organizations use the Internet as an integral part of their computing infrastructure, expanding their use of the Web to enable mission-critical applications 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,” social networking, peer-to-peer file sharing, instant messaging and other personal matters.
As organizations create collaborative virtual networks with their customers, suppliers, technology partners and other stakeholders, they increase the value and volume of confidential and sensitive data that travels across these networks. The growing adoption of cloud-based IT architectures, SaaS offerings, and mobile devices further obscures the boundaries of organizations’ networks and increases the amount of sensitive data stored 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 malware injection, increases exposure to cyber-threats. At the same time, cyber-attacks targeting data have increased in sophistication, as well as scale and frequency. Securing confidential data in this environment has become a top priority for IT executives, but the success of recent high-profile cyber-attacks demonstrates that traditional security solutions that are focused on network perimeters are ineffective.
To build a sound defense against modern threats, organizations must implement security that monitors both inbound and outbound network traffic (Web pages, emails, and attached documents) for content, context and data, as well as the behavior of any embedded applications. Real-time analysis and dynamic categorization of internal data, Web content, email content, and embedded applications are necessary to keep up with the social Web, newly created internal information, and mutating cyber-threats. Enforcement policies must be user-, content- and destination-aware to provide adequate protection without hindering established business processes, and policies must extend across both the Web and email communication channels. As a result, we believe there is a significant opportunity for IT security solutions that unify Web security, email security and data loss prevention technologies to continuously monitor network traffic and apply policies based on deep content analysis and dynamic categorization.
Our Products and Services
Overview of our Solutions
Our products are designed to provide content security by protecting an organization’s data and users from modern cyber-threats and advanced malware attacks, information leaks, legal liability and productivity loss, and can be grouped into three categories:
Web filtering and Web security solutions that protect against Web-based malware and targeted cyber-attacks, and prevent access to inappropriate content;
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email security solutions that filter spam, malicious links, inappropriate images and malware from inbound email; and
data security 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 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 software 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 functionality integrated within our TRITON Web and email security gateways and SaaS offerings, or may be implemented separately as server-based software. All Websense security solutions include several reporting modules to meet the information needs of different management groups.
We sell subscriptions to our software and SaaS products generally in 12, 24 or 36 month durations, based on the number of seats or devices managed. Our 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 subscriptions to our legacy Web filtering solutions, including the Websense Web Filter and Websense Web Security Suite, accounted for 46% of billings in 2011 and the majority of billings in 2010 and 2009. We expect sales of our TRITON solutions will be the primary driver of our billings and 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.
Websense TRITON Solutions
Our TRITON security platform provides advanced content security by integrating our Web, email and data security technologies 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 core of the TRITON architecture is the Advanced Classification Engine (ACE), which scans inbound and outbound Web and email traffic and uses advanced analytics and contextual awareness to identify and classify security threats, sensitive internal data, and inappropriate content in real-time. The TRITON management console unifies policies and enforcement across an organization for Web, email and internal network traffic, creating a consistent security profile and reducing the overall cost of management.
Our TRITON content security solutions include Web, email and combined security gateways with or without integrated data loss prevention, along with functionally equivalent SaaS solutions, Websense-optimized appliances for mid-sized and enterprise-class organizations, and stand-alone enterprise data security solutions.
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TRITON Web Security
Websense Web Security Gateway is a Web security solution that combines traditional Web filtering with dynamic content scanning and classification using our ACE Classification Engine. The ACE Classification Engine uses analytics generated by our ThreatSeeker Network, which scans billions of Web sites, emails and other content to identify new threats. The analytics used by the ACE Classification Engine detect and block new and uncategorized threats and inappropriate content. Additionally, our Websense Security Labs technology populates our master database of uniform record locators (“URLs”), protocols, applications and malware using a proprietary process of automatic content assessment and classification, with manual verification as necessary. With our Web Security Gateway, customers can proactively discover and mitigate new security risks, block dangerous malware, prevent access to inappropriate 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 Anywhere 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 and enforcing 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 filtering and policy enforcement within an organization. Our email software blocks threats such as spam, phishing attacks 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 IT hardware or on a Websense-optimized appliance. Websense Email Security Gateway Anywhere expands our Email Security Gateway product with the addition of 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.
TRITON Cloud Security
The SaaS deployment model eliminates the need for customers to maintain an on-site server-based solution and provides centralized policy management for any type of IT environment, including environments with remote locations, home offices, and mobile devices. 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 and email SaaS solutions are managed from the TRITON management console in the cloud and can be deployed as complete filtering and security solutions, or layered with existing server-based Web and email security solutions to provide 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 same security and acceptable use policies to mobile and remote users that are applied to server-based users.
Websense Cloud Web Security Gateway. Websense Cloud Web Security Gateway combines traditional Web filtering with dynamic content scanning and classification by our ACE Classification Engine, with in-the-cloud deployment to protect against both previously known and new unclassified threats. With Websense
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Cloud Web Security Gateway, customers can proactively discover and mitigate new security risks, block dangerous malware, prevent access to inappropriate content, and manage social 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, malicious links and embedded malware without the need 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 data 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. In addition to offering stand-alone data security solutions, we have integrated our data security policy controls with our Web and email security solutions under the 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 via email or the Web, or by download to devices utilizing the universal serial bus (“USB”) protocol or other exchange technologies.
Websense Data Security Suite is an integrated data 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. Additionally, the Websense Data Security Suite can 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 the Websense Data Security Suite separately as they develop and deploy their data security policies.
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 and file and hypertext 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 devices and other portable media, or printing 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. |
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• | 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 simple 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
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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 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 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
Websense Web Security Suite 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. 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.
• | 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 identified as 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 access to utilize hacking tools. |
• | Real Time Security Updates. Real Time Security Updates use cloud-based technology to deliver security category updates as new Web and application-based threats are identified and categorized by Websense Security Labs and our ThreatSeeker Network. |
Websense Web Security Suite can be deployed on standard servers or other IT hardware, including Websense-optimized appliances, or as a SaaS offering. The SaaS deployment model eliminates the need for the customer to maintain an on-site server-based solution and provides centralized policy management for any type of IT environment, including environments with remote locations, home offices, and mobile devices.
Additional Websense Products and Services
SurfControl Products
Through our acquisition of SurfControl plc (“SurfControl”) in October 2007, we acquired certain 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 renewal subscriptions to SurfControl RiskFilter within China.
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Additional Services
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.
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 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. In total, these customers have subscribed toinstitutions in approximately 44 million seats as of December 31, 2008.150 countries around the world. Ingram Micro, one of our broad-line distributor fordistributors in North America, accounted for approximately 23%28%, 31% and 12%30% of our revenuerevenues during 20082011, 2010 and 2007,2009, respectively. Ingram Micro sold subscriptions through approximately 1,3001,200 resellers in North America in 2008.2011.
Sales, Marketing and Distribution
Sales.Sales Our.Our sales strategy is to increase sales to new customers and increase subscription renewals, upgrades and other salesincremental 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 2008,2011, 2010 and 2009, indirect channel sales comprised over 90% of total billings and revenues. We expect that the large majority of our revenue in 2009billings and revenues will continue to be derived almost entirely 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 end-users.
We sell our products in North America principally through a two-tier distribution system. We sell productsexisting customers. Both agreements are non-exclusive and either party to our distributors and our distributors market, distribute and support our software through value added resellers. We also sell directly to resellers that specialize in security software. These resellers often build implementation services around our products, particularly our Data Security Suite offering.each agreement may terminate the agreement at any time without cause.
Internationally, we sell our products through a multi-tiered distribution network ofto distributors and resellers in over 100approximately 130 countries, who in turn sell our products to customers located in overapproximately 150 countries. No international distributor accounted for more
Our channel sales efforts are coordinated worldwide through a sales team of approximately 250 individuals. Certain customers, who are typically large organizations, from time to time require that we sell directly to them.
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In connection with the acquisition of SurfControl, we acquired approximately 35 arrangements with original equipment manufacturers (“OEM”) that grant the OEM customers the right to incorporate the Web filtering products into the OEM’s products for resale to end-users.
In 2008, we generated 46%than 10% of our total revenuerevenues in 2011. In 2011, 2010 and 2009, we derived approximately 50% of our revenues from customers outside of the United States. Revenueinternational sales. Revenues generated in the United Kingdom representedcomprised approximately 15%11%, 13% and 14% of our total revenue.revenues during 2011, 2010 and 2009, respectively. See Note 7 of Notes4 to the Consolidated Financial Statementsconsolidated financial statements for further explanation of our revenuerevenues based on geography. Our currentWe believe international effortsmarkets continue to represent a significant growth opportunity and we are focused on expandingcontinuing to expand our indirect sales channelsinternational operations, particularly in Europe,selected countries in the European, Asia/Pacific and Latin America.American markets. Our continuing reliance on sales in international markets exposes us to risks attendant toinherent in foreign sales. See “Item 1A. Risk Factors—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 also sell directly to resellers that specialize in security 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 advanced TRITON content security solutions.
Our channel sales efforts are coordinated worldwide through an internal sales team of approximately 460 individuals located in our key markets. Our internal sales force focuses on new customer 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.
Marketing.Marketing. Our marketing efforts are designed to increase recognition of Websense as a leading provider of integratedunified Web, filtering and security, data loss prevention (“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.Technology IntegrationsThrough.Our solutions integrate with a variety of network and IT platforms and our objective is for Websense security solutions to be effective in any network environment desired by a customer.
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, updates to existing 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. In 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 joint marketing programs,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 2011, 2010 and 2009, we spent approximately $58 million, $54 million and $53 million, respectively, on research and development activities.
Competition
The markets for our North American broad-line distributor, Ingram Micro, focuses its efforts on recruitingTRITON content security solutions and servicing resellers focused on selling to the smalllegacy Web filtering solutions is highly competitive, quickly evolving 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 23% and 12% of our revenue during 2008 and 2007, respectively. Ingram Micro sold subscriptions through approximately 1,300 resellers in North America in 2008. Our agreement with Ingram Micro is not subject to any minimumrapid technological change. Increased competition and pricing pressures generally could result in reduced sales, obligations reduced renewals and/or obligations to marketdeclining seat counts from existing customers, reduced margins or failure of our products to itsachieve or maintain more widespread market acceptance. Competitors vary in size and in the scope and breadth of the products and services they offer. The competitive environments in which we operate and the principal competitors within each environment are described below.
TRITON Solutions for Content Security
Web Security. Our principal competitors offering Web security software solutions include companies such as McAfee (acquired by Intel), Symantec, Trend Micro, Check Point Software Technologies, 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, 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, SonicWALL, Trend Micro, Microsoft, Axway, Sophos, Proofpoint, Clearswift, Commtouch, Zix, WatchGuard Technologies, M86 Security, Webroot Software, EdgeWave, Zscaler and Fortinet.
Data Security.Our principal competitors offering data loss prevention solutions include companies such as Symantec, Verdasys, Trustwave, EMC, McAfee, IBM, Trend Micro, Proofpoint, Palisade Systems, CATechnologies, Raytheon, Intrusion, Fidelis Security Systems, GTB Technologies, Workshare, Check Point
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Software Technologies and Code Green Networks; and companies offering desktop security solutions, such as Check Point Software Technologies, Cisco Systems, McAfee, Microsoft, Symantec, CA Technologies, Sophos, Webroot Software, IBM and Trend Micro.
Web Filtering Solutions
Our principal competitors offering Web filtering solutions, including through specialized security appliances, include companies such as McAfee, Symantec, Trend Micro, Check Point Software Technologies, 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 SonicWALL.
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, develop and/or bundle competitive products with their 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, Web management service 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 | • lower cost of ownership | |
• price | • integration and manageability of products | |
• functionality | • threat research |
We believe that we compete effectively 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 SMB and enterprise customers, and a larger installed base of users. In addition, current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the agreementfunctionality of their products to address customer 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 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 time period and contain terms and conditions prohibiting the unauthorized reproduction or transfer of our products. In addition, our policy is non-exclusiveto enter into confidentiality and eitherinvention 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,
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Iceland, India, Morocco, Peru, Chile, Hong Kong, Jordan, New Zealand, Russia and Turkey. In addition, we have registrations for other Websense trademarks pending in several 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 33 patents issued in the United States, 28 patents issued internationally, 35 patent applications pending in the United States and 88 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 data 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, 2011, we had 1,502 employees worldwide, including 265 in cost of revenue departments, 615 in selling and marketing, 502 in research and development and 120 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 Securities and Exchange Commission Filings
We maintain a Web site atwww.websense.com. The content of our Web site is not part of this Annual Report on Form 10-K. We make our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or Ingram Micro can terminatefurnished pursuant to Section 13(a) or 15(d) of the agreementSecurities Exchange Act of 1934, as amended (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 Securities and Exchange Commission (the “SEC”).
Executive Officers of the Registrant
Our executive officers and their ages as of February 15, 2012 are as follows:
Name | Age | Position(s) | ||||
Gene Hodges | 60 | Chief Executive Officer | ||||
John McCormack | 52 | President | ||||
Didier Guibal | 50 | Executive Vice President, Worldwide Sales | ||||
Michael A. Newman | 42 | Sr. Vice President, Interim Chief Financial Officer, 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, 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, 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 for Cisco Systems, Inc.,
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a publicly-traded computer hardware and software company, most recently as General Manager of the Secure Managed Networks Business Unit. Mr. McCormack received his Master’s degree in Engineering Management from George Washington University and a B.S. in Computer Science from the University of New Hampshire.
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 any time without cause.Rightnow Technologies, Inc., a 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 his Master’s degree in Business from Sup de Co-Business School in Montpellier, France.
Michael A. Newman has served as Senior Vice President, General Counsel, Chief Administrative Officer and Corporate Secretary of Websense since 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 personal computer manufacturer, and prior to that, Mr. Newman practiced as an attorney with Cooley 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. | 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 world capital marketsglobal economy and the financial services industrymacroeconomic conditions may adversely impact our business, results of operations, financial condition or liquidity.
Recently, the world capital markets and the financial services industry have been experiencingThe global economy has experienced 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. The recent economic crisis could causeWe 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 to not renew their contracts at all, reducing our cash flow, and also could negatively affect our ability to maintain or expandreduce the number of seats and/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, most recently in continental Europe, have negatively impacted the duration and scope of contract renewals in certain countries or regions in the world and, in some cases, resulted 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 offeringsmix. Credit markets may also adversely affect our resellers through whom our distributors distribute products and limit the credit value-added resellers may extend to large customers upon renewal due to adverse developments within the customer’s organization.their customers. The volatility of currency exchange rates can also significantly affect sales of our products denominated in foreign currencies. In addition, recent 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.
If our security gateway products, data loss prevention products, SaaS offerings and our appliance platforms are unable to achieve more widespread market acceptance our business will be seriously harmed, particularly as Web filtering products continue to commoditize.
Our future successability to generate revenue growth depends on our ability to sell new, renewalcontinue to diversify our offerings by successfully developing, introducing and upgraded Web filtering and Web security subscriptions.
Substantially allgaining customer acceptance of our revenue for the fiscal year ended December 31, 2008 was derived from new products and renewal subscriptions toservices, particularly our security gateway offerings as our Web filtering products have become more of a commodity. We sell our TRITON and Webgateway security products to address emerging Web threats, Websense Web Security Gateway, as well as our V-Series and we expect that a significant majority ofX-Series appliances pre-loaded with our sales for 2009 will continue to be derived fromsoftware. We also sell the Websense Data Security Suite, our Web filtering and Web security products. We expect sales of our Web security gateway, data loss prevention offering, Websense Cloud Web Security and Websense Cloud Email Security, our SaaS offerings, and Websense Email Security, our email filtering solution. We offer our products (“DLP”), hostedwith TRITON, our unified Web, email and data security servicessolution, which combines our products into a single platform. We continue to develop and otherrelease products under development to comprisein 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 relatively small portion of our overall sales in 2009.result. If our Web filtering and Web security 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 increasefail to continue to upgrade and diversify our customer base with the addition of new customers, particularly in the SMB segment, increase seats underproducts, we could lose revenues from renewal subscriptions from existing customers or renew a sufficient number of SurfControl’s Web filtering customers or migrate them to our Web filtering product, we will not be able to grow our business to meet expectations.
Subscriptions for our Web filtering and security products typically have durations of 12, 24 or 36 months. 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 Websense and SurfControl customers may elect to renew subscriptions for shorter durations and may not add seats or product offerings due to contractions of work forces of their respective organizations. Our revenue also depends upon maintaining a high rate of sales of renewal subscriptions and upon adding additional seats or
product offerings to existing customers. 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 oras these products continue to generate increasing revenuesuffer from existing customers.commoditization.
Our revenue isV-Series and X-Series appliance platforms 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 V-Series appliances in 2009, we began selling products that are hardware-based and not solely software-based. Our appliances are manufactured by a single third-party contract manufacturer, and a single third-party logistics company provides logistical services, including product configuration and shipping.
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Our ability to deliver our 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 appliances. If our third-party providers fail for any reason to manufacture and deliver the 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 appliance platforms may also face greater obsolescence risks than our pure software products.
Our revenues 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 23%28%, 31% and 30% of our revenuerevenues during the fiscal year ended December 31, 2008.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 significantly 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,Security Gateway, our DLPV-Series and X-Series appliances, our data loss prevention and email offerings, our SaaS offerings or our hostedTRITON content security services;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
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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 404billings, revenues, operating expenses and tax provisions. 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 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 number, size and length of subscriptions to our products that are sold in that quarter as well as our appliance sales which are, following January 1, 2011, fully recognized in the quarter in which they are sold. In addition, we have become 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 predict and sales expected in a quarter may not be completed until a subsequent quarter. The unpredictability of quarterly fluctuations is further 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 Sarbanes-Oxley Act of 2002 requires companieslargest enterprise customers purchasing subscriptions 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 management’s assessment and the effectiveness of internal control over financial reporting.
Management had previously concluded that we maintained effective internal control over financial reporting as of December 31, 2008. In connection with the restatement discussed under the heading “Restatement of Previously Reported Consolidated Financial Statements” in Note 2products nearer to the consolidated financial statements included in “Part II—Item 8. Financial Statements and Supplementary Data”end of this report, management determined that the material weaknesses described below existed aslast month of December 31, 2008. Accordingly, management has now concluded that our internal control over financial reporting was not effective as of December 31, 2008.each quarter.
As described in “Part II—Item 9A. Controls and Procedures” of this report, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were not effective at the reasonable assurance level as of December 31, 2008. We and our auditors have also identified material weaknesses in our internal control over financial reporting relating 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.
We have taken and are taking actions to remediate these material weaknesses, including implementing a new system for review to determine the maximum period of our performance obligations under each OEM contract and strengthening the controlsOur operating expenses may increase in the reconciliationfuture if we expand our selling and review of the computation ofmarketing activities, increase our income tax provision.research and development efforts or hire additional personnel which could impact our margins. In addition, our audit committee has directed managementoperating expenses historically have fluctuated, and may continue to developfluctuate in the future, as the result of the factors described below and present a planelsewhere in this report:
changes in currency exchange rates impacting our international operating expenses;
timing of marketing expenses for activities such as trade shows and timetable foradvertising 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
fluctuations in expenses associated with commissions paid on sales of subscriptions to our products which generally increase with billings growth in the implementationshort term because such expenses are recognized immediately upon sales of remediation measures (tosubscriptions while revenues are recognized ratably over the extent not already implemented),subscription term.
Consequently, these factors limit our ability to accurately predict our results of operations and our audit committee intends to monitor such implementation. We believe that these actions will remediate the control deficiencies we have identified and strengthen our internal control over financial reporting. Although we have begun the processexpectations of remediating these material weaknesses, this process will take time, and we willcurrent or potential investors may not be able to assert that we have remediated these material weaknesses untilmet. If this occurs, the procedures that we put in place have been working for a sufficient period of time for us to determine that they are effective.
Although we believe we are taking appropriate actions to remediate the control deficiencies we have identified to strengthen our internal control over financial reporting, we cannot assure you that we will not discover other material weaknesses in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in implementation, could cause us to fail to meet our periodic reporting obligations or result in material misstatements 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 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
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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 productbasic 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/Secure Computing,McAfee (acquired by Intel), Symantec, Trend Micro, Check Point Software Technologies, Cisco Systems, Juniper Networks, Trend Micro, Google, BrightCloud, ScanSafe, Blue Coat Systems, Aladdin, Finjan, FaceTime, Mi5 Networks, St. BernardMicrosoft, Google, Webroot Software, Marshal8e6,SafeNet, Actiance, EdgeWave, FireEye, M86 Security, Clearswift, Sophos, Kaspersky Lab, AhnLab, IBM, Panda Security, F-Secure, Commtouch, CA Technologies, Juniper Networks, Black Box Network Services and Barracuda Digital Arts and Computer Associates;Networks.
companies integrating Web filtering into specializedEmail Security.Our principal competitors offering messaging or email security appliances,solutions include companies such as Blue Coat Systems,McAfee, Symantec/Message Labs, Google, Cisco Systems, McAfee/Secure Computing, WatchGuard, Check Point Software, St. Bernard Software, Barracuda Juniper Networks, SonicWALL, Trend Micro, Mi5 Networks, SonicWALL,Microsoft, Axway, Sophos, Network BoxProofpoint, Clearswift, Commtouch, Zix, WatchGuard Technologies, M86 Security, Webroot Software, EdgeWave, Zscaler and Marshal8e6;Fortinet.
companiesData Security.Our principal competitors offering DLPdata loss prevention solutions include companies such as Symantec, Verdasys, Vericept,Trustwave, EMC, McAfee/Secure Computing,McAfee, IBM, Trend Micro, Proofpoint, Palisade Systems, Orchestria (acquisition pending by 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/Secure Computing, Symantec/Message Labs, Google, Cisco Systems, Barracuda, SonicWALL, Trend Micro, Axway/Tumbleweed, MX Logic, Sophos, Microsoft, Proofpoint, Clearswift and BorderWare;
companies offering on-demand email and Web security services, such as Google, Symantec/Message Labs, McAfee, MX Logic, Webroot, St. Bernard Software, Purewire, BrightCloud, Zscaler, Trend Micro and 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. On September 15, 2009, we announced that our previously issued financial statements contained in our annual reports on Form 10-K for the years ended December 31, 2007 and 2008, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2008, June 30, 2008, September 30, 2008, March 31, 2009 and June 30, 2009 should no longer be relied upon because of errors in these financial statements. We subsequently restated our financial statements for these periods. We do not believe that these restatements of our financial statements resulted in any material non-compliance by us with the covenants or representations and warranties in our Senior Credit Agreement. While we have confirmed our compliance to our lenders and we have not received any notifications from our lenders to the contrary, there can be no assurance that our lenders will not take a different position from ours, seek to modify the interest rate or other terms of the SeniorThe 2010 Credit Agreement or pursue an acceleration of our obligations under the Senior Credit Agreement. As collateral for the loan, we pledgedis 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 $125 million remained outstanding as of December 31, 2008. 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. 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.
Failure of our security products, including our DLP products and hosted security solutions, to achieve more widespread market acceptance will seriously harm our business.
Our future financial performance depends on our ability to diversify our offerings by successfully developing, introducing and gaining customer acceptance of our new products and services, particularly our security offerings. We now sell the Websense Data Security Suite, our DLP offering for the data security market, Websense Hosted Web Security and Websense Hosted Email Security, our hosted security services, and Websense Email Security, our email filtering solution. During the third quarter of 2008, we released our next generation Web content gateway to address emerging Web 2.0 threats, Websense Web Security Gateway, and our new DLP endpoint module, Websense Data Security Suite, and we are continuing 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. Moreover, our recent increased emphasis on the development, marketing and sale of our security offerings and DLP products could distract us from sales of our core Web filtering and Web security offerings, negatively impacting our overall sales. Any failure or delay in diversifying our existing offerings, or diversification at the detriment to our core Web filtering and Web security offerings, could harm our business, results of operations and financial condition and our growth.
We have experienced declining growth rates, particularly for Web filtering sales to large enterprises in North America and Western Europe.
Our growth plans for new sales in North America and Western Europe are largely dependent on our ability to increase sales in the SMB segment and maintain our subscription base in the large enterprise market through subscription renewals and product upgrades. We need to increase sales through our two-tier distribution channel in North America and in Western Europe. We sell products specifically targeted at the SMB segment, Websense Express and Websense Hosted Security, though we cannot assure that these products will ultimately increase sales to the SMB segment. Numerous competitors target the SMB segment for Web filtering and security sales, many of whom are different competitors from our primary competitors in the large enterprise market segment. If Websense Express and Websense Hosted Security do not meet our customers’ expectations in the SMB segment or if we fail to compete effectively for volume business through our two-tier distribution model, our financial results and growth will be negatively affected.
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; andlanguages.
currency exchange risks.
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. 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, 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. currencies. 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. As a result, the strengthening of the U.S. dollar for current sales will not only reduce current cash flows from these sales, but will also reduce our revenue from these contracts, even if these foreign currencies should strengthen in the future.
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 46%approximately 50% of our total revenuerevenues generated during the fiscal year ended December 31, 2008 compared with 41% of our total revenue during the fiscal year ended December 31, 2007.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.
Security threats to our IT infrastructure could expose us to liability, and damage our reputation and business.
SomeIt 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 international revenue is denominated in U.S. dollars. Ininternal systems and services. If successful, any of these markets, fluctuations in the valueattacks could negatively affect our reputation as a provider of the U.S. dollarsecurity solutions, damage our network infrastructure and foreign currencies may makeour ability to deploy our products more expensive for international customers, which couldand services, harm our business. We also currently bill certain internationalrelationship with customers in Euros, British Pounds, Australian Dollars, Chinese Yuan Renminbithat are affected and Japanese Yen. 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. 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 failexpose us to properly forecast rate fluctuations these 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 technologytechnologies 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.
We may spend significant time and money on research and development to design and develop our DLP products, our hosted security services and our content gateway products. If these products fail to achieve broad market acceptance in our target markets, we may be unable to generate significant revenue from our research and development efforts. As a result, our business, results of operations and financial condition would be adversely impacted.
If we fail to maintain adequate operations infrastructure, we may experience disruptions of our hosted services.
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 hosted service offerings, our customer service, our delivery of products or our operations and result in increased costs and lost opportunities for business.
Acquired companies or technologies can be difficult to integrate, disrupt our business, dilute stockholder value and adversely affect our operating results.
In October 2007 we acquired SurfControl and, as a result of the acquisition, Websense became an unprofitable operating business under generally accepted accounting principles (“GAAP”) after more than five years as a profitable operating business under GAAP. Given our subscription model, we expect to continue to operate at a loss under GAAP in the first half of 2009 until we generate sufficient revenue from the subsequent renewal of subscriptions from the installed SurfControl customer base to offset the expenses we began to incur as of the close of the SurfControl acquisition to operate the SurfControl business. Although we expect to continue to compete effectively for subscription renewals from the SurfControl customers when their contracts are up for renewal, we face substantial competition and may not retain as high a percentage of the SurfControl customer
base as we expect, which could negatively impact our results of operations and the timing of our return to profitability under GAAP.
Acquisitions involve numerous risks, including:
difficulties in integrating operations, technologies, services and personnel of the acquired company;
potential loss of customers and original equipment manufacturing relationships of the acquired company;
diversion of financial and management resources from existing operations and core businesses;
risk of entering 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 of liabilities of the acquired company, including debt and litigation;
inability to generate sufficient revenue 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.
Acquisitions may also cause us to:
issue equity securities that would dilute our current stockholders’ percentage ownership;
assume certain liabilities;
incur additional debt, such as the debt we incurred to partially fund the acquisition of SurfControl;
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.
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.
Our products may fail to keep pace with the rapid growth and technological change of the Internet in accordance with our customers’ expectations.
The ongoing evolution of the Internet and computing environments will require us to continually improve the functionality, features and reliability of our databases. 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 enhance our TRITON management console, appliances, content gateway products, data loss prevention products and our SaaS offerings. If these products fail to achieve broad market acceptance in our target markets, we may be unable to generate significant revenues 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
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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.
Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for state, federal and international 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 international authorities relating to tax matters. We fully cooperate with all audits. 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, are appropriately 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. We believe sufficient accruals have been recorded for these tax exposures. However, if the reserves are insufficient upon completion of any audits, there could be an adverse impact on our financial position and 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 Websense and Websense Enterprise 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 eleven33 patents issued patents in the United States and 2128 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. 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 hosted services.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.
Our quarterlyAcquired companies or technologies can be difficult to integrate, disrupt our business, dilute stockholder value and adversely affect our operating results may fluctuate significantly, and these fluctuations may cause our stock price to fall.results.
Our quarterly operating results have varied significantly in the past,We may acquire additional companies, services 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 increasetechnologies in the future as part of our efforts to expand and diversify our business. Although we expand our sellingreview 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 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, anddeficiencies. Integration of acquired companies may continue to fluctuate indisrupt or slow the future, as the resultmomentum of the factors described belowactivities of our business. As a result, if we fail to properly evaluate, execute and elsewhere in this quarterly report:integrate future acquisitions, our business and prospects may be seriously harmed.
