xý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 20112012¨o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Delaware 51-0380839
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Item 1. Item 2. Item 3. Item 1A. Item 2. Item 3. Assets Current assets: Cash and cash equivalents Cash and cash equivalents – restricted Accounts receivable, net Income tax receivable / prepaid income tax Current portion of deferred income taxes Other current assets Total current assets Cash and cash equivalents – restricted, less current portion Property and equipment, net Intangible assets, net Goodwill Deferred income taxes, less current portion Deposits and other assets Total assets Liabilities and stockholders’ equity Current liabilities: Accounts payable Accrued compensation and related benefits Other accrued expenses Current portion of income taxes payable Current portion of deferred tax liability Current portion of deferred revenue Total current liabilities Other long term liabilities Income taxes payable, less current portion Secured loan Deferred tax liability, less current portion Deferred revenue, less current portion Total liabilities Stockholders’ equity: Common stock Additional paid-in capital Treasury stock, at cost Retained earnings Accumulated other comprehensive loss Total stockholders’ equity Total liabilities and stockholders’ equity notes to consolidated financial statements Operations Revenues: Software and service Appliance Total revenues Cost of revenues: Software and service Appliance Total cost of revenues Gross profit Operating expenses: Selling and marketing Research and development General and administrative Total operating expenses Income from operations Interest expense Other income (expense), net Income before income taxes Provision for income taxes Net income Net income per share: Basic net income per share Diluted net income per share Weighted average shares — basic Weighted average shares — diluted notes to consolidated financial statements Comprehensive Income Balance at December 31, 2010 Issuance of common stock upon exercise of options Issuance of common stock for ESPP purchase Issuance of common stock from restricted stock units, net Share-based compensation expense Net tax windfall from share-based compensation Purchase of treasury stock Components of comprehensive income: Net income Net change in unrealized gain on derivative contract, net of tax Translation adjustments Comprehensive income Balance at September 30, 2011 notes to consolidated financial statements Operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization Share-based compensation Deferred income taxes Unrealized gain on foreign exchange Excess tax benefit from share-based compensation Changes in operating assets and liabilities: Accounts receivable Other assets Accounts payable Accrued compensation and related benefits Other liabilities Deferred revenue Income taxes payable and receivable/prepaid Net cash provided by operating activities Investing activities: Change in restricted cash and cash equivalents Purchase of property and equipment Purchase of intangible assets Net cash used in investing activities Financing activities: Proceeds from secured loan Principal payments on secured loan Principal payments on capital lease obligation Proceeds from exercise of stock options Proceeds from issuance of common stock for stock purchase plan Excess tax benefit from share-based compensation Tax payments related to restricted stock unit issuances Purchase of treasury stock Net cash used in financing activities Effect of exchange rate changes on cash and cash equivalents (Decrease)/Increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period Supplemental disclosures of cash flow information: Income taxes paid, net of refunds Interest paid Change in operating assets and liabilities for unsettled purchase of treasury stock and exercise of stock options Capital lease obligation incurred for a software license arrangement notes to consolidated financial statements 2011 this report. For the Three Months Ended: September 30, 2011: Basic EPS Effect of dilutive securities Diluted EPS September 30, 2010: Basic EPS Effect of dilutive securities Diluted EPS For the Nine Months Ended: September 30, 2011: Basic EPS Effect of dilutive securities Diluted EPS September 30, 2010: Basic EPS Effect of dilutive securities Diluted EPS Net income Net change in unrealized gain on derivative contracts, net of tax (benefit)/expense of ($655), $80, ($1,128) and $255, respectively Translation adjustment Comprehensive income Beginning balance Net change during the period Ending balance Beginning balance Net change during the period Ending balance Technology Customer relationships Trade name Total Years Ending December 31, 2011 2012 2013 2014 2015 Thereafter Total expected amortization expense Consolidated Leverage Ratio <1.25:1.0 ³1.25:1.0 The unused portion of the revolving credit facility as of Assets: Cash equivalents - money market funds Foreign currency forward contracts not designated as hedges Liabilities: Interest rate swap Foreign currency forward contracts not designated as hedges quoted prices in active markets for identical assets or liabilities observable inputs other than quoted prices in active markets for identical assets and liabilities no observable pricing inputs in the market March 2013. Fair Value Hedges Euro (net sold) British Pound (net sold) Australian Dollar (net purchased) Balance Sheet Location Interest rate contracts designated as cash flow hedges Currency contracts not designated as hedges Total derivatives Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives (Effective Portion) Location and Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) Derivatives in Cash Flow Hedging Relationships Derivatives in Cash Flow Hedging Relationships Interest rate contracts Currency contracts Total Location and Amount of Gain (Loss) Derivatives Not Designated as Hedges Currency forward contracts Amount of Gain (Loss) Recognized in Accumulated OCI on Derivatives (Effective Portion) Location and Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) Derivatives in Cash Relationships Derivatives in Cash Flow Hedging Relationships Interest rate contracts Currency contracts Total Location and Amount of Gain (Loss) Derivatives Not Designated as Hedges Currency forward contracts Balance at December 31, 2010 Granted Released Canceled Balance at September 30, 2011 2011 Balance at December 31, 2010 Granted Exercised Canceled Balance at September 30, 2011 2011 Share-based compensation in: Cost of revenues Total share-based compensation in cost of revenues Selling and marketing Research and development General and administrative Total share-based compensation in operating expenses Total share-based compensation Average expected life (years) Average expected volatility factor Average risk-free interest rate Average expected dividend yield Shares repurchased through December 31, 2010 Shares repurchased during the nine months ended September 30, 2011 Total shares repurchased through September 30, 2011 non-deductible share-based payments, partially offset by the favorable impact from earnings in lower tax rate jurisdictions. U.S. federal tax related to the payment of $ lawsuit vigorously. anticipated trends in revenues and billings; management’s plans, strategies and objectives growth opportunities in domestic and international markets; anticipated product enhancements or releases; customer acceptance and satisfaction with our products, services and fee structures; expectations regarding competitive products and pricing; risks associated with launching new product offerings; risks associated with fluctuations in exchange rates of the foreign the impact of macroeconomic conditions on our customers; expected trends in anticipated cash and intentions regarding usage of cash; risks related to compliance with the covenants in our credit agreement; changes in effective tax rates, laws and interpretations and statements related to tax risks related to changes in accounting interpretations or accounting guidance; the volatile and competitive nature of the Internet and security industries; and the success of our marketing programs and brand development efforts. prevent access to undesirable and dangerous elements on the Web, identify and remove malware from incoming Web content; manage the use of non-Web Internet traffic, such as peer-to-peer communications and instant messaging; filter spam, viruses and malicious attachments from incoming email and instant messages; sophisticated, targeted cyber-attacks designed to steal valuable information. Our sales force supports our channel sales by generating leads and helping close sales. We plan to increase headcount in our sales force as part of our strategy to expand our subscription business to existing customers and to grow sales to new customers. 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 review goodwill that has an indefinite useful life for impairment at least annually in our fourth fiscal quarter, or more frequently if an event occurs indicating the potential for impairment. We amortize the cost of identified intangible assets using amortization methods that reflect the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up. We review Revenues: Software and service Appliance Total revenues Cost of revenues: Software and service Appliance Total cost of revenues Gross profit Operating expenses: Selling and marketing Research and development General and administrative Total operating expenses Income from operations Interest expense Other income (expense), net Income before income taxes Provision for income taxes Net income Software and service revenues. Software and service revenues increased to $82.3 million in the third quarter of 2012 from $81.8 million in the third quarter of 2011. January 1, 2011. 2012. increased third-party professional service fees. agreement. Revenues: Software and service Appliance Total revenues Cost of revenues: Software and service Appliance Total cost of revenues Gross profit Operating expenses: Selling and marketing Research and development General and administrative Total operating expenses Income from operations Interest expense Other income (expense), net Income before income taxes Provision for income taxes Net income Software and service revenues. Software and service revenues increased to $246.0 million in the first nine months of 2012 from $243.1 million in the first nine months of 2011. The increase was primarily the result of year-over-year growth in billings for TRITON software and service during 2011 2011. 2011. subject to an unfavorable fixed rate swap agreement. $5.0 million under the 2010 Credit Agreement. 2011. same period. Consolidated Leverage Ratio <1.25:1.0 >1.25:1.0 2010 Credit Agreement: Scheduled principal payments Estimated interest and fees Operating leases Other commitments Total directors suspended the stock repurchase program, after repurchasing approximately $2.9 million of our common stock in the third quarter of 2012, to better align with third quarter cash flow. In October 2012, the board of directors resumed the stock repurchase program and authorized management to repurchase up to $5.0 million of the Company's common stock in the fourth quarter of 2012. We hedged our Israeli Shekel denominated operating expenses during the Fair Value Hedges Euro (net sold) British Pound (net sold) Australian Dollar (net purchased) 2012. 2012. reporting. lawsuit vigorously. 23, 2012. our resellers and distributors 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 ensure that our channel partners will market and sell our newer product offerings such as our 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. changes in currency exchange rates impacting our international operating expenses; timing of marketing expenses for activities such as trade shows and advertising campaigns; quarterly variations in general and administrative expenses, such as recruiting expenses and professional services fees; increased research and development costs prior to new or enhanced product launches; and fluctuations in expenses associated with commissions paid on sales of subscriptions to our products which generally increase with billings growth in the short term because such expenses are recognized immediately upon sales of subscriptions while * affected. Mobile Security. Our principal competitors offering mobile security solutions include companies such as Symantec, McAfee, AirWatch, Good Technology and MobileIron. companies offering desktop security solutions, such as Check Point Software Technologies, Cisco Systems, McAfee, Microsoft, Symantec, CA Technologies, Sophos, Webroot Software, IBM and Trend 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. * may be unable to repurchase our securities due to certain financial ratios set forth in the 2010 Credit Agreement. 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; 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; 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. 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; 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. * Page Page 3 4 5 67Item 4. 30 Item 4.Controls and Procedures32 Item 1.Legal Proceedings 32Item 1.3245Item 4. Item 5. Item 6. 45 Item 4.45Item 5.Other Information45Item 6.Exhibits4647 September 30,