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Acquisitions involve numerous risks, including:
timingdifficulties in integrating operations, technologies, services and personnel of marketing expenses for activities such as trade shows and advertising campaigns;the acquired company;
quarterly variations in generalpotential loss of customers and administrative expenses, such as recruiting expenses and professional services fees;OEM relationships of the acquired company;
increased researchdiversion of financial and development costs prior to new or enhanced product launches;management resources from existing operations and core businesses;
timing of expensesrisks associated with commissions paid on sales of subscriptions to our products;entrance into new markets;
amortizationpotential loss of key employees of the acquired intangible assets associatedcompany;
integrating personnel with our PortAuthoritydiverse business and SurfControl acquisitions in 2007;cultural backgrounds;
preserving the development, distribution, marketing and other important relationships of the companies;
assuming liabilities of the acquired company, including debt and litigation;
inability to generate sufficient revenues from newly acquired products and/or cost savings needed to offset acquisition related costs; and
changesthe continued use by acquired companies of accounting policies that differ from 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;
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 currency exchange rates impacting our international operating expenses.significant impairment charges and/or amortization expense.
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.
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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 Global Select Marketlisting 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 small and medium sized businesses.international expansion. Each of these initiatives requires an investment of our
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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 stockholdersstockholders..
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 for a classified board, with each board member serving a staggered three-year term. It also 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 board of 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. | Unresolved Staff Comments |
None.
Item 2. | Properties |
Our corporate headquarters and principal offices are located at a 122,000 square foot facility we lease in San Diego, California. The lease expires in December 2013, however, 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, England; Ra’anana, Israel; Sydney, Australia and Shanghai, Guangzhou and Beijing, China. We also have executive suite arrangements on monthly or annual 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 and Turkey.
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
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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 have not accrued any liability that may result from any of our 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. | Mine Safety Disclosures |
Not applicable.
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Part II
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 under the symbol “WBSN.” The following table sets forth the range of high and low closing sale prices for our common stock for the periods indicated, as reported by the NASDAQ Global Select Market. Such quotations represent prices without retail markups, markdowns or commissions.
Years Ended December 31, | ||||||||||||||||
2011 | 2010 | |||||||||||||||
High | Low | High | Low | |||||||||||||
First Quarter | $ | 23.23 | $ | 19.16 | $ | 24.29 | $ | 17.46 | ||||||||
Second Quarter | 26.02 | 22.56 | 24.96 | 18.90 | ||||||||||||
Third Quarter | 27.82 | 17.08 | 21.38 | 17.73 | ||||||||||||
Fourth Quarter | 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, 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 15, 2012, there were 16 holders of record of our common stock and we estimate that there were approximately 6,700 beneficial owners of our common stock that hold our shares in “street name” through brokerage firms, banks, dealers or similar organizations.
Issuer Purchases of Equity Securities
The following table sets forth information about purchases of our common stock during the quarter ended December 31, 2011:
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 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 |
32 | 2011 ANNUAL REPORT |
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 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 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 $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 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 |
The following selectedtable summarizes certain historical financial information at the dates and for the periods indicated prepared in accordance with GAAP. The consolidated statement of operations data arefor each of the years ended December 31, 2011, 2010 and 2009, and the consolidated balance sheet data as of December 31, 2011 and 2010, have been derived from our consolidated financial statements and have been restatedaudited by Ernst & Young LLP, an independent registered public accounting firm, included elsewhere in this Annual Report on Form 10-K. The consolidated statement of operations data for each of the years ended December 31, 2008 and 2007 (including interim periods therein) to reflect adjustments that are further discussed in Note 2 toand the consolidated balance sheet data as of December 31, 2009, 2008 and 2007 have been derived from our financial statements not included in Item 8 of this report. These tablesherein. The selected consolidated financial data should be read in conjunction with Items 7“Management’s Discussion and 8Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes thereto, which are included elsewhere in this report.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, | |||||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||||
(In thousands, except for per share data) | |||||||||||||||||
(As Restated) | (As Restated) | ||||||||||||||||
Statement of Operations Data: | |||||||||||||||||
Revenues | $ | 288,274 | $ | 210,307 | $ | 178,814 | $ | 148,636 | $ | 111,859 | |||||||
Cost of revenues | 48,160 | 29,140 | 15,274 | 10,642 | 7,769 | ||||||||||||
Gross margin | 240,114 | 181,167 | 163,540 | 137,994 | 104,090 | ||||||||||||
Operating expenses: | |||||||||||||||||
Selling and marketing | 175,365 | 126,247 | 80,135 | 55,288 | 42,625 | ||||||||||||
Research and development | 53,274 | 40,913 | 22,663 | 16,277 | 14,509 | ||||||||||||
General and administrative | 45,343 | 32,708 | 21,279 | 11,729 | 8,200 | ||||||||||||
Total operating expenses | 273,982 | 199,868 | 124,077 | 83,294 | 65,334 | ||||||||||||
(Loss) income from operations | (33,868 | ) | (18,701 | ) | 39,463 | 54,700 | 38,756 | ||||||||||
Interest expense | (13,134 | ) | (4,308 | ) | — | — | — | ||||||||||
Other income, net | 739 | 9,461 | 11,287 | 5,411 | 2,226 | ||||||||||||
(Loss) income before income taxes | (46,263 | ) | (13,548 | ) | 50,750 | 60,111 | 40,982 | ||||||||||
(Benefit) provision for income taxes | (19,484 | ) | 2,933 | 18,657 | 21,343 | 14,806 | |||||||||||
Net (loss) income | $ | (26,779 | ) | $ | (16,481 | ) | $ | 32,093 | $ | 38,768 | $ | 26,176 | |||||
Net (loss) income per share: | |||||||||||||||||
Basic | $ | (0.59 | ) | $ | (0.37 | ) | $ | 0.69 | $ | 0.82 | $ | 0.57 | |||||
Diluted | $ | (0.59 | ) | $ | (0.37 | ) | $ | 0.68 | $ | 0.79 | $ | 0.54 | |||||
Weighted average shares—basic | 45,190 | 45,107 | 46,494 | 47,491 | 46,161 | ||||||||||||
Weighted average shares—diluted | 45,190 | 45,107 | 47,116 | 49,196 | 48,228 |
Years Ended December 31, | ||||||||||||||||||||
2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||
(In thousands, except for per share data) | ||||||||||||||||||||
Statement of Operations Data: | ||||||||||||||||||||
Revenues: | ||||||||||||||||||||
Software and service | $ | 325,373 | $ | 320,544 | $ | 311,476 | $ | 288,274 | $ | 210,307 | ||||||||||
Appliance | 38,810 | 12,218 | 2,237 | 0 | 0 | |||||||||||||||
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| |||||||||||
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 | |||||||||||||||
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|
|
| |||||||||||
Total cost of revenues | 59,619 | 53,090 | 50,806 | 48,160 | 29,140 | |||||||||||||||
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| |||||||||||
Gross profit | 304,564 | 279,672 | 262,907 | 240,114 | 181,167 | |||||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 161,039 | 157,758 | 166,910 | 175,365 | 126,247 | |||||||||||||||
Research and development | 58,247 | 54,325 | 52,643 | 53,274 | 40,913 | |||||||||||||||
General and administrative | 40,863 | 36,779 | 40,295 | 45,343 | 32,708 | |||||||||||||||
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|
|
|
|
|
|
|
|
| |||||||||||
Total operating expenses | 260,149 | 248,862 | 259,848 | 273,982 | 199,868 | |||||||||||||||
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|
|
|
|
|
| |||||||||||
Income (loss) from operations | 44,415 | 30,810 | 3,059 | (33,868 | ) | (18,701 | ) | |||||||||||||
Interest expense | (1,635 | ) | (3,715 | ) | (7,084 | ) | (13,134 | ) | (4,308 | ) | ||||||||||
Other income (expense), net | 1,239 | (834 | ) | 384 | 739 | 9,461 | ||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Income (loss) before income taxes | 44,019 | 26,261 | (3,641 | ) | (46,263 | ) | (13,548 | ) | ||||||||||||
Provision (benefit) for income taxes | 13,025 | 7,609 | 7,056 | (19,484 | ) | 8,748 | ||||||||||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
Net income (loss) | $ | 30,994 | $ | 18,652 | $ | (10,697 | ) | $ | (26,779 | ) | $ | (22,296 | ) | |||||||
|
|
|
|
|
|
|
|
|
| |||||||||||
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 | 39,711 | 42,409 | 44,262 | 45,190 | 45,107 | |||||||||||||||
Weighted average shares—diluted | 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, | |||||||||||||||
2008 | 2007 | 2006 | 2005 | 2004 | |||||||||||
(In thousands) | |||||||||||||||
(As Restated) | (As Restated) | ||||||||||||||
Balance Sheet Data: | |||||||||||||||
Cash and cash equivalents (including restricted cash) and marketable securities | $ | 66,811 | $ | 87,733 | $ | 326,905 | $ | 320,389 | $ | 243,788 | |||||
Total assets | 724,663 | 780,739 | 424,257 | 403,675 | 315,293 | ||||||||||
Deferred revenue | 341,784 | 288,043 | 220,343 | 179,925 | 132,317 | ||||||||||
Long-term liabilities | 261,965 | 322,829 | 71,804 | 60,807 | 41,631 | ||||||||||
Total stockholders’ equity | 176,660 | 192,437 | 180,725 | 205,811 | 167,944 |
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 known to us that could cause reported financial information not to be necessarily indicative of future results.
Restatement of Previously Reported Audited Annual and Unaudited Interim Consolidated Financial Information
The accompanying Management’s Discussion and Analysis of Financial Condition and Results of Operations gives effect to certain restatement adjustments made to the previously reported consolidated financial statements for the years ended December 31, 2008 and 2007 (including interim periods therein). See Notes 2 and 15 to the consolidated financial statements in Item 8 of this report for additional information.Annual Report on Form 10-K. The cautionary statements made in this Annual Report on Form 10-K should be read as applying to all related forward-looking statements wherever they appear in this Annual Report on Form 10-K.
Overview
We are a leadingglobal provider of unified Web, filteringemail and data security solutions designed to protect an organization’s data loss prevention (“DLP”), and email anti-spamusers from external and security solutions.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 IT hardware, including our optimized appliances, as a SaaS offering, or in a hybrid hardware/SaaS configuration. Our products and services protect organizations’ employeesare sold worldwide to provide content security to enterprise customers, SMBs, public sector entities, and critical business data from external Web-basedInternet service providers through a network of distributors, value-added resellers and email-based attacks, and from internal employee-generated threats such as employee errors and malfeasance.OEMs. Our customersproducts use our software products to provide a secureadvanced content classification, deep content inspection, and productive computing environment for employees, business partners and customers. Our portfolio of Web filtering, Web security, DLP and email anti-spam and messaging security software allows organizationspolicy enforcement technologies to:
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 sites with user-generated content (Web 2.0 sites);that contain inappropriate content;
identify and remove malicious applicationsmalware from incoming Web traffic;content;
filter “spam” outmanage the use 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;
prevent the unauthorized use and loss of sensitive data, such as customer or employee information; and
control 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 contentIT security software solutions, including Web security, DLP, email 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.sophisticated, targeted cyber-attacks designed to steal valuable information.
During 2008, weWe derived 46%approximately 50% of our revenuerevenues from international sales compared with 41% for 2007,during 2011, 2010 and 2009, with the United Kingdom comprising approximately 15%11%, 13% and approximately 11%14% of our total revenue in 2008revenues during 2011, 2010 and 2007,2009, 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 small and medium sized business 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 a distributorand 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 sellssell 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 1,300 resellers, accounted for approximately 23% of our revenue in 2008 and 12% of our revenue in 2007.
In connection with the acquisition of SurfControl, we acquired approximately 352011. We also have several arrangements with OEMs that grant the OEM customersthem the right to incorporate our Web filtering 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 software and SaaS products including add-on modules, 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 are delivered. Our operating expenses, including cost of revenues, in 2011 increased as compared with 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 overall favorable movement of currency exchange rates.
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 a 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 balance sheet as deferred revenue and then recognized to our income statement as revenue ratably over the subscription term or, in the 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 delivered. Operating expenses have continueduseful 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 periods due to expanded selling and marketing efforts, continued product research and development and investmentsperiod or in administrative infrastructure to support subscription sales that we will recognize asthe 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 in subsequent periods.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 reflectsreflected the fair value of the post-contract technical support services that will beis recognized daily in accordance with our revenue recognition policy. We did not expect to generate significant revenue from the installed SurfControl customer base until the subscriptions we acquired were up for renewal. In connection with the acquisition, we have 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. As a result, we reported a net loss for fiscal years 2007 and 2008. Given the average remaining term of the SurfControl subscriptions we acquired and the elimination of many of the non-recurring acquisition related expenses, we currently expect to report income from operations for fiscal year 2009, although not in the first half of 2009. Our ability to retain SurfControl customers when contracts are up for renewal and maintain our overall pricing levels for our products will impact our results of operations and the timing of our return to profitability.
In connection with the acquisition of SurfControl, we approved plans to restructure the operations of the acquired company through involuntarily terminating 320 of SurfControl’s employees and exiting certain SurfControl facilities. We began formulating our restructuring plans for the operations of SurfControl in April 2007 when the acquisition was first announced. As of December 31, 2008, all of the 320 employees that we identified as being subject to the involuntary termination have been terminated and all the severance costs have been paid. These workforce reductions were across all functions and geographies and affected employees were provided cash severance packages. Additionally, we have consolidated facilities and have exited, or will be exiting, leases in certain locations as well as reducing the square footage required to operate some locations. Our facility exit plans were finalized during fiscal year 2008. We have accrued the estimated costs associated with the employee severance and facility exit obligations as liabilities assumed in the acquisition of SurfControl and, accordingly, included the costs as part of the purchase price of SurfControl. Changes to the estimates of the facility exit costs will be recorded in future periods either as a reduction to goodwill or as an expense to the results of operations.
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 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 users. 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, 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 then promptly invoice 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 the invoice. 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.
We record amounts billedadopted 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 customersprovide 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. 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 revenue was amortized over the remaining life of the software subscription or estimated delivery term of the services, whichever was longer.
For our U.S. dollar functional currency entities, whentransactions 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 web filtering 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 purchaseacquisition method of accounting, in accordance with SFAS No. 141,Business Combinations (“SFAS 141”),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.
In accordance with SFAS No. 142,Goodwill and Other Intangible Assets (“SFAS 142”), weWe 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. In accordance with SFAS No. 144,Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), 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 under SFAS 144, which is 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 Compensation. Effective January 1, 2006, we adopted the provisions of SFAS No. 123,Share-Based Payment(“SFAS 123R”) and Staff Accounting Bulletin No. 107(“SAB 107”) requiring the measurement and recognition of allWe 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 in accordance with the provisions prescribed under SFAS 123R and SAB 107.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, 2008,2011, there was $51.8$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 2.41.9 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, consistent with SFAS 123R and SAB 107.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 in accordance with SFAS 123R and SAB 107 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.
Statement of Financial Accounting Standards No. 109,Accounting for Income Taxes(“SFAS 109”), requires that deferred tax assets be 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.
Effective January 1, 2007, we adopted the provisions of FASB Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109(“FIN 48”). FIN 48 contains a two-step approach to recognizing and measuring uncertain tax positions accounted for in accordance with SFAS 109. 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.
Allowance for Doubtful Accounts.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, | |||||||||
2008 | 2007 | 2006 | |||||||
(As Restated) | (As Restated) | ||||||||
Revenues | 100 | % | 100 | % | 100 | % | |||
Cost of revenues | 17 | 14 | 9 | ||||||
Gross margin | 83 | 86 | 91 | ||||||
Operating expenses: | |||||||||
Selling and marketing | 61 | 60 | 44 | ||||||
Research and development | 18 | 19 | 13 | ||||||
General and administrative | 16 | 16 | 12 | ||||||
Total operating expenses | 95 | 95 | 69 | ||||||
(Loss) income from operations | (12 | ) | (9 | ) | 22 | ||||
Interest expense | (4 | ) | (2 | ) | — | ||||
Other income, net | — | 4 | 6 | ||||||
(Loss) income before income taxes | (16 | ) | (7 | ) | 28 | ||||
(Benefit) provision for income taxes | (7 | ) | 1 | 10 | |||||
Net (loss) income | (9 | )% | (8 | )% | 18 | % | |||
Years Ended December 31, | ||||||||||||
2011 | 2010 | 2009 | ||||||||||
Revenues: | ||||||||||||
Software and service | 89 | % | 96 | % | 99 | % | ||||||
Appliance | 11 | 4 | 1 | |||||||||
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Total revenues | 100 | % | 100 | % | 100 | % | ||||||
Cost of revenues: | ||||||||||||
Software and service | 11 | 14 | 15 | |||||||||
Appliance | 5 | 2 | 1 | |||||||||
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Total cost of revenues | 16 | 16 | 16 | |||||||||
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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 | |||||||||
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Total operating expenses | 71 | 75 | 83 | |||||||||
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Income from operations | 13 | 9 | 1 | |||||||||
Interest expense | (1 | ) | (1 | ) | (2 | ) | ||||||
Other income (expense), net | 0 | 0 | 0 | |||||||||
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Income (loss) before income taxes | 12 | 8 | (1 | ) | ||||||||
Provision for income taxes | 4 | 2 | 2 | |||||||||
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Net income (loss) | 8 | % | 6 | % | (3 | %) | ||||||
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Year ended December 31, 20082011 compared with the year ended December 31, 20072010
RevenueRevenues
RevenueSoftware and service revenues. Software and service revenues increased to $288.3$325.4 million in 20082011 from $210.3$320.6 million in 2007.2010. Because we recognize software and service revenues ratably over the term of the subscription, growth in software and service revenues reflect changes in current deferred revenue at the beginning of the period compared with the prior period, as well as the change in current period billings. The increase in 2011 software and service revenues compared with 2010 was aprimarily the result primarily of additional customer seatsincreased incremental billings to new customers and upgrades to existing customers, as well as higher OEM revenues in new, renewed2011 as compared with 2010. Software 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 soldservice revenues generated in the United States accounted for $155.7$163.0 million, or 54%45% of 2008 revenue2011 revenues, compared to $123.4with $158.5 million, or 59%47% in 2007. Revenue from products sold2010. Software and service revenues generated internationally accounted for $132.6$162.4 million, or 46%44% of 2008 revenue2011 revenues, compared to $86.9with $162.1 million, or 41%49%, in 2007.2010. We had current deferred revenue relating to software and service revenues of $223.9$244.6 million as of December 31, 2008,2011, compared to $191.0with $240.5 million as of December 31, 2007. 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 2009 revenuesoftware and service revenues in 2012 to increase over 2008 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 2009, subscriptions that are scheduled for renewal in 2009 that are expected to be renewed and upgraded, and expected new business during 2009 for which some revenuerevenues will be recognized during 2009.2012. These trends are anticipated to be partially offset by an expected decline in revenue from OEM arrangements. Our revenue in 2009 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 RevenueRevenues
CostSoftware and service cost of revenuerevenues.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 hosted security servicesSaaS offerings. Software and amortizationservice cost of acquired technology. Cost of revenue increasedrevenues decreased to $48.2$41.6 million in 20082011 from $29.1$45.7 million in 2007.2010. The $19.1$4.1 million increasedecrease was primarily consisted of $7.2 million of increaseddue to decreased amortization of acquired technology primarily
due to the acquisition of SurfControl in October 2007, $3.7$6.0 million related toand 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 our technical support2011 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 remaining 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 cost of revenues departments decreased from an average of 266 employees during 2010 to an average of 261 employees during 2011, and database groups, including the increased headcount attributableis expected to the acquisition of SurfControl, $2.9 million related to the hosted services operations we acquired from SurfControl and $3.7 million related to increased allocated costs.remain relatively flat in 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 179 during 2007 to an average of 223 during 2008. As of December 31, 2008, the acquired technology is being amortized over a remaining weighted average period of 2.5 years. We expect to record $12.9 million in amortization expense of acquired technology in 2009 based on our existing acquired technology assets as of December 31, 2008. In addition, we expect cost of revenue to increase to support the growth and maintenance of our databases and costs associated with providing our hosted 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 increased to 17% during 2008 fromrevenues was 13% for 2011, compared with 14% in 2007. for 2010.
We expect thatsoftware and service cost of revenuerevenues will increase in absolute dollars in 20092012 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 2009 compared to 2008.
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 $240.1$18.1 million in 20082011, from $181.2$7.4 million in 2007. 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 marginappliance revenues, appliance cost of revenues decreased to 83%47% in 20082011 from 86%61% in 2007 primarily2010.
We expect appliance cost of revenues will decrease in absolute dollars in 2012 as compared with 2011 due to the decline 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 costs describedto $304.6 million in the preceding Cost2011 from $279.7 million in 2010, primarily as a result of Revenue section.increased revenues. As a percentage of 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 2009.2012.
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 do not include payments to channel partners for marketing services and rebates as those are recorded as an offset to revenue. Selling and marketing expenses increased to $175.4$161.0 million, or 44% of revenues, in 20082011 from $126.2$157.8 million, or 48% of revenues, in 2007. Approximately $24.22010. The $3.2 million of the increase in total selling and marketing expenses was primarily due to the amortizationincreased personnel costs of acquired customer relationships which resulted$6.2 million resulting from the acquisitionhigher average head count and costs associated with changes to our internal sales team during 2011 and increased allocated costs of SurfControl$1.7 million, partially offset by a reduction in October 2007. As of December 31, 2008, the acquired customer relationships intangible assets are being 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(customer relationships) 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.$4.9 million. Our headcount in sales and marketing increased from an average of 425583 employees during 20072010 to an average of 529608 employees during 2008. Operating expenses2011. Headcount is expected to increase slightly in 2008 were reduced by improvements in 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 2009 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 approximately $11.1 millionrevenues are recognized in future periods, if our 2012 billings exceed expectations, our selling and marketing expenses as a percentage of amortization of acquired intangibles fromrevenues could increase in 2012 compared with 2011. Based on the SurfControl acquisitionexisting sales and an elimination of the non-recurring acquisitionmarketing related expenses. We expect amortization of acquired intangibles of $26.4 million in 2009 based on our existing acquired intangible assets as of December 31, 20082011, we expect amortization of sales and marketing related acquired intangibles of $6.0 million for 2012, which would be a reduction of approximately $6.6 million from the SurfControl2011. Fluctuations in foreign currencies may also impact our selling and PortAuthority acquisitions.marketing expenses in 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 increased to $53.3$58.2 million, or 16% of revenues, in 20082011 from $40.9$54.3 million, or 16% of revenues, in 2007.2010. The increase of $12.4$3.9 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,costs of $2.4 million and increased hiring to supportallocated costs of $1.5 million. Although our 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
44 | 2011 ANNUAL REPORT |
454 employees during 20072010 to an average of 355490 employees during 2008. Included2011, the impact of the higher headcount was partially mitigated by an increase in research and development for 2007 was $1.3 millionthe number of in-process research and development related to our PortAuthority acquisitionemployees in January 2007. relatively low cost foreign locations.
We expect research and development expenses to increase in absolute dollars in
2009 2012 as compared with 2011 due to ouran expanded base of product offerings and the hiring of personnelincreased average headcount compared with 2011 to support our continued enhancements of our existing and new products.product developments. Fluctuations in foreign currencies may also impact our research and development expenses in 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. As a result of the PortAuthority and SurfControl acquisitions, we nowWe also have research and development facilities in Ra’anana, Israel; Los Gatos and San Diego, California and Reading, England, that have contributed to our increased research and development expenses. While we expect research and development expenses to increase in absolute dollars in 2009, weEngland. We expect that research and development expenses as a percentage of revenuerevenues will decreaseremain relatively flat in 20092012 compared to 2008 due to the expected increase in revenue.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 $45.3$40.9 million, or 11% of revenues, in 20082011 from $32.7$36.8 million, or 11% of revenues, in 2007.2010. The $12.6$4.1 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 SurfControlan increase in October 2007, $4.9 million of increasedthird-party professional services primarilyservice fees, which were largely related to SurfControl integration activitiesthe global restructuring of our international distribution operations, and $2.3 million of increased allocatedpersonnel costs. Our headcount increasedremained consistent in general and administrative departments fromwith an average of 80120 employees during 20072010 to an average of 111121 employees 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. 2011.
We expect general and administrative expenses to increaseremain relatively constant in absolute dollars but declineand as a percentage of revenue in 2009 due to the expected increase in revenue.2012 compared with 2011.
Interest Expense
Interest expense represents the interest incurreddecreased 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 senior secured credit facility that we utilized to pay for a portionloan of $67.8 million during 2011, compared with an average loan balance of $73.0 million during 2010. In addition, the SurfControl purchase priceeffective interest rate was lower in October 2007. Interest expense increased to $13.1 million in 20082011 compared to $4.3 million in 2007. The increase waswith 2010 primarily due to the senior secured credit facility being outstanding for only one quarter in 2007 compared to the full year in 2008.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 $2.4$0.2 million and $763,000$1.0 million for 20082011 and 2007,2010, 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 million2010 Credit Facility and 2007 Credit Facility, 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, ourapplicable.
Our weighted average interest rate decreased from 7.3% atwas 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 31, 2007 to 5.7% as of December 31, 2008. The amount of30, 2011. Our interest expense will fluctuateis expected to increase in 2012 as compared with 2011 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. Interest expense should decline in 2009 compared to 2008 due to the lowera higher weighted average outstanding principal amount under the senior secured credit facility and the expected lower marginal interest rate on the non-fixed rate component of our senior secured credit facility due to the reduction in our spread over LIBOR. Fluctuations in LIBOR could impact our marginal interest rate. See “Liquidity and Capital Resources” for a description of our senior secured credit facility.the 2010 Credit Agreement.
Other Income (Expense), Net
Net otherOther income decreasedincreased to $0.7$1.2 million in 2008 from $9.52011, compared with other expense of $0.8 million in 2007. The decrease was due primarily to reduced cash, cash equivalents and marketable securities balances from which we generate interest income2010, 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 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 foreignthe currency exchange rates during 2008 as compared with 2007. 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 weWe expect our net other income in 20092012 will be less than 2008 levels.2011 levels because 2011 included these foreign exchange related net gains which are expected to be non-recurring.
Provision for Income Taxes
In 2008,2011, we recognized an income tax benefitexpense of $19.5$13.0 million compared towith an income tax expense of $2.9$7.6 million for 2007.2010. The annual effective income tax rate for 20082011 was (42.1)29.6 % compared to 21.6%with 29.0% for 2007. The 20082010.
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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 losses generatedearnings recognized in a lowlower tax jurisdiction (Ireland)jurisdictions, and the establishmentreduction of a valuation allowance related to net operating losses for one of our subsidiaries in the United Kingdom, partially offset by releasethe write-down of a valuation allowance relateddeferred tax asset relating to the 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.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 magnitude of our tax-exempt income, any future acquisitions and any futurepotential 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, 20072010 compared with the year ended December 31, 20062009
RevenueRevenues
RevenueRevenues increased to $210.3$332.8 million in 20072010 from $178.8$313.7 million in 2006.2009. The increase was primarily a result of the additionincremental sales, which include new customers and upgrades to existing customers, including increased sales of new, renewedour Web Security and upgraded subscriptionsWeb Security Gateway products pre-installed on appliances from our customers that resulted in a 1.3 million increase2009 to 2010. Revenue from products sold in the numberUnited States accounted for $165.3 million, or 50% of seats under subscription (excluding2010 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 additionnext twelve months) of approximately 26.7$251.9 million SurfControl seats) from
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as of December 31, 2006 to2010, compared with $239.0 million as of December 31, 2007. Our 20072009, and we had total deferred revenue also increasedof $394.3 million as of December 31, 2010, compared to 2006with $380.1 million as a result of the acquisitions of PortAuthority in January 2007 and SurfControl in October 2007.December 31, 2009.
Cost of RevenueRevenues
Cost of revenuerevenues increased to $29.1$53.1 million in 20072010 from $15.3$50.8 million in 2006.2009. The $2.3 million increase was primarily due to $6.6increased 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 which resulted from the acquisitions of SurfControl$3.9 million. Amortization of acquired technology was $9.0 million in October 2007 and PortAuthority2010 compared with $12.9 million in January 2007, as well as increased costs for additional personnel2009. The decrease of $3.9 million in our technical support and database groups, including the increaseamortization of acquired technology was primarily due to certain acquired technology being fully amortized in headcount attributable to the acquisition of SurfControl and the addition of DLP products, and allocated costs.2009. Our full-time employee headcount in cost of revenue departments increased from 152 at December 31, 2006an average of 258 employees during 2009 to 232 at December 31, 2007. Asan average of December 31, 2007, the acquired technology is being amortized over a remaining weighted average period of 3.7 years. As a percentage of revenue, cost of revenue266 employees during 2010.
Gross Profit
Gross profit increased to 14% during 2007 from 9% in 2006.
Gross Margin
Gross margin increased to $181.2$279.7 million in 20072010 from $163.5$262.9 million in 2006.2009. The increase was primarily due to increased revenue.revenue as described in the preceding Revenues section. As a percentage of revenue, gross margin decreased to 86% in 2007 from 91% in 2006 primarily due to the increased costs described in the preceding Cost of Revenue section.profit was 84% for both 2010 and 2009.