2011 December 31,
2010 (Unaudited) $ 75,550 $ 77,390 — 256 59,765 82,182 2,648 2,760 37,330 36,191 13,716 14,708 189,009 213,487 625 434 17,087 16,944 30,316 41,078 372,445 372,445 7,071 6,352 10,324 11,203 $ 626,877 $ 661,943 $ 9,102 $ 6,858 22,629 22,168 17,516 18,704 7,018 549 662 367 238,590 251,890 295,517 300,536 2,666 2,388 16,973 16,065 73,000 67,000 3,988 1,877 131,160 142,414 523,304 530,280 564 548 406,828 373,229 (360,390 ) (282,570 ) 61,872 41,253 (5,301 ) (797 ) 103,573 131,663 $ 626,877 $ 661,943 September 30,
2012 December 31,
2011 (Unaudited) Assets Current assets: Cash and cash equivalents $ 57,602 $ 76,201 Accounts receivable, net of allowance for doubtful accounts of $1,538 and $979 as of September 30, 2012 and December 31, 2011, respectively 54,436 80,147 Income tax receivable / prepaid income tax 2,187 738 Current portion of deferred income taxes 30,234 30,021 Other current assets 11,589 13,793 Total current assets 156,048 200,900 Cash and cash equivalents – restricted 640 628 Property and equipment, net 18,617 16,832 Intangible assets, net 20,058 26,412 Goodwill 372,445 372,445 Deferred income taxes, less current portion 8,670 8,599 Deposits and other assets 7,348 8,622 Total assets $ 583,826 $ 634,438 Liabilities and stockholders’ equity Current liabilities: Accounts payable $ 6,404 $ 9,026 Accrued compensation and related benefits 23,358 22,770 Other accrued expenses 11,722 16,534 Current portion of income taxes payable 1,533 3,187 Current portion of deferred tax liability 86 86 Current portion of deferred revenue 231,576 250,597 Total current liabilities 274,679 302,200 Other long term liabilities 2,256 2,600 Income taxes payable, less current portion 10,308 11,955 Secured loan 68,000 73,000 Deferred tax liability, less current portion 2,512 2,501 Deferred revenue, less current portion 139,163 142,437 Total liabilities 496,918 534,693 Stockholders’ equity: Common stock 577 568 Additional paid-in capital 434,089 415,573 Treasury stock, at cost (431,290 ) (385,544 ) Retained earnings 86,788 72,247 Accumulated other comprehensive loss (3,256 ) (3,099 ) Total stockholders’ equity 86,908 99,745 Total liabilities and stockholders’ equity $ 583,826 $ 634,438 notes.Income Three Months Ended Nine Months Ended September 30, September 30, September 30, September 30, 2011 2010 2011 2010 $ 81,803 $ 81,152 $ 243,057 $ 238,388 10,308 3,596 28,393 8,000 92,111 84,748 271,450 246,388 10,234 11,395 30,993 33,869 4,665 2,168 13,661 4,804 14,899 13,563 44,654 38,673 77,212 71,185 226,796 207,715 38,445 36,428 121,285 116,134 15,084 13,186 43,556 40,957 9,969 9,161 30,922 27,479 63,498 58,775 195,763 184,570 13,714 12,410 31,033 23,145 (374 ) (791 ) (1,167 ) (2,834 ) 204 (59 ) 1,530 (949 ) 13,544 11,560 31,396 19,362 5,426 5,779 10,777 9,626 $ 8,118 $ 5,781 $ 20,619 $ 9,736 $ 0.21 $ 0.14 $ 0.51 $ 0.23 $ 0.20 $ 0.13 $ 0.50 $ 0.22 39,575 42,200 40,081 42,622 40,428 42,907 41,273 43,613 Three Months Ended Nine Months Ended September 30,
2012 September 30,
2011 September 30,
2012 September 30,
2011Revenues: Software and service $ 82,285 $ 81,803 $ 245,992 $ 243,057 Appliance 8,078 10,308 23,769 28,393 Total revenues 90,363 92,111 269,761 271,450 Cost of revenues: Software and service 11,643 10,234 33,918 30,993 Appliance 3,337 4,665 9,929 13,661 Total cost of revenues 14,980 14,899 43,847 44,654 Gross profit 75,383 77,212 225,914 226,796 Operating expenses: Selling and marketing 35,661 38,445 112,226 121,285 Research and development 15,786 15,084 46,745 43,556 General and administrative 10,132 9,969 30,960 30,922 Total operating expenses 61,579 63,498 189,931 195,763 Income from operations 13,804 13,714 35,983 31,033 Interest expense (644 ) (374 ) (1,943 ) (1,167 ) Other income (expense), net (81 ) 204 (221 ) 1,530 Income before income taxes 13,079 13,544 33,819 31,396 Provision for income taxes 4,628 5,426 19,278 10,777 Net income $ 8,451 $ 8,118 $ 14,541 $ 20,619 Net income per share: Basic net income per share $ 0.23 $ 0.21 $ 0.39 $ 0.51 Diluted net income per share $ 0.23 $ 0.20 $ 0.39 $ 0.50 Weighted average shares — basic 36,457 39,575 37,010 40,081 Weighted average shares — diluted 36,782 40,428 37,590 41,273 notes.StatementStatements of Stockholders’ Equity Additional
paid-in capital Treasury
stock Retained
earnings Accumulated
other
comprehensive
loss Total
stockholders’
equity Common stock Shares Amount 41,001 $ 548 $ 373,229 $ (282,570 ) $ 41,253 $ (797 ) $ 131,663 840 9 14,452 — — — 14,461 246 2 3,444 — — — 3,446 316 5 — (2,829 ) — — (2,824 ) — — 14,433 — — — 14,433 — — 1,270 — — — 1,270 (3,400 ) — — (74,991 ) — — (74,991 ) — — — — 20,619 — 20,619 — — — — — (1,693 ) (1,693 ) — — — — — (2,811 ) (2,811 ) 16,115 39,003 $ 564 $ 406,828 $ (360,390 ) $ 61,872 $ (5,301 ) $ 103,573 Three Months Ended Nine Months Ended September 30,
2012 September 30,
2011 September 30,
2012 September 30,
2011Net income $ 8,451 $ 8,118 $ 14,541 $ 20,619 Other comprehensive income (loss) before tax: Foreign currency translation adjustments 363 (1,122 ) 251 (2,811 ) Unrealized losses on derivative contracts, net (144 ) (1,638 ) (613 ) (2,822 ) Other comprehensive income (loss) before tax 219 (2,760 ) (362 ) (5,633 ) Income tax benefit related to components of other comprehensive income 81 655 205 1,129 Other comprehensive income (loss), net of tax 300 (2,105 ) (157 ) (4,504 ) Comprehensive income $ 8,751 $ 6,013 $ 14,384 $ 16,115 notes. Additional paid-in capital Treasury stock Retained earnings Accumulated other comprehensive loss Total stockholders' equity Common stock Shares Amount Balance at December 31, 2011 38,048 $ 568 $ 415,573 $ (385,544 ) $ 72,247 $ (3,099 ) $ 99,745 Issuance of common stock upon exercise of options 130 2 2,075 — — — 2,077 Issuance of common stock for ESPP purchase 241 2 3,593 — — — 3,595 Issuance of common stock from restricted stock units, net 359 5 — (2,835 ) — — (2,830 ) Share-based compensation expense — — 14,675 — — — 14,675 Tax shortfall from share-based compensation — — (1,827 ) — — — (1,827 ) Purchase of treasury stock (2,269 ) — — (42,911 ) — — (42,911 ) Net income — — — — 14,541 — 14,541 Other comprehensive loss — — — — — (157 ) (157 ) Balance at September 30, 2012 36,509 $ 577 $ 434,089 $ (431,290 ) $ 86,788 $ (3,256 ) $ 86,908 Nine Months Ended September 30, September 30, 2011 2010 $ 20,619 $ 9,736 19,716 28,037 14,433 17,496 (360 ) (4,352 ) (47 ) (14 ) (2,267 ) (1,220 ) 21,149 30,939 470 (3,863 ) 2,244 2,914 533 (1,577 ) (3,385 ) (3,152 ) (24,575 ) (10,682 ) 8,722 11,814 57,252 76,076 33 (197 ) (7,176 ) (6,162 ) (500 ) — (7,643 ) (6,359 ) 87,000 — (81,000 ) (20,000 ) (569 ) (532 ) 14,461 12,217 3,446 3,131 2,267 1,220 (2,824 ) (2,736 ) (73,998 ) (59,714 ) (51,217 ) (66,414 ) (232 ) (427 ) (1,840 ) 2,876 77,390 82,862 $ 75,550 $ 85,738 $ 5,045 $ 2,850 $ 968 $ 2,332 $ 994 $ 284 $ — $ 1,688 Nine Months Ended September 30,
2012 September 30,
2011Operating activities: Net income $ 14,541 $ 20,619 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 15,133 19,716 Share-based compensation 14,675 14,433 Deferred income taxes — (360 ) Unrealized loss (gain) on foreign exchange 412 (47 ) Excess tax benefit from share-based compensation (532 ) (2,267 ) Changes in operating assets and liabilities: Accounts receivable 26,760 21,149 Other assets 2,412 470 Accounts payable (3,437 ) 2,244 Accrued compensation and related benefits 451 533 Other liabilities (3,761 ) (3,385 ) Deferred revenue (22,297 ) (24,575 ) Income taxes payable and receivable/prepaid (6,559 ) 8,722 Net cash provided by operating activities 37,798 57,252 Investing activities: Change in restricted cash and cash equivalents (20 ) 33 Purchase of property and equipment (9,576 ) (7,176 ) Purchase of intangible assets — (500 ) Net cash used in investing activities (9,596 ) (7,643 ) Financing activities: Proceeds from secured loan — 87,000 Principal payments on secured loan (5,000 ) (81,000 ) Principal payments on capital lease obligation (587 ) (569 ) Proceeds from exercise of stock options 2,257 14,461 Proceeds from issuance of common stock for stock purchase plan 3,595 3,446 Excess tax benefit from share-based compensation 532 2,267 Tax payments related to restricted stock unit issuances (2,830 ) (2,824 ) Purchase of treasury stock (44,674 ) (73,998 ) Net cash used in financing activities (46,707 ) (51,217 ) Effect of exchange rate changes on cash and cash equivalents (94 ) (232 ) Decrease in cash and cash equivalents (18,599 ) (1,840 ) Cash and cash equivalents at beginning of period 76,201 77,390 Cash and cash equivalents at end of period $ 57,602 $ 75,550 Cash paid during the period for: Income taxes including interest and penalties, net of refunds $ 25,385 $ 5,045 Interest $ 1,746 $ 968 Non-cash financing activities: Change in operating assets and liabilities for unsettled purchase of treasury stock and exercise of stock options $ (1,583 ) $ 994 notes.10-Q10‑Q and Article 10 of Regulation S-X. Accordingly, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of ourthe Company’s financial position and results of operations for the interim periods presented.2010,2011, included in Websense, Inc.’s Annual Report on Form 10-K filed with the SEC. Operating results for the three and nine months ended September 30, 20112012 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending December 31, 2011.2012. The balance sheet at December 31, 20102011 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.revenue recognition and the change in functional currency designations for certain subsidiaries, eachreporting comprehensive income, as discussed below, there have been no material changes to the Company’s significant accounting policies as compared towith the significant accounting policies described in the Annual Report on Form 10-K for the fiscal year ended December 31, 2010.Revenue Recognition.The Company is a global provider of unified Web, data and email content security solutions designed to protect data and users from modern cyber-threats, information leaks, legal liability and productivity loss. The Company provides its solutions to its customers as software installed on standard server hardware, as software pre-installed on optimized appliances, as a cloud-based service (software-as-a-service or “SaaS”) offering, or in a hybrid appliance/SaaS configuration.The majority of the Company’s revenues are derived from software and SaaS sold on a subscription basis. A subscription is generally 12, 24 or 36 months in duration and for a fixed number of seats. The Company recognizes revenues for the software and SaaS subscriptions, including any related technical support and professional 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, the Company electronically delivers software access codes to customers and then promptly invoices customers for the full amount of their subscriptions. Payment is due for the full term of the subscription, generally within 30 to 60 days of the invoice date.October 2009,June 2011, 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 updatedissued authoritative guidance on whether multiple elements exist, how the elements in an arrangement should be separated and howpresentation of other comprehensive income within the arrangement consideration should be allocatedfinancial statements that became effective for the Company beginning January 1, 2012. Pursuant to the guidance, registrants may present total comprehensive income, the components of net income and the components of other comprehensive income in a single continuous statement or two separate elements; andrequire 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 isbut consecutive statements, but may not available; or the best estimate of selling price (“BESP”), if neither VSOE nor TPE is available.The Company adopted the amended standardspresent other comprehensive income components as of January 1, 2011 on a prospective basis for transactions entered into or materially modified after December 31, 2010.A portionpart of the Company’s revenues are generated from the saleconsolidated statement of appliances, which are standard server hardware platforms 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 revenue recognized is based upon BESP, as outlined further below.The Company also enters into multiple element revenue arrangements in which a customer may purchase a combination of software or SaaS subscriptions, appliances, appliance and software upgrades, technical support and professional services.