Operating Expenses
Selling and marketing.marketing. Selling and marketing expenses increaseddecreased to $126.2$157.8 million in 20072010 from $80.1$166.9 million in 2006. Approximately $13.6 million of the increase was due to the amortization of acquired intangibles (primarily customer relationships) which resulted from the acquisitions of SurfControl in October 2007 and PortAuthority in January 2007. As of December 31, 2007, the acquired customer relationships intangible assets
are being amortized over a remaining weighted average period of approximately 6.8 years. In addition to the amortization of acquired intangibles, the increase2009. The decrease in selling and marketing expenses was primarily due to additional expenses associated with our new channel strategy startedan $8.8 million reduction in 2006,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 and related travel, including new personnel addedof $1.0 million resulting from the PortAuthority and SurfControl acquisitions and allocated costs.changes to our internal sales team during 2010. Our headcount in sales and marketing increaseddecreased slightly from 358 employees at December 31, 2006an average of 594 during 2009 to 546 employees at December 31, 2007.an average of 583 during 2010.
Research and development.development. Research and development expenses increased to $40.9$54.3 million in 20072010 from $22.7$52.6 million in 2006.2009. The increase of $18.2$1.7 million in research and development expenses was primarily due to increased personnel cost, including costs of adding new full time employees due to the PortAuthority and SurfControl acquisitions, and increased hiring to support$2.4 million offset by a reduction in allocated costs of $0.9 million. Although our expanding list of technology partners, the enhancements of Websense Enterprise, the development of Websense Express and enhancements to additional products, and allocated costs. Our headcount increased in research and development from 129an 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 at December 31, 2006 to 346 employees at December 31, 2007. Includedwere in research and development for 2007 was $1.3 million of in-process research and development related to our PortAuthority acquisition in January 2007.relatively low cost foreign locations.
General and administrative.administrative. General and administrative expenses increaseddecreased to $32.7$36.8 million in 20072010 from $21.3$40.3 million in 2006.2009. The $11.4$3.5 million increasedecrease in general and administrative expenses was primarily due to additionala reduction in personnel needed to support our growing operations, including the acquisitions of PortAuthority and SurfControlcosts and allocated costs. Our headcount increaseddecreased in general and administrative departments from 63 at December 31, 2006an average of 127 during 2009 to 113 at December 31, 2007.an average of 120 during 2010.
Interest Expense
Interest expense representsdecreased to $3.7 million in 2010 compared with $7.1 million in 2009. The decrease was primarily due to a lower average outstanding loan balance under 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, as well as lower interest incurred on our senior secured credit facilityrates due to the reduction in the notional amount of principal subject to an unfavorable fixed rate swap agreement that we utilized to pay for a portion of the SurfControl purchase priceexpired in October 2007.September 2010. Also included in the interest expense is $763,000 of amortization of deferred financing fees of $1.0 million and $1.2 million for 2010 and 2009, 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
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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 debt outstanding under the respective 2007 Credit Agreement and 2010 Credit Agreement that reduced the outstanding balance from $87 million as of December 31, 2009 to $67 million as of December 31, 2010. As a result of more favorable terms in the 2010 Credit Agreement, our weighted average interest rate decreased from 5.7% in 2009 to 3.9% in 2010.
Other (Expense) Income, Net
NetOther (expense) income, net went from a net other income decreased to $9.5of $0.4 million in 2007 from $11.32009 to a net other expense of $0.8 million in 2006.2010. The decreasechange was due primarily to reduced cash, cash equivalents and marketable securities balances from which we generate interest income as a resultforeign exchange related net losses of our use of an aggregate of $272$1.3 million to fund the acquisitions of SurfControl in October 2007 and PortAuthority in January 2007 and related transaction costs. This decline in cash, cash equivalents and marketable securities was partially offset by higher interest rates realized on our balances of cash, cash equivalents and marketable securities during 2007 as2010 compared with 2006.net gains of $0.1 million in 2009 due to movements in the currency exchange rates during 2010 and 2009.
Provision for Income Taxes
In 2007,2010, we recognized an income tax expenseprovision of $2.9$7.6 million as compared to $18.7with an income tax provision of $7.1 million for 2006.2009. The annual effective income tax rate for 20072010 was 21.6%29.0% compared with 193.8% for 2009. The 2010 effective tax rate variance from the statutory rate primarily related to 36.8%earnings recognized in lower tax jurisdictions, and the reduction of a valuation allowance related to net operating losses for 2006. The decreaseone 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 the result of the following factors. Relatedrelated to the acquisition of SurfControl, we recorded certain post-acquisitionan increase in reserves for uncertain tax positions and an increase in valuation allowance related to net operating losses related to SurfControl’s U.S. operations for which noone of our subsidiaries in the United Kingdom, partially offset by income generated in low tax benefit is currently recorded due to the uncertainty of future utilization of these losses. Related to the acquisition of PortAuthority, we expensed acquired in-process research and development in our 2007 loss before income taxes for which a tax deduction is not allowed. In addition, although the share-based compensation for which no tax benefit is recorded in 2007 and our state income tax provision are both comparable to prior year’s amounts, the impact of these items on the effective tax rate percentage is greater due to the relative size of the pre-tax loss of $13.5 million in 2007 compared to the pre-tax income of $50.8 million in 2006.jurisdictions.
Recent Accounting Pronouncements
In March 2008June 2011, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133(“SFAS 161”),which requires additional disclosures about the objectives of derivative instruments and hedging activities, the method of accounting for such instruments under SFAS 133 and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged itemsauthoritative guidance on the Company’spresentation of other comprehensive income within the financial position, financial performance and cash flows. SFAS 161 isstatements that will become effective for usthe Company beginning January 1, 2009.2012, with earlier adoption permitted. The guidance provides an option to registrants to present total comprehensive income, the components 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 consolidated statement of stockholders’ equity. We are currently assessing the potential impactdo not believe that adoption of SFAS 161 maythe guidance will have a significant impact on our financial statements.
In December 2007 the FASB issued SFAS No. 141R,Business Combinations (“SFAS 141R”). SFAS 141R establishes principles and requirements for how the acquirerposition, results of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations we engage in after January 1, 2009 will be recorded and disclosed following SFAS 141R. We expect SFAS 141R will have an impact on our consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we may consummate after the effective date.operations or cash flows.
Liquidity and Capital Resources
As of December 31, 2008,2011, we had cash and cash equivalents (including restricted cash and cash equivalents) of approximately $66.8$76.2 million and retained earnings of $39.1$72.2 million. As of December 31, 2007,2010, we had cash and cash equivalents (including restricted cash and cash equivalents) of $68.0 million, investments in marketable securities of $19.8$77.4 million and retained earnings of $65.9$41.3 million. During 2008, we used $65Of the $76.2 million of cash and cash equivalents held as of December 31, 2011, $31.9 million was held by our foreign subsidiaries, and we plan to indefinitely reinvest the undistributed foreign earnings into our foreign operations. During 2011, we primarily used cash to pay down principal on our senior secured term loan and to repurchase approximately $20 millioncash equivalents in excess of our common stock.cash required for operations and for stock repurchases totaling $98.7 million.
Net cash provided by operating activities was $65.8$79.2 million in 20082011, compared with $53.5$90.1 million in 2007.2010. The $12.3$10.9 million increasedecrease in cash provided by operating activitiesflow from operations in 20082011 compared with 2010 was primarily athe result of our cash collections increasing due principally to increased sales resulting from the SurfControl acquisition and sales of new products, partially off-set by increased cash expenses principally associated with increasedhigher cash operating expenses after the SurfControl acquisitionresulting from higher headcount costs, third-party professional fees and interest payments associated with the senior secured credit facility utilized to finance the SurfControl acquisition.increased cash tax 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 2009.
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Net cash provided byused in investing activities was $10.1$9.9 million in 20082011, compared with $9.5 million in 2010. The $0.4 million increase in net cash used in investing activities of $259.9 million in 2007. The $270.0 million change in net cash provided by investing activities for 2008 was primarily due to the net cash paid for the acquisitionsacquisition of PortAuthority and SurfControl totaling approximately $477 million in 2007 and offset by the increase of net maturities over purchases of marketable securities of approximately $204 million in 2007 compared to 2008.intangible assets (acquired technology) during 2011.
Net cash used in financing activities was $76.2$70.4 million in 20082011, compared with net cash provided by financing activities of $189.0$85.6 million in 2007.2010. 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 $265.2$15.2 million changedecrease in net cash used in financing activities in 2008 was primarily due to borrowing $210 million on our senior secured term loana reduction in 2007 and making debt relatednet principal payments made under the Company’s credit facilities during 2011 compared with 2010, partially offset by increased purchases of approximately $30 million ($25.4 million on the senior secured credit facility related to SurfControl and $4.2 million related to PortAuthority) in 2007 compared to $65 million of debt related payments (on the senior secured term loan) in 2008. We also repurchased approximately $20 million of our commontreasury stock in 20082011 compared to making no stock repurchases in 2007.with 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, 2008, we have made prepayments totaling $85 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 $125 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 initially amortized at a minimum rate of 2.5%, 10%, 12.5%, and 15%, respectively, during the first four years of the term and 60% during the fifth year. In conjunction with our $20 million prepayment on December 31, 2007, we amended our Senior Credit Agreement to eliminate any additional mandatory principal payments until September 30, 2009. 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. The initial interest rate on the credit facility was LIBOR plus 250 basis points, and was subject to step downs in the spread over LIBOR based upon potential future improvements in our total leverage ratio. The unused portion of the revolving credit facility required a 50 basis points fee per annum, also subject to a step down based upon potential future improvements in our total leverage ratio. As of July 2008, the spread on both the senior secured term loan and revolving credit facility was reset to LIBOR plus 225 basis points per annum for the senior secured term loan and reduced by 25 basis points per annum for the unused portion of the revolving credit facility. The weighted average interest rate on the senior secured term loan at December 31, 2008 was 5.7%. 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 restrictions on (a) the incurrence of more than $15 million of new debt, includingto incur liens, to enter into mergers and acquisitions, to make dispositions, to pay cash dividends or repurchase capital leases (subjectstock, and to make investments, 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. On September 15, 2009, we announced that our previously issued financial statements contained in our annual reports on Form 10-K for the years ended December 31, 2007 and 2008, and our quarterly reports on Form 10-Q for the quarters ended March 31, 2008, June 30, 2008, September 30, 2008, March 31, 2009 and June 30, 2009 should no longer be relied upon because of errors in these financial statements. We subsequently restated our financial statements for these periods. We do not believe that these restatements of our financial statements resulted in any material non-compliance by us with the covenants or representations and warranties in our Senior Credit Agreement. While we have confirmed our compliance to our lenders and we have not received any notifications from our lenders to the contrary, there can be no assurance that our lenders will not take a different position from ours, seek to modify the interest rate or other terms of the Seniorexceptions. The 2010 Credit Agreement or pursue andoes not require us to use excess cash to pay down debt.
The 2010 Credit Agreement provides for acceleration of our obligations under the Senior Credit Agreement.
thereunder upon certain events of default. The Senior Credit Agreement provides that we must maintain hedge agreements so that at least 50%events 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 agreementdefault include, without limitation, failure to pay loan amounts when due, any material inaccuracy in our representations and warranties, failure to observe covenants, defaults on any other indebtedness, entering bankruptcy, existence of a fixed ratejudgment or decree against us or our subsidiaries involving an aggregate liability of $10 million or more, the security interest (4.85% per annum)or guarantee ceasing to be in full force and receive a floating rate interest payment (based on three month LIBOR) on an equivalent amount. The initial notional amounteffect, any person becoming the beneficial owner 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 we entered into an interest rate cap agreement to limit the maximum interest rate on a portionmore than 35% of our senior secured term loanoutstanding common stock, or our board of directors ceasing to 6.5% per annum. The amountconsist of principal protected by this agreement increases from $5.0 million at December 31, 2007 to $74.3 million on June 30, 2010. Botha majority of Continuing Directors (as defined in 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, 20082011 (in thousands):
Payment Obligations by Year | |||||||||||||||||||||
2009 | 2010 | 2011 | 2012 | 2013 | Thereafter | Total | |||||||||||||||
Senior secured term loan: | |||||||||||||||||||||
Scheduled principal payments | $ | 4,112 | $ | 17,270 | $ | 20,724 | $ | 82,894 | $ | — | $ | — | $ | 125,000 | |||||||
Estimated interest and fees | 6,764 | 4,774 | 3,610 | 1,996 | — | — | 17,144 | ||||||||||||||
Operating leases | 6,409 | 5,509 | 4,166 | 3,881 | 3,762 | 1,001 | 24,728 | ||||||||||||||
Facility exit obligation | 1,013 | 1,064 | 733 | — | — | — | 2,810 | ||||||||||||||
Software licenses | 585 | 97 | — | — | — | — | 682 | ||||||||||||||
Total | $ | 18,883 | $ | 28,714 | $ | 29,233 | $ | 88,771 | $ | 3,762 | $ | 1,001 | $ | 170,364 | |||||||
Payment Obligations by Year | ||||||||||||||||||||||||||||
2012 | 2013 | 2014 | 2015 | 2016 | Thereafter | Total | ||||||||||||||||||||||
2010 Credit Agreement: | ||||||||||||||||||||||||||||
Contractual principal payments | $ | 0 | $ | 0 | $ | 0 | $ | 73,000 | $ | 0 | $ | 0 | $ | 73,000 | ||||||||||||||
Estimated interest and fees | 2,419 | 2,406 | 2,406 | 1,991 | 0 | 0 | 9,222 | |||||||||||||||||||||
Operating leases | 6,616 | 6,403 | 2,203 | 792 | 0 | 0 | 16,014 | |||||||||||||||||||||
Other commitments | 3,144 | 2,196 | 1,469 | 0 | 0 | 0 | 6,809 | |||||||||||||||||||||
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Total | $ | 12,179 | $ | 11,005 | $ | 6,078 | $ | 75,783 | $ | 0 | $ | 0 | $ | 105,045 | ||||||||||||||
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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, 20082011 (see Note 96 to the auditedconsolidated financial statements).
We lease our facilities under operating lease agreements that expire at various dates through 2015. Approximately one-half35% 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.
Facility exit obligation represents estimated future lease costs from a facility acquired from SurfControl that is being exited (as more fully described in Note 5 to the audited financial statements). These costs will be paid over the respective lease term through 2011. These amounts are included in our consolidated balance sheet.
Software licenseAs of December 31, 2011, we had contractual commitment obligations represent purchase commitments for inbound software licenses, madeequipment maintenance, royalty agreements and automobile leases in the ordinary course of business.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, 2008,2011, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities. Therefore, $8.8$10.1 million of gross unrecognized tax benefits (as more fully described in Note 1310 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, 20082011, 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 2007,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. 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
2011 ANNUAL REPORT | 51 |
be commenced or suspended at any time, or from time to time, without prior notice to us. During 2008, we repurchased 1,079,049 shares of our common stock for an aggregate of approximately $20 million at an average price of $18.53 per share. As of December 31, 2008, we had cumulatively repurchased 9,249,109 shares of our common stock under this program for an aggregate of $190.4 million at an average price of $20.59 per share. Under the terms of the Senior Credit Agreement, we
Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Our market risk exposures are restricted from repurchasing our common stock for an aggregate purchase price that exceeds the sum of $25 million plus 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. As of December 31, 2008, we can repurchase uprelated to $29.9 million of our common stock under our Senior Credit Agreement, excluding shares we had repurchased through December 31, 2008. We intend to purchase shares during the remainder of 2009.
Prospective Capital Needs. We believe that our cash and cash equivalents balances,and 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 secured 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 the 2010 Credit Facility. In connection with the 2010 Credit Agreement we 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.
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 agreement that became effective on December 30, 2011. Based on our revolving credit balancesbalance at December 31, 2011 and taking into consideration our ongoing cash flow from operations will be sufficient to satisfyinterest rate swap agreement, our cash requirements, including our capital expenditures, debt repayment obligations and stock repurchases, if any, for at leastinterest expense would increase on a pre-tax basis by approximately $0.2 million during the next 12 months. During 2008, we made voluntary prepayments on our senior secured term loan of $65 million and repurchased $20 millionmonths if a 100 basis point adverse move in the interest rate yield 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 common stock. Ourinterest sensitive investments at December 31, 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 to hedge foreign currency market exposures of underlying assets, liabilities and expenses. 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 requirements may increase for reasons weflows associated with changes in currency exchange rates. We do not currently foreseeuse foreign currency contracts for speculative or we may make acquisitions as parttrading purposes.
Notional and fair values of our growth strategyhedging positions at December 31, 2011 and 2010 are presented in the table below (in thousands):
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 $3.5 million notional increase in our Euro hedge position at December 31, 2011 compared with December 31, 2010 was primarily due to the 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, 2011 are scheduled to be settled before June 2012. For 2011 and 2010, less than 15% and 20%, respectively, of our total billings were denominated in the Euro. We expect Euro billings to represent less than 15% of our total billings during 2012.
The $1.9 million notional decrease in our British Pound hedge position at December 31, 2011 compared with December 31, 2010 was due to having no British Pound hedging contracts in place as of December 31, 2011. For 2011 and 2010, less than 15% of our total billings were denominated in the British Pound. We expect British Pound billings to represent less than 15% of our total billings during 2012.
We had no Australian Dollar or Chinese Renminbi hedging contracts in place as of December 31, 2011 or 2010.
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. 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 increase our cash requirements. We may elect to raise fundsare not denominated in U.S. dollars. Our revenues and deferred revenue for these purposes through capital markets transactions or debt or private equity transactions as appropriate.foreign currencies are recorded in U.S. dollars when the 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 intend to continue to investengage in currency hedging activities with the intent of limiting the risk of exchange rate fluctuations, but our cashforeign exchange hedging activities also involve inherent risks that could result in excess of current operating and capital requirements in interest-bearing, investment-grade securities.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, 2008 (as restated),2011 and 2007 (as restated),2010 and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the twothree years in the period ended December 31, 2008 (as restated) and the year ended December 31, 2006.2011. 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, 2008 (as restated),2011 and 2007 (as restated),2010, and the consolidated results of its operations and its cash flows for each of the twothree years in the period ended December 31, 2008 (as restated) and the year ended December 31, 2006,2011, 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 2, the accompanying consolidated financial statements have been restated for the correction of errors in the Company’s application of Statement of Position No. 97-2,Software Revenue Recognitionas it relates to arrangements with original equipment manufacturer customers that were acquired in connection with the acquisition of SurfControl in October 2007 and errors in the Company’s computation of its income tax benefit for the year ended December 31, 2008.
As discussed in Note 1 to the consolidated financial statements, Websense Inc. adopted FASB Interpretation No. 48 “Accountingchanged its method of accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109,”revenue recognition effective January 1, 2007.2011.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Websense, Inc.’s internal control over financial reporting as of December 31, 2008,2011, 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 24, 2009, except for the effects of the material weaknesses described in the sixth paragraph of that report, as to which the date is October 28, 2009,23, 2012 expressed an adverseunqualified opinion on the effectiveness of internal control over financial reporting.thereon.
/S/s/ ERNST & YOUNG LLP
San Diego, California
February 24, 2009, except for the effects on the consolidated financial statements of the restatement described in Note 2, as to which the date is
October 28, 200923, 2012
54 | 2011 ANNUAL REPORT |
Websense, Inc.
Consolidated Balance Sheets
(In thousands, except par value amounts)
December 31, | ||||||||||||||||
2008 | 2007 | December 31, | ||||||||||||||
(As Restated) (See Note 2) | (As Restated) (See Note 2) | 2011 | 2010 | |||||||||||||
Assets | ||||||||||||||||
Current assets: | ||||||||||||||||
Cash and cash equivalents | $ | 64,096 | $ | 66,090 | $ | 76,201 | $ | 77,390 | ||||||||
Cash and cash equivalents—restricted | 2,500 | — | 0 | 256 | ||||||||||||
Marketable securities | — | 19,781 | ||||||||||||||
Accounts receivable, net of allowance for doubtful accounts of $1,752 and $2,131 at December 31, 2008 and 2007 | 82,099 | 76,328 | ||||||||||||||
Income tax receivable | 10,927 | 3,734 | ||||||||||||||
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 | 34,198 | 22,870 | 30,021 | 36,191 | ||||||||||||
Other current assets | 9,029 | 10,109 | 13,793 | 14,708 | ||||||||||||
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Total current assets | 202,849 | 198,912 | 200,900 | 213,487 | ||||||||||||
Cash and cash equivalents—restricted, less current portion | 215 | 1,862 | 628 | 434 | ||||||||||||
Property and equipment, net | 14,312 | 17,657 | 16,832 | 16,944 | ||||||||||||
Intangible assets, net | 106,493 | 152,906 | 26,412 | 41,078 | ||||||||||||
Goodwill | 372,624 | 385,916 | 372,445 | 372,445 | ||||||||||||
Deferred income taxes, less current portion | 24,237 | 19,288 | 8,599 | 6,352 | ||||||||||||
Deposits and other assets | 3,933 | 4,198 | 8,622 | 11,203 | ||||||||||||
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Total assets | $ | 724,663 | $ | 780,739 | $ | 634,438 | $ | 661,943 | ||||||||
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Liabilities and stockholders’ equity | ||||||||||||||||
Current liabilities: | ||||||||||||||||
Accounts payable | $ | 2,719 | $ | 3,255 | $ | 9,026 | $ | 6,858 | ||||||||
Accrued compensation and related benefits | 19,129 | 28,960 | 22,770 | 22,168 | ||||||||||||
Other accrued expenses | 27,946 | 30,449 | 16,534 | 18,704 | ||||||||||||
Current portion of income taxes payable | 7,135 | 1,388 | 3,187 | 549 | ||||||||||||
Current portion of senior secured term loan | 4,112 | — | ||||||||||||||
Current portion of deferred tax liability | 1,053 | 10,399 | 86 | 367 | ||||||||||||
Current portion of deferred revenue | 223,944 | 191,022 | 250,597 | 251,890 | ||||||||||||
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Total current liabilities | 286,038 | 265,473 | 302,200 | 300,536 | ||||||||||||
Other long term liabilities | 2,616 | 1,634 | 2,600 | 2,388 | ||||||||||||
Income taxes payable, less current portion | 10,098 | 13,210 | 11,955 | 16,065 | ||||||||||||
Senior secured term loan, less current portion | 120,888 | 190,000 | ||||||||||||||
Secured loan, less current portion | 73,000 | 67,000 | ||||||||||||||
Deferred tax liability, less current portion | 10,523 | 20,964 | 2,501 | 1,877 | ||||||||||||
Deferred revenue, less current portion | 117,840 | 97,021 | 142,437 | 142,414 | ||||||||||||
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Total liabilities | 548,003 | 588,302 | 534,693 | 530,280 | ||||||||||||
Stockholders’ equity: | ||||||||||||||||
Common stock—$0.01 par value; 100,000 shares authorized; 45,048 and 45,394 shares issued and outstanding at December 31, 2008 and 2007 | 522 | 515 | ||||||||||||||
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 | 300,050 | 267,142 | 415,573 | 373,229 | ||||||||||||
Treasury stock, at cost | (159,842 | ) | (139,792 | ) | (385,544 | ) | (282,570 | ) | ||||||||
Retained earnings | 39,113 | 65,892 | 72,247 | 41,253 | ||||||||||||
Accumulated other comprehensive loss | (3,183 | ) | (1,320 | ) | (3,099 | ) | (797 | ) | ||||||||
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Total stockholders’ equity | 176,660 | 192,437 | 99,745 | 131,663 | ||||||||||||
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Total liabilities and stockholders’ equity | $ | 724,663 | $ | 780,739 | $ | 634,438 | $ | 661,943 | ||||||||
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See accompanying notes.notes to consolidated financial statements
2011 ANNUAL REPORT | 55 |
Websense, Inc.
Consolidated Statements of Operations
(In thousands, except per share amounts)
Years Ended December 31, | |||||||||||
2008 | 2007 | 2006 | |||||||||
(As Restated) (See Note 2) | (As Restated) (See Note 2) | ||||||||||
Revenues | $ | 288,274 | $ | 210,307 | $ | 178,814 | |||||
Cost of revenues | 48,160 | 29,140 | 15,274 | ||||||||
Gross margin | 240,114 | 181,167 | 163,540 | ||||||||
Operating expenses: | |||||||||||
Selling and marketing | 175,365 | 126,247 | 80,135 | ||||||||
Research and development | 53,274 | 40,913 | 22,663 | ||||||||
General and administrative | 45,343 | 32,708 | 21,279 | ||||||||
Total operating expenses | 273,982 | 199,868 | 124,077 | ||||||||
(Loss) income from operations | (33,868 | ) | (18,701 | ) | 39,463 | ||||||
Interest expense | (13,134 | ) | (4,308 | ) | — | ||||||
Other income, net | 739 | 9,461 | 11,287 | ||||||||
(Loss) income before income taxes | (46,263 | ) | (13,548 | ) | 50,750 | ||||||
(Benefit) provision for income taxes | (19,484 | ) | 2,933 | 18,657 | |||||||
Net (loss) income | $ | (26,779 | ) | $ | (16,481 | ) | $ | 32,093 | |||
Net (loss) income per share: | |||||||||||
Basic net (loss) income per share | $ | (0.59 | ) | $ | (0.37 | ) | $ | 0.69 | |||
Diluted net (loss) income per share | $ | (0.59 | ) | $ | (0.37 | ) | $ | 0.68 | |||
Weighted average shares—basic | 45,190 | 45,107 | 46,494 | ||||||||
Weighted average shares—diluted | 45,190 | 45,107 | 47,116 |
Years Ended December 31, | ||||||||||||
2011 | 2010 | 2009 | ||||||||||
Revenues: | ||||||||||||
Software and service | $ | 325,373 | $ | 320,544 | $ | 311,476 | ||||||
Appliance | 38,810 | 12,218 | 2,237 | |||||||||
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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 | |||||||||
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|
|
|
|
| |||||||
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.
Consolidated Statements of Stockholders’ Equity
(In thousands)
Common stock | Additional paid-in capital | Treasury stock | Retained earnings | Accumulated other comprehensive income (loss) | Total stockholders’ equity | Accumulated other comprehensive loss | Total stockholders’ equity | |||||||||||||||||||||||||||||||||||||||||||||||
Shares | Amount | Common stock | Additional paid-in capital | Treasury stock | Retained earnings | |||||||||||||||||||||||||||||||||||||||||||||||||
(As Restated) (See Note 2) | (As Restated) (See Note 2) | Shares | Amount | |||||||||||||||||||||||||||||||||||||||||||||||||||
Balance at January 1, 2006 | 47,942 | $ | 500 | $ | 197,826 | $ | (48,340 | ) | $ | 50,655 | $ | (624 | ) | $ | 200,017 | |||||||||||||||||||||||||||||||||||||||
Issuance of common stock upon exercise of options | 946 | 7 | 11,573 | — | — | — | 11,580 | |||||||||||||||||||||||||||||||||||||||||||||||
Issuance of common stock for ESPP purchase | 197 | 2 | 3,978 | — | — | — | 3,980 | |||||||||||||||||||||||||||||||||||||||||||||||
Share-based compensation expense | — | — | 20,358 | — | — | — | 20,358 | |||||||||||||||||||||||||||||||||||||||||||||||
Excess tax benefit of share-based compensation | — | — | 3,567 | — | — | — | 3,567 | |||||||||||||||||||||||||||||||||||||||||||||||
Purchase of treasury stock | (4,300 | ) | — | — | (91,404 | ) | — | — | (91,404 | ) | ||||||||||||||||||||||||||||||||||||||||||||
Net income | — | — | — | — | 32,093 | — | 32,093 | |||||||||||||||||||||||||||||||||||||||||||||||
Net change in unrealized gain on marketable securities, net of tax | — | — | — | — | — | 458 | 458 | |||||||||||||||||||||||||||||||||||||||||||||||
Net change in unrealized gain on fair value of foreign currency contracts, net of tax | — | — | — | — | — | 76 | 76 | |||||||||||||||||||||||||||||||||||||||||||||||
Comprehensive income | 32,627 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Balance at December 31, 2006 | 44,785 | 509 | 237,302 | (139,744 | ) | 82,748 | (90 | ) | 180,725 | |||||||||||||||||||||||||||||||||||||||||||||
Cumulative impact of change in accounting for uncertainties in income taxes —upon adoption of FIN 48 (see Note 13) | — | — | (859 | ) | — | (375 | ) | — | (1,234 | ) | ||||||||||||||||||||||||||||||||||||||||||||
Balance at January 1, 2007 upon adoption of FIN 48 | 44,785 | 509 | 236,443 | (139,744 | ) | 82,373 | (90 | ) | 179,491 | |||||||||||||||||||||||||||||||||||||||||||||
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 | 339 | 4 | 3,256 | — | — | — | 3,260 | 205 | 3 | 2,430 | 0 | 0 | 0 | 2,433 | ||||||||||||||||||||||||||||||||||||||||
Issuance of common stock for ESPP purchase | 240 | 2 | 4,315 | — | — | — | 4,317 | 378 | 4 | 5,428 | 0 | 0 | 0 | 5,432 | ||||||||||||||||||||||||||||||||||||||||
Issuance of common stock from restricted stock units, net | 30 | — | — | (48 | ) | — | — | (48 | ) | 64 | 0 | 0 | (330 | ) | 0 | 0 | (330 | ) | ||||||||||||||||||||||||||||||||||||
Share-based compensation expense | — | — | 22,076 | — | — | — | 22,076 | 0 | 0 | 24,765 | 0 | 0 | 0 | 24,765 | ||||||||||||||||||||||||||||||||||||||||
Excess tax benefit of share-based compensation | — | — | 1,052 | — | — | — | 1,052 | |||||||||||||||||||||||||||||||||||||||||||||||
Net loss (as restated—See Note 2) | — | — | — | — | (16,481 | ) | — | (16,481 | ) | |||||||||||||||||||||||||||||||||||||||||||||
Net change in unrealized gain on marketable securities, net of tax | — | — | — | — | — | 81 | 81 | |||||||||||||||||||||||||||||||||||||||||||||||
Tax shortfall from share-based compensation | 0 | 0 | (2,222 | ) | 0 | 0 | 0 | (2,222 | ) | |||||||||||||||||||||||||||||||||||||||||||||
Purchase of treasury stock | (2,285 | ) | 0 | 0 | (34,500 | ) | 0 | 0 | (34,500 | ) | ||||||||||||||||||||||||||||||||||||||||||||
Components of comprehensive loss: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net loss | 0 | 0 | 0 | 0 | (10,697 | ) | 0 | (10,697 | ) | |||||||||||||||||||||||||||||||||||||||||||||
Net change in unrealized loss on derivative contracts, net of tax | — | — | — | — | — | (989 | ) | (989 | ) | 0 | 0 | 0 | 0 | 0 | 1,189 | 1,189 | ||||||||||||||||||||||||||||||||||||||
Translation adjustments | — | — | — | — | — | (322 | ) | (322 | ) | |||||||||||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Comprehensive loss (as restated—See Note 2) | (17,711 | ) | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Comprehensive loss | (9,508 | ) | ||||||||||||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
| ||||||||||||||||||||||||||||||||||||||||||||||||
Balance at December 31, 2007 (as restated—See Note 2) | 45,394 | 515 | 267,142 | (139,792 | ) | 65,892 | (1,320 | ) | 192,437 | |||||||||||||||||||||||||||||||||||||||||||||
Balance at December 31, 2009 | 43,410 | 529 | 330,451 | (194,672 | ) | 22,601 | (1,994 | ) | 156,915 | |||||||||||||||||||||||||||||||||||||||||||||
Issuance of common stock upon exercise of options | 356 | 4 | 4,307 | — | — | — | 4,311 | 973 | 10 | 15,982 | 0 | 0 | 0 | 15,992 | ||||||||||||||||||||||||||||||||||||||||
Issuance of common stock for ESPP purchase | 347 | 3 | 5,318 | — | — | — | 5,321 | 440 | 5 | 5,986 | 0 | 0 | 0 | 5,991 | ||||||||||||||||||||||||||||||||||||||||
Issuance of common stock from restricted stock units, net | 30 | — | — | (52 | ) | — | — | (52 | ) | 268 | 4 | 0 | (2,900 | ) | 0 | 0 | (2,896 | ) | ||||||||||||||||||||||||||||||||||||
Share-based compensation expense | — | — | 24,089 | — | — | — | 24,089 | 0 | 0 | 22,565 | 0 | 0 | 0 | 22,565 | ||||||||||||||||||||||||||||||||||||||||
Tax shortfall from stock option exercises | — | — | (806 | ) | — | — | — | (806 | ) | |||||||||||||||||||||||||||||||||||||||||||||
Tax shortfall from share-based compensation | 0 | 0 | (1,755 | ) | 0 | 0 | 0 | (1,755 | ) | |||||||||||||||||||||||||||||||||||||||||||||
Purchase of treasury stock | (1,079 | ) | — | — | (19,998 | ) | — | — | (19,998 | ) | (4,090 | ) | 0 | 0 | (84,998 | ) | 0 | 0 | (84,998 | ) | ||||||||||||||||||||||||||||||||||
Net loss (as restated—See Note 2) | — | — | — | — | (26,779 | ) | — | (26,779 | ) | |||||||||||||||||||||||||||||||||||||||||||||
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 | — | — | — | — | — | (560 | ) | (560 | ) | 0 | 0 | 0 | 0 | 0 | (1,764 | ) | (1,764 | ) | ||||||||||||||||||||||||||||||||||||
Translation adjustments | — | — | — | — | — | (1,303 | ) | (1,303 | ) | 0 | 0 | 0 | 0 | 0 | (538 | ) | (538 | ) | ||||||||||||||||||||||||||||||||||||
| ||||||||||||||||||||||||||||||||||||||||||||||||||||||
Comprehensive loss (as restated—See Note 2) | (28,642 | ) | ||||||||||||||||||||||||||||||||||||||||||||||||||||
Comprehensive income | 28,692 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
| ||||||||||||||||||||||||||||||||||||||||||||||||
Balance at December 31, 2008 (as restated—See Note 2) | 45,048 | $ | 522 | $ | 300,050 | $ | (159,842 | ) | $ | 39,113 | $ | (3,183 | ) | $ | 176,660 | |||||||||||||||||||||||||||||||||||||||
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.
Consolidated Statements of Cash Flows
(In thousands)
Years ended December 31, | ||||||||||||
2008 | 2007 | 2006 | ||||||||||
(As Restated) (See Note 2) | (As Restated) (See Note 2) | |||||||||||
Operating activities: | ||||||||||||
Net (loss) income | $ | (26,779 | ) | $ | (16,481 | ) | $ | 32,093 | ||||
Adjustments to reconcile net (loss) income to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 62,994 | 28,604 | 3,406 | |||||||||
Share-based compensation | 24,089 | 22,076 | 20,358 | |||||||||
Deferred income taxes | (28,229 | ) | (14,882 | ) | (10,170 | ) | ||||||
Unrealized (gain) loss on foreign exchange | (632 | ) | 543 | 76 | ||||||||
Tax shortfall (windfall) from stock option exercises | 806 | (1,052 | ) | (3,567 | ) | |||||||
Changes in operating assets and liabilities, net of effects from purchases of PortAuthority and SurfControl: | ||||||||||||
Accounts receivable | (3,765 | ) | (6,744 | ) | (2,170 | ) | ||||||
Other assets | (8,271 | ) | (5,160 | ) | 211 | |||||||
Accounts payable | (1,111 | ) | (1,181 | ) | 639 | |||||||
Accrued compensation and related benefits | (5,718 | ) | 1,088 | 688 | ||||||||
Other liabilities | (2,584 | ) | (5,658 | ) | 1,999 | |||||||
Deferred revenue | 54,465 | 47,664 | 34,624 | |||||||||
Income taxes payable | 546 | 4,717 | 5,491 | |||||||||
Net cash provided by operating activities | 65,811 | 53,534 | 83,678 | |||||||||
Investing activities: | ||||||||||||
Change in restricted cash and cash equivalents | (1,240 | ) | (261 | ) | — | |||||||
Purchase of property and equipment | (7,911 | ) | (5,866 | ) | (4,143 | ) | ||||||
Purchase of intangible assets | (2,061 | ) | — | (1,200 | ) | |||||||
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 | ) | (649,486 | ) | ||||||
Maturities of marketable securities | 39,963 | 730,595 | 665,322 | |||||||||
Net cash provided by (used in) investing activities | 10,138 | (259,938 | ) | 10,493 | ||||||||
Financing activities: | ||||||||||||
Borrowings under senior secured term loan | — | 210,000 | — | |||||||||
Principal payments on senior secured term loan | (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 exercise of stock options | 4,311 | 3,260 | 11,580 | |||||||||
Proceeds from issuance of common stock for stock purchase plan | 5,321 | 4,317 | 3,980 | |||||||||
Tax (shortfall) windfall from stock option exercises | (806 | ) | 1,052 | 3,567 | ||||||||
Purchase of treasury stock | (19,998 | ) | — | (91,404 | ) | |||||||
Net cash (used in) provided by financing activities | (76,172 | ) | 188,971 | (72,277 | ) | |||||||
Effect of exchange rate changes on cash and cash equivalents | (1,771 | ) | — | — | ||||||||
Increase (decrease) in cash and cash equivalents | (1,994 | ) | (17,433 | ) | 21,894 | |||||||
Cash and cash equivalents at beginning of year | 66,090 | 83,523 | 61,629 | |||||||||
Cash and cash equivalents at end of year | $ | 64,096 | $ | 66,090 | $ | 83,523 | ||||||
Supplemental disclosures of cash flow information: | ||||||||||||
Income taxes paid | $ | 13,066 | $ | 15,994 | $ | 17,493 | ||||||
Interest paid | $ | 10,778 | $ | 3,526 | $ | — | ||||||
Unrealized gain on marketable securities | $ | — | $ | 81 | $ | 458 |
Years Ended December 31, | ||||||||||||
2011 | 2010 | 2009 | ||||||||||
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 | 26,286 | 37,873 | 51,374 | |||||||||
Share-based compensation | 18,976 | 22,565 | 24,765 | |||||||||
Deferred income taxes | 5,423 | (264 | ) | (586 | ) | |||||||
Unrealized loss (gain) on foreign exchange | (137 | ) | 490 | 512 | ||||||||
Excess tax benefit from share-based compensation | (2,596 | ) | (1,552 | ) | (208 | ) | ||||||
Changes in operating assets and liabilities: | ||||||||||||
Accounts receivable | 957 | 1,712 | (535 | ) | ||||||||
Other assets | 2,251 | (5,121 | ) | (10,256 | ) | |||||||
Accounts payable | 1,667 | 2,346 | 2,659 | |||||||||
Accrued compensation and related benefits | 449 | (274 | ) | 3,431 | ||||||||
Other liabilities | (4,161 | ) | (2,246 | ) | (7,785 | ) | ||||||
Deferred revenue | (1,246 | ) | 14,191 | 38,329 | ||||||||
Income taxes payable and receivable/prepaid | 328 | 1,747 | 1,852 | |||||||||
|
|
|
|
|
| |||||||
Net cash provided by operating activities | 79,191 | 90,119 | 92,855 | |||||||||
|
|
|
|
|
| |||||||
Investing activities: | ||||||||||||
Change in restricted cash and cash equivalents | 31 | (199 | ) | 2,347 | ||||||||
Purchase of property and equipment | (9,117 | ) | (9,259 | ) | (12,167 | ) | ||||||
Purchase of intangible assets | (765 | ) | 0 | (320 | ) | |||||||
|
|
|
|
|
| |||||||
Net cash used in investing activities | (9,851 | ) | (9,458 | ) | (10,140 | ) | ||||||
|
|
|
|
|
| |||||||
Financing activities: | ||||||||||||
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 | 16,719 | 15,992 | 2,433 | |||||||||
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 | (98,712 | ) | (84,854 | ) | (34,158 | ) | ||||||
|
|
|
|
|
| |||||||
Net cash used in financing activities | (70,366 | ) | (85,611 | ) | (64,414 | ) | ||||||
|
|
|
|
|
| |||||||
Effect of exchange rate changes on cash and cash equivalents | (163 | ) | (522 | ) | 465 | |||||||
(Decrease) increase in cash and cash equivalents | (1,189 | ) | (5,472 | ) | 18,766 | |||||||
Cash and cash equivalents at beginning of year | 77,390 | 82,862 | 64,096 | |||||||||
|
|
|
|
|
| |||||||
Cash and cash equivalents at end of year | $ | 76,201 | $ | 77,390 | $ | 82,862 | ||||||
|
|
|
|
|
| |||||||
Cash paid during the period for: | ||||||||||||
Income taxes paid, net of refunds | $ | 8,597 | $ | 6,792 | $ | 9,899 | ||||||
Interest paid | $ | 1,421 | $ | 3,571 | $ | 5,867 | ||||||
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 |
Notes to Consolidated Financial Statements
December 31, 2008
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 unified Web, filteringemail and security, data loss prevention, and email anti-spam andcontent security solutions providing products thatdesigned to protect organizations’ employeesan organization’s data and critical business datausers from external Web-based and email-basedinternal threats, including modern cyber-threats, advanced malware attacks, information leaks, legal liability and from internal employee-generated threats suchproductivity loss. The Company provides its solutions to its customers as employee errorssoftware installed on standard servers or malfeasance.other information technology hardware, including the Company’s optimized appliances, as a cloud-based service (software-as-a-service or “SaaS”) offering, or in a hybrid hardware/SaaS configuration. The Company’s customers use its software products and services are sold worldwide to provide content security to enterprise customers, small and medium sized businesses, public sector entities, and Internet service providers through a securenetwork of distributors, value-added resellers and productive computing environment for employees, business partnersoriginal equipment manufacturers (“OEMs”).
Reclassifications
Certain prior year amounts relating to the breakout of appliance revenues and customers.appliance cost of revenues in the consolidated statement of operations have been reclassified to 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.
PriorFunctional Currency Designations
As of December 31, 2010, the Company’s international subsidiaries had the U.S. dollar as their functional currencies. In connection with the completion of a global restructuring of the Company’s 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 Company’s acquisitionrespective local currency for certain of SurfControl plc (“SurfControl”)its subsidiaries was appropriate as the primary economic environment in October 2007,which these entities operate changed as a result of the Company’s sales were primarily denominatedrestructuring. The change in its functional currency which had beendesignation was made prospectively effective as of the U.S. dollar. Withbeginning of fiscal 2011 and the acquisition of SurfControl, Websense has certain subsidiaries with functional currencies other than the U.S. dollar. The assets and liabilities ofadjustment from translating these subsidiaries, wheresubsidiaries’ financial statements from the local currency isto the functional currency, are translated to U.S. dollars at exchange rates in effect at the balance sheet date, with the resulting translation adjustments directlydollar was recorded toas 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 (loss). Revenue and expense accounts are translatedstatement at an average exchange ratesrate in effect during the year. 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) gains of $1.0 million, ($888,000), $453,0001.3 million) and $70,000$0.1 million for the years ended December 31, 2008, 20072011, 2010 and 2006,2009, respectively, which are included in “Otherother income net”(expense), net on its consolidated statements of operations.
Revenue Recognition
The Company has adopted American Institutemajority of Certified Public Accountants Statement of Position No. 97-2,Software Revenue Recognition(“SOP 97-2”) as amended by Statement of Position No. 98-9, as well as Staff Accounting Bulletin No. 104,Revenue Recognition, as issued by the SecuritiesCompany’s revenues are derived from software and Exchange Commission. These statements and bulletin provide guidance for recognizing revenue related to sales by software vendors.
The Company sells itsSaaS 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, 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 and all the other elements of revenue recognition have
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
been met.assured. Upon entering into a subscription arrangement for a fixed or determinable fee, the Company electronically delivers software access codes to userscustomers and then promptly invoices customers for the full amount of their subscriptions. Payment is due for the full term of the subscription, generally within 30-6030 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 web filtering 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 in accordance with Emerging Issues Task Force Issue No. 01-09,Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products),which states these payments and rebates should be recorded 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 2011, 2010 and 2009, the Company offset revenue for distributor marketing payments of $3.1 million, $3.1 million and $2.7 million, respectively, and channel rebates of $3.8 million, $3.5 million and $3.2 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. TheAs of December 31, 2011, the Company’s restricted cash is restrictedrelates to certain lease guarantees in its use for a credit card account, a capital reduction account in connection with a restructuring of an international subsidiary and lease guarantees.
Marketable Securities
The Company did not have any investments in marketable securities at December 31, 2008. Marketable securities at December 31, 2007 primarily consisted of municipal bonds. Securities classified as available for sale are reported at fair value, adjusted for other-than-temporary declines in value. The Company records other-than-temporary declines in value to earnings as realized losses. The Company has not had any investment security losses taken to date related to other-than-temporary declines in value. Unrealized holding gains and losses on securities available for sale are reported as a net amount in a separate component of accumulated other comprehensive income (loss) until realized. Realized gains and losses are recorded based on the specific identification method.
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
locations.
Interest on Cash and Marketable SecuritiesCash Equivalents
The Company’s interest on cash and cash equivalents, and marketable securities, included as a component of other income (expense), net in the Company’s consolidated statements of operations, was $1.6 million, $8.5 million and $11.2$0.2 million for each of the years ended December 31, 2008, 20072011, 2010 and 2006, respectively.2009.
Acquisitions, Goodwill and Other Intangible Assets
The Company accounts for acquired businesses using the purchaseacquisition method of accounting, in accordance with SFAS No. 141,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. In accordance with SFAS No. 142, theThe 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 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. In accordance with SFAS No. 144,The Company reviews for impairment by facts or circumstances, either external or internal, indicating that the Company reviews intangible assets for impairment whenever events or changes in circumstances indicate thatmay 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 2008, 20072011, 2010 or 2006.2009.
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 the senior secured term loanincome 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 facility.agreements. Deferred financing costs included in other current assets (current portion) and deposits and other assets (long term portion) on the consolidated balance sheets were $0.9 million and $1.2 million as of 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.
During 2008The Company utilizes Euro and 2007, the Company utilized EuroBritish Pound foreign currency forward contracts to hedge anticipated Euroforeign 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. Net realizedThe net gains (losses) related to the contracts designated as fair value hedges settled during 2008 and 2007 are included in other income (expense), net, in the accompanying consolidated statements of operations and amounted to approximately $132,000$0.9 million, $0.4 million and $0.2 million for 20082011, 2010 and $279,000 for 2007,2009, respectively.
During 2008, All of the Company utilizedfair value hedging contracts in place as of December 31, 2011 will be settled before June 2012. There were no outstanding British Pound foreign currency forwardhedging contracts to hedge anticipated British Pound denominated net monetary assets. All such contracts entered into were designatedin place as fair value
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
of December 31, 2008
hedges and were not required to be tested for effectiveness as hedge accounting was not elected. Net realized gains related to the contracts designated as fair value hedges settled during 2008 are included in other income, net in the accompanying consolidated statements of operations and amounted to approximately $161,000 for 2008.
During 2008, the Company utilized Israeli Shekel zero-cost collar contracts to hedge anticipated operating expenses. All such contracts entered into were designated as cash flow hedges and were considered effective as defined by SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), as amended. None of the contracts were terminated prior to settlement. Net realized losses related to the contracts designated as cash flow hedges settled during 2008 are included in the respective operating categories the Company hedged its Israeli Shekel expenditures against. These net realized losses amounted to approximately ($23,000) in 2008.2011.
Notional and fair values of the Company’s hedging positions at December 31, 20082011 and 20072010 are presented in the table below (in thousands):
December 31, 2008 | December 31, 2007 | December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||||||||||
Notional Value Local Currency | Notional Value USD | Fair Value USD | Notional Value Local Currency | Notional Value USD | Fair Value USD | |||||||||||||||||||||||||||||||||||||
Fair Value Hedges | Notional Value Local Currency | Notional Value USD | Fair Value USD | Notional Value Local Currency | Notional Value USD | Fair Value USD | ||||||||||||||||||||||||||||||||||||
Euro | €13,000 | $ | 16,820 | $ | 15,512 | € | 1,500 | $ | 2,189 | $ | 2,167 | 11,000 | $ | 14,909 | $ | 14,266 | 8,550 | $ | 11,405 | $ | 11,449 | |||||||||||||||||||||
British Pound | £ | 5,500 | 8,196 | 8,419 | £ | — | — | — | 0 | 0 | 0 | 1,250 | 1,938 | 1,958 | ||||||||||||||||||||||||||||
Israeli Shekel | ILS 950 | 251 | 254 | ILS — | — | — | ||||||||||||||||||||||||||||||||||||
Total | $ | 25,267 | $ | 24,185 | $ | 2,189 | $ | 2,167 | ||||||||||||||||||||||||||||||||||
Euro forward contracts at December 31, 2008 were designated as fair value hedgesIn connection with the 2007 amended and were not required to be tested for effectiveness as hedge accounting was not elected. All Euro contracts outstanding at December 31, 2008 will be settled before March 31, 2009. Realized gains or losses related to the settlements, if any, will be recorded in other income, net at the time of settlement.
British Pound forward contracts at December 31, 2008 were designated as fair value hedges and were not required to be tested for effectiveness as hedge accounting was not elected. All British Pound contracts outstanding at December 31, 2008 will be settled before February 28, 2009. Realized gains or losses related to the settlements, if any, will be recorded in other income, net at the time of settlement.
Israeli Shekel zero-cost collar contracts at December 31, 2008 were designated as cash flow hedges and were determined to be effective as of December 31, 2008. All Israeli Shekel contracts outstanding at December 31, 2008 will be settled before February 28, 2009. Realized gains and losses related to the settlements, if any, will be recorded in the respective operating categories the Company hedges its Israeli Shekel expenditures against.
The Company’s Senior Credit Agreement provides that the Company must maintain hedge agreements so that at least 50% of the aggregate principal amount of therestated 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
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
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.America (See Note 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 23%28%, 31% and 12%30% of the Company’s revenues during 2011, 2010 and 2009, 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 appliance 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 $2.2 million and $2.1 million at December 31, 2011 and 2010, respectively.
Deferred Cost of Revenues
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 during 2008recognition rules under which the related costs are generally recognized when the appliances are sold. Deferred costs of revenues included in other current assets (current portion) and 2007,deposits and other assets (long term portion) on the consolidated balance sheets were $4.4 million and $9.1 million as of December 31, 2011 and 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
In accordance with SFAS No. 86,AccountingComputer software development costs for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed, costs are capitalized, when significant, in 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.
The Company accounts for internally developed computer software costs in accordance with SOP No. 98-1,Accounting for Costs of Computer Software Developed or Obtained for Internal Use.
Advertising Expenses
Advertising costs are expensed as incurred. Total advertising costs for each of the years ended December 31, 2008, 20072011, 2010 and 20062009 were $7.8$6.1 million, $7.8$6.0 million and $4.9$6.6 million, respectively.
64 | 2011 ANNUAL REPORT |
Share-Based Compensation
Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R),Share-Based Payment(“SFAS 123R”), using the modified prospective transition method. Under that transition method, compensation expense that the Company recognizes beginning on that date includes: (a) compensation expense for all share-based awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all share-based awards granted on or after January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R.
Effective January 1, 2006, the Company adopted FASB Staff Position FAS No. 123R-3,Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards, (“FAS 123R-3”). FAS 123R-3 provides a practical exception when transitioning to the accounting requirements in SFAS 123R. The Company has used the simplified method to calculate the pool of excess tax benefits available to absorb tax deficiencies recognized subsequent to adopting SFAS 123R (termed the “APIC Pool”).
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Share-based compensation expense for 2008, 2007 and 2006 of $24.1 million, $22.1 million and $20.4 million, respectively, (excluding tax effects) werewas recorded in the following expense categories of the consolidated statements of operations.
Years Ended December 31, | |||||||||||||||||||||
2008 | 2007 | 2006 | Years Ended December 31, | ||||||||||||||||||
(As Restated) | (As Restated) | 2011 | 2010 | 2009 | |||||||||||||||||
Share-based compensation in: | |||||||||||||||||||||
Cost of revenue | $ | 1,318 | $ | 1,500 | $ | 1,476 | $ | 1,097 | $ | 1,270 | $ | 1,381 | |||||||||
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Total share-based compensation in cost of revenue | 1,318 | 1,500 | 1,476 | 1,097 | 1,270 | 1,381 | |||||||||||||||
Selling and marketing | 8,957 | 8,886 | 8,264 | 5,893 | 7,160 | 7,964 | |||||||||||||||
Research and development | 4,734 | 4,099 | 3,573 | 3,827 | 5,285 | 5,206 | |||||||||||||||
General and administrative | 9,080 | 7,591 | 7,045 | 8,159 | 8,850 | 10,214 | |||||||||||||||
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Total share-based compensation in operating expenses | 22,771 | 20,576 | 18,882 | 17,879 | 21,295 | 23,384 | |||||||||||||||
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Total share-based compensation | $ | 24,089 | $ | 22,076 | $ | 20,358 | $ | 18,976 | $ | 22,565 | $ | 24,765 | |||||||||
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At December 31, 2008,2011, there was $51.8$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 2.41.9 years.
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, consistent with SFAS 123R and Securities and Exchange Commission Staff Accounting Bulletin No. 107.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, 2008, 20072011, 2010 and 2006:2009:
Years Ended December 31, | |||||||||
2008 | 2007 | 2006 | |||||||
Average expected life (years) | 3.0 | 3.1 | 3.1 | ||||||
Average expected volatility factor | 35.3 | % | 35.2 | % | 40.2 | % | |||
Average risk-free interest rate | 2.5 | % | 4.5 | % | 3.6 | % | |||
Average expected dividend yield | — | — | — |
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
Average expected life (years) Average expected volatility factor Average risk-free interest rate Average expected dividend yieldDecember 31, 2008 Years Ended December 31, 2011 2010 2009 3.4 3.4 3.1 42.1 % 42.4 % 45.4 % 1.1 % 1.4 % 1.4 % 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 grantgrants during the years ended December 31, 2008, 20072011, 2010 and 2006:2009:
Years Ended December 31, | Years Ended December 31, | ||||||||||||||||||||
2008 | 2007 | 2006 | 2011 | 2010 | 2009 | ||||||||||||||||
Average expected life (years) | 1.3 | 1.3 | 1.3 | 1.3 | 1.3 | 1.3 | |||||||||||||||
Average expected volatility factor | 50.7 | % | 34.4 | % | 36.2 | % | 44.4 | % | 41.7 | % | 48.8 | % | |||||||||
Average risk-free interest rate | 1.6 | % | 4.3 | % | 4.9 | % | 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 in accordance with SFAS 123R and SAB 107 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.grant and is recognized ratably over the vesting period of the awards. 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)
SFAS No. 130,Reporting Comprehensive Income, requires that all components of comprehensive income, including net income, be reported in the financial statements in the period in which they are recognized. 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) andwere as follows (in thousands):
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 | ||||||||
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Comprehensive income (loss) | $ | 28,692 | $ | 19,849 | $ | (9,508 | ) | |||||
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66 | 2011 ANNUAL REPORT |
The accumulated unrealized derivative (losses) gains, net of tax, on the Company’s derivative contracts included in accumulated other comprehensive income (loss), including foreign currency translation adjustments and unrealized gains and losses on investments and certain derivative contracts, shall be reported, net of their related tax effect, to arrive at comprehensive income (loss).loss were as follows (in thousands):
Years Ended December 31, | ||||||||||||
2011 | 2010 | 2009 | ||||||||||
Beginning balance | $ | 828 | $ | (369 | ) | $ | (1,558 | ) | ||||
Net change during the period | (1,764 | ) | 1,197 | 1,189 | ||||||||
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Ending balance, net of tax of $624, $552 and $246, respectively | $ (936 | ) | $ | 828 | $ (369 | ) | ||||||
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Accumulated Other Comprehensive Loss
Accumulated other comprehensive loss on the Company’s consolidated balance sheet consisted of the following (in thousands):
December 31, | ||||||||
2008 | 2007 | |||||||
(As Restated) | (As Restated) | |||||||
Unrealized gain on fair value of foreign currency contracts | $ | 3 | $ | — | ||||
Unrealized loss on interest rate swap and cap | (1,561 | ) | (998 | ) | ||||
Translation adjustment | (1,625 | ) | (322 | ) | ||||
$ | (3,183 | ) | $ | (1,320 | ) | |||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
December 31, | ||||||||
2011 | 2010 | |||||||
Unrealized (loss) gain on interest rate derivatives, net of tax | $ | (936 | ) | $ | 828 | |||
Translation adjustments | (2,163 | ) | (1,625 | ) | ||||
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$ | (3,099 | ) | $ | (797 | ) | |||
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Net Income Per Share
The Company computesBasic net income per share in accordance with SFAS No. 128,Earnings Per Share(“SFAS 128”EPS”). Under the provisions of SFAS 128, basic net income per share 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.
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 2008 and 2007,2009, 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. Potentially dilutive securities totaling 4,666,000 for the year ended December 31, 2006 were excluded from historical basic and diluted earnings per share because of their anti-dilutive effect as these stock options had exercise prices greater than the average market price of the common shares.
2011 ANNUAL REPORT | 67 |
The following is a reconciliation of the numerator and denominator ofused in calculating basic earnings per share (“EPS”)EPS to the numerator and denominator ofused in calculating diluted EPS for all periods presented.