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.stockholders’ equity. As a result of this guidance, 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 functionalityhas included a separate statement of comprehensive income as part 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.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 the three and nine month periods ended September 30, 2011, the Company recognized $10.3 million and $28.4 million, respectively, in revenues from appliance sales, of which $7.7 million and $19.1 million, respectively, represented the immediate recognition of revenues upon shipment and the remaining $2.6 million and $9.3 million, respectively, represented primarily the ratable recognition of deferred revenue from appliance sales recorded prior to the adoption of the amended revenue recognition rules. Had the Company not adopted the amended revenue recognition rules, the amount of revenues recognized from appliance sales would have been $5.3 million and $14.6 million for the three and nine month periods ended September 30, 2011, respectively. The new accounting guidance for revenue recognition is expected to continue to have a significant effect on 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”) contracts, the Company grants its OEM customers the right to incorporate the Company’s products into the OEMs’ products for resale to end users. The OEM customer pays the Company a royalty fee for each resale of a subscription to the Company’s product to an end user over a specified period of time. The Company recognizes revenues associated with the OEM contracts ratably over the contractual period for which the Company is obligated to provide 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 distributor marketing payments and channel rebates as an offset to revenues, unless it receives an identifiable benefit in exchange for the consideration and it can estimate the fair value of the benefit received. The Company recognizes distributor marketing payments as an offset to revenues in the period the marketing service is provided and it recognizes channel rebates as an offset to revenues on a straight-line basis over the term of the corresponding subscription agreement.Functional Currency DesignationsAs of December 31, 2010, the Company’s international subsidiaries used 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 respective local currency for certain of its subsidiaries was appropriate as the primary economic environment in which these entities operate changed as a result of the restructuring. The change in functional currency designation was made prospectively effective as of the beginning of fiscal year 2011 and the adjustment from translating these subsidiaries’consolidated financial statements from the respective local currency to the U.S. dollar was recorded as a separate component of accumulated other comprehensive loss. Foreign currency translation adjustments generally reflect the translation of the balance sheet at period end exchange rates and the income statement at an average exchange rate in effect during the respective period. Upon the change in functional currency, the Company recorded a cumulative translation loss adjustment of approximately $1.4 million, which is included in the consolidated balance sheets.4,260,0005,802,000 and 6,188,0004,260,000 weighted average shares for the three months ended September 30, 20112012 and 2010,2011, respectively, and approximately 3,656,0005,426,000 and 5,618,0003,656,000 weighted average shares for the nine months ended September 30, 20112012 and 2010,2011, respectively, were excluded from the diluted EPS calculation because of their anti-dilutive effect. Net Income
(Numerator) Shares
(Denominator) Per Share
Amount (In thousands, except per share amounts) $ 8,118 39,575 $ 0.21 — 853 (0.01 ) $ 8,118 40,428 $ 0.20 $ 5,781 42,200 $ 0.14 — 707 (0.01 ) $ 5,781 42,907 $ 0.13 Net Income
(Numerator) Shares
(Denominator) Per Share
Amount (In thousands, except per share amounts) $ 20,619 40,081 $ 0.51 — 1,192 (0.01 ) $ 20,619 41,273 $ 0.50 $ 9,736 42,622 $ 0.23 — 991 (0.01 ) $ 9,736 43,613 $ 0.22 (In thousands, except per share amounts) For the Three Months Ended: September 30, 2012: Basic EPS $ 8,451 36,457 $ 0.23 Effect of dilutive securities — 325 — Diluted EPS $ 8,451 36,782 $ 0.23 September 30, 2011: Basic EPS $ 8,118 39,575 $ 0.21 Effect of dilutive securities — 853 (0.01 ) Diluted EPS $ 8,118 40,428 $ 0.20 (In thousands, except per share amounts) For the Nine Months Ended: September 30, 2012: Basic EPS $ 14,541 37,010 $ 0.39 Effect of dilutive securities — 580 — Diluted EPS $ 14,541 37,590 $ 0.39 September 30, 2011: Basic EPS $ 20,619 40,081 $ 0.51 Effect of dilutive securities — 1,192 (0.01 ) Diluted EPS $ 20,619 41,273 $ 0.50 Comprehensive IncomeThe components of comprehensive income were as follows (in thousands):00000 00000 00000 00000 Three Months Ended Nine Months Ended September 30,
2011 September 30,
2010 September 30,
2011 September 30,
2010 $ 8,118 $ 5,781 $ 20,619 $ 9,736 (983 ) 152 (1,693 ) 393 (1,122 ) — (2,811 ) — $ 6,013 $ 5,933 $ 16,115 $ 10,129 The accumulated unrealized derivative gains (losses), net of tax, on the Company’s derivative contracts included in “Accumulated other comprehensive loss” were as follows (in thousands):00000 00000 00000 00000 Three Months Ended Nine Months Ended September 30,
2011 September 30,
2010 September 30,
2011 September 30,
2010 $ 118 $ (128 ) $ 828 $ (369 ) (983 ) 152 (1,693 ) 393 $ (865 ) $ 24 $ (865 ) $ 24 The translation adjustments included in “Accumulated other comprehensive loss” were as follows (in thousands):00000 00000 00000 00000 Three Months Ended Nine Months Ended September 30,
2011 September 30,
2010 September 30,
2011 September 30,
2010 $ (3,314 ) $ (1,625 ) $ (1,625 ) $ (1,625 ) (1,122 ) — (2,811 ) — $ (4,436 ) $ (1,625 ) $ (4,436 ) $ (1,625 ) 4. Intangible Assets20112012 (in thousands)thousands, except years): Remaining
Weighted Average
Life (in years) Cost Accumulated
Amortization Net 3.2 $ 16,469 $ (11,822 ) $ 4,647 4.8 126,200 (100,556 ) 25,644 0.3 510 (485 ) 25 4.6 $ 143,179 $ (112,863 ) $ 30,316 Cost Net Technology 3.8 $ 15,157 $ (13,074 ) $ 2,083 Customer relationships 4.1 69,200 (51,225 ) 17,975 Total 4.1 $ 84,357 $ (64,299 ) $ 20,058 Cost Net Technology 3.2 $ 15,157 $ (11,255 ) $ 3,902 Customer relationships 4.8 69,200 (46,690 ) 22,510 Total 4.6 $ 84,357 $ (57,945 ) $ 26,412 2011,2012, remaining amortization expense is expected to be as follows (in thousands): $ 3,874 8,477 5,725 4,693 3,867 3,680 $ 30,316 5. Years Ending December 31, 2012 $ 2,118 2013 5,721 2014 4,689 2015 3,862 2016 3,430 Thereafter 238 Total expected amortization expense $ 20,058 In October 2007, the Company entered into an amended and restated senior credit agreement, which was subsequently amended in December 2007, June 2008 and February 2010 (the “2007 Credit Agreement”). The $225 million senior credit facility consisted of a five year $210 million senior secured term loan and a $15 million revolving credit facility. newsenior credit agreementfacility (the “2010 Credit Agreement”) and used the proceeds to repay the term loan under 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 29, 2015 with an initial maximum aggregate commitment of $120$120 million, including a $15$15 million sublimit for issuances of letters of credit and $5a $5 million sublimit for swing line loans. The Company willmay borrow and make repayments under the revolving credit facility depending on its liquidity position. During the first nine months of 2011,2012, the Company borrowed $87 million and made repayments of $81$5 million under its revolvingthis credit facility. The Company may increase the maximum aggregate commitment under the 2010 Credit Agreement to up to $200$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. As of September 30, 2011,2012, the Company’s weighted average interest rate was 1.98%3.11%. Eurodollar Rate
Loans Base Rate
Loans 1.75% 0.75% 2.00% 1.00% Consolidated Leverage Ratio <1.25:1.0 1.75% 0.75% ≥1.25:1.0 2.00% 1.00% Letterletter of Credit,credit, the Company must pay a fee equal to 0.125% per annum times the daily amount available to be drawn under such Letterletter of Creditcredit and, for each standby Letterletter of Credit,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 Letterletter of Credit.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.$10$10 million or more, the security interest or guarantee ceasing to be in full force and effect, any person becoming the beneficial owner of more than 35% of the Company’s outstanding common stock, or the Company’s board of directors ceasing to consist of a majority of Continuing Directors (as defined in the 2010 Credit Agreement).“Secured loan”"Secured loan" on ourthe Company’s consolidated balance sheets.sheets and had a balance of $68.0 million and $73.0 million as of September 30, 2012 and December 31, 2011, respectively. As of September 30, 2011,2012, future remaining minimum principal payments under the secured loan will be due in October 2015 when the revolving credit facility matures.6.September 30, 2012 was $52.0 million. Level 1 (1) Level 2 (2) Level 3 (3) Total $ 1,558 $ — $ — $ 1,558 — 623 — 623 — (1,443 ) — (1,443 ) — (514 ) — (514 ) September 30, 2012 December 31, 2011 Assets: Cash equivalents - money market funds $ 1,560 $ — $ — $ 1,558 $ — $ — Foreign currency forward contracts not designated as hedges — 10 — — 643 — Foreign currency contracts designated as cash flow hedges — 9 — — — — Liabilities: Interest rate swap — (2,075 ) — — (1,561 ) — Foreign currency forward contracts not designated as hedges — (279 ) — — — — Foreign currency contracts designated as cash flow hedges — (109 ) — — — — (1) – -(2) – -(3) – -and foreign currency forward contracts and foreign currency cash flow hedges 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.(1.778%(1.778% per annum) and receive a floating rate interest payment (based on the three-month LIBOR) on a principal amount of $50 million.$50 million. The $50$50 million swap agreement becomesbecame effective on December 30, 2011 and expires on October 29, 2015.2015. 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.20112012 and 2010,2011, the Company utilized Euro, British Pound and Australian Dollar foreign currency forward contracts to hedge anticipated foreign currency denominated net monetary assets. All such contracts entered into were designated as fair value hedges and were not required to be tested for effectiveness as hedge accounting was not elected. The gains related to the contracts designated as fair value hedges are included in other income (expense), net, in the accompanying consolidated statements of income and amounted to approximately $155,000 and $(766,000) for the three months ended September 30, 2011 and 2010, respectively, and $166,000 and $405,000 for the nine months ended September 30, 2011 and 2010, respectively. All of the fair value hedging contracts in place as of September 30, 20112012 are scheduled to be settled before January 2012.20112012 and December 31, 20102011 are presented in the table below (in thousands): September 30, 2011 December 31, 2010 Notional
Value
Local
Currency Notional
Value
USD Fair
Value
USD Notional
Value
Local
Currency Notional
Value
USD Fair
Value
USD 7,250 $ 10,264 $ 9,735 8,550 $ 11,405 $ 11,449 — — — 1,250 1,938 1,958 6,243 6,428 5,945 — — — September 30, 2012 December 31, 2011 Fair Value Hedges Euro 5,900 $ 7,335 $ 7,590 11,000 $ 14,909 $ 14,266 Australian dollar 1,500 $ 1,537 $ 1,550 — $ — $ — Cash Flow Hedges Israeli Shekel 18,666 $ 4,845 $ 4,745 — $ — $ — 20112012 and December 31, 20102011 and for the three and nine months ended September 30, 20112012 and 20102011 (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 September 30,
2011 December 31,
2010 (Other accrued expenses)/
other assets $ (265 ) $ 1,379 (Other long term liabilities) (1,178 ) — Other assets /
(other accrued expenses) 623 (64 ) (Other accrued expenses) (514 ) — $ (1,334 ) $ 1,315
Three Months Ended September 30,
Three Months Ended September 30, 2011 2010 2011 2010 $ (983 ) $ 73 Interest expense $ — $ (121 ) — 79 R&D — (18 ) $ (983 ) $ 152 $ — $ (139 )
Recognized in Income on Derivatives Three Months Ended
September 30, 2011 2010 Other income (expense), net $ 155 $ (766 )
Flow Hedging
Nine Months Ended September 30,
Nine Months Ended September 30, 2011 2010 2011 2010 $ (1,693 ) $ 369 Interest expense $ — $ (625 ) — 24 R&D — (33 ) $ (1,693 ) $ 393 $ — $ (658 )