Net (Loss) Income (Numerator) | Shares (Denominator) | Per Share Amount | ||||||||
(In thousands, except per share amounts) | ||||||||||
(As Restated) (See Note 2) | (As Restated) (See Note 2) | |||||||||
For the Years Ended: | ||||||||||
December 31, 2008: | ||||||||||
Basic EPS (as restated—See Note 2) | $ | (26,779 | ) | 45,190 | $ | (0.59 | ) | |||
Effect of options | — | — | — | |||||||
Diluted EPS (as restated—See Note 2) | $ | (26,779 | ) | 45,190 | $ | (0.59 | ) | |||
December 31, 2007: | ||||||||||
Basic EPS (as restated—See Note 2) | $ | (16,481 | ) | 45,107 | $ | (0.37 | ) | |||
Effect of options | — | — | — | |||||||
Diluted EPS (as restated—See Note 2) | $ | (16,481 | ) | 45,107 | $ | (0.37 | ) | |||
December 31, 2006: | ||||||||||
Basic EPS | $ | 32,093 | 46,494 | $ | 0.69 | |||||
Effect of options | — | 622 | (0.01 | ) | ||||||
Diluted EPS | $ | 32,093 | 47,116 | $ | 0.68 | |||||
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 | ) | ||||||||
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Diluted EPS | $ | 30,994 | 40,739 | $ | 0.76 | |||||||
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December 31, 2010: | ||||||||||||
Basic EPS | $ | 18,652 | 42,409 | $ | 0.44 | |||||||
Effect of dilutive securities | 0 | 1,029 | (0.01 | ) | ||||||||
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Diluted EPS | $ | 18,652 | 43,438 | $ | 0.43 | |||||||
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December 31, 2009: | ||||||||||||
Basic EPS | $ | (10,697 | ) | 44,262 | $ | (0.24 | ) | |||||
Effect of dilutive securities | 0 | 0 | 0 | |||||||||
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Diluted EPS | $ | (10,697 | ) | 44,262 | $ | (0.24 | ) | |||||
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Income Taxes
The Company applies the liability method of accounting for income taxes as set forth in SFAS No. 109.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.
Websense, Inc.
NotesThe Company uses a two-step approach to Consolidated Financial Statements (Continued)
December 31, 2008
recognizing and measuring uncertain tax positions. The Financial Accounting Standards Board’s Interpretation No. 48,Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109(“FIN 48”) became effective forfirst step is to evaluate the Company beginning in 2007. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position takenfor 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 expectedlitigation processes, if any. The second step is to be taken in ameasure the tax return and also provides guidance on various related matters suchbenefit as derecognition, interest and penalties and disclosure.the largest amount which is more than 50% likely of being realized upon ultimate settlement. The Company adopted FIN 48 effective January 1, 2007considers many factors when evaluating and the provisions of FIN 48 have been applied to all incomeestimating its tax positions commencing from that date.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. The cumulative effect of applying the provisions of FIN 48 has been reported as an adjustment to the January 1, 2007 balance of additional paid-in capital and retained earnings on the consolidated balance sheet.
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 March 2008June 2011, the FASB issued SFAS No. 161 which requires additional disclosures about the objectives of derivative instruments and hedging activities, the method of accounting for such instruments under SFAS 133 and its related interpretations, and a tabular disclosure of the effects of such instruments and related hedged itemsauthoritative guidance on the Company’spresentation of other comprehensive income within the financial position, financial performance and cash flows. SFAS 161 isstatements that will become effective for the Company beginning January 1, 2009.2012, with earlier adoption permitted. The guidance provides an option to registrants to present total comprehensive income, the components 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 consolidated statement of stockholders’ equity. The Company is currently assessing the potential impactdoes not believe that adoption of SFAS 161 maythe guidance will have on its financial statements.
In December 2007 the FASB issued SFAS No. 141R which establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination and determines what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for financial statements issued for fiscal years beginning after December 15, 2008. Accordingly, any business combinations the Company engages in after January 1, 2009 will be recorded and disclosed following SFAS 141R. The Company expects SFAS 141R may have ansignificant impact on its consolidatedthe Company’s financial statements when effective, but the nature and magnitudeposition, results of the specific effects will depend upon the nature, terms and size of the acquisitions, if any, consummated after the effective date.operations or cash flows.
The Company has restated its consolidated financial statements as of and for the years ended December 31, 2008 and 2007.
The determination to restate these consolidated financial statements and the quarterly consolidated financial statements was made by the Company’s Audit Committee upon management’s recommendation following the identification of errors related to the Company’s recording of royalty revenue related to OEM contracts which were acquired in connection with the acquisition of SurfControl in October 2007. Management determined
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
whether the amounts involved were material under Staff Accounting Bulletin No. 99,Materiality(“SAB 99”), and Staff Accounting Bulletin No. 108,Considering Effects of Prior Misstatements When Quantifying Misstatements in Current Year Financial Statements(“SAB 108”), for one or more periods. Management determined that there was an error in its application of SOP 97-2 and that the adjustments necessary to properly state revenues were material for the years ended December 31, 2008 and 2007, the interim periods within fiscal 2008, the fourth quarter of 2007 and the first and second quarters of 2009. Accordingly, management recommended to the Audit Committee that a restatement was required. During the restatement process, the Company also identified a material error in its income tax benefit computation for the year ended December 31, 2008. The general nature and scope of the errors and adjustments are summarized as follows:
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Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
|
Over(Under) statement of pre-tax loss | ||||||||
Description | Fiscal 2008 | Fiscal 2007 | ||||||
Correction of preacquisiton deferred revenue | $ | 75 | $ | (75 | ) | |||
Correction of foreign currency gain/(loss) | (692 | ) | (31 | ) | ||||
Share-based compensation adjustment related to modification in Employee Stock Purchase Plan (ESPP) | (456 | ) | 65 | |||||
Goodwill adjustment for costs incurred beyond one year allocation period | (115 | ) | — | |||||
Correction of accrued expenses | 544 | 14 | ||||||
Correction of revenue for a contract with a grace period | (56 | ) | — | |||||
Correction of contra revenue accruals | 74 | — | ||||||
Total | $ | (626 | ) | $ | (27 | ) | ||
The Company also restated its income tax expense (benefit) for the periods described above to reflect the tax impact of the OEM Revenue—Timing Adjustments, Other Adjustments and other tax provision errors as summarized in the table below (in thousands):
Description | (Increase) Decrease to Income Tax Benefit for Fiscal 2008 | Increase (Decrease) to Provision for Income Taxes for Fiscal 2007 | ||||||
Tax impact of OEM revenue—timing adjustment | $ | (3,022 | ) | $ | (492 | ) | ||
Reverse valuation allowance for OEM revenue adjustment | (453 | ) | 453 | |||||
Interperiod reclassification of tax on share based compensation | (558 | ) | 558 | |||||
Interperiod reclassification of tax deduction related to restricted stock unit awards | (470 | ) | 470 | |||||
Interperiod reclassification of tax exempt interest benefit | 358 | (358 | ) | |||||
Tax impact related to modification in ESPP | 155 | (25 | ) | |||||
Goodwill adjustment for pre-acquisition SurfControl tax payable balances | 457 | — | ||||||
Adjustment in foreign tax witholding | (67 | ) | — | |||||
Total | $ | (3,600 | ) | $ | 606 | |||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
The following tables present the adjustments due to the restatements of the Company’s previously issued consolidated financial statements as of and for the years ended December 31, 2008 and 2007:
Consolidated Balance Sheet December 31, 2008 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(In thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 66,983 | $ | (2,887 | ) | $ | 64,096 | |||||
Cash and cash equivalents—restricted | — | 2,500 | 2,500 | |||||||||
Accounts receivable, net | 82,032 | 67 | 82,099 | |||||||||
Income tax receivable | 3,723 | 7,204 | 10,927 | |||||||||
Current portion of deferred income taxes | 33,125 | 1,073 | 34,198 | |||||||||
Other current assets | 9,029 | — | 9,029 | |||||||||
Total current assets | 194,892 | 7,957 | 202,849 | |||||||||
Cash and cash equivalents—restricted, less current portion | — | 215 | 215 | |||||||||
Property and equipment, net | 14,312 | — | 14,312 | |||||||||
Intangible assets, net | 106,493 | — | 106,493 | |||||||||
Goodwill | 374,410 | (1,786 | ) | 372,624 | ||||||||
Deferred income taxes, less current portion | 21,092 | 3,145 | 24,237 | |||||||||
Deposits and other assets | 3,933 | — | 3,933 | |||||||||
Total assets | $ | 715,132 | $ | 9,531 | $ | 724,663 | ||||||
Liabilities and stockholders’ equity | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 2,719 | $ | — | $ | 2,719 | ||||||
Accrued compensation and related benefits | 19,087 | 42 | 19,129 | |||||||||
Other accrued expenses | 28,440 | (494 | ) | 27,946 | ||||||||
Current portion of income taxes payable | 8,010 | (875 | ) | 7,135 | ||||||||
Current portion of senior secured term loan | 4,112 | — | 4,112 | |||||||||
Current portion of deferred tax liability | 1,053 | — | 1,053 | |||||||||
Current portion of deferred revenue | 220,607 | 3,337 | 223,944 | |||||||||
Total current liabilities | 284,028 | 2,010 | 286,038 | |||||||||
Other long term liabilities | 2,617 | (1 | ) | 2,616 | ||||||||
Income taxes payable, less current portion | 10,098 | — | 10,098 | |||||||||
Senior secured term loan, less current portion | 120,888 | — | 120,888 | |||||||||
Deferred tax liability, less current portion | 10,523 | — | 10,523 | |||||||||
Deferred revenue, less current portion | 112,157 | 5,683 | 117,840 | |||||||||
Total liabilities | 540,311 | 7,692 | 548,003 | |||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 522 | — | 522 | |||||||||
Additional paid-in capital | 299,657 | 393 | 300,050 | |||||||||
Treasury stock, at cost | (159,842 | ) | — | (159,842 | ) | |||||||
Retained earnings | 37,937 | 1,176 | 39,113 | |||||||||
Accumulated other comprehensive loss | (3,453 | ) | 270 | (3,183 | ) | |||||||
Total stockholders’ equity | 174,821 | 1,839 | 176,660 | |||||||||
Total liabilities and stockholders’ equity | $ | 715,132 | $ | 9,531 | $ | 724,663 | ||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Year Ended December 31, 2008 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 295,861 | $ | (7,680 | ) | $ | 93 | $ | — | $ | 288,274 | |||||||||
Cost of revenues | 48,178 | — | (18 | ) | — | 48,160 | ||||||||||||||
Gross margin | 247,683 | (7,680 | ) | 111 | — | 240,114 | ||||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 175,210 | — | 155 | — | 175,365 | |||||||||||||||
Research and development | 53,105 | — | 169 | — | 53,274 | |||||||||||||||
General and administrative | 45,622 | — | (279 | ) | — | 45,343 | ||||||||||||||
Total operating expenses | 273,937 | — | 45 | — | 273,982 | |||||||||||||||
(Loss) income from operations | (26,254 | ) | (7,680 | ) | 66 | — | (33,868 | ) | ||||||||||||
Interest expense | (13,134 | ) | — | — | — | (13,134 | ) | |||||||||||||
Other income (expense), net | 1,431 | — | (692 | ) | — | 739 | ||||||||||||||
Loss before income taxes | (37,957 | ) | (7,680 | ) | (626 | ) | — | (46,263 | ) | |||||||||||
Benefit for income taxes | (8,086 | ) | — | — | (11,398 | ) | (19,484 | ) | ||||||||||||
Net (loss) income | $ | (29,871 | ) | $ | (7,680 | ) | $ | (626 | ) | $ | 11,398 | $ | (26,779 | ) | ||||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.66 | ) | $ | (0.59 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,190 | 45,190 | ||||||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Cash Flows Year Ended December 31, 2008 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(In thousands) | ||||||||||||
Operating activities: | ||||||||||||
Net (loss) income | $ | (29,871 | ) | $ | 3,092 | $ | (26,779 | ) | ||||
Adjustments to reconcile net (loss) income to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 62,994 | — | 62,994 | |||||||||
Share-based compensation | 23,633 | 456 | 24,089 | |||||||||
Deferred income taxes | (25,464 | ) | (2,765 | ) | (28,229 | ) | ||||||
Unrealized (gain) loss on foreign exchange | (1,324 | ) | 692 | (632 | ) | |||||||
Tax shortfall from stock option exercises | 765 | 41 | 806 | |||||||||
Changes in operating assets and liabilities: | — | |||||||||||
Accounts receivable | (3,698 | ) | (67 | ) | (3,765 | ) | ||||||
Other assets | 533 | (8,804 | ) | (8,271 | ) | |||||||
Accounts payable | (1,111 | ) | — | (1,111 | ) | |||||||
Accrued compensation and related benefits | (5,718 | ) | — | (5,718 | ) | |||||||
Other liabilities | (2,538 | ) | (46 | ) | (2,584 | ) | ||||||
Deferred revenue | 46,804 | 7,661 | 54,465 | |||||||||
Income taxes payable | 2,366 | (1,820 | ) | 546 | ||||||||
Net cash provided by (used in) operating activities | 67,371 | (1,560 | ) | 65,811 | ||||||||
Investing activities: | ||||||||||||
Change in restricted cash and cash equivalents | — | (1,240 | ) | (1,240 | ) | |||||||
Purchase of property and equipment | (7,911 | ) | — | (7,911 | ) | |||||||
Purchase of intangible assets | (2,061 | ) | — | (2,061 | ) | |||||||
Cash refunded from PortAuthority acquisition | 147 | — | 147 | |||||||||
Cash received from sale of CyberPatrol assets | 1,400 | — | 1,400 | |||||||||
Purchases of marketable securities | (20,160 | ) | — | (20,160 | ) | |||||||
Maturities of marketable securities | 39,963 | — | 39,963 | |||||||||
Net cash provided by (used in) investing activities | 11,378 | (1,240 | ) | 10,138 | ||||||||
Financing activities: | ||||||||||||
Principal payments on senior secured term loan | (65,000 | ) | — | (65,000 | ) | |||||||
Proceeds from exercise of stock options | 4,311 | — | 4,311 | |||||||||
Proceeds from issuance of common stock for stock purchase plan | 5,321 | — | 5,321 | |||||||||
Tax shortfall from stock option exercises | (765 | ) | (41 | ) | (806 | ) | ||||||
Purchase of treasury stock | (19,998 | ) | — | (19,998 | ) | |||||||
Net cash used in financing activities | (76,131 | ) | (41 | ) | (76,172 | ) | ||||||
Effect of exchange rate changes on cash and cash equivalents | (2,018 | ) | 247 | (1,771 | ) | |||||||
Increase (decrease) in cash and cash equivalents | 600 | (2,594 | ) | (1,994 | ) | |||||||
Cash and cash equivalents at beginning of year | 66,383 | (293 | ) | 66,090 | ||||||||
Cash and cash equivalents at end of year | $ | 66,983 | $ | (2,887 | ) | $ | 64,096 | |||||
Supplemental disclosures of cash flow information: | ||||||||||||
Income taxes paid | $ | 10,526 | $ | 2,540 | $ | 13,066 | ||||||
Interest paid | $ | 10,778 | $ | — | $ | 10,778 |
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Balance Sheet December 31, 2007 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(In thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 66,383 | $ | (293 | ) | $ | 66,090 | |||||
Cash and cash equivalents—restricted | — | — | — | |||||||||
Marketable securities | 19,781 | — | 19,781 | |||||||||
Accounts receivable, net | 76,328 | — | 76,328 | |||||||||
Income tax receivable | 3,734 | — | 3,734 | |||||||||
Current portion of deferred income taxes | 22,870 | — | 22,870 | |||||||||
Other current assets | 10,109 | — | 10,109 | |||||||||
Total current assets | 199,205 | (293 | ) | 198,912 | ||||||||
Cash and cash equivalents—restricted, less current portion | — | 1,862 | 1,862 | |||||||||
Property and equipment, net | 17,657 | — | 17,657 | |||||||||
Intangible assets, net | 152,906 | — | 152,906 | |||||||||
Goodwill | 385,916 | — | 385,916 | |||||||||
Deferred income taxes, less current portion | 19,048 | 240 | 19,288 | |||||||||
Deposits and other assets | 5,798 | (1,600 | ) | 4,198 | ||||||||
Total assets | $ | 780,530 | $ | 209 | $ | 780,739 | ||||||
Liabilities and stockholders’ equity | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 3,255 | $ | — | $ | 3,255 | ||||||
Accrued compensation and related benefits | 28,960 | — | 28,960 | |||||||||
Other accrued expenses | 30,463 | (14 | ) | 30,449 | ||||||||
Current portion of income taxes payable | 1,531 | (143 | ) | 1,388 | ||||||||
Current portion of deferred tax liability | 10,399 | — | 10,399 | |||||||||
Current portion of deferred revenue | 190,569 | 453 | 191,022 | |||||||||
Total current liabilities | 265,177 | 296 | 265,473 | |||||||||
Other long term liabilities | 1,634 | — | 1,634 | |||||||||
Income taxes payable, less current portion | 12,264 | 946 | 13,210 | |||||||||
Senior secured term loan | 190,000 | — | 190,000 | |||||||||
Deferred tax liability, less current portion | 20,964 | — | 20,964 | |||||||||
Deferred revenue, less current portion | 96,116 | 905 | 97,021 | |||||||||
Total liabilities | 586,155 | 2,147 | 588,302 | |||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 515 | — | 515 | |||||||||
Additional paid-in capital | 267,164 | (22 | ) | 267,142 | ||||||||
Treasury stock, at cost | (139,792 | ) | — | (139,792 | ) | |||||||
Retained earnings | 67,808 | (1,916 | ) | 65,892 | ||||||||
Accumulated other comprehensive loss | (1,320 | ) | — | (1,320 | ) | |||||||
Total stockholders’ equity | 194,375 | (1,938 | ) | 192,437 | ||||||||
Total liabilities and stockholders’ equity | $ | 780,530 | $ | 209 | $ | 780,739 | ||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Year Ended December 31, 2007 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 211,665 | $ | (1,283 | ) | $ | (75 | ) | $ | — | $ | 210,307 | ||||||||
Cost of revenues | 29,080 | — | 60 | — | 29,140 | |||||||||||||||
Gross margin | 182,585 | (1,283 | ) | (135 | ) | — | 181,167 | |||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 126,335 | — | (88 | ) | — | 126,247 | ||||||||||||||
Research and development | 40,951 | — | (38 | ) | — | 40,913 | ||||||||||||||
General and administrative | 32,721 | — | (13 | ) | — | 32,708 | ||||||||||||||
Total operating expenses | 200,007 | — | (139 | ) | — | 199,868 | ||||||||||||||
(Loss) income from operations | (17,422 | ) | (1,283 | ) | 4 | — | (18,701 | ) | ||||||||||||
Interest expense | (4,308 | ) | — | — | — | (4,308 | ) | |||||||||||||
Other income (expense), net | 9,492 | — | (31 | ) | — | 9,461 | ||||||||||||||
Loss before income taxes | (12,238 | ) | (1,283 | ) | (27 | ) | — | (13,548 | ) | |||||||||||
Provision for income taxes | 2,327 | — | — | 606 | 2,933 | |||||||||||||||
Net loss | $ | (14,565 | ) | $ | (1,283 | ) | $ | (27 | ) | $ | (606 | ) | $ | (16,481 | ) | |||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.32 | ) | $ | (0.37 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,107 | 45,107 | ||||||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Cash Flows Year Ended December 31, 2007 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(In thousands) | ||||||||||||
Operating activities: | ||||||||||||
Net loss | $ | (14,565 | ) | $ | (1,916 | ) | $ | (16,481 | ) | |||
Adjustments to reconcile net loss to net cash provided by operating activities: | ||||||||||||
Depreciation and amortization | 28,604 | — | 28,604 | |||||||||
Share-based compensation | 22,140 | (64 | ) | 22,076 | ||||||||
Deferred income taxes | (14,642 | ) | (240 | ) | (14,882 | ) | ||||||
Unrealized loss on foreign exchange | 543 | — | 543 | |||||||||
Tax windfall from stock option exercises | (1,010 | ) | (42 | ) | (1,052 | ) | ||||||
Changes in operating assets and liabilities, net of effects from purchases of PortAuthority and SurfControl: | ||||||||||||
Accounts receivable | (6,744 | ) | — | (6,744 | ) | |||||||
Other assets | (5,160 | ) | — | (5,160 | ) | |||||||
Accounts payable | (1,181 | ) | — | (1,181 | ) | |||||||
Accrued compensation and related benefits | 1,088 | — | 1,088 | |||||||||
Other liabilities | (5,644 | ) | (14 | ) | (5,658 | ) | ||||||
Deferred revenue | 46,306 | 1,358 | 47,664 | |||||||||
Income taxes payable | 3,872 | 845 | 4,717 | |||||||||
Net cash provided by (used in) operating activities | 53,607 | (73 | ) | 53,534 | ||||||||
Investing activities: | ||||||||||||
Change in restricted cash and cash equivalents | — | (261 | ) | (261 | ) | |||||||
Purchase of property and equipment | (5,866 | ) | — | (5,866 | ) | |||||||
Cash paid to acquire PortAuthority, net of cash acquired | (81,988 | ) | — | (81,988 | ) | |||||||
Cash paid to acquire SurfControl, net of cash acquired | (395,062 | ) | — | (395,062 | ) | |||||||
Net cash paid for option contracts on SurfControl acquisition | (442 | ) | (1 | ) | (443 | ) | ||||||
Purchases of marketable securities | (506,913 | ) | — | (506,913 | ) | |||||||
Maturities of marketable securities | 730,595 | — | 730,595 | |||||||||
Net cash used in investing activities | (259,676 | ) | (262 | ) | (259,938 | ) | ||||||
Financing activities: | ||||||||||||
Borrowings under senior secured term loan | 210,000 | — | 210,000 | |||||||||
Principal payments on senior secured term loan | (20,000 | ) | — | (20,000 | ) | |||||||
Cash paid for deferred financing fees under senior secured term loan | (5,444 | ) | — | (5,444 | ) | |||||||
Repayment of PortAuthority loan | (4,214 | ) | — | (4,214 | ) | |||||||
Proceeds from exercise of stock options | 3,260 | — | 3,260 | |||||||||
Proceeds from issuance of common stock for stock purchase plan | 4,317 | — | 4,317 | |||||||||
Tax windfall from stock option exercises | 1,010 | 42 | 1,052 | |||||||||
Net cash provided by financing activities | 188,929 | 42 | 188,971 | |||||||||
Decrease in cash and cash equivalents | (17,140 | ) | (293 | ) | (17,433 | ) | ||||||
Cash and cash equivalents at beginning of year | 83,523 | — | 83,523 | |||||||||
Cash and cash equivalents at end of year | $ | 66,383 | $ | (293 | ) | $ | 66,090 | |||||
Supplemental disclosures of cash flow information: | ||||||||||||
Income taxes paid | $ | 14,454 | $ | 1,540 | $ | 15,994 | ||||||
Interest paid | $ | 3,526 | $ | — | $ | 3,526 | ||||||
Unrealized gain on marketable securities | $ | 81 | $ | — | $ | 81 |
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
The Company had no investments in marketable securities at December 31, 2008. As of December 31, 2007, the Company had investments in marketable securities, which consisted of municipal bonds with contractual maturities of less than one year, with an amortized cost and estimated fair value of $19.8 million. The Company recorded no realized gains (losses) from investments in marketable securities for the years ended 2008, 2007 and 2006.
Property and Equipment |
Property and equipment consisted of the following (in thousands):
Estimated Useful Lives | December 31, | Estimated Useful Lives | December 31, | |||||||||||||||||||
2008 | 2007 | 2011 | 2010 | |||||||||||||||||||
Computer hardware and software | 3 years | $ | 37,906 | $ | 33,400 | 3 years | $ | 45,783 | $ | 40,020 | ||||||||||||
Office furniture and equipment | 3-7 years | 6,634 | 6,339 | |||||||||||||||||||
Leasehold improvements, office furniture and equipment | 3-7 years | 13,124 | 11,904 | |||||||||||||||||||
|
| |||||||||||||||||||||
44,540 | 39,739 | 58,907 | 51,924 | |||||||||||||||||||
Accumulated depreciation | (30,228 | ) | (22,082 | ) | (42,075 | ) | (34,980 | ) | ||||||||||||||
|
| |||||||||||||||||||||
$ | 14,312 | $ | 17,657 | $ | 16,832 | $ | 16,944 | |||||||||||||||
|
|
Depreciation expense, including amortization of assets recorded under capital leases, for 2008, 20072011, 2010 and 20062009 was $10.8$10.4 million, $5.9$10.3 million and $3.3$10.7 million, respectively.
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 net book value of approximately $0.6 million and $1.2 million as of December 31, 2011 and 2010, respectively.
SurfControl
In October 2007, the Company completed the acquisition of SurfControl, a U.K.-based provider of Web and email security solutions. The total purchase price of the acquisition was as follows (in thousands):
Cash paid for SurfControl | $ | 448,760 | |
Transaction costs | 12,114 | ||
Total purchase price | $ | 460,874 | |
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
The purchase price was allocated as follows (in thousands):
Fair value of net tangible assets acquired and liabilities assumed: | ||||||||
Cash and cash equivalents | $ | 65,995 | ||||||
Accounts receivable | 16,825 | |||||||
Other current assets | 3,550 | |||||||
Property and equipment | 10,666 | |||||||
Deferred income taxes | (32,632 | ) | ||||||
Accounts payable and accrued expenses | (45,050 | ) | ||||||
Deferred revenue | (19,729 | ) | ||||||
(375 | ) | |||||||
Fair value of identifiable intangible assets acquired: | ||||||||
Technology | 29,265 | |||||||
Customer relationships | 128,500 | |||||||
157,765 | ||||||||
Goodwill | 303,484 | |||||||
Total purchase price | $ | 460,874 | ||||||
In connection with the acquisition, the Company’s management approved plans to restructure the operations of the acquired company by terminating 320 of SurfControl’s employees and exiting certain SurfControl facilities. As of December 31, 2008, all of the 320 employees originally identified for termination have been terminated and all the severance costs have been paid. These workforce reductions were across all functions and geographies and affected employees were provided cash severance packages. Additionally, the Company has consolidated facilities and has exited leases in certain locations as well as reduced the square footage required to operate some locations. The Company accrued the estimated costs associated with the employee severance and facility exit obligations as liabilities assumed in the acquisition of SurfControl and accordingly, these estimated costs are included as part of the purchase price of SurfControl. Changes to the estimates of the facility exit costs after 2008 will be recorded as a reduction to goodwill or as an expense to the results of operations, as appropriate, in accordance with Emerging Issues Task Force Issue No. 95-3,Recognition of Liabilities in Connection with a Purchase Business Combination. As of December 31, 2008, $2.2 million of facility exit obligations remain accrued for payments in future periods as follows (in thousands):
Balance at December 31, 2007 | Cash Payments | Charged to Expense | Adjustments | Foreign Exchange Adjustments | Balance at December 31, 2008 | ||||||||||||||||
Severance costs | $ | 6,761 | $ | (4,760 | ) | $ | — | $ | (2,011 | ) | $ | 10 | $ | — | |||||||
Facility exit costs | 9,379 | (3,584 | ) | 35 | (2,946 | ) | (641 | ) | 2,243 | ||||||||||||
Total | $ | 16,140 | $ | (8,344 | ) | $ | 35 | $ | (4,957 | ) | $ | (631 | ) | $ | 2,243 | ||||||
The accrual for facility exit costs at December 31, 2008 represents the remaining fair value of lease obligations net of estimated sublease income, as determined at the expected cease-use date, and will be paid out over the remaining lease term, which ends in fiscal year 2011.
In connection with the acquisition of SurfControl, Websense acquired SurfControl’s consumer Internet safety software business known as CyberPatrol. In accordance with an Asset Purchase Agreement, the Company sold certain assets and deferred revenue relating to CyberPatrol for $1.4 million cash on March 31, 2008. The
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
assets sold were primarily intellectual property for the technology and existing customer contracts. As the Company had not completed its purchase price allocation for the purchase of SurfControl as of March 31, 2008, and the best indication of fair value is a third party sale between a willing buyer and a willing seller, the Company recorded the sale as follows: increase to cash of $1.4 million, decrease to deferred revenue of $0.7 million and a reduction to goodwill of $2.1 million with no gain or loss recorded from the sale.
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.