Recognized in Income on Derivatives Nine Months Ended
September 30, 2011 2010 Other income, net $ 166 $ 405 Fair Value of Derivatives September 30,
2012 December 31,
2011 Balance Sheet Location Interest rate contracts designated as cash flow hedges $ (673 ) $ (407 ) Other accrued expenses Interest rate contracts designated as cash flow hedges (1,402 ) (1,154 ) Other long term liabilities Currency contracts not designated as hedges 10 643 Other current assets Currency contracts not designated as hedges (279 ) — Other accrued expenses Foreign exchange contracts designated as cash flow hedges 9 — Other current assets Foreign exchange contracts designated as cash flow hedges (109 ) — Other accrued expenses Total derivatives $ (2,444 ) $ (918 ) Three Months Ended September 30, Three Months Ended September 30, 2012 2011 2012 2011 Interest rate contracts $ (120 ) $ (983 ) Interest expense $ 169 $ — Currency contracts 57 — R&D (79 ) — Total $ (63 ) $ (983 ) $ 90 $ — Three Months Ended September 30, Derivatives Not Designated as Hedges 2012 2011 Currency forward contracts Other income (expense), net $ (232 ) $ 155 Nine Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Interest rate contracts $ (308 ) $ (1,693 ) Interest expense $ 487 $ — Currency contracts (100 ) — R&D (58 ) — Total $ (408 ) $ (1,693 ) $ 429 $ — Nine Months Ended September 30, Derivatives Not Designated as Hedges 2012 2011 Currency forward contracts Other income (expense), net $ 64 $ 166 2011,2012, the Company did not re-measure any nonfinancial assets and liabilities measured at fair value on a nonrecurring basis (e.g., goodwill, intangible assets, property and equipment and nonfinancial assets and liabilities initially measured at fair value in a business combination). As of September 30, 2011,2012, the Company’s secured loan, with a carrying value of $73.0$68.0 million, had an estimated fair value of $73.1$68.1 million, which the Company determined using a discounted cash flow model with a discount rate of 2.0%2.11%, which represents the Company’s estimated incremental borrowing rate.7.2010: Number of
Shares Weighted
Average
Fair
Value 1,348,147 $ 17.03 962,277 21.30 (450,438 ) 21.32 (281,073 ) 17.58 1,578,913 19.60 Balance at December 31, 2011 1,545,725 $ 19.54 Granted 891,047 17.46 Released (528,235 ) 16.93 Canceled (199,657 ) 19.57 Balance at September 30, 2012 1,708,880 18.73 2010: Number of
Shares Weighted
Average
Exercise
Price 7,880,754 $ 22.39 66,000 23.99 (839,813 ) 17.22 (314,178 ) 21.41 6,792,763 23.09 Balance at December 31, 2011 6,101,486 $ 23.25 Granted 596,000 17.51 Exercised (129,691 ) 16.01 Canceled (744,674 ) 23.78 Balance at September 30, 2012 5,823,121 22.75 20112012 and 20102011 include share-based compensation expense in the following expense categories of the consolidated statements of incomeoperations (in thousands): Three Months Ended
September 30, Nine Months Ended
September 30, 2011 2010 2011 2010 $ 276 $ 294 $ 829 $ 990 276 294 829 990 1,333 1,569 4,311 5,449 961 1,126 2,887 4,135 1,710 1,794 6,406 6,922 4,004 4,489 13,604 16,506 $ 4,280 $ 4,783 $ 14,433 $ 17,496 Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Share-based compensation in: Cost of revenues $ 238 $ 276 $ 883 $ 829 Total share-based compensation in cost of revenues 238 276 883 829 Selling and marketing 1,522 1,333 5,321 4,311 Research and development 1,097 961 3,539 2,887 General and administrative 1,573 1,710 4,932 6,406 Total share-based compensation in operating expenses 4,192 4,004 13,792 13,604 Total share-based compensation $ 4,430 $ 4,280 $ 14,675 $ 14,433 Three Months Ended September 30, Nine Months Ended September 30, 2011 2010 2011 2010 3.4 3.4 3.4 3.4 42.6 % 42.6 % 42.1 % 42.4 % 0.5 % 0.9 % 1.1 % 1.4 % — — — — Three Months Ended September 30, Nine Months Ended September 30, 2012 2011 2012 2011 Average expected life (years) 3.4 3.4 3.4 3.4 Average expected volatility factor 39.0 % 42.6 % 43.4 % 42.1 % Average risk-free interest rate 0.5 % 0.5 % 0.5 % 1.1 % Average expected dividend yield — — — — 20112012 as follows: Number of
Shares Average
Price Per
Share 15,624,519 $ 19.83 3,400,011 22.05 19,024,530 20.23 The Shares repurchased through December 31, 2011 20,411,821 $ 20.08 Shares repurchased during the nine months ended September 30, 2012 2,268,696 18.91 Total shares repurchased through September 30, 2012 22,680,517 19.96 Company’s program aswas 1,319,483. In October 2012, the board of September 30, 2011 was 4,975,470 shares.directors resumed the stock repurchase program and authorized management to repurchase up to $5.0 million of the Company's common stock in the fourth quarter of 2012. The 2010 Credit Agreement permits the Company to repurchase its securities so long as it is not in default under the 2010 Credit Agreement, has complied with all of its financial covenants, and has available cash and cash equivalents (including availability under the secured revolving loan) of at least $20 million;$20 million; provided, however, if, after giving effect to any repurchase, the Company’s leverage ratio is greater than 1.75:1.75:1, such repurchase cannot exceed $10$10 million in the aggregate in any fiscal year.8.20112012, the Company recognized an income tax expense of $5.4$4.6 million, which represents an effective tax rate of 40.1%35.4%. For the nine months ended September 30, 20112012, the Company recognized an income tax expense of $10.8$19.3 million, which represents an effective tax rate of 34.3%57.0%.20112012 is primarily related to the favorable impact from earnings in lower tax rate jurisdictions offset by the unfavorable impact of foreign withholding taxes and non-deductible share-based payments and increased earnings in higher tax rate jurisdictions.payments. The effective tax rate variance from the U.S. federal statutory rate for the nine months ended September 30, 20112012 is primarily related to the unfavorable impacts noted above, offset by a nonrecurring net discrete tax benefitprovision of $2.8$8.8 million related primarily to our global distribution restructuring which was completed during 2010 and became effective at the beginning of 2011. This $2.8 million net tax benefit primarily relates to the nonrecurring 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. The entire net tax benefit of $2.8 million was reflected recorded in the first quarter of 2011 upon completion2012 resulting from an agreement in principle with the U.S. Internal Revenue Service (“IRS”) Appeals Office to settle all remaining audit issues for the 2005 through 2007 tax years, as discussed further below, as well as the unfavorable impact of our global distribution restructuringforeign withholding taxes and is not expected to recur.by the respective tax authorities for tax years 2005 to2008 and 2009 in the United States for 2005 to 2008 in the United Kingdom and for 2006 tothrough 2010 in Israel. The Company has various other on-going audits in various stages of completion. In general, the tax years 2005 through 20102011 could be subject to examination by U.S. federal and most state tax authorities. In significant foreign jurisdictions such as Australia, China, Ireland, Israel and the United Kingdom, the statute of limitations for tax years 2005 through 20102011 is still open, and these years could be subject to examinationexamined by the respective tax authorities.DuringCompany was informed byIRS completed its audit of the U.S. Internal Revenue Service (the “IRS”) that they had completed their auditCompany for the tax years ended December 31, 2005 through December 31, 2007. Accordingly, the IRS2007 and issued the Company a 30-day letter which outlined all of theirits proposed audit adjustments. The 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 relaterelated 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’sCompany'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 initially proposed by the IRS totalsfor the audited years totaled approximately $19.0$19 million, of which $14.8$14.8 million relates related to the amount of the cost sharing buy-in, $2.5$2.5 million relates related to research and development credits and $1.7$1.7 million relates related to equity compensation awarded to certain executive officers. The total additional tax proposed excludesexcluded 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 disagreesdisagreed 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 compensationcompensation.$1.7 million resulting2012, the Company reached an agreement in no additional tax liability. This reduces 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 atprinciple with the IRS Appeals Office including through litigation if required. The timingto settle the remaining audit adjustments related to the cost sharing buy-in and research and development tax credits. Due to these negotiations, the Company recorded a tax provision of $8.8 million in the quarter ended March 31, 2012. As a result of the ultimate resolution of these matters cannot be reasonably estimated at this time, however,final settlement with the IRS under the Closing Agreement, the Company expectsmade payments in the appeals processaggregate amount of $14.7 million in the third quarter of 2012 described above, consisting of (i) $7.1 million in U.S. federal tax related to continue throughout the remainderproposed adjustments, (ii) $5.4 million in state tax and accumulated interest related to the additional federal and state taxes and (iii) $2.2 million of 2011.9.23.4 million owed to the Company by its Irish subsidiary, which will be settled through an intercompany loan agreement.the Company’sby making, using, importing, selling and/or offering for sale Websense Web Filter, Websense Web Security and Websense Web Security Gateway, the Company infringes U.S. Patent No. 6,092,194 (“194 Patent”Patent”). Since filing the complaint, Finjan withdrew its contention that Websense Web Filter and Websense Web Security infringes the 194 Patent. Finjan Inc.has also accused additional products of infringing the 194 Patent in response to discovery and in expert reports, namely TRITON Enterprise, TRITON Security Gateway Anywhere, Websense Web Security Gateway Anywhere, Websense Web Security Gateway Hosted and the Websense V-Series appliances. Finjan seeks an injunction from further infringement of the 194 Patent and damages. The court has set a date of January 30, 2012 forCourt held a hearing on the construction of the claims in the 194 Patent.Patent on January 30, 2012 and issued a claim construction order on February 29, 2012. The Court has set a pretrial conference for November 5, 2012 and a trial date of December 3, 2012. The Company denies infringing any valid claims of the 194 Patent and intends to vigorously defend the lawsuit.Company’s attorneys, management believes itCompany cannot currently determine and has adequately reserved fornot accrued any ultimate liability that may result from any of its pending legal actions because the Company is unable to predict or reasonably estimate the possible losses, if any, relating to such actions. The Company’s evaluation of the likely impact of these actions includingcould change in the Finjan litigation, suchfuture, the Company may determine that any liability would not materially affectit is required to accrue for potential liabilities in one or more legal actions and unfavorable outcomes and/or defense costs, depending upon the Company’s consolidated financial position,amount and timing, which could have a material adverse effect on its results of operations or cash flows. Itflows in a future period. If the Company later determines that it is 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 the Company has accrued for; however, management is not able to estimate any amount over what it has already accrued for at thisthat time. Management’s evaluationof management for future operations;new and enhanced reliance on indirect channels of distribution;currency exchange rates;operating and other expenses;risks associated with launching new product offerings;audits and proposed adjustments;dataemail, mobile and email contentdata 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. We provideOur customers deploy our solutions to our customers assubscription software installedsolutions on standard serverservers or other information technology (“IT”) hardware, as software pre-installed onincluding our optimized appliances, as a cloud-based service (software-as-a-service or “SaaS”) offering or in a hybrid appliance/hardware/SaaS configuration. Our products and services are sold worldwide to public sector entities,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 manufacturermanufacturers (“OEM”OEMs”) arrangements.. Our portfolio of Web security, data securityproducts use our advanced content classification, deep content inspection and email content security solutions allows organizationspolicy enforcement technologies to:such asincluding Web sites that contain inappropriate content or Web sitespages that download viruses, spyware, keyloggers, hacking tools and an ever-increasing variety of malicious code, including Web 2.0 sites with user-generatedthat contain inappropriate content;protect against spam, inappropriate content and malware embedded in user-generated content on Web 2.0 sites;prevent unauthorized use and leaks of sensitive data, such as customer or employee information;filter spam from incoming email;filter viruses and other malicious attachments from email and instant messages;controlprevent misuse of valuable computing resources, including unauthorized downloading of high-bandwidth content;monitorand enforcing pre-determined policies regarding its use and transmission within and outside the movementorganization; andthroughout the networkloss and enforce pre-determined usagetheft of intellectual property, and movement policies.by providing mobile device management features that keep mobile devices secure, minimize risk and maintain compliance.computernetwork security products to a leading developer and provider of information technology (“IT”)IT security software solutions. Our first Web filteringcommercial software product was released in 1996 and preventedcontrolled employee access to inappropriate Web content.sites. Since then, we have focused on adaptingdeveloping our Web filtering and content classification capabilities to address changingchanges in the Internet use patterns,and the external threat environment, including the rise of Web-based social and business applications and the growing incidence of Web-based criminal activity.sales, as compared to 50% and 51% duringsales. Revenues from the three and nine months ended September 30, 2010, respectively. The United Kingdom comprised approximately 11% of our total revenues in the three and nine months ended September 30, 2011 compared to 12%2012 and 13% in the three and nine months ended September 30, 2010, 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.resellers.reseller channels. Sales through indirect channels currently account for more than 90%approximately 95% of our revenues.revenues, which is consistent with previous periods. We also have several arrangements with OEMs that grant the OEM customersthem the right to incorporate our products into the OEM customers’their products for resale to end users.tofor 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 revenues from subscriptions tofor our software and SaaS products on a daily straight-line basis, commencing on the day the term of the subscription begins, over the term of the subscription agreement. We recognize revenues 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 agreement and are fully expensed in the period the product and/or software activation key is delivered. Our operating expenses, including costincome statement of operations 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 United States generally accepted accounting principles (“GAAP”). We provide this measurement (net of distributor marketing payments, channel rebates and adjustments to the allowance for doubtful accounts) in reporting financial performance because this measurement provides a consistent basis for understanding our sales activities each period. We believe the billings measurement is useful because the GAAP measurements of revenue and deferred revenue in the current period include subscription contracts commenced in prior periods.Billingsend-user customers increased 15% year-over-year$81.5 million during the third quarter of 2012 from $73.0$84.3 million during the third quarter of 2011, primarily due to the negative impact of currency exchange rates on billings as well as fewer customer upgrades in the United States in the third quarter of 2010 to $83.8 million in the third quarter of 2011. Billings from OEM arrangements declined from $4.4 million in the third quarter of 2010 to $0.5 million in2012 compared with the third quarter of 2011. Our totalappliance billings including our OEM business, grew 9%decreased from $77.4$8.0 million during in the third quarter of 20102011 to $84.3$6.9 million during in the third quarter of 2011. 2012, primarily due to reduced software billings as software sales are the general driver of our appliance sales.TRITON™ solution productsTRITON content security solutions accounted for 54%61% of total billings in the third quarter of 20112012 and grew 50% year-over-yearapproximately 9% to $49.4 million, from $30.1$45.3 million in the third quarter of 2010 to $45.2 million in the third quarter of 2011, whereas billings from our non-TRITON solution products declined from $42.918% to $32.1 million in the third quarter of 2010 to $38.62012 from $39.0 million in the third quarter of 2011.2011. The decrease in non-TRITON billings reflects the ongoing migration of existing customers to our more advanced TRITON security solutions, and to a lesser extent, customer losses to lower priced competitive solutions. Our TRITON solutions include our TRITON family of security gateways for web,Web, email, mobile and data security (including appliances)related appliances and technical support subscriptions), our standalone data security suite and our cloud-based security solutions. Our non-TRITON solutions include our Web filtering products, such as our Websense Web security suite, on-premises e-mailFilter, Web Security Suite, server-based email security and related hardware. Our applianceWe expect the proportion of billings increased from $5.2 millionour TRITON solutions to increase slightly as a percentage of total billings in the thirdfourth quarter of 2010 to $8.0 million in2012 compared with the thirdfourth quarter of 2011. Billings from incremental sales, which includes product purchases by new customers and the purchase of additional products or upgrades by existing customers, increased from $22.2 million in the third quarter of 2010 to $23.8 million in the third quarter of 2011 which increase was driven by increased sales of our TRITON solution products. .to end-user customers represented $37.0$42.2 million, or 44%52% of our total billings, for the third quarter of 20112012, compared to $35.2with $37.1 million, or 48%44% of total billings, for the third quarter of 2010. The decrease in the percentage of total billings represented by2011, reflecting our maturing and stabilized international billings to end-user customers from the third quarter of 2010 to the third quarter of 2011 was primarily due to strong billings performance in the U.S. in the third quarter of 2011 compared to slower billings growth in continental Europe. The average annual value of each subscription sold during the third quarter of 2011 was $10,700 compared to $8,700 during the third quarter of 2010, reflecting increased sales of our TRITON advanced security solutions, including Web Security Gateway and email and data security products to larger enterprise customers. force. from 21.8 to 24.1 months for the third quarter of 2010 to 2012, from 23.1 months for the third quarter of 2011 with approximately 51%49% of our billings in 12 month contracts, 8%7% in 24 month contracts and 41%44% in contracts with durations of 36 months or more. We expect our billingsThe average contract duration increased compared with the third quarter of 2011 due to grow for the remainderincrease in sales of 2011 relativeTRITON solutions and sales to 2010 billings. new customers, which tend to have longer average contract durations. The number of transactions valued at over $100,000 in the third quarter of 2012increased by 9% from 132 transactions to 144 transactions compared with the third quarter of 2011.seasonalcyclical variations, with the highest billings occurring in the fourth quarter generally being our strongest quarter in billings, and the lowest billings occurring in the first quarter generally being our lowest quarter for billings each fiscal year.quarter. As a trend, the percentage of billings from subscriptions to our TRITON advancedcontent security products,solutions, including those pre-installed on appliances is increasing, and the percentage of billings from our pure Weblegacy filtering products is declining.During 2010, 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 and expect to increase our taxable income in a foreign jurisdiction with a lower tax rate where we streamlined and consolidated the ownership of our intellectual property and distribution rights. The restructuring did not materially impact our U.S. business operations or the relative amount of taxable income in the U.S. versus outside the U.S. While we anticipate that our GAAP effective tax rate will be lower than it would have been without the restructuring, we cannot predict whether the GAAP effective tax rate in any particular period will be less than the GAAP effective tax rate in the immediately preceding prior period or in the comparable period of the prior fiscal year. The actual impact of the restructuring on our GAAP effective tax rate is highly dependent on our future results of operations.In October 2007, the Company entered into an amended and restated senior credit agreement, which was subsequently amended in December 2007, June 2008 and February 2010 (the “2007 Credit Agreement”). This $225 million senior credit facility consisted of a five year $210 million senior secured term loan and a $15 million revolving credit facility (the “2007 Credit Facility”). In October 2010, the Company entered into a new credit agreement (the “2010 Credit Agreement”) and used the proceeds to repay the term loan under the 2007 Credit Agreement and retired the 2007 Credit Facility. The 2010 Credit Agreement provides for a secured revolving credit facility that matures on October 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 “2010 Credit Facility”). See “Liquidity and Capital Resources” for further discussion of the terms of the 2010 Credit Agreement.areis derived from software and SaaS products sold on a subscription basis. A subscription is generally 12, 24 or 36 months in duration and for a fixed number of seats. We recognize revenues for the software and SaaS subscriptions, including any related technical support and professional 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 customers 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 invoicing.the invoice date.areis generated from the sale of appliances, which are standard server hardware platforms optimized for our software products. These appliances contain software components, such as operating systems, that operate together with the hardware platform to provide the essential functionality of the appliance. Based on the amended accounting standards, when sold in a 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.deliverables. When appliance orders are taken, we ship the product, invoice the customer and recognize 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.We also enter into multiple element revenue arrangements in which a customer may purchase a combination of software or SaaS subscriptions, appliances, appliance and software upgrades, technical support and professional services. 