Intangible Assets |
Intangible assets subject to amortization consisted of the following as of December 31, 20082011 (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 | $ | 45,267 | $ | (17,806 | ) | $ | 27,461 | 3.2 | $ | 15,157 | $ | (11,255 | ) | $ | 3,902 | ||||||||||
Customer relationships | 5.6 | 129,200 | (50,474 | ) | 78,726 | 4.8 | 69,200 | (46,690 | ) | 22,510 | ||||||||||||||||
Trade name | 3.0 | 510 | (204 | ) | 306 | |||||||||||||||||||||
|
|
| ||||||||||||||||||||||||
Total | 4.8 | $ | 174,977 | $ | (68,484 | ) | $ | 106,493 | 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 2008, 20072011, 2010 and 20062009 was $49.9$15.7 million, $20.6$26.5 million and $0.1$39.3 million, respectively. As of December 31, 2008,2011, remaining amortization expense is expected to be as follows (in thousands):
Years Ending December 31, | |||||||
2009 | $ | 39,251 | |||||
2010 | 26,442 | ||||||
2011 | 15,507 | ||||||
2012 | 8,290 | $ | 8,473 | ||||
2013 | 5,538 | 5,720 | |||||
2014 | 4,689 | ||||||
2015 | 3,862 | ||||||
2016 | 3,668 | ||||||
Thereafter | 11,465 | 0 | |||||
| |||||||
Total expected amortization expense | $ | 106,493 | $ | 26,412 | |||
|
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
The following table summarizes the activity related to the carrying value of the Company’s goodwill during 2008 (in thousands):
Year Ended December 31, 2008 | ||||
Balance at December 31, 2007 | $ | 385,916 | ||
Reduction from sale of CyberPatrol assets | (2,148 | ) | ||
Refund related to PortAuthority acquisition | (147 | ) | ||
PortAuthority deferred income tax adjustment (as restated) | (2,869 | ) | ||
SurfControl deferred income tax adjustment | (5,100 | ) | ||
Facility exit accrual adjustment (as restated) | (3,050 | ) | ||
Severance cost adjustment | (2,011 | ) | ||
Tax contingency adjustment (as restated) | 1,115 | |||
Other SurfControl purchase accounting adjustments (as restated) | 918 | |||
Balance at December 31, 2008 (as restated) | $ | 372,624 | ||
2011 ANNUAL REPORT | 69 |
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, | |||||||||||||||||||||
2008 | 2007 | 2006 | Years Ended December 31, | ||||||||||||||||||
(As Restated) | (As Restated) | 2011 | 2010 | 2009 | |||||||||||||||||
United States | $ | 155,720 | $ | 123,445 | $ | 113,941 | $ | 182,402 | $ | 165,272 | $ | 155,837 | |||||||||
Europe, Middle East and Africa | 91,182 | 59,166 | 44,354 | 117,971 | 113,721 | 108,290 | |||||||||||||||
Asia/Pacific | 18,556 | 10,745 | 7,704 | 31,903 | 25,785 | 22,684 | |||||||||||||||
Canada and Latin America | 22,816 | 16,951 | 12,815 | 31,907 | 27,984 | 26,902 | |||||||||||||||
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| |||||||||||||||||||
$ | 288,274 | $ | 210,307 | $ | 178,814 | $ | 364,183 | $ | 332,762 | $ | 313,713 | ||||||||||
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|
The United Kingdom represented $43.2$40.5 million, $22.5$42.9 million and $17.7$45.2 million of total revenue for the fiscal years ended 2008, 20072011, 2010 and 2006,2009, respectively. No other foreign country represented more than 5% of total revenue.
The net carrying values of the Company’s property and equipment assets are located in the following geographic areas (in thousands):
December 31, | ||||||||
2011 | 2010 | |||||||
United States | $ | 9,421 | $ | 9,311 | ||||
China | 2,879 | 2,643 | ||||||
United Kingdom | 1,366 | 1,731 | ||||||
Ireland | 1,579 | 1,845 | ||||||
Other | 1,587 | 1,414 | ||||||
|
|
|
| |||||
$ | 16,832 | $ | 16,944 | |||||
|
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|
|
Deferred Revenue |
The Company expects to recognize revenuesrevenue related to subscriptionscontractual arrangements in existence as of December 31, 20082011 as follows (in thousands):
(As Restated) | |||
Years Ending December 31, | |||
2009 | $ | 223,944 | |
2010 | 81,278 | ||
2011 | 32,355 | ||
2012 and thereafter | 4,207 | ||
$ | 341,784 | ||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Years Ending December 31, | ||||
2012 | $ | 250,597 | ||
2013 | 93,058 | |||
2014 | 40,664 | |||
2015 | 6,511 | |||
2016 and thereafter | 2,204 | |||
|
| |||
$ | 393,034 | |||
|
|
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, 2008,2011, 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 $125 million as a result of the Company making optional prepayments totaling $65 million during 2008, as well as an optional $20 million prepayment on December 31, 2007. 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 initially amortized at2010 Credit Agreement contains affirmative and negative covenants, including an obligation to maintain a minimum rate of 2.5%, 10%, 12.5%,certain consolidated leverage ratio and 15%, respectively, duringconsolidated interest coverage ratio and restrictions on the first four yearsCompany’s ability 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 term and 60% during the fifth year. In conjunction withCompany’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 optional $20 million prepaymentrepresentations and warranties, failure to observe covenants, defaults on December 31, 2007,any other indebtedness, entering bankruptcy, existence of a judgment or decree against the Company amendedor its Senior Credit Agreementsubsidiaries involving an aggregate liability of $10 million or more, the security interest or guarantee ceasing to eliminatebe in full force and effect, any additional mandatory payments until September 30, 2009. The senior secured term loan bears interest at a spread above LIBOR withperson becoming the spread determined based uponbeneficial owner of more than 35% of the Company’s total leverage ratio, asoutstanding 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 initial annual interest rate was LIBOR plus 250 basis points, and was subject to a potential step downsecured revolving credit facility under the 2010 Credit Agreement is included in the spread over LIBOR based upon potential future improvements inline item secured loan on the Company’s total leverage ratio.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 required a 50 basis points fee per annum, also subject to a step down based upon potential future improvements in the Company’s total leverage ratio. During 2008, the spread on both the senior secured term loan and revolving credit facility was reset to LIBOR plus 225 basis points per annum for the senior secured term loan and reduced by 25 basis points per annum for the unused portion of the revolving credit facility. The weighted average interest rate on the senior secured term loan at December 31, 2008 was 5.7%. 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, 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. In connection with the restatements of its financial statements as described in Notes 2 and 15, the Company does not believe that these restatements of its financial statements resulted in any material non-compliance with the covenants or representations and warranties in its Senior Credit Agreement.
As of December 31, 2008, future remaining minimum principal payments under the senior secured term loan will be as follows (in thousands):
Years Ending December 31, | |||
2009 | $ | 4,112 | |
2010 | 17,270 | ||
2011 | 20,724 | ||
2012 | 82,894 | ||
Total | $ | 125,000 | |
The Senior Credit Agreement provides that the Company 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
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
conjunction with the funding of the senior secured term loan, 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 notional amount of the swap agreement2011 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 into an interest rate cap agreement to limit the maximum interest rate on a portion of its senior secured term loan to 6.5% per annum. The amount of principal protected by this agreement increases from $5 million at December 31, 2007 to $74.3 million on June 30, 2010. Both the interest rate swap and cap expire on September 30, 2010.$47 million.
2011 ANNUAL REPORT | 71 |
Fair Value Measurements and Derivatives |
SFAS No. 157
SFAS No. 157,Fair Value Measurements (“SFAS 157”) defines fair value, establishes a framework for measuring fair value and establishes a hierarchy that categorizes and prioritizes the sources to be used to estimate fair value. SFAS 157 also expands financial statement disclosures about fair value measurements. On February 12, 2008, the FASB issued FASB Staff Position 157-2 (“FSP 157-2”), which delays the effective date of SFAS 157 for one year for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company elected a partial deferral of SFAS 157 under the provisions of FSP 157-2 related to the measurement of fair value used when evaluating nonfinancial assets and liabilities. The Company is currently evaluating the impact of FSP 157-2 on its financial statements. The impact of partially adopting SFAS 157 effective January 1, 2008 was not material to the Company’s financial statements.
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, 20082010 (in thousands):
Level 1(1) | Level 2(2) | Level 3(3) | Total | |||||||||
Assets: | ||||||||||||
Interest rate cap | $ | — | $ | 3 | $ | — | $ | 3 | ||||
Zero-cost collar contracts | — | 3 | — | 3 | ||||||||
Liabilities: | ||||||||||||
Interest rate swaps | $ | — | $ | 2,607 | $ | — | $ | 2,607 | ||||
Foreign currency forward contracts | — | 1,085 | — | 1,085 |
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 | 0 | 64 | 0 | 64 |
(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, 20082011 are derivative contracts, comprised of interest rate swaps and an interest rate cap as well asswap contract and foreign currency
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
forward contracts and zero-cost collar 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, 2011 and 2010 and for each of the years 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, | ||||||||||
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 | ) | ||||||
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| |||||||
Total derivatives | $ | (918 | ) | $ | 1,315 | |||||
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72 | 2011 ANNUAL REPORT |
Amount of Gain (Loss) | 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 | ||||||||||||||||||
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| |||||||||||||||
Total | $ | (2,940 | ) | $ | 1,991 | $ | 1,985 | $ | 0 | $ | (611 | ) | $ | (2,169 | ) | |||||||||||
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Location and Amount of Gain | ||||||||||||||
Year Ended December 31, | ||||||||||||||
Derivatives Not Designated as Hedges | 2011 | 2010 | 2009 | |||||||||||
Currency forward contracts | Other income, net | $ | 860 | $ | 443 | $ | 170 |
Fair Value Measurements on a Nonrecurring Basis
As permitted by FSP 157-2,of December 31, 2011, the Company’s secured loan, with a carrying value of $73.0 million, had an estimated fair value of $73.1 million which the Company elected to defer the fair value measurement disclosuredetermined using a discounted cash flow model with a discount rate of its nonfinancial assets and liabilities.
SFAS No. 159
SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of SFAS 115 (“SFAS 159”), permits but does not require companies to measure financial instruments and certain other items at fair value. Unrealized gains and losses on items for2.3% which the fair value option has been elected are reported in earnings. As the Company did not elect to fair value any of its financial instruments under the provisions of SFAS 159, the adoption of this statement effective January 1, 2008 did not have an impact onrepresents the Company’s financial statements.estimated incremental borrowing rate.
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, 20082011 are as follows (in thousands):
Operating Leases | |||
Years Ending December 31, | |||
2009 | $ | 6,409 | |
2010 | 5,509 | ||
2011 | 4,166 | ||
2012 | 3,881 | ||
2013 | 3,762 | ||
Thereafter | 1,001 | ||
$ | 24,728 | ||
Operating Leases | ||||
Years Ending December 31, | ||||
2012 | $ | 6,616 | ||
2013 | 6,403 | |||
2014 | 2,203 | |||
2015 | 792 | |||
2016 and thereafter | 0 | |||
|
| |||
Total | $ | 16,014 | ||
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|
Rent expense totaled $7.9$7.1 million, $6.6$7.1 million and $4.2$7.2 million for the years ended December 31, 2008, 20072011, 2010 and 2006,2009, respectively. Rent expense is generally recognized on a straight-line basis over the term of the respective leases.
FASB Interpretation No. 45, GuaranteesAs of Indebtedness of Others (“FIN 45”), elaborates on previously existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor’s obligations does not apply to product warranties, indemnifications or to guarantees accounted for as derivatives.
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 20082011, the Company has contractual commitment obligations for inbound software licenses, equipment maintenance, royalty agreements and automobile leases in the following amounts: $3.1 million for 2012, $2.2 million for 2013 and $1.5 million for 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 under SFAS No. 5,Accounting for Contingencies, as interpreted by FIN 45. The Companyand 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 the Company’s attorneys,its lawyers, the Company believes it has adequately reserved fornot accrued any ultimate liability that may result from these actions such that any liability would not materially affect our consolidated financial positions, results of operations or cash flows.its pending 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.
Stockholders’ Equity |
Stock PlansShare-Based Compensation
Employee Stock Purchase Plan
TheBeginning 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 businesstrading 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:
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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 | |||
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
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
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.
During 2008 and 2007, the Company issued 347,523 and 239,921 shares, respectively, under the Purchase Plan.
Employee Stock Plans
TheIn 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 (the “2000 Plan”) provides forand the grant of stock options and otherCompany’s 2007 Stock Incentive Assumption Plan (collectively, the “Prior Plans”). All outstanding stock awards under the Prior Plans continue to be subject to the Company’s directors, officers, employeesterms and consultants.conditions as set forth in the agreements evidencing such awards. The 20002009 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 andstock options, non-statutory stock options, stock appreciation rights, restricted stock unitsawards, restricted stock unit awards, performance stock awards, performance cash awards and rights to purchaseother stock to employees, directors or consultants of the Company.awards. The 2000 Plan provides that incentive stock options will be granted only to employees and are subject to certain limitations as to fair value during a calendar year.
In addition, the 2000 Plan provides for automatic annual increases in theaggregate number of shares authorized and reserved for issuance thereunder equalof Common Stock that may be issued pursuant to the lesser2009 Plan is not to exceed 17,500,442 shares (the “Share Reserve”); however, if any shares of (i) 4% ofcommon stock issued pursuant to a stock award are forfeited back to the Company’s outstandingCompany, then the shares on the last business day in December of the calendar year immediately preceding or (ii) 3,000,000 shares. At December 31, 2008, a total of 23,165,288 shares have been authorizedthat are forfeited become available for issuance under the 20002009 Plan. The stock issuable under the 2009 Plan are shares of which 50,742 remain available for grant.
In January 2007, the Compensation Committee of Websense’s Board of Directors adopted the Websense, Inc. 2007authorized but unissued or reacquired Common Stock, Incentive Assumption Plan (the “2007 Plan”). In connection with the acquisition of PortAuthority,including shares repurchased by the Company agreed to substitute unvested stock options to purchase PortAuthority common stock that were granted under PortAuthority’s stock option plan and outstanding immediately prior to the effective time of the acquisition with options to purchase an aggregate of 74,891 shares of Websense common stock (the “Substitute Options”). The Substitute Options have the same contractual lives and vesting periods as they did under the PortAuthority option plan. The number of shares and exercise prices of the Substitute Options were determined based on the conversion ratio as defined by the merger agreement with PortAuthority. At December 31, 2008, 204,083 shares were authorized for issuance and 6,215 shares were available for grant.
The exercise price of both incentive and non-statutory stockopen market or otherwise. Stock options and the issuance price of common stock under the 2000 Plan and the 2007 Plan must equal at least the fair value on the date of grant or issuance, as the case may be. Through April 2005, the option grants were generally exercisable for a period of ten years, and beginning in May 2005, the option grants are generally exercisable for a period of seven years afterfrom 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. Unvested common shares obtained through earlyThe exercise price of stock options are subject to repurchase bygenerally must not be less than the Company atfair market value on the original issue price.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 without any payment.date. The vesting schedules, including acceleration events, for restricted stock units may vary ingenerally vest 25% one year from the individual cases.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 2000 PlanPrior Plans and only non-statutory stock options have been granted under the 20072009 Plan. Through December 31, 2008,2011, the Company granted 411,7703,450,482 restricted stock units of which 65,3331,047,984 have vested and been issued and 10,750856,773 have been forfeited. The remaining 335,6871,545,725 restricted stock units have a weighted average grant date fair value of $19.73,$19.54 per share, a weighted average remaining contractual term of 1.61.3 years and an aggregate intrinsic value of $5.0$28.9 million as of December 31, 2008.
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
2011.
During 2008,2009, the Company granted a total of 44,00074,000 restricted stock unit awards with performance based vesting schedules to certain of its officers under the 2000 Plan.Prior Plans. The performance criteria were based on the Company’s achievement of combined annual billings and operating income objectives for 20082009 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. During 2010, the Company granted a total of 126,750 restricted stock unit awards with performance based vesting schedules to 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 thecertain performance requirements,objectives in 2011, 86,268 total shares of restricted stock units are subject to vest as follows: 50% of the restricted stock units will vest on February 5, 201010, 2013 and the remaining 50% will vest on February 5, 2011.10, 2014. These restricted units are subject to vest only if the officer is continuously employed through each vesting date.
2011 ANNUAL REPORT | 75 |
The following table summarizes the Company’s restricted stock unit activity for fiscal years 2006, 20072009, 2010 and 2008:2011:
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Number of Shares | Weighted Average Fair Value | |||||||
Balance at December 31, 2008 | 335,687 | $ | 19.73 | |||||
Granted | 1,123,158 | 13.05 | ||||||
Released | (87,775 | ) | 14.61 | |||||
Canceled | (167,667 | ) | 13.06 | |||||
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Balance at December 31, 2009 | 1,203,403 | 14.30 | ||||||
Granted | 904,682 | 19.90 | ||||||
Released | (417,065 | ) | 19.45 | |||||
Canceled | (342,873 | ) | 17.52 | |||||
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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 | |||||
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Balance at December 31, 2011 | 1,545,725 | 19.54 | ||||||
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The following table summarizes the Company’s stock option activity for fiscal years 2006, 20072009, 2010 and 2008:2011:
Number of Shares | Weighted Average Exercise Price | Number of Shares | Weighted Average Exercise price | |||||||||||
Balance at December 31, 2005 | 5,214,702 | $ | 17.86 | |||||||||||
Balance at December 31, 2008 | 10,431,100 | $ | 22.08 | |||||||||||
Granted | 4,792,930 | 28.16 | 802,259 | 14.74 | ||||||||||
Exercised | (945,553 | ) | 12.25 | (204,818 | ) | 11.88 | ||||||||
Cancelled | (2,023,820 | ) | 28.35 | |||||||||||
Canceled | (1,252,863 | ) | 20.88 | |||||||||||
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Balance at December 31, 2006 | 7,038,259 | 22.61 | ||||||||||||
Balance at December 31, 2009 | 9,775,678 | 21.85 | ||||||||||||
Granted | 3,229,009 | 21.51 | 316,000 | 20.27 | ||||||||||
Exercised | (339,368 | ) | 9.60 | (973,047 | ) | 16.43 | ||||||||
Cancelled | (841,114 | ) | 23.58 | |||||||||||
Canceled | (1,237,877 | ) | 22.25 | |||||||||||
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Balance at December 31, 2007 | 9,086,786 | 22.62 | ||||||||||||
Balance at December 31, 2010 | 7,880,754 | 22.39 | ||||||||||||
Granted | 2,718,725 | 19.12 | 66,000 | 23.99 | ||||||||||
Exercised | (356,084 | ) | 12.11 | (1,026,023 | ) | 16.47 | ||||||||
Cancelled | (1,018,327 | ) | 22.44 | |||||||||||
Canceled | (819,245 | ) | 23.51 | |||||||||||
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Balance at December 31, 2008 | 10,431,100 | 22.08 | ||||||||||||
Balance at December 31, 2011 | 6,101,486 | 23.25 | ||||||||||||
|
The weighted average fair value of stock options granted during the yearyears ended December 31, 20082011, 2010 and 2009 was $5.15$7.54, $6.49 and $4.85 per share, respectively, based on the grant date fair value of the stock options estimated in accordance with the provisions of SFAS 123R.options.
The total intrinsic value of stock options exercised during the yearyears ended December 31, 20082011, 2010 and 2009 was $3.0 million.
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
The total fair value of stock options vested during the years ended December 31, 20082011, 2010 and 2009 was $4.3 million, $8.1 million and $13.4 million, respectively.
76 | 2011 ANNUAL REPORT |
The following table summarizes all stock options outstanding and exercisable by price range as of December 31, 2008:2011:
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 | |||||
$ 0.25 – $18.74 | 2,871,679 | 5.3 | $15.60 | 1,207,574 | $12.45 | |||||
$18.75 – $21.30 | 2,093,772 | 5.7 | 20.01 | 732,379 | 19.76 | |||||
$21.32 – $23.93 | 2,645,758 | 5.2 | 22.92 | 1,211,859 | 22.81 | |||||
$24.15 – $32.24 | 2,706,816 | 4.7 | 29.24 | 1,735,379 | 28.49 | |||||
$32.47 – $99.96 | 113,075 | 3.6 | 33.69 | 84,520 | 33.77 | |||||
10,431,100 | 5.2 | 22.08 | 4,971,711 | 22.01 | ||||||
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 | |||||||||||||
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6,101,486 | 2.7 | 23.25 | 5,603,644 | 23.52 | ||||||||||||||
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The Company defines in-the-money stock options at December 31, 20082011 as stock options that had exercise prices that were lower than $18.73, the $14.97 market price of the Company’s common stock at that date. TheAs of December 31, 2011, the weighted-average remaining contractual term of options outstanding is 2.7 years and the weighted-average remaining contractual term of options currently exercisable is 4.52.6 years. The aggregate intrinsic value of all exercisable and non-exercisable stock options outstanding and in-the-money at December 31, 20082011 was $4.2$3.0 million. The aggregate intrinsic value of only exercisable stock options outstanding and in-the-money at December 31, 20082011 was $4.1$2.4 million. There were 805,5361,181,540 stock options in-the-money at December 31, 2008,2011, of which 792,012969,008 stock options were exercisable.
Shares Reserved for Future Issuance
The following shares of common stock are reserved for future issuance as of December 31, 2008:2011:
Stock options and restricted stock units: | ||||
Granted and outstanding | 7,647,211 | |||
Reserved for future grants | 5,628,409 | |||
Employee Stock Purchase Plan: | ||||
Reserved for future issuance | 1,391,081 | |||
Total | 14,666,701 | |||
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. The repurchases will be made from time to time on the open market at prevailing market prices. In January 2008,2010, the Company’s 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, 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.
In connection with the stock repurchase program, the Company adopted atwo 10b5-1 plan that providesstock repurchase plans (the “2009 Repurchase Plans”) in August 2009. The 2009 Repurchase Plans initially provided for quarterly purchases of up
2011 ANNUAL REPORT | 77 |
to an aggregate of $7.5 million of the Company’s common stock per calendar quarter in open market transactions.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
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
2008, 2011, the Company repurchased 1,079,049an aggregate of 4,787,302 shares of its common stock for an aggregate of approximately $20$100.0 million at an average price of $18.53$20.89 per share. As of December 31, 2008,2011, the Company had repurchased a total of 9,249,10920,411,821 shares of its common stock under these programsthe stock repurchase program, for an aggregate of $190.4$409.8 million at an average price of $20.59$20.08 per share. Under the terms of the SeniorThe 2010 Credit Agreement permits the Company to repurchase its securities so long as it is restricted from repurchasingnot in default under the 2010 Credit Agreement, has complied with all of its common stock for an aggregate purchase price that exceedsfinancial covenants, and has liquidity of at least $20 million; provided, however, if, after giving effect to any repurchase, the sum of $25Company’s leverage ratio is greater than 1.75:1, such repurchase cannot exceed $10 million plus 50% ofin the aggregate amount of its 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 the Company has filed quarterly financial statements. As of December 31, 2008, the Company can repurchase up to $29.9 million of its common stock under the Senior Credit Agreement, excluding amounts repurchased by the Company prior to December 31, 2008.any fiscal year.
Income Taxes |
For financial reporting purposes, income (loss) income before income taxes includes the following components:
Years Ended December 31, | Years Ended December 31, | ||||||||||||||||||||||
2008 | 2007 | 2006 | 2011 | 2010 | 2009 | ||||||||||||||||||
(In thousands) | (in thousands) | ||||||||||||||||||||||
(As Restated) | (As Restated) | ||||||||||||||||||||||
(Loss) income before income taxes | |||||||||||||||||||||||
Income (loss) before income taxes | |||||||||||||||||||||||
United States | $ | (27,407 | ) | $ | (3,906 | ) | $ | 40,269 | $ | 26,674 | $ | 16,820 | $ | 2,922 | |||||||||
Foreign | (18,856 | ) | (9,642 | ) | 10,481 | 17,345 | 9,441 | (6,563 | ) | ||||||||||||||
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Total | $ | (46,263 | ) | $ | (13,548 | ) | $ | 50,750 | $ | 44,019 | $ | 26,261 | $ | (3,641 | ) | ||||||||
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The (benefit) provision for income taxes is as follows:
Years Ended December 31, | ||||||||||||
2008 | 2007 | 2006 | ||||||||||
(In thousands) | ||||||||||||
(As Restated) | (As Restated) | |||||||||||
Current | ||||||||||||
Federal | $ | (1,105 | ) | $ | 7,840 | $ | 19,685 | |||||
Foreign | 13,331 | 5,943 | 2,579 | |||||||||
State | (2,316 | ) | 3,628 | 4,147 | ||||||||
9,910 | 17,411 | 26,411 | ||||||||||
Deferred | ||||||||||||
Federal | (13,577 | ) | (6,100 | ) | (6,727 | ) | ||||||
Foreign | (12,380 | ) | (6,623 | ) | (159 | ) | ||||||
State | (3,437 | ) | (1,755 | ) | (868 | ) | ||||||
(29,394 | ) | (14,478 | ) | (7,754 | ) | |||||||
(Benefit) provision for income taxes | $ | (19,484 | ) | $ | 2,933 | $ | 18,657 | |||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
Current Federal Foreign State Deferred Federal Foreign State Provision for income taxes December 31, 2008 Years Ended December 31, 2011 2010 2009 (in thousands) $ 2,882 $ 3,251 $ (247 ) 4,606 4,099 5,443 528 2,286 2,519 8,016 9,636 7,715 6,596 1,288 5,612 (1,863 ) (3,881 ) (7,192 ) 276 566 921 5,009 (2,027 ) (659 ) $ 13,025 $ 7,609 $ 7,056
78 | 2011 ANNUAL REPORT |
The reconciliation of income tax computed at the federal statutory rate to the (benefit) provision for income taxes is as follows:
Years Ended December 31, | ||||||||||||||||||||||||
2008 | 2007 | 2006 | Years Ended December 31, | |||||||||||||||||||||
(In thousands) | 2011 | 2010 | 2009 | |||||||||||||||||||||
(As Restated) | (As Restated) | (in thousands) | ||||||||||||||||||||||
Statutory rate | $ | (16,192 | ) | $ | (4,742 | ) | $ | 17,808 | $ | 15,407 | $ | 9,200 | $ | (1,274 | ) | |||||||||
Foreign tax | 4,350 | 674 | (1,336 | ) | 480 | (4,436 | ) | (1,505 | ) | |||||||||||||||
State tax | (5,641 | ) | 1,112 | 3,378 | 1,421 | 2,632 | 2,690 | |||||||||||||||||
Valuation allowance | (1,986 | ) | 4,822 | — | ||||||||||||||||||||
Credits | (432 | ) | (680 | ) | (282 | ) | (1,648 | ) | (1,307 | ) | 0 | |||||||||||||
Tax-exempt interest | 348 | (651 | ) | (2,151 | ) | |||||||||||||||||||
Share-based compensation | 304 | 2,323 | 914 | 1,297 | 1,777 | 1,498 | ||||||||||||||||||
Uncertain tax positions | (3,260 | ) | (1,386 | ) | 2,530 | |||||||||||||||||||
Other | (235 | ) | 75 | 326 | (672 | ) | 1,129 | 3,117 | ||||||||||||||||
|
|
| ||||||||||||||||||||||
(Benefit) provision for income taxes | $ | (19,484 | ) | $ | 2,933 | $ | 18,657 | |||||||||||||||||
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, | ||||||||||||||||
2008 | 2007 | December 31, | ||||||||||||||
(In thousands) | 2011 | 2010 | ||||||||||||||
(As Restated) | (As Restated) | (in thousands) | ||||||||||||||
Deferred tax assets: | ||||||||||||||||
Deferred revenue | $ | 40,757 | $ | 12,945 | $ | 29,112 | $ | 37,019 | ||||||||
Share-based compensation | 16,436 | 11,421 | 18,983 | 20,045 | ||||||||||||
State tax | 498 | 471 | 78 | 183 | ||||||||||||
Reserves and accruals not currently deductible | 11,686 | 17,864 | 4,693 | 4,534 | ||||||||||||
Net operating losses | 17,678 | 12,029 | 1,885 | 4,383 | ||||||||||||
Tax credits | 920 | — | 897 | 503 | ||||||||||||
Other | 2,630 | 2,825 | 825 | 794 | ||||||||||||
|
| |||||||||||||||
Gross deferred tax assets | 90,605 | 57,555 | 56,473 | 67,461 | ||||||||||||
Valuation allowance for deferred tax assets | (5,049 | ) | (9,503 | ) | (2,227 | ) | (1,816 | ) | ||||||||
|
| |||||||||||||||
Deferred tax assets, net | 85,556 | 48,052 | 54,246 | 65,645 | ||||||||||||
Deferred tax liabilities: | ||||||||||||||||
Basis difference in intangibles | (36,303 | ) | (37,257 | ) | (15,591 | ) | (20,074 | ) | ||||||||
Other | (2,394 | ) | — | (2,622 | ) | (5,272 | ) | |||||||||
|
| |||||||||||||||
Net deferred taxes | $ | 46,859 | $ | 10,795 | $ | 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 2008,2011, 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. Accordingly, the valuation allowance of $9.5 million asrealized.
As of December 31, 2007 was released and recorded as a credit to goodwill of $4.7 million and a credit to income tax provision of
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
approximately $4.8 million during 2008. As part of2011, the application of SFAS 141 and in relation to transactions in fiscal year 2008, a valuation allowance of $5.0 million was established related to the following items: $2.0 million for stateCompany had net operating loss carryforwards for SurfControl, Inc., $0.6 million of foreign tax credits due to the uncertainty of future utilization and $2.4 million for net deferred tax assets related to net operating losses of one of Websense’s subsidiaries in the United Kingdom as the subsidiary has no history of earnings. If recognized, the tax benefits relating to the reversal of the valuation allowance would result in a future reduction to income tax expense of approximately $5.0 million.