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 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.regularly review all of our assumptions and inputs around BESP on a quarterly basis and maintain internal controls over the establishment and updates of these estimates.2011,2012, we recognized $10.3$8.1 million and $28.4$23.8 million, respectively, in revenues from appliance sales, of which $7.7$6.6 million and $19.1$19.0 million, respectively, represented the immediate recognition of revenue upon shipment and the remaining $2.6$1.5 million and $9.3$4.8 million, respectively, represented primarily the ratable recognition of deferred revenue from appliance sales recorded prior to the adoption of the amended revenue recognition rules. We expect to recognize revenues of $1.2 million throughout the remainder of 2011 of $2.1 million2012 from appliance sales made prior to 2011 that are recorded in deferred revenue as of September 30, 2011. Had we not adopted the2012. The amended revenue recognition rules, the amount of revenues recognized from appliance sales would have been $5.3 million and $14.6 million for the three and nine months ended September 30, 2011, respectively. The new accounting guidance for revenue recognition isstandards are expected to continue to have a significant effect onaffect 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.customer payscustomers generally pay us a royalty fee for each resale of our product to an end user over a specified period of time. We recognize revenues associated with the OEM contracts ratably over the contractual period for which we are obligated to provide our services to the OEM. The time period overOEMs, which we recognize revenue associated with OEM contracts is determined by the contractual obligation period and will vary for each OEM depending on the information available, such as underlying end-userend user subscription periods. To the 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.valuesvalue 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 roadmaps, 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; andpreparing 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.intangible assets that have finite useful lives when an event occurs indicating the potential for impairment. We review for impairment by analyzing facts orand circumstances, either external or internal, indicating that we may not recover the carrying value of the asset. We measure impairment losses related to long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values. We measure fair value generally based on the estimated future cash flows 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.2011,2012, there was $39.8$39.0 million of total unrecognized compensation cost related to share-based compensation arrangements granted under all equity compensation plans (excluding tax effects). ThatThis total unrecognized compensation cost will be adjusted for estimated forfeitures as well as for future changes in estimated forfeitures. We expect to recognize thatthis cost over a weighted averageweighted-average period of approximately 2.02.1 years.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 results of operations in the future.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 course20112012 compared with the three months ended September 30, 20102011 Three Months Ended September 30, 2011 2010 89 % 96 % 11 4 100 100 11 13 5 3 16 16 84 84 42 43 16 15 11 11 69 69 15 15 0 (1 ) 0 0 15 14 6 7 9 % 7 % Three Months Ended September 30, 2012 2011 Revenues: Software and service 91 % 89 % Appliance 9 11 Total revenues 100 100 Cost of revenues: Software and service 13 11 Appliance 4 5 Total cost of revenues 17 16 Gross profit 83 84 Operating expenses: Selling and marketing 40 42 Research and development 17 16 General and administrative 11 11 Total operating expenses 68 69 Income from operations 15 15 Interest expense (1 ) — Other income (expense), net — — Income before income taxes 14 15 Provision for income taxes 5 6 Net income 9 % 9 % Revenues2011 from $81.2 million in the third quarter of 2010.2011. The increase was primarily athe result of increased incremental sales to new customersyear-over-year growth in billings for TRITON software and upgrades to existing customers,service during 2011 and the first nine months of 2012, which resulted in higher beginning current deferred software and service revenue and higher revenues recognized in the current period, compared with the third quarter of 2011. Because we recognize software and service revenues ratably over the term of the subscription, growth in software and service revenues reflects changes in current deferred revenue at the beginning of the period compared with the prior period, as well as higher OEM revenuesthe change in the third quarter of 2011 as compared to the third quarter of 2010. current period billings.$40.6$39.7 million, or 44.2%44% of third quarter 20112012 revenues, compared to $40.2with $40.3 million, or 47.5%also 44% of revenues, in the third quarter of 2010. Software and service revenues generated internationally accounted for $41.2 million or 44.8% of third quarter 2011 revenues compared to $41.0 million or 48.5% in the third quarter of 2010. We had current deferred revenue relating to2011. International software and service revenues accounted for $42.6 million, or 47% ofthird quarter 2012 revenues, compared with $41.5 million, or 45% of revenues, in the third quarter of 2011. compared to $224.9. Total deferred software and service revenue was $364.9 million as of September 30, 2010.2012, compared with $358.2 million as of September 30, 2011. Of the $231.6$228.4 million in current deferred software and service revenue as of September 30, 2011, $79.22012, $78.9 million is expected to be recognized as revenue in the fourth quarter of 2011. We expect our software and service revenues in the fourth quarter to exceed our revenues in the fourth quarter of 2010 due to the amount of current deferred revenue that will be recognized as revenue, subscriptions that are scheduled for renewal that are expected to be renewed and upgraded, and expected new business for which some revenues will be recognized during the fourth quarter. 2012.decreasebe relatively flat in absolute dollars and as a percentage of total revenues as appliance revenues increase at a faster rate than software and service revenues increase.revenue in the fourth quarter of 2012 compared with the fourth quarter of 2011. Our software and service revenues in 2011 are impacted by the 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 revenuesales activity and the effect of currency exchange rates on new and renewal subscriptions in international markets.ApplianceThird quarter appliance revenues increasedof $8.1 million consisted of $6.6 million in revenue from sales of appliances sold in the third quarter of 2012 and $1.5 million recognized primarily from deferred revenue for sales of appliances recorded prior to the adoption of the amended revenue recognition rules, as described above. This compares with $10.3 million in appliance revenues in the third quarter of 2011, from $3.6which included $7.7 million in the third quarter of 2010. The increase was primarily a result of increased appliance salesrevenue from appliances sold in the third quarter of 2011 and our adoption of new$2.6 million recognized from deferred revenue. The decrease in total appliance revenue recognition rules (as more fully described in Note 1 to the Consolidated Financial Statements) starting January 1, 2011 under which revenues fromreflects reduced appliance sales of appliances are now generally recognized when sold. Accordingly, $2.6$1.1 million of the revenue recognized in the third quarter of 2011 represented primarily2012 as well as the ratable recognition ofdecline in appliance revenue recognized from deferred revenue forcompared with the third quarter of 2011, due to the adoption of the amended revenue recognition rules related to hardware sales. As of September 30, 2012, deferred appliance revenue was $5.8 million and included $3.9 million related to appliance sales recorded prior to the adoption of the amended revenue recognition rules and the remaining $7.7 million represented revenues from sales of appliances sold in the third quarter of 2011. As of September 30, 2011, we had $11.6 million of remaining deferred revenue primarily for sales recorded prior to the adoption of the amended revenue recognition rules.6.0% of third quarter 2011 revenues compared to $2.0 million or 2.3%6% of revenues, in the third quarter of 2010.2011. Appliance revenues generated internationally accounted for $4.7$4.3 million, or 5.0%5% of third quarter 20112012 revenues, compared to $1.6with $4.7 million, or 1.8%also 5% of revenues, in the third quarter of 2010. For2011.remainderfourth quarter of 2011,2012, we expect our appliance revenues to increase in both absolute dollars anddecrease as a percentage of totalcompared with 2011 appliance revenues over 2010 revenue levels primarily as a result of the adoptiondecline in deferred appliance revenue to be recognized in the remainder of 2012. In the newfourth quarter of 2012, we expect to recognize $1.2 million of deferred revenue recognition rules as offor appliance sales recorded prior to January 1, 2011 and expected increase in sales of our appliances.review,analysis, amortization of acquired technology, technical support and infrastructure costs associated with maintaining our databases and costs associated with providing our hosted security services.SaaS offerings. Software and service cost of revenues decreasedincreased to $11.6 million in the third quarter of 2012 from $10.2 million in the third quarter of 2011 from $11.42011. The $1.4 million in the third quarter of 2010. The $1.2 million decreaseincrease was primarily due to decreased amortizationincreased costs of acquired technology of $1.5 million and partially offset by increased personnel costs. The decrease in amortization of acquired technology from the third quarter of 2010 to the third quarter of 2011 was primarily due to certain acquired technology being fully amortized in 2010. As of September 30, 2011, the remaining acquired technology is being amortized over a remaining weighted average period of 3.2 years. We expect to incur $0.7 million in amortization expense of acquired technology during the remainder of 2011 and that full year 2011 levels will be lower than 2010 levels by approximately $5.9 million. Our full-time employee headcount in cost of revenues departments increased slightly from an average of 260 employees during the third quarter of 2010 to an average of 263 employees during the third quarter of 2011. We allocate the costsoperating our infrastructure for human resources, employee benefits, payroll taxes, IT, facilities and fixed asset depreciation to each of our functional areas based on headcount data.SaaS offerings. As a percentage of total revenues, software and service cost of revenues decreased to 11% fromwere 13% during the third quarter of 2011 compared to 2010.2012 and 11% during the third quarter of 2011. We expect software and service cost of total revenues will decreaseincrease in absolute dollars and as a percentage of software and service revenues in 2011the remainder of 2012 as compared to 2010 primarily due to the expected increase in revenues and decreased amortizationwith 2011.products.products, primarily the cost of the hardware platform and software installation costs. Appliance cost of revenues increaseddecreased to $3.3 million in the third quarter of 2012 from $4.7 million in the third quarter of 2011 from $2.22011. The $1.4 million in the third quarter of 2010. As described in the Appliance revenues section above, the $2.5 million increasedecrease was primarily due to our adoptionthe decreased number of new revenue recognition rules under whichappliances sold as well as the related costs are generally recognized when the appliances are sold.decreased cost of revenues from sales prior to 2011. In appliance cost of revenues for the third quarter of 2012, we also recognized $1.1$0.6 million of the ratable cost of appliances sold prior to 2011 that were recognized in revenuescompared with $1.1 million in the third quarter of 2011. The remaining $2.7 million represents costs of appliances sold in the third quarter of 2012. As a percentage of total revenues, appliance cost of revenues increased towere 4% and 5% from 3% during thethird quarter of 2012 and third quarter of 2011, compared to 2010. respectively.increaseremain relatively flat in absolute dollars and as a percentage of total revenues in 2011 asthe fourth quarter of 2012 compared with the fourth quarter of 2011. In the fourth quarter of 2012, we expect to 2010 primarily duerecognize $0.5 million in deferred cost of revenues recorded prior to the adoption of the new revenue recognition rules in 2011 under which the related costs are generally recognized when the appliances are sold as well as due to increased sales of our appliance products.increaseddecreased to $75.4 million in the third quarter of 2012 from $77.2 million in the third quarter of 2011, from $71.2 million in the third quarter of 2010 primarily as a result of decreased appliance revenues and increased revenues.cost of revenues related to our expanding SaaS infrastructure. As a percentage of total revenues, our gross profit was 83% in the third quarter of 2012 and 84% in both the third quarter of 2011 and in the third quarter of 2010.2011. We expect that gross profit as a percentage of total revenues will remain in excess of 80% for the remainder of 2011.revenue. revenues.2011, compared to $36.42011. The $2.7 million or 43% of revenues, in the third quarter of 2010. The $2.0 million increasedecrease in total selling and marketing expenses was primarily due to our increased personnel costs of $2.6 million and increased allocated costs of $0.6 million, partially offset by a reduction in thedecreased amortization of acquired intangibles (customer relationships) of approximately $1.2 million. Our headcount in sales and marketing increased from an average of 573 employees during the third quarter of 2010 to an average of 616 employees for the third quarter of 2011. As of September 30, 2011, the acquired$1.6 million, as certain customer relationships intangible assets are beingwere fully amortized over a remaining weighted average period of approximately 4.8 years. in 2011, as well as decreased travel costs.remainderfourth quarter of 2012 compared with the fourth quarter of 2011, as comparedwe expect to 2010, with the reduction of amortization of acquired intangibles from the SurfControl acquisition due to the accelerated nature of the amortization being offset by additional sales and marketing personnel supportingexperience an increase in our expanding selling and marketing efforts worldwide andexpenses associated with increased sales resulting in higher overall sales commission expenses. headcount.salesbillings in the fourth quarter of 2012 exceed expectations, our sales commission expenses would alsocan be expected to exceed our expectationsforecasts and result in higher than expected selling and marketing expenses. Because commission expenses are primarily recognized in 2011,the period incurred, while a substantial portion of revenues from the higher sales of software and services would beare recognized in future periods. We also expect thatperiods, if our 2012 billings exceed expectations, our selling and marketing expenses as a percentage of revenues will decrease in 2011 compared to 2010 due to the expectedcould increase in revenues.the fourth quarter of 2012 compared with 2011. Based on the existing sales and marketing related intangible assets as of September 30, 2011,2012, we expect amortization of sales and marketing related acquired intangibles of $3.2$1.5 million for the fourth quarterremainder of 2011,2012, which would be a reduction of approximately $1.2$1.6 million from 2010.in comparison to the fourth quarter of 2011.2011 from $13.2 million, or 15% of revenues, in the third quarter of 2010.2011. The increase of $1.9$0.7 million in research and development expenses was primarily due to increased personnel costs. OurWe allocate the costs for human resources, employee benefits, payroll taxes, IT, facilities and fixed asset depreciation to each of our functional areas based on headcount data. Although our headcount increased in research and development from an average of 456495 employees for the third quarter of 20102011 to an average of 495523 employees for the third quarter of 2011. 2012, the impact of the higher headcount was partially offset by an increase in the number of employees in relatively low cost foreign locations.2011 as2012 compared towith the fourth quarter of 20102011 due to an expanded base of product offerings and increased average headcount compared to 2010 to support our continued enhancements and new products. product developments. Fluctuations in foreign currencies may also impact our research and development expenses in 2012. absolute research and development expenses by operating research and development facilities in multiple lower cost international locations, including facilities in Beijing, China and Ra’anana, Israel, that have lower costs than our operations in the United States.Israel. We also have research and development facilities in Los Gatos and San Diego, California and Reading, England. While we expect research and development expenses to increase in absolute dollars for the remainder of 2011, we expect that research and development expenses as a percentage of revenues will remain relatively flat in 2011 compared to 2010 due to the expected increase in revenues.increased to $10.0remained consistent at $10.1 million, or 11% of revenues, in the third quarter of 2011 from $9.22012 compared with $10.0 million, oralso 11% of revenues, in the third quarter of 2010. The $0.8 million increase in general and administrative expenses was primarily due to increased personnel costs and an increase in third-party professional service fees which was largely related to the global restructuring of our international distribution operations. Our headcount in general and administrative departments decreased slightly from an average of 122 employees during the third quarter of 2010 to an average of 121 employees for the third quarter of 2011 relative to 2010. 2011.primarily due to expected higher third-party professional service fees, but remain relatively flatand as a percentage of revenues forrevenue in the remainderfourth quarter of 2012 compared with the fourth quarter of 2011 as compared to 2010 due to the expected increase in revenues.decreasedincreased to $0.6 million in the third quarter of 2012 from $0.4 million in the third quarter of 2011, from $0.8 million in the third quarter of 2010. The decrease was primarily due to a lowerinterest expense recognized on an unfavorable interest rate swap that became effective on December 30, 2011. The average outstanding loan balance on our secured loan ofwas $68.0 million during the third quarter of 2012 and 2011.20112011. We expect interest expense to remain moderately higher in 2012 compared to an average loan balance of $69.0 million during the third quarter of 2010. In addition, the effective interest rate was lower in the third quarter ofwith 2011 compared to 2010 primarily due to the reductionan increase in the notional amount of principal subject to thean unfavorable fixed rate swap agreement which expired on September 30, 2010 and the reduction in the margin as a result of the 2010 Credit Facility entered into in October 2010. Included in the interest expense for both the third quarter of 2011 and the third quarter of 2010 is $0.1 million of amortization of deferred financing fees that were capitalized as part of the 2010 Credit Facility and 2007 Credit Facility, as applicable. We borrowed a total of $10.0 million (net of principal payments) on the secured loan under the 2010 Credit Facility during the third quarter of 2011 and principal payments (net of borrowings) totaling $3.0 million on the secured loan under the 2007 Credit Facility during the third quarter of 2010. Primarily as a result of the reduction in the notional amount of principal subject to the unfavorable fixed rate swap agreement which expired on September 30, 2010 and the reduction in the margin as a result of the 2010 Credit Facility entered into in October 2010, our weighted average interest rate decreased from 2.51% at September 30, 2010 to 1.98% at September 30, 2011. Interest expense should decline in the remaining quarters of 2011 as compared to 2010 primarily due to the expected lower effective interest rate from our 2010 Credit Facility and the reduction in the notional amount of principal subject to the unfavorable fixed rate swap agreement which expired on September 30, 2010.income (expense), net went from a net other expense ofwas $0.1 million in the third quarter of 2012, compared with $0.2 million other income in the third quarter of 2010 to a net other income of $0.2 in the third quarter of 2011. Due to a continued low interest rate environment, we expect our net other income (expense) for the remainder of 2011 to be similar to 2010 levels.20112012, we recognized an income tax expense of $5.4$4.6 million compared towith an income tax expense of $5.8$5.4 million for the three months ended September 30, 2010.2011. The effective tax rates were 35.4% for the three months ended September 30, 2012 and 40.1% for the three months ended September 30, 2011 and 50.0% for the three months ended September 30, 2010.. For the third quarter of 2012, the effective tax rate variance from the U.S. federal statutory rate was primarily related to the favorable impact from earnings in lower tax rate jurisdictions offset by the unfavorable impact of foreign withholding taxes and non-deductible share-based payments. For the third quarter of 2011, the effective tax rate variance from the U.S. federal statutory rate was primarily related to the unfavorable impact of foreign withholding taxes, non-deductible share-based payments and increased earnings in higher tax rate jurisdictions. For the third quarter of 2010, the effective tax rate variance from the U.S. federal statutory rate was primarily related to an increase in the valuation allowance related to net operating losses of one of our subsidiaries in the United Kingdom, the unfavorable impact on deferred tax amounts resulting from a California law change, a favorable state tax ruling, foreign withholding taxes and non-deductible share-based payments, which offset the benefit of income taxed at lower rates in foreign jurisdictions. During 2010, 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 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.2011,2012, 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-notmore likely than not that we will fully realize the balance of the deferred tax assets currently reflected on our consolidated balance sheets.20112012 compared with the nine months ended September 30, 20102011 Nine Months Ended September 30, 2011 2010 90 % 97 % 10 3 100 100 11 14 5 2 16 16 84 84 45 47 16 17 11 11 72 75 12 9 0 (1 ) 0 0 12 8 4 4 8 % 4 % Nine Months Ended September 30, 2012 2011 Revenues: Software and service 91 % 90 % Appliance 9 10 Total revenues 100 100 Cost of revenues: Software and service 12 11 Appliance 4 5 Total cost of revenues 16 16 Gross profit 84 84 Operating expenses: Selling and marketing 42 45 Research and development 17 16 General and administrative 11 11 Total operating expenses 70 72 Income from operations 14 12 Interest expense (1 ) — Other income (expense), net — — Income before income taxes 13 12 Provision for income taxes 7 4 Net income 6 % 8 % Revenuesfrom $238.4 million inand the first nine months of 2010. The increase was primarily a result of increased incremental sales to new customers2012, which resulted in higher beginning current deferred software and upgrades to existing customers, as well asservice revenue and higher OEM revenues recognized in the current period, compared with the first nine months of 2011 as compared to the first nine months of 2010. 2011.$121.8$119.7 million, or 44.9%44% of the first nine months of 20112012 revenues, compared to $117.5with $121.1 million, or 47.7%45% of revenues, in the first nine months of 2010. Software2011. International software and service revenues generated internationally accounted for $121.3$126.3 million, or 44.8%47% of the first nine months of 20112012 revenues, compared to $120.9with $122.0 million, or 49.1%45% of revenues, in the first nine months of 2010.ApplianceThe first nine months of 2012 appliance revenues increased to $28.4of $23.8 million consisted of $19.0 million in revenue from sales of appliances sold in the first nine months of 20112012 and $4.8 million recognized from $8.0 million in the first nine months of 2010. The increase was primarily a result of our adoption of newdeferred revenue recognition rules (as more fully described in Note 1 to the Consolidated Financial Statements) starting January 1, 2011 under which revenues fromfor sales of appliances are now generally recognized when sold. Accordingly, $9.3 million of the revenues recognized in the first nine months of 2011 represented primarily the ratable recognition of deferred revenue for appliance sales recorded prior to the adoption of the amended revenue recognition rules, andas described previously. This compares with $28.4 million in appliance revenues in the remainingfirst nine months of 2011, which included $19.1 million representedin revenue from appliances sold in the first nine months of 2011 and $9.3 million recognized from deferred revenue. The decrease in total appliance revenues was primarily the result of the decline in appliance revenue recognized from salesdeferred revenue in the first nine months of appliances sold2012 compared with the first nine months of 2011, due to the adoption of the amended revenue recognition rules.in the United Statesinternationally accounted for $14.7$12.7 million, or 5.3%5% of the first nine months of 20112012 revenues, compared to $4.3with $13.8 million, or 1.7%also 5% of revenues, in the first nine months of 2010. Appliance2011.generated internationally accounted for $13.7increased to $33.9 million or 5.0% of the first nine months of 2011 revenues compared to $3.7 million or 1.5% in the first nine months of 2010.Cost of RevenuesSoftware and service cost of revenues. Software and service cost of revenues decreased to2012 from $31.0 million in the first nine months of 2011 from $33.9 million in the first nine months of 2010.2011. The $2.9 million decreaseincrease was primarily due to decreased amortizationincreased costs of acquired technology of $4.4 million and decreased allocated costs partially offset by increased personnel costs. The decrease in amortization of