As of December 31, 2008, the Company had federal, state, United Kingdom, Austria, Ireland, Brazil, France and Netherlands net operating loss carryforwardsChina of approximately $24.7$2.9 million, $47.2$21.4 million, $22.7$0.2 million, $0.4$0.8 million, $1.4 million, $0.8 million, and $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 NetherlandsChina net operating loss carryforward will expire in 2012.2013. The net operating loss carryforwards in the United Kingdom, Austria, IrelandFrance and Brazil have no expiration date.
As of December 31, 2008,2011, the Company had approximately $25.2$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 accountsoperates 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 uncertain tax positions in accordance with FIN 48. 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, | |||||||||||||||||||
2008 | 2007 | 2011 | 2010 | 2009 | ||||||||||||||||
(In thousands) | (in thousands) | |||||||||||||||||||
Balance at beginning of year | $ | 12,338 | $ | 9,707 | $ | 13,878 | $ | 14,225 | $ | 8,772 | ||||||||||
Additions for tax positions related to the current year | 705 | 1,892 | 461 | 703 | 2,578 | |||||||||||||||
Additions for tax positions of prior years | 1,515 | 2,243 | 227 | 833 | 5,050 | |||||||||||||||
Reductions for tax positions related to prior years | (3,979 | ) | (145 | ) | (75 | ) | (630 | ) | (8 | ) | ||||||||||
Reductions for settlements | (65 | ) | — | (4,399 | ) | (1,253 | ) | (1,325 | ) | |||||||||||
Reductions for lapse of statute of limitations for assessment of taxes | (1,742 | ) | (1,359 | ) | 0 | 0 | (842 | ) | ||||||||||||
|
|
| ||||||||||||||||||
Balance at end of year | $ | 8,772 | $ | 12,338 | $ | 10,092 | $ | 13,878 | $ | 14,225 | ||||||||||
|
|
|
Included in the balance of unrecognized tax benefits as of December 31, 20082011 and 2010, are $8.1$7.0 million and $9.7 million, respectively, of tax benefits that, if recognized, would affect the Company’s effective tax rate and $0.7$1.0 million and $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 $0.5$0.4 million, $0.4 million and $0.4 million related to these uncertain tax positions during 2008,2011, 2010 and 2009, respectively, and in total, as of December 31, 2008,2011 and 2010, the Company has recorded a liability for potentialgross penalties and interest of $1.3 million. During 2008, the$2.2 million and $2.1 million, respectively. The Company received a favorable ruling regarding unrecognized state income tax benefits, resulting in the reduction of the uncertain tax liability including theclassifies interest accrual of $4.2 million. This favorable ruling resulted in approximately $2.7 million of net tax benefit being recognized in the consolidated statement of operations with the remaining $1.5 million being recorded as a reductionand penalties relating to the related deferred tax asset. In addition, due to the
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
potential resolution of federal, state and foreign tax examinations, and the expiration of various statutes of limitations, it is reasonably possible that the Company’s gross unrecognized tax benefits balance 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 bydue 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 rangesettlement agreement with the tax authorities in the United Kingdom concerning various tax matters relating to tax years 2005 through 2008. As a result of zerothis 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 $1.2 million.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 yearyears 2005 to 20072009 in the United States for 2002 to 2005 in the United Kingdom and for 20052006 to 20072010 in France.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 20022006 through 20082010 are still open and these years could be subject to examinationexamined by the respective tax authorities.
During the first quarter of 2010, the 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 the Company a 30-day letter which outlined all of their 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 Websense, Inc. and its Irish subsidiary, including the amount of cost sharing buy-in, as well as to the Company’s 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 the Company’s cost sharing arrangement could have on the Company’s effective tax rate. The Company disagrees with all of the proposed adjustments and has submitted a formal protest to the IRS for each matter. The IRS assigned the Company’s 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. The Company intends to continue to defend its 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.
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, 2008, 20072011, 2010 and 20062009 were $1,462,000, $900,000$2.7 million, $1.3 million and $727,000,$1.4 million, respectively.
Summarized Quarterly Data (Unaudited) |
The following tables present the Company’s unaudited quarterly consolidated statement of operations data for 20082011 and 2007. It has been derived from the Company’s unaudited consolidated financial statements which have been restated for each of the quarterly periods in the years ended December 31, 2008 and 2007 to reflect adjustments that are further discussed in Note 2 to the consolidated financial statements.2010.
1st Quarter | 2nd Quarter | 3rd Quarter | 4th Quarter | |||||||||||||
(In thousands, except per share data) | ||||||||||||||||
(As Restated) | (As Restated) | (As Restated) | (As Restated) | |||||||||||||
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 loss per share(1) | $ | (0.15 | ) | $ | (0.21 | ) | $ | (0.11 | ) | $ | (0.13 | ) | ||||
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) | ||||||||||||||||
(As Restated) | (As Restated) | (As Restated) | ||||||||||||||
2007 | ||||||||||||||||
Revenues | $ | 49,747 | $ | 50,449 | $ | 50,429 | $ | 59,682 | ||||||||
Gross margin | 45,090 | 45,013 | 45,339 | 45,725 | ||||||||||||
Income (loss) from operations | 4,595 | 2,963 | 4,978 | (31,237 | ) | |||||||||||
Income (loss) before income taxes | 7,035 | 4,438 | 8,906 | (33,927 | ) | |||||||||||
Net income (loss) | $ | 3,867 | $ | 1,276 | $ | 6,351 | $ | (27,975 | ) | |||||||
Basic income (loss) per share(1) | $ | 0.09 | $ | 0.03 | $ | 0.14 | $ | (0.62 | ) | |||||||
Diluted income (loss) per share(1) | $ | 0.09 | $ | 0.03 | $ | 0.14 | $ | (0.62 | ) |
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
2011 Revenues Gross profit Income from operations Income before income taxes Net income Basic income per share(1) Diluted income per share(1)December 31, 2008 1st Quarter 2nd Quarter 3rd Quarter 4th Quarter (In thousands, except per share data) $ 88,634 $ 90,705 $ 92,111 $ 92,733 73,971 75,613 77,212 77,768 7,792 9,527 13,714 13,382 8,830 9,022 13,544 12,623 $ 8,121 $ 4,380 $ 8,118 $ 10,375 $ 0.20 $ 0.11 $ 0.21 $ 0.27 $ 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 |
Adjustments to Quarterly Consolidated Financial Statements (Unaudited)
As more fully described in Note 2 to the consolidated financial statements, the Company has restated its historical consolidated financial statements as of and for the years ended December 31, 2008 and 2007.
The following tables present the effects of the restatements on the Company’s previously issued consolidated financial statements for the quarter ended December 31, 2008, as of and for the quarters and year-to-date periods ended September 30, 2008, June 30, 2008 and March 31, 2008, for the quarter ended December 31, 2007, as of and for the quarters and year-to-date periods ended September 30, 2007 and June 30, 2007 and as of March 31, 2007 and have been provided to present the effects of the restatements on the interim periods for the years ended December 31, 2008 and 2007 presented in Note 2 to the consolidated financial statements.
Consolidated Statement of Operations Three Months Ended December 31, 2008 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(Unaudited) (In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 79,256 | $ | (1,266 | ) | $ | 18 | $ | — | $ | 78,008 | |||||||||
Cost of revenues: | ||||||||||||||||||||
Cost of revenues | 9,119 | — | 20 | — | 9,139 | |||||||||||||||
Amortization of acquired technology | 3,163 | — | — | — | 3,163 | |||||||||||||||
Total cost of revenues | 12,282 | — | 20 | — | 12,302 | |||||||||||||||
Gross margin | 66,974 | (1,266 | ) | (2 | ) | — | 65,706 | |||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 45,100 | — | (87 | ) | — | 45,013 | ||||||||||||||
Research and development | 13,306 | — | 60 | — | 13,366 | |||||||||||||||
General and administrative | 10,181 | — | (326 | ) | — | 9,855 | ||||||||||||||
Total operating expenses | 68,587 | — | (353 | ) | — | 68,234 | ||||||||||||||
(Loss) income from operations | (1,613 | ) | (1,266 | ) | 351 | — | (2,528 | ) | ||||||||||||
Interest expense | (2,777 | ) | — | — | — | (2,777 | ) | |||||||||||||
Other income (expense), net | 522 | — | (556 | ) | — | (34 | ) | |||||||||||||
Loss before income taxes | (3,868 | ) | (1,266 | ) | (205 | ) | — | (5,339 | ) | |||||||||||
Provision (benefit) for income taxes | 8,075 | — | — | (7,760 | ) | 315 | ||||||||||||||
Net (loss) income | $ | (11,943 | ) | $ | (1,266 | ) | $ | (205 | ) | $ | 7,760 | $ | (5,654 | ) | ||||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.27 | ) | $ | (0.13 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,065 | 45,065 | ||||||||||||||||||
82 | 2011 ANNUAL REPORT |
Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008None.
Consolidated Balance Sheet September 30, 2008 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(Unaudited and in thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 63,364 | $ | (2,978 | ) | $ | 60,386 | |||||
Cash and cash equivalents—restricted | — | 1,336 | 1,336 | |||||||||
Accounts receivable, net | 64,649 | — | 64,649 | |||||||||
Income tax receivable | 2,177 | — | 2,177 | |||||||||
Current portion of deferred income taxes | 30,476 | 913 | 31,389 | |||||||||
Other current assets | 8,062 | — | 8,062 | |||||||||
Total current assets | 168,728 | (729 | ) | 167,999 | ||||||||
Cash and cash equivalents—restricted, less current portion | — | 1,642 | 1,642 | |||||||||
Property and equipment, net | 15,691 | — | 15,691 | |||||||||
Intangible assets, net | 117,748 | — | 117,748 | |||||||||
Goodwill | 374,643 | (1,215 | ) | 373,428 | ||||||||
Deferred income taxes, less current portion | 36,276 | 2,837 | 39,113 | |||||||||
Deposits and other assets | 4,419 | — | 4,419 | |||||||||
Total assets | $ | 717,505 | $ | 2,535 | $ | 720,040 | ||||||
Liabilities and stockholders’ equity | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 1,303 | $ | — | $ | 1,303 | ||||||
Accrued compensation and related benefits | 18,156 | 136 | 18,292 | |||||||||
Other accrued expenses | 26,763 | — | 26,763 | |||||||||
Current portion of income taxes payable | 12,837 | (467 | ) | 12,370 | ||||||||
Current portion of senior secured term loan | 737 | — | 737 | |||||||||
Current portion of deferred tax liability | 5,530 | — | 5,530 | |||||||||
Current portion of deferred revenue | 206,058 | 2,779 | 208,837 | |||||||||
Total current liabilities | 271,384 | 2,448 | 273,832 | |||||||||
Other long term liabilities | 1,410 | — | 1,410 | |||||||||
Income taxes payable, less current portion | 9,192 | — | 9,192 | |||||||||
Senior secured term loan, less current portion | 139,263 | — | 139,263 | |||||||||
Deferred tax liability, less current portion | 10,334 | — | 10,334 | |||||||||
Deferred revenue, less current portion | 101,281 | 4,918 | 106,199 | |||||||||
Total liabilities | 532,864 | 7,366 | 540,230 | |||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 521 | — | 521 | |||||||||
Additional paid-in capital | 291,292 | 283 | 291,575 | |||||||||
Treasury stock, at cost | (154,836 | ) | — | (154,836 | ) | |||||||
Retained earnings | 49,881 | (5,114 | ) | 44,767 | ||||||||
Accumulated other comprehensive loss | (2,217 | ) | — | (2,217 | ) | |||||||
Total stockholders’ equity | 184,641 | (4,831 | ) | 179,810 | ||||||||
Total liabilities and stockholders’ equity | $ | 717,505 | $ | 2,535 | $ | 720,040 | ||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Three Months Ended September 30, 2008 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(Unaudited) (In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 76,663 | $ | (1,779 | ) | $ | — | $ | — | $ | 74,884 | |||||||||
Cost of revenues: | ||||||||||||||||||||
Cost of revenues | 9,181 | — | 6 | — | 9,187 | |||||||||||||||
Amortization of acquired technology | 3,108 | — | — | — | 3,108 | |||||||||||||||
Total cost of revenues | 12,289 | — | 6 | — | 12,295 | |||||||||||||||
Gross margin | 64,374 | (1,779 | ) | (6 | ) | — | 62,589 | |||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 42,952 | — | 41 | — | 42,993 | |||||||||||||||
Research and development | 13,139 | — | 19 | — | 13,158 | |||||||||||||||
General and administrative | 10,753 | — | 10 | — | 10,763 | |||||||||||||||
Total operating expenses | 66,844 | — | 70 | — | 66,914 | |||||||||||||||
Loss from operations | (2,470 | ) | (1,779 | ) | (76 | ) | — | (4,325 | ) | |||||||||||
Interest expense | (2,985 | ) | — | — | — | (2,985 | ) | |||||||||||||
Other expense, net | (94 | ) | — | (34 | ) | — | (128 | ) | ||||||||||||
Loss before income taxes | (5,549 | ) | (1,779 | ) | (110 | ) | — | (7,438 | ) | |||||||||||
Benefit for income taxes | (2,052 | ) | — | — | (573 | ) | (2,625 | ) | ||||||||||||
Net (loss) income | $ | (3,497 | ) | $ | (1,779 | ) | $ | (110 | ) | $ | 573 | $ | (4,813 | ) | ||||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.08 | ) | $ | (0.11 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,097 | 45,097 | ||||||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Nine Months Ended September 30, 2008 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(Unaudited) (In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 216,605 | $ | (6,414 | ) | $ | 75 | $ | — | $ | 210,266 | |||||||||
Cost of revenues: | ||||||||||||||||||||
Cost of revenues | 26,635 | — | (38 | ) | — | 26,597 | ||||||||||||||
Amortization of acquired technology | 9,261 | — | — | — | 9,261 | |||||||||||||||
Total cost of revenues | 35,896 | — | (38 | ) | — | 35,858 | ||||||||||||||
Gross margin | 180,709 | (6,414 | ) | 113 | — | 174,408 | ||||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 130,109 | — | 243 | — | 130,352 | |||||||||||||||
Research and development | 39,798 | — | 110 | — | 39,908 | |||||||||||||||
General and administrative | 35,441 | — | 47 | — | 35,488 | |||||||||||||||
Total operating expenses | 205,348 | — | 400 | — | 205,748 | |||||||||||||||
Loss from operations | (24,639 | ) | (6,414 | ) | (287 | ) | — | (31,340 | ) | |||||||||||
Interest expense | (10,357 | ) | — | — | — | (10,357 | ) | |||||||||||||
Other income (expense), net | 908 | — | (135 | ) | — | 773 | ||||||||||||||
Loss before income taxes | (34,088 | ) | (6,414 | ) | (422 | ) | — | (40,924 | ) | |||||||||||
Benefit for income taxes | (16,161 | ) | — | — | (3,638 | ) | (19,799 | ) | ||||||||||||
Net (loss) income | $ | (17,927 | ) | $ | (6,414 | ) | $ | (422 | ) | $ | 3,638 | $ | (21,125 | ) | ||||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.40 | ) | $ | (0.47 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,233 | 45,233 | ||||||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Balance Sheet June 30, 2008 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(Unaudited and in thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 65,074 | $ | (1,523 | ) | $ | 63,551 | |||||
Cash and cash equivalents—restricted | — | 1,482 | 1,482 | |||||||||
Accounts receivable, net | 61,588 | — | 61,588 | |||||||||
Income tax receivable | 2,241 | — | 2,241 | |||||||||
Current portion of deferred income taxes | 30,279 | 683 | 30,962 | |||||||||
Other current assets | 12,922 | — | 12,922 | |||||||||
Total current assets | 172,104 | 642 | 172,746 | |||||||||
Cash and cash equivalents—restricted, less current portion | — | 1,642 | 1,642 | |||||||||
Property and equipment, net | 16,304 | — | 16,304 | |||||||||
Intangible assets, net | 129,496 | — | 129,496 | |||||||||
Goodwill | 376,135 | — | 376,135 | |||||||||
Deferred income taxes, less current portion | 35,258 | 1,218 | 36,476 | |||||||||
Deposits and other assets | 4,690 | (1,600 | ) | 3,090 | ||||||||
Total assets | $ | 733,987 | $ | 1,902 | $ | 735,889 | ||||||
Liabilities and stockholders’ equity | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 1,640 | $ | — | $ | 1,640 | ||||||
Accrued compensation and related benefits | 18,527 | 132 | 18,659 | |||||||||
Other accrued expenses | 26,936 | — | 26,936 | |||||||||
Current portion of income taxes payable | 15,934 | (559 | ) | 15,375 | ||||||||
Current portion of deferred tax liability | 6,055 | — | 6,055 | |||||||||
Current portion of deferred revenue | 204,663 | 2,009 | 206,672 | |||||||||
Total current liabilities | 273,755 | 1,582 | 275,337 | |||||||||
Other long term liabilities | 1,796 | — | 1,796 | |||||||||
Income taxes payable, less current portion | 9,661 | — | 9,661 | |||||||||
Senior secured term loan | 155,000 | — | 155,000 | |||||||||
Deferred tax liability, less current portion | 11,582 | — | 11,582 | |||||||||
Deferred revenue, less current portion | 97,878 | 3,909 | 101,787 | |||||||||
Total liabilities | 549,672 | 5,491 | 555,163 | |||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 519 | — | 519 | |||||||||
Additional paid-in capital | 282,281 | 208 | 282,489 | |||||||||
Treasury stock, at cost | (149,829 | ) | — | (149,829 | ) | |||||||
Retained earnings | 53,377 | (3,797 | ) | 49,580 | ||||||||
Accumulated other comprehensive loss | (2,033 | ) | — | (2,033 | ) | |||||||
Total stockholders’ equity | 184,315 | (3,589 | ) | 180,726 | ||||||||
Total liabilities and stockholders’ equity | $ | 733,987 | $ | 1,902 | $ | 735,889 | ||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Three Months Ended June 30, 2008 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(Unaudited) (In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 72,958 | $ | (2,696 | ) | $ | — | $ | — | $ | 70,262 | |||||||||
Cost of revenues: | ||||||||||||||||||||
Cost of revenues | 8,587 | — | 16 | — | 8,603 | |||||||||||||||
Amortization of acquired technology | 3,081 | — | — | — | 3,081 | |||||||||||||||
Total cost of revenues | 11,668 | — | 16 | — | 11,684 | |||||||||||||||
Gross margin | 61,290 | (2,696 | ) | (16 | ) | — | 58,578 | |||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 44,338 | — | 104 | — | 44,442 | |||||||||||||||
Research and development | 13,198 | — | 49 | — | 13,247 | |||||||||||||||
General and administrative | 11,836 | — | 22 | — | 11,858 | |||||||||||||||
Total operating expenses | 69,372 | — | 175 | — | 69,547 | |||||||||||||||
Loss from operations | (8,082 | ) | (2,696 | ) | (191 | ) | — | (10,969 | ) | |||||||||||
Interest expense | (2,941 | ) | — | — | — | (2,941 | ) | |||||||||||||
Other income (expense), net | 1,113 | — | (132 | ) | — | 981 | ||||||||||||||
Loss before income taxes | (9,910 | ) | (2,696 | ) | (323 | ) | — | (12,929 | ) | |||||||||||
Benefit for income taxes | (1,716 | ) | — | — | (1,602 | ) | (3,318 | ) | ||||||||||||
Net (loss) income | $ | (8,194 | ) | $ | (2,696 | ) | $ | (323 | ) | $ | 1,602 | $ | (9,611 | ) | ||||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.18 | ) | $ | (0.21 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,208 | 45,208 | ||||||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Six Months Ended June 30, 2008 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(Unaudited) (In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 139,942 | $ | (4,635 | ) | $ | 75 | $ | — | $ | 135,382 | |||||||||
Cost of revenues: | ||||||||||||||||||||
Cost of revenues | 17,454 | — | (44 | ) | — | 17,410 | ||||||||||||||
Amortization of acquired technology | 6,153 | — | — | — | 6,153 | |||||||||||||||
Total cost of revenues | 23,607 | — | (45 | ) | — | 23,563 | ||||||||||||||
Gross margin | 116,335 | (4,635 | ) | 119 | — | 111,819 | ||||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 87,159 | — | 199 | — | 87,358 | |||||||||||||||
Research and development | 26,658 | — | 92 | — | 26,750 | |||||||||||||||
General and administrative | 24,689 | — | 37 | — | 24,726 | |||||||||||||||
Total operating expenses | 138,506 | — | 328 | — | 138,834 | |||||||||||||||
Loss from operations | (22,171 | ) | (4,635 | ) | (209 | ) | — | (27,015 | ) | |||||||||||
Interest expense | (7,373 | ) | — | — | — | (7,373 | ) | |||||||||||||
Other income (expense), net | 1,004 | — | (102 | ) | — | 902 | ||||||||||||||
Loss before income taxes | (28,540 | ) | (4,635 | ) | (311 | ) | — | (33,486 | ) | |||||||||||
Benefit for income taxes | (14,109 | ) | — | — | (3,065 | ) | (17,174 | ) | ||||||||||||
Net (loss) income | $ | (14,431 | ) | $ | (4,635 | ) | (311 | ) | $ | 3,065 | $ | (16,312 | ) | |||||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.32 | ) | $ | (0.36 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,299 | 45,299 | ||||||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Balance Sheet March 31, 2008 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(Unaudited and in thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 71,037 | $ | (1,513 | ) | $ | 69,524 | |||||
Cash and cash equivalents—restricted | — | 1,471 | 1,471 | |||||||||
Marketable securities | 632 | — | 632 | |||||||||
Accounts receivable, net | 47,044 | — | 47,044 | |||||||||
Income tax receivable | 2,161 | — | 2,161 | |||||||||
Current portion of deferred income taxes | 29,203 | 431 | 29,634 | |||||||||
Other current assets | 11,325 | — | 11,325 | |||||||||
Total current assets | 161,402 | 389 | 161,791 | |||||||||
Cash and cash equivalents—restricted, less current portion | — | 1,642 | 1,642 | |||||||||
Property and equipment, net | 17,288 | — | 17,288 | |||||||||
Intangible assets, net | 140,875 | — | 140,875 | |||||||||
Goodwill | 377,726 | — | 377,726 | |||||||||
Deferred income taxes, less current portion | 28,940 | 617 | 29,557 | |||||||||
Deposits and other assets | 5,076 | (1,600 | ) | 3,476 | ||||||||
Total assets | $ | 731,307 | $ | 1,048 | $ | 732,355 | ||||||
Liabilities and stockholders’ equity | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 256 | $ | — | $ | 256 | ||||||
Accrued compensation and related benefits | 19,958 | — | 19,958 | |||||||||
Other accrued expenses | 31,132 | — | 31,132 | |||||||||
Current portion of income taxes payable | 7,677 | 149 | 7,826 | |||||||||
Current portion of deferred tax liability | 7,984 | — | 7,984 | |||||||||
Current portion of deferred revenue | 194,570 | 924 | 195,494 | |||||||||
Total current liabilities | 261,577 | 1,073 | 262,650 | |||||||||
Other long term liabilities | 3,426 | — | 3,426 | |||||||||
Income taxes payable, less current portion | 9,322 | — | 9,322 | |||||||||
Senior secured term loan | 160,000 | — | 160,000 | |||||||||
Deferred tax liability, less current portion | 15,959 | — | 15,959 | |||||||||
Deferred revenue, less current portion | 93,058 | 2,298 | 95,356 | |||||||||
Total liabilities | 543,342 | 3,371 | 546,713 | |||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 516 | — | 516 | |||||||||
Additional paid-in capital | 273,555 | 57 | 273,612 | |||||||||
Treasury stock, at cost | (144,797 | ) | — | (144,797 | ) | |||||||
Retained earnings | 61,571 | (2,380 | ) | 59,191 | ||||||||
Accumulated other comprehensive loss | (2,880 | ) | — | (2,880 | ) | |||||||
Total stockholders’ equity | 187,965 | (2,323 | ) | 185,642 | ||||||||
Total liabilities and stockholders’ equity | $ | 731,307 | $ | 1,048 | $ | 732,355 | ||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Three Months Ended March 31, 2008 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(Unaudited) (In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 66,984 | $ | (1,939 | ) | $ | 75 | $ | — | $ | 65,120 | |||||||||
Cost of revenues: | ||||||||||||||||||||
Cost of revenues | 8,867 | — | (60 | ) | — | 8,807 | ||||||||||||||
Amortization of acquired technology | 3,072 | — | — | — | 3,072 | |||||||||||||||
Total cost of revenues | 11,939 | — | (60 | ) | — | 11,879 | ||||||||||||||
Gross margin | 55,045 | (1,939 | ) | 135 | — | 53,241 | ||||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 42,821 | — | 95 | — | 42,916 | |||||||||||||||
Research and development | 13,460 | — | 43 | — | 13,503 | |||||||||||||||
General and administrative | 12,853 | — | 15 | — | 12,868 | |||||||||||||||
Total operating expenses | 69,134 | — | 153 | — | 69,287 | |||||||||||||||
Loss from operations | (14,089 | ) | (1,939 | ) | (18 | ) | — | (16,046 | ) | |||||||||||
Interest expense | (4,432 | ) | — | — | — | (4,432 | ) | |||||||||||||
Other (expense) income, net | (109 | ) | — | 30 | — | (79 | ) | |||||||||||||
(Loss) income before income taxes | (18,630 | ) | (1,939 | ) | 12 | — | (20,557 | ) | ||||||||||||
Benefit for income taxes | (12,393 | ) | — | — | (1,463 | ) | (13,856 | ) | ||||||||||||
Net (loss) income | $ | (6,237 | ) | $ | (1,939 | ) | $ | 12 | $ | 1,463 | $ | (6,701 | ) | |||||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.14 | ) | $ | (0.15 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,395 | 45,395 | ||||||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Three Months Ended December 31, 2007 | ||||||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | ||||||||||||||||
(Unaudited) (In thousands, except per share amounts) | ||||||||||||||||||||
Revenues | $ | 61,040 | $ | (1,283 | ) | $ | (75 | ) | $ | — | $ | 59,682 | ||||||||
Cost of revenues: | ||||||||||||||||||||
Cost of revenues | 9,167 | — | 63 | — | 9,230 | |||||||||||||||
Amortization of acquired technology | 4,727 | — | — | — | 4,727 | |||||||||||||||
Total cost of revenues | 13,894 | — | 63 | — | 13,957 | |||||||||||||||
Gross margin | 47,146 | (1,283 | ) | (138 | ) | — | 45,725 | |||||||||||||
Operating expenses: | ||||||||||||||||||||
Selling and marketing | 51,046 | — | (69 | ) | — | 50,977 | ||||||||||||||
Research and development | 13,892 | — | (30 | ) | — | 13,862 | ||||||||||||||
General and administrative | 12,132 | — | (9 | ) | — | 12,123 | ||||||||||||||
Total operating expenses | 77,070 | — | (108 | ) | — | 76,962 | ||||||||||||||
Loss from operations | (29,924 | ) | (1,283 | ) | (30 | ) | — | (31,237 | ) | |||||||||||
Interest expense | (4,308 | ) | — | — | — | (4,308 | ) | |||||||||||||
Other income (expense), net | 1,649 | — | (31 | ) | — | 1,618 | ||||||||||||||
Loss before income taxes | (32,583 | ) | (1,283 | ) | (61 | ) | — | (33,927 | ) | |||||||||||
Benefit for income taxes | (5,627 | ) | — | — | (325 | ) | (5,952 | ) | ||||||||||||
Net (loss) income | $ | (26,956 | ) | $ | (1,283 | ) | $ | (61 | ) | $ | 325 | $ | (27,975 | ) | ||||||
Net loss per share: | ||||||||||||||||||||
Basic and diluted net loss per share | $ | (0.59 | ) | $ | (0.62 | ) | ||||||||||||||
Weighted average shares—basic and diluted | 45,339 | 45,339 | ||||||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Balance Sheet September 30, 2007 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(Unaudited and in thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 45,645 | $ | — | $ | 45,645 | ||||||
Cash and cash equivalents—restricted | 196,162 | — | 196,162 | |||||||||
Marketable securities | 15,035 | — | 15,035 | |||||||||
Marketable securities—restricted | 22,991 | — | 22,991 | |||||||||
Accounts receivable, net | 42,643 | — | 42,643 | |||||||||
Income tax receivable | 2,357 | — | 2,357 | |||||||||
Current portion of deferred income taxes | 18,052 | — | 18,052 | |||||||||
Other current assets | 5,167 | — | 5,167 | |||||||||
Total current assets | 348,052 | — | 348,052 | |||||||||
Cash and cash equivalents—restricted, less current portion | — | 1,600 | 1,600 | |||||||||
Property and equipment, net | 7,592 | — | 7,592 | |||||||||
Intangible assets, net | 13,138 | — | 13,138 | |||||||||
Goodwill | 73,625 | — | 73,625 | |||||||||
Deferred income taxes, less current portion | 21,608 | 388 | 21,996 | |||||||||
Deposits and other assets | 7,386 | (1,600 | ) | 5,786 | ||||||||
Total assets | $ | 471,401 | $ | 388 | $ | 471,789 | ||||||
Liabilities and stockholders’ equity | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 1,425 | $ | — | $ | 1,425 | ||||||
Accrued compensation and related benefits | 13,216 | — | 13,216 | |||||||||
Other accrued expenses | 12,414 | — | 12,414 | |||||||||
Current portion of income taxes payable | 1,105 | 372 | 1,477 | |||||||||
Current portion of deferred revenue | 145,742 | — | 145,742 | |||||||||
Total current liabilities | 173,902 | 372 | 174,274 | |||||||||
Income taxes payable, less current portion | 9,522 | 946 | 10,468 | |||||||||
Deferred revenue, less current portion | 73,528 | — | 73,528 | |||||||||
Total liabilities | 256,952 | 1,318 | 258,270 | |||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 514 | — | 514 | |||||||||
Additional paid-in capital | 258,958 | (33 | ) | 258,925 | ||||||||
Treasury stock, at cost | (139,786 | ) | — | (139,786 | ) | |||||||
Retained earnings | 94,763 | (897 | ) | 93,866 | ||||||||
Total stockholders’ equity | 214,449 | (930 | ) | 213,519 | ||||||||
Total liabilities and stockholders’ equity | $ | 471,401 | $ | 388 | $ | 471,789 | ||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Three Months Ended September 30, 2007 | |||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | |||||||||||||
(Unaudited) (In thousands, except per share amounts) | |||||||||||||||||
Revenues | $ | 50,429 | $ | — | $ | — | $ | — | $ | 50,429 | |||||||
Cost of revenues: | |||||||||||||||||
Cost of revenues | 4,466 | — | (5 | ) | — | 4,461 | |||||||||||
Amortization of acquired technology | 629 | — | — | — | 629 | ||||||||||||
Total cost of revenues | 5,095 | — | (5 | ) | — | 5,090 | |||||||||||
Gross margin | 45,334 | — | 5 | — | 45,339 | ||||||||||||
Operating expenses: | |||||||||||||||||
Selling and marketing | 25,249 | — | (34 | ) | — | 25,215 | |||||||||||
Research and development | 8,338 | — | (15 | ) | — | 8,323 | |||||||||||
General and administrative | 6,828 | — | (5 | ) | — | 6,823 | |||||||||||
Total operating expenses | 40,415 | — | (54 | ) | — | 40,361 | |||||||||||
Income from operations | 4,919 | — | 59 | — | 4,978 | ||||||||||||
Other income, net | 3,928 | — | — | — | 3,928 | ||||||||||||
Income before income taxes | 8,847 | — | 59 | — | 8,906 | ||||||||||||
Provision for income taxes | 2,452 | — | — | 103 | 2,555 | ||||||||||||
Net income (loss) | $ | 6,395 | $ | — | $ | 59 | $ | (103 | ) | $ | 6,351 | ||||||
Net income per share: | |||||||||||||||||
Basic net income per share | $ | 0.14 | $ | 0.14 | |||||||||||||
Diluted net income per share | $ | 0.14 | $ | 0.14 | |||||||||||||
Weighted average shares—basic | 45,194 | 45,194 | |||||||||||||||
Weighted average shares—diluted | 45,607 | 45,607 | |||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Nine Months Ended September 30, 2007 | |||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | |||||||||||||
(Unaudited) (In thousands, except per share amounts) | |||||||||||||||||
Revenues | $ | 150,625 | $ | — | $ | — | $ | — | $ | 150,625 | |||||||
Cost of revenues: | |||||||||||||||||
Cost of revenues | 13,299 | — | (3 | ) | — | 13,296 | |||||||||||
Amortization of acquired technology | 1,887 | — | — | — | 1,887 | ||||||||||||
Total cost of revenues | 15,186 | — | (3 | ) | — | 15,183 | |||||||||||
Gross margin | 135,439 | — | 3 | — | 135,442 | ||||||||||||
Operating expenses: | |||||||||||||||||
Selling and marketing | 75,289 | — | (18 | ) | — | 75,271 | |||||||||||
Research and development | 27,059 | — | (8 | ) | — | 27,051 | |||||||||||
General and administrative | 20,589 | — | (5 | ) | — | 20,584 | |||||||||||
Total operating expenses | 122,937 | — | (31 | ) | — | 122,906 | |||||||||||
Income from operations | 12,502 | — | 34 | — | 12,536 | ||||||||||||
Other income, net | 7,843 | — | — | — | 7,843 | ||||||||||||
Income before income taxes | 20,345 | — | 34 | — | 20,379 | ||||||||||||
Provision for income taxes | 7,954 | — | — | 931 | 8,885 | ||||||||||||
Net income (loss) | 12,391 | $ | — | $ | 34 | $ | (931 | ) | $ | 11,494 | |||||||
Net income per share: | |||||||||||||||||
Basic net income per share | $ | 0.28 | $ | 0.26 | |||||||||||||
Diluted net income per share | $ | 0.27 | $ | 0.25 | |||||||||||||
Weighted average shares—basic | 45,028 | 45,028 | |||||||||||||||
Weighted average shares—diluted | 45,517 | 45,517 | |||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Balance Sheet June 30, 2007 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(Unaudited and in thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 28,513 | $ | — | $ | 28,513 | ||||||
Cash and cash equivalents—restricted | 1,285 | — | 1,285 | |||||||||
Marketable securities | 16,380 | — | 16,380 | |||||||||
Marketable securities—restricted | 215,716 | — | 215,716 | |||||||||
Accounts receivable, net | 43,813 | — | 43,813 | |||||||||
Income tax receivable | 1,875 | — | 1,875 | |||||||||
Current portion of deferred income taxes | 18,092 | — | 18,092 | |||||||||
Other current assets | 5,385 | — | 5,385 | |||||||||
Total current assets | 331,059 | — | 331,059 | |||||||||
Cash and cash equivalents—restricted, less current portion | — | 1,600 | 1,600 | |||||||||
Property and equipment, net | 7,679 | — | 7,679 | |||||||||
Intangible assets, net | 14,017 | — | 14,017 | |||||||||
Goodwill | 73,467 | — | 73,467 | |||||||||
Deferred income taxes, less current portion | 20,212 | 388 | 20,600 | |||||||||
Deposits and other assets | 9,275 | (1,600 | ) | 7,675 | ||||||||
Total assets | $ | 455,709 | $ | 388 | $ | 456,097 | ||||||
Liabilities and stockholders’ equity | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 2,542 | $ | — | $ | 2,542 | ||||||
Accrued compensation and related benefits | 11,341 | — | 11,341 | |||||||||
Other accrued expenses | 12,529 | — | 12,529 | |||||||||
Current portion of income taxes payable | 216 | 270 | 486 | |||||||||
Current portion of deferred revenue | 145,362 | — | 145,362 | |||||||||
Total current liabilities | 171,990 | 270 | 172,260 | |||||||||
Income taxes payable, less current portion | 10,242 | 946 | 11,188 | |||||||||
Deferred revenue, less current portion | 72,171 | — | 72,171 | |||||||||
Total liabilities | 254,403 | 1,216 | 255,619 | |||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 513 | — | 513 | |||||||||
Additional paid-in capital | 252,261 | 25 | 252,286 | |||||||||
Treasury stock, at cost | (139,779 | ) | — | (139,779 | ) | |||||||
Retained earnings | 88,368 | (853 | ) | 87,515 | ||||||||
Accumulated other comprehensive loss | (57 | ) | — | (57 | ) | |||||||
Total stockholders’ equity | 201,306 | (828 | ) | 200,478 | ||||||||
Total liabilities and stockholders’ equity | $ | 455,709 | $ | 388 | $ | 456,097 | ||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Three Months Ended June 30, 2007 | |||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | |||||||||||||
(Unaudited) (In thousands, except per share amounts) | |||||||||||||||||
Revenues | $ | 50,449 | $ | — | $ | — | $ | — | $ | 50,449 | |||||||
Cost of revenues: | |||||||||||||||||
Cost of revenues | 4,805 | — | 2 | — | 4,807 | ||||||||||||
Amortization of acquired technology | 629 | — | — | — | 629 | ||||||||||||
Total cost of revenues | 5,434 | — | 2 | — | 5,436 | ||||||||||||
Gross margin | 45,015 | — | (2 | ) | — | 45,013 | |||||||||||
Operating expenses: | |||||||||||||||||
Selling and marketing | 25,127 | — | 15 | — | 25,142 | ||||||||||||
Research and development | 10,325 | — | 7 | — | 10,332 | ||||||||||||
General and administrative | 6,575 | — | 1 | — | 6,576 | ||||||||||||
Total operating expenses | 42,027 | — | 23 | — | 42,050 | ||||||||||||
Income (loss) from operations | 2,988 | — | (25 | ) | — | 2,963 | |||||||||||
Other income, net | 1,475 | — | — | — | 1,475 | ||||||||||||
Income (loss) before income taxes | 4,463 | — | (25 | ) | — | 4,438 | |||||||||||
Provision for income taxes | 2,334 | — | — | 828 | 3,162 | ||||||||||||
Net income (loss) | $ | 2,129 | $ | — | $ | (25 | ) | $ | (828 | ) | $ | 1,276 | |||||
Net income per share: | |||||||||||||||||
Basic net income per share | $ | 0.05 | $ | 0.03 | |||||||||||||
Diluted net income per share | $ | 0.05 | $ | 0.03 | |||||||||||||
Weighted average shares—basic | 45,060 | 45,060 | |||||||||||||||
Weighted average shares—diluted | 45,561 | 45,561 | |||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Statement of Operations Six Months Ended June 30, 2007 | |||||||||||||||||
Previously Reported | OEM Revenue – Timing Adjustments | Other Adjustments | Income Tax Adjustments | As Restated | |||||||||||||
(Unaudited) (In thousands, except per share amounts) | |||||||||||||||||
Revenues | $ | 100,196 | $ | — | $ | — | $ | — | $ | 100,196 | |||||||
Cost of revenues: | |||||||||||||||||
Cost of revenues | 8,833 | — | 2 | — | 8,835 | ||||||||||||
Amortization of acquired technology | 1,258 | — | — | — | 1,258 | ||||||||||||
Total cost of revenues | 10,091 | — | 2 | — | 10,093 | ||||||||||||
Gross margin | 90,105 | — | (2 | ) | — | 90,103 | |||||||||||
Operating expenses: | |||||||||||||||||
Selling and marketing | 50,040 | — | 15 | — | 50,055 | ||||||||||||
Research and development | 18,721 | — | 7 | — | 18,728 | ||||||||||||
General and administrative | 13,761 | — | 1 | — | 13,762 | ||||||||||||
Total operating expenses | 82,522 | — | 23 | — | 82,545 | ||||||||||||
Income (loss) from operations | 7,583 | — | (25 | ) | — | 7,558 | |||||||||||
Other income, net | 3,915 | — | — | — | 3,915 | ||||||||||||
Income (loss) before income taxes | 11,498 | — | (25 | ) | — | 11,473 | |||||||||||
Provision for income taxes | 5,502 | — | — | 828 | 6,330 | ||||||||||||
Net income (loss) | $ | 5,996 | $ | — | $ | (25 | ) | $ | (828 | ) | $ | 5,143 | |||||
Net income per share: | |||||||||||||||||
Basic net income per share | $ | 0.13 | $ | 0.11 | |||||||||||||
Diluted net income per share | $ | 0.13 | $ | 0.11 | |||||||||||||
Weighted average shares—basic | 44,978 | 44,978 | |||||||||||||||
Weighted average shares—diluted | 45,499 | 45,499 | |||||||||||||||
Websense, Inc.
Notes to Consolidated Financial Statements (Continued)
December 31, 2008
Consolidated Balance Sheet March 31, 2007 | ||||||||||||
Previously Reported | Adjustments | As Restated | ||||||||||
(Unaudited and in thousands) | ||||||||||||
Assets | ||||||||||||
Current assets: | ||||||||||||
Cash and cash equivalents | $ | 27,238 | $ | — | $ | 27,238 | ||||||
Cash and cash equivalents—restricted | — | — | — | |||||||||
Marketable securities | 234,123 | — | 234,123 | |||||||||
Accounts receivable, net | 36,866 | — | 36,866 | |||||||||
Income tax receivable | 113 | — | 113 | |||||||||
Current portion of deferred income taxes | 18,073 | — | 18,073 | |||||||||
Other current assets | 5,212 | — | 5,212 | |||||||||
Total current assets | 321,625 | — | 321,625 | |||||||||
Cash and cash equivalents—restricted, less current portion | — | 1,600 | 1,600 | |||||||||
Property and equipment, net | 7,288 | — | 7,288 | |||||||||
Intangible assets, net | 14,897 | — | 14,897 | |||||||||
Goodwill | 73,380 | — | 73,380 | |||||||||
Deferred income taxes, less current portion | 16,713 | — | 16,713 | |||||||||
Deposits and other assets | 2,513 | (1,600 | ) | 913 | ||||||||
Total assets | $ | 436,416 | $ | — | $ | 436,416 | ||||||
Liabilities and stockholders’ equity | ||||||||||||
Current liabilities: | ||||||||||||
Accounts payable | $ | 1,935 | $ | — | $ | 1,935 | ||||||
Accrued compensation and related benefits | 10,354 | — | 10,354 | |||||||||
Other accrued expenses | 9,495 | — | 9,495 | |||||||||
Current portion of income taxes payable | 2,232 | — | 2,232 | |||||||||
Current portion of deferred revenue | 143,509 | — | 143,509 | |||||||||
Total current liabilities | 167,525 | — | 167,525 | |||||||||
Income taxes payable, less current portion | 9,248 | — | 9,248 | |||||||||
Deferred revenue, less current portion | 69,935 | — | 69,935 | |||||||||
Total liabilities | 246,708 | — | 246,708 | |||||||||
Stockholders’ equity: | ||||||||||||
Common stock | 511 | — | 511 | |||||||||
Additional paid-in capital | 242,750 | — | 242,750 | |||||||||
Treasury stock, at cost | (139,744 | ) | — | (139,744 | ) | |||||||
Retained earnings | 86,239 | — | 86,239 | |||||||||
Accumulated other comprehensive loss | (48 | ) | — | (48 | ) | |||||||
Total stockholders’ equity | 189,708 | — | 189,708 | |||||||||
Total liabilities and stockholders’ equity | $ | 436,416 | $ | — | $ | 436,416 | ||||||
Item 9A. | Controls and Procedures |
Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e)13a—15(e) and 15d-15(e)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 by our CEO and CFO, has designed our disclosure controls and procedures to provide reasonable assurance of achieving desired objectives. As of December 31, 2008the end of the period covered by this Annual Report on Form 10-K, we carried out an evalutation,evaluation, under the supervision of 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, (asas defined in RuleRules 13a-15(e) promulgatedand 15d-15(e) under the Exchange Act).Act. Based on thethis evaluation, as of December 31, 2008, our CEO and CFO originally concluded that our disclosure controls and procedures were effective.
In connection with the restatementeffective as of our financial statements for the fiscal years ended December 31, 2007 and December 31, 2008, our management, with the participation of our CEO and CFO, has reevaluated the effectiveness of our disclosure controls and procedures. Based upon that evaluation, management identified material weaknesses in our internal control over financial reporting with respect to our application of SOP 97-2 as it relates to the recognition of royalty revenue related to OEM contracts for the years ended December 31, 2008 and 2007 and our computation of our income tax benefit for the year ended December 31, 2008, as described below under “Management’s2011.
Management’s Report on Internal Control over Financial Reporting (Restated).” Solely as a result of these material weaknesses, our CEO and CFO have revised their conclusions regarding the effectiveness of our internal control over financial reporting as of December 31, 2008 and 2007. Accordingly, management now concludes that our disclosure controls and procedures were not effective at a reasonable assurance level as of December 31, 2008 and 2007 and through the date of this filing.
In light of the material weaknesses referred to above, the Company performed additional analyses and procedures in order to conclude that its consolidated financial statements, for the years ended December 31, 2008 and December 31, 2007 (including restated interim periods therein) are fairly presented, in all material respects, in accordance with GAAP and has undertaken remediation initiatives as discussed below.
Other than as described above, during the three months ended December 31, 2008, there was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our 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.
In connectionUnder the supervision and with the restatement discussed in the Explanatory Note to this Form 10-K/A and in Note 2 toparticipation of our consolidated financial statements, under the direction ofmanagement, including our CEO and CFO, managementwe conducted a reevaluationan evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2008 and through the date of this filing.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”). Under Audit Standard No. 5, a material weakness is a control deficiency, or combination of control deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. Based on theour evaluation andunder the criteria set forth in the COSO Report, our management identified the following material weaknessesconcluded our internal control over financial reporting was effective as of December 31, 2008 and through the date of this filing:2011.
There were deficiencies in our internal controls over the application of Statement of Position 97-2,Software Revenue Recognition,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.
These material weaknesses resulted in the accounting errors which have caused us to restate our consolidated financial statements as of and for the years ended December 31, 2008 and 2007 (including interim periods therein), and our consolidated financial statements as of and for the quarterly periods ended June 30, 2009 and March 31, 2009.
Based on its assessment, including consideration of the aforementioned material weaknesses, and the criteria discussed above, management has revised its conclusion relative to theThe effectiveness of our internal control over financial reporting as of December 31, 2008. Accordingly, management now concludes that our internal control over financial reporting was not effective at a reasonable assurance level as of December 31, 20082011 has been audited and through the date of this filing.
attested to by Ernst & Young LLP, thean independent registered public accounting firm, that audited the consolidated financial statements, has issued an attestationas stated in their report on our internal control over financial reporting which is included herein.
Changes in Internal Control over Financial Reporting
We have takenAn evaluation was also performed under the supervision and are takingwith the following actions to remediate the material weaknesses described above. We performed a detailed review of all OEM contracts, our billing and revenue systems, and processes for recording revenue. We are in the process of implementing stronger internal controls surrounding our review of
contracts with our customers, including implementing a new system for review of each OEM contract to determine the maximum periodparticipation of our performance obligations under each OEM contract, which are designed to detectmanagement, including our CEO and CFO, of any material errors and misapplication of revenue recognition principles. We are alsochange in the process of reviewing our tax provisioning process to strengthen controls in terms of separation of the provisioning and review processes together with revising and improving the tools used for tax to financial statement reconciliations prior to and during the review process.
The Audit Committee has directed management to develop and present to the Committee a plan and timetable for the implementation of the remediation measures described above (to the extent not already implemented), and the Committee intends to monitor such implementation. We believe that the actions described above will remediate the material weakness control deficiencies we have identified and strengthen our control over financial reporting. As we improve our internal control over financial reporting and implement remediation measures, we may determinethat occurred during
2011 ANNUAL REPORT | 83 |
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, 2011 that have materially affected, or are reasonably likely to supplement or modify the remediation measures described above.materially affect, our internal control over financial reporting.
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, 2008,2011, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Websense’sWebsense, 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 Overover 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 report dated February 24, 2009, we expressed an unqualified opinion, on the effectiveness of internal control over financial reporting as of December 31, 2008. As described in the following paragraph, the Company subsequently identified material misstatements in its financial statements, which caused such annual financial statements to be restated. Accordingly, our opinion on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2008, expressed herein is different from that expressed in our previous report.
A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The following material weaknesses have been identified and included in management’s assessment. Management has identified material weaknesses in its internal control over the application of generally accepted accounting principles and its application to the Company’s recognition of royalty revenue related to OEM contracts and over the computation of its income tax benefit for the year ended December 31, 2008. These material weaknesses were considered in determining the nature, timing and extent of audit tests applied in our audit of the 2008 financial statements and this report does not affect our report dated February 24, 2009, except for the effects on the consolidated financial statements of the restatement described in Note 2, as to which the date is October 28, 2009, on those consolidated financial statements (as restated).
In our opinion, because of the effect of the material weaknesses described above on the achievement of the objectives of the control criteria, Websense, Inc. has not maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008,2011, 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/s/ ERNST & YOUNG LLP
San Diego, California
February 24, 2009, except23, 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 captioned“Election of Directors”contained in our Proxy Statement related to the Annual Meeting of Stockholders to be held on May 31, 2012.
(b) Executive Officers. Information concerning our executive officers is set forth under the section captioned“Executive 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 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 effectsChief Executive Officer, Senior Financial Officers and All Finance, Tax and Accounting Department Personnel (“Code of Ethics”). The Code of Business Conduct and the Code 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 the Code of Business Conduct or Code 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 our Code of Business Conduct and our Code of Ethics can be obtained from our Web site free of charge atwww.websense.com.
material weaknesses described(e) Audit Committee. Information concerning the audit committee of our board of directors 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 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 sixth paragraphsections captioned“Compensation of Executive Officers” and“Compensation of Directors”in our Proxy Statement related to the Annual Meeting of Stockholders to be held on May 31, 2012.
above, as
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 which the date is October 28, 2009Annual Meeting of Stockholders to be held on May 31, 2012.
86 | 2011 ANNUAL REPORT |
The following table provides information as of December 31, 2011 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) | |||||||||
Equity compensation plans approved by security holders(1) | 7,646,377 | $ | 22.50 | 7,019,490 | (3) | |||||||
Equity compensation plans not approved by security holders(2) | 834 | $ | 11.50 | 0 | ||||||||
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|
|
| |||||||||
Total | 7,647,211 | $ | 22.50 | 7,019,490 | ||||||||
|
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|
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(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 834 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 $11.50 per share. |
(3) | Consists of shares available for future issuance under the 2009 Equity Incentive Plan. As of December 31, 2011, an aggregate of 1,391,081 shares of Common Stock were available for issuance under the Employee Stock Purchase Plan and 5,628,409 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 May 31, 2012.
Item 14. | Principal Accounting Fees and Services |
The information required by Item 14 of Form 10-K is incorporated by reference from the information contained in the section captioned“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 May 31, 2012.
2011 ANNUAL REPORT | 87 |
PART IV
Item 15. | Exhibits, Financial |
(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 | ||||
Consolidated balance sheets—December 31, | ||||
55 | ||||
Consolidated statements of operations—Years ended December 31, | ||||
56 | ||||
57 | ||||
Consolidated statements of cash flows—Years ended December 31, | ||||
58 | ||||
Notes to consolidated financial statements—December 31, | 59 | |||
2. Financial schedules required to be filed by Item 8 of this | ||||
92 |
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 | |
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
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Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
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Schedule II—VALUATION AND QUALIFYING ACCOUNTS
WEBSENSE, INC.
(In thousands)
A | B | C | D | E | ||||||||||||
Description | Balance at Beginning of Period | Additions | Deductions— Describe | Balance at End of Period | ||||||||||||
Charged to Costs and Expenses | Charged to Other Accounts—Describe | |||||||||||||||
YEAR ENDED | ||||||||||||||||
Reserves and allowances deducted from asset accounts: | ||||||||||||||||
Allowance for doubtful accounts | $ | 1,460 | — | $ | 400 | (2) | $ | 435 | (1) | $ | 1,425 | |||||
YEAR ENDED | ||||||||||||||||
Reserves and allowances deducted from asset accounts: | ||||||||||||||||
Allowance for doubtful accounts | $ | 1,425 | — | $ | 1,356 | (2) | $ | 650 | (1) | $ | 2,131 | |||||
YEAR ENDED | ||||||||||||||||
Reserves and allowances deducted from asset accounts: | ||||||||||||||||
Allowance for doubtful accounts | $ | 2,131 | — | $ | — | $ | 379 | (1) | $ | 1,752 |
EXHIBIT INDEX
|
| |
| Amended and Restated Certificate of Incorporation | |
| Amended and Restated Bylaws | |
4.1(2) | Specimen Stock Certificate of Websense, Inc. | |
| ||
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| Employment Agreement by and between Websense, Inc. and Gene Hodges, dated January 9, 2006 | |
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| Employment Agreement by and between Websense, Inc. and John McCormack, dated July 5, 2006 | |
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10.6(1)* | 2009 Equity Incentive Plan | |
| ||
| ||
| ||
| 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 | |
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| ||
| Form of Indemnification Agreement between Websense, Inc. and its directors |
88 | 2011 ANNUAL REPORT |
| Description of Document | |
10.13(16) | Form of Indemnification Agreement between Websense, Inc. and its officers | |
| ||
| Lease Agreement between Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated April 19, | |
10.15(7) | First Amendment to Lease between Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated October 1, | |
10.16(7) | Second Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated April 30, 2003 | |
| Third Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated July 30, 2004 | |
10.18(3) | Fourth Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated March 24, 2005 | |
| Fifth Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated December 21, 2006 | |
| Sixth Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated January 30, 2007 | |
| Seventh Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated February 12, 2007 | |
10.22(10) |
|
| |
| ||
| ||
| Officer Change in Control Severance Benefit Plan | |
| Form of Severance Plan Participation Agreement for Tier One Officers | |
| Form of Severance Plan Participation Agreement for Tier Two Officers | |
| Form of Severance Plan Participation Agreement for Tier Three Officers | |
10.28(13)* | 2011 Management Bonus Program | |
10.29(13)* | 2011 EVP of Worldwide Sales Bonus Program | |
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 |
(2) | Filed as an exhibit to our Registration Statement on Form |
(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 |
(6) | Filed as an exhibit to our Quarterly Report on Form 10-Q for the period ended |
(7) | Filed as an exhibit to our Quarterly Report on Form |
(8) | Filed as an |
(9) | Filed as an |
(10) | Filed as an exhibit to our Current Report on Form |
(11) | Filed as an |
(12) | Filed as an |
(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. |
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 |
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, 2012 | By: | /S/ MICHAEL A. NEWMAN | ||||
Michael 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 23, 2012 | ||
/s/ MICHAEL A. NEWMAN Michael A. Newman | Sr. Vice President and Chief Financial Officer (principal financial and accounting officer) | February 23, 2012 | ||
/s/ JOHN B. CARRINGTON John B. Carrington | Chairman of the Board | February 23, 2012 | ||
/s/ MARK ST.CLARE Mark St.Clare | Director | February 23, 2012 | ||
/s/ BRUCE T. COLEMAN Bruce T. Coleman | Director | February 23, 2012 | ||
/s/ JOHN SCHAEFER John Schaefer | Director | February 23, 2012 | ||
/s/ GARY E. SUTTON Gary E. Sutton | Director | February 23, 2012 | ||
Peter Waller | Director | February __, 2012 |
2011 ANNUAL REPORT | 91 |
Schedule II—VALUATION AND QUALIFYING ACCOUNTS
WEBSENSE, INC.
(in thousands)
A | B | C | D | E | ||||||||||||||||
Description | Balance at Beginning of Period | Additions | Deductions- Describe | Balance at End of Period | ||||||||||||||||
Charged to Costs and Expenses | Charged to Other Accounts-Describe | |||||||||||||||||||
YEAR ENDED DECEMBER 31, 2009 | ||||||||||||||||||||
Reserves and allowances deducted from asset accounts: | ||||||||||||||||||||
Allowance for doubtful accounts | $ | 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(13)* | Douglas Wride Retirement Agreement, dated January 31, 2011 | |
10.2(4)* | Employment Agreement by and between Websense, Inc. and Gene Hodges, dated January 9, 2006 | |
10.3(5)* | Separation Agreement, dated September 6, 2011, by and between Websense, Inc. and Arthur S. Locke III | |
10.4(6)* | Employment Agreement by and between Websense, Inc. and John McCormack, dated July 5, 2006 | |
10.5(14)* | Employment Agreement by and between Websense, Inc. and Didier Guibal, dated July 14, 2009 | |
10.6(1)* | 2009 Equity Incentive Plan | |
10.7(1)* | Form of Stock Option Agreement under the 2009 Equity Incentive Plan | |
10.8(1)* | Form of Restricted Stock Unit Award Agreement under the 2009 Equity Incentive Plan | |
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 | |
10.10(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 | |
10.13(16) | Form of Indemnification Agreement between Websense, Inc. and its officers | |
10.14(7) | Lease Agreement between Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated April 19, 2002 | |
10.15(7) | First Amendment to Lease between Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated October 1, 2002 | |
10.16(7) | Second Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated April 30, 2003 | |
10.17(8) | Third Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated July 30, 2004 | |
10.18(3) | Fourth Amendment to Lease between Websense, Inc. and Sorrento Valley Road LLC, dated March 24, 2005 | |
10.19(9) | Fifth Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated December 21, 2006 | |
10.20(9) | Sixth Amendment to Lease between Websense, Inc. and Arden Realty Limited Partnership, dated January 30, 2007 | |
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 | |
10.24(17)* | Officer Change in Control Severance Benefit Plan | |
10.25(17)* | Form of Severance Plan Participation Agreement for Tier One Officers | |
10.26(17)* | Form of Severance Plan Participation Agreement for Tier Two Officers | |
10.27(17)* | Form of Severance Plan Participation Agreement for Tier Three Officers | |
10.28(13)* | 2011 Management Bonus Program | |
10.29(13)* | 2011 EVP of Worldwide Sales Bonus Program | |
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 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 September 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. |
Filed as an |
(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 10-Q for the period ended June 30, 2010 filed with the SEC on August 6, 2010 and incorporated herein by reference. |
(11) | Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on October 26, 2010 and incorporated herein by reference. |
(12) | Filed as an exhibit to our Annual Report on Form 10-K for the period ended December 31, |
(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 |
(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. |
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.