acquired technology from the first nine months of 2010 to the first nine months of 2011 was primarily due to certain acquired technology being fully amortized in 2010.operating our infrastructure for our SaaS offerings. Our full-time employee headcount in cost of revenues departments decreased from an average of 268 employees during the first nine months of 2010 to an average ofaveraged approximately 260 employees during the first nine months of 2012 and 2011.increaseddecreased to $9.9 million in the first nine months of 2012 from $13.7 million in the first nine months of 20112011. The $3.8 million decrease was primarily due to decreased cost of revenues from $4.8 million insales prior to 2011. In appliance cost of revenues for the first nine months of 2010. As described in the Appliance revenues section above, the $8.9 million increase was primarily due to our adoption of new revenue recognition rules under which the related costs are generally2012, we recognized when the appliances are sold. In appliance cost of revenues, we also recognized $4.2$2.1 million of the ratable cost of appliances sold prior to 2011 that were recognized in revenuescompared with $4.2 million in the first nine months of 2011. The remaining $7.8 million represents costs of appliances sold in the first nine months of 2012 as compared with $9.5 million in the first nine months of 2011. As a percentage of total revenues, appliance cost of revenues decreased to 4% in the first nine months of 2012 from 5% during the first nine months of 2011.increaseddecreased slightly to $225.9 million in the first nine months of 2012 from $226.8 million in the first nine months of 2011, from $207.7 million in the first nine months of 2010 primarily as a result of decreased appliance revenues and increased revenues.cost of revenues related to our expanding SaaS infrastructure. As a percentage of total revenues, our gross profit was 84% in both the first nine months of 20112012 and the first nine months of 2010. million, or 45% of revenues, in the first nine months of 2011, compared to $116.12011. The $9.1 million or 47% of revenues, in the first nine months of 2010. The $5.2 million increasedecrease in total selling and marketing expenses was primarily due to our increased personnel costs of $6.8 million and increased allocated costs of $1.7 million offset by a reductiondecrease in the amortization of acquired intangibles (customer relationships) of approximately $3.6 million. Our headcount$4.9 million, as certain customer relationships were fully amortized in sales2011. The remaining decrease is related to a reduction in travel and marketingpersonnelcosts.from an averageto $46.7 million, or 17% of 583 employees duringrevenues, in the first nine months of 2010 to an average of 606 employees for the first nine months of 2011.Research and development.Research and development expenses increased to2012 from $43.6 million, or 16% of revenues, in the first nine months of 2011 from $41.0 million, or 17% of revenues, in the first nine months of 2010.2011. The increase of $2.6$3.1 million in research and development expenses was primarily due to increased personnel costs of $2.1 million and increased allocated costs. Ourcosts of $1.1 million. Although our headcount increased in research and development from an average of 447 employees for the first nine months of 2010 to an average of 488 employees for the first nine months of 2011.General and administrative. General and administrative expenses increased to $30.9 million, or 11% of revenues, in the first nine months of 2011 from $27.5 million, or 11% of revenues, in the first nine months of 2010. The $3.4 million increase in general and administrative expenses was primarily due to an increase in third-party professional service fees of $3.1 million and an increase in personnel costs of approximately $0.3 million. The increase in third-party professional service fees was primarily related to the global restructuring of our international distribution operations. Our headcount in general and administrative departments increased slightly from an average of 120 employees during the first nine months of 2010 to an average of 121516 employees for the first nine months of 2011.2012, the impact of the higher headcount was partially mitigated by an increase in the number of employees in relatively low cost foreign locations.decreasedincreased to $1.9 million in the first nine months of 2012 from $1.2 million in the first nine months of 2011, from $2.8 million in the first nine months of 2010. The decrease was primarily due to a lowerhigher average outstanding loan balance on our secured loan of $69.3 million during the first nine months of 2012 compared with an average loan balance of $66.5 million during the first nine months of 2011, comparedas well as interest expense recognized on an unfavorable interest rate swap that became effective on December 30, 2011.an average loan balancethe 2010 Credit Facility, we made $5.0 million of $75.0 millionprincipal payments during the first nine months of 2010. In addition, the effective interest rate was lower in the first nine months of 2011 compared to 2010 primarily due to the reduction in the notional amount of principal subject to the unfavorable fixed rate swap agreement which expired on September 30, 20102012 and the reduction in the margin as a result of the 2010 Credit Facility entered into in October 2010. Included in the interest expense for the first nine months of 2011 and 2010 is $0.2 million and $0.6 million, respectively, of amortization of deferred financing fees that were capitalized as part of the 2010 Credit Facility and 2007 Credit Facility, as applicable. We borrowed a total of $6.0 million (net of principal payments) on the secured loan under the 2010 Credit Facility during the first nine months of 2011.We expect interest expense to remain higher in 2012 compared with 2011 primarily due to higher average borrowings and made netan increase in the notional amount of principal payments totaling $20.0 million on the secured loan under the 2007 Credit Facility during the first nine months of 2010.income (expense), net changed from a net other expense of $0.9was $0.2 million expense in the first nine months of 2010 to a net2012, compared with $1.5 million other income of $1.5 million in the first nine months of 2011. The change was due primarily to foreign exchange related gains of $1.3 millionOther income in the first nine months of 2011 compared to lossesincluded a non-recurring gain on foreign currency transactions of $1.1 million in the first nine months$1.4 million.20112012, we recognized an income tax expense of $10.8$19.3 million compared towith an income tax expense of $9.6$10.8 million for the nine months ended September 30, 2010.2011. The effective tax rates were 57.0% for the nine months ended September 30, 2012 and 34.3% for the nine months ended September 30, 2011 and 49.7% for2011. For the first nine months ended September 30, 2010.of 2012, the effective tax rate variance from the U.S. federal statutory rate was primarily related to the tax provision of $8.8 million recorded in the first quarter of 2012 resulting from an agreement in principle with the IRS, as discussed previously, as well as the unfavorable impact of foreign withholding taxes and non-deductible share-based payments, partially offset by the favorable impact from earnings in lower tax rate jurisdictions. For the first nine months of 2011, the effective tax rate variance from the U.S. federal statutory rate was primarily related to the unfavorable impact of foreign withholding taxes and non-deductible share-based payments, and increased earnings in higher tax jurisdictions, offset by a nonrecurringnon-recurring net discrete tax benefit of $2.8 million related primarily to our global distribution restructuring, which was completed during 2010restructuring. This $2.8 million net tax benefit primarily relates to the non-recurring tax effect from the transfer of customer relationship intangible assets and became effective at the beginning of 2011.related deferred tax liabilities from a higher tax rate jurisdiction to a lower tax rate jurisdiction. The entire net tax benefit of $2.8 million was reflected in the first quarter of 2011 upon completion of our global distribution restructuring and is not expected to recur. For the first nine months of 2010, the effective tax rate variance from the U.S. federal statutory rate was primarily related to an increase in the valuation allowance related to net operating losses of one of our subsidiaries in the United Kingdom, the unfavorable impact on deferred tax amounts resulting from a California law change, a favorable state tax ruling, foreign withholding taxes and non-deductible share-based payments, which offset the benefit of income taxed at lower rates in foreign jurisdictions.2011,2012, we had cash and cash equivalents of $75.6$57.6 million and retained earnings of $61.9$86.8 million. Of the $75.6$57.6 million of cash and cash equivalents $29.2held as of September 30, 2012, $37.1 million was held by our foreign subsidiaries, and we plan to indefinitely reinvest the undistributed foreign earnings into our foreign operations. During the first nine months of 2011,2012, we primarily used cash and cash equivalents in excess of cash required for operations forto repurchase $44.7 million of our stock repurchasesand to make principal payments of approximately $74.0 million.2011 compared with $76.1 million in the first nine months of 2010.2011. The decrease in cash flow from operations for the first nine months of 20112012 compared towith the first nine months of 20102011 was primarily a result of higher cash operating expenses resulting from higher headcount costs, third-party professional fees and increasedtaxes in 2012 due to a settlement of certain tax obligations with the IRS related to prior years which resulted in $14.7 million in cash tax payments in 2011.the third quarter of 2012. Our operating cash flow is typically more significantly influenced by the timing of new and renewal subscriptions, accounts receivable collections and cash expenses. A decrease in sales of new and/or renewal subscriptions or accounts receivable collections, or an increase in our cash expenses, would negatively impact our operating cash flow.2011 compared with $6.4 million in the first nine months of 2010.2011. The $1.2$2.0 million increase in net cash used in investing activities was primarily due to increased purchases of property and equipment during the first nine months of 20112012 compared towith the first nine months of 2010.2011 compared with $66.4 million in the first nine months of 2010.2011. In the first nine months of 2011, the Company2012, we used approximately $74.0$44.7 million to repurchase itsour common stock which was offset in part by $14.5 million in proceeds from the exerciseand made principal payments of options and net borrowings of $6.0$5.0 million under the 2010 Credit Agreement. The $4.5 million decrease in cash used in financing activities was driven primarily by a reduction in net principal payments made under the Company’s credit facilitiesrepurchases of our common stock during the first nine months of 20112012 compared towith the first nine months of 2010.During the first quarter of 2010, we were informed2011, partially offset 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 its 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 haveproceeds from exercises of stock options and reduced borrowings 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 commencedsecured loan 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 reduces 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 however, we expect the appeals process to continue throughout the remainder of 2011.the Companywe entered into the “2010 Credit Agreement” and used the proceeds to repay the term loan under the 2007 Credit Agreement and retired the 20072010 Credit Agreement. The 2010 Credit Agreement provides for a secured revolving credit facility that matures on October 29, 2015 with an initial maximum aggregate commitment of $120 million, including a $15 million sublimit for issuances of letters of credit and a $5 million sublimit for swing line loans. The CompanyWe may increase the maximum aggregate commitment under the 2010 Credit Agreement to up to $200 million if certain conditions are satisfied, including that it iswe are 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’sour 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 September 30, 2011,2012, the total amount outstanding under the 2010 Credit Facility was $73$68.0 million and the weighted average interest rate was 1.98%3.11%. Eurodollar Rate
Loans Base Rate
Loans 1.75% 0.75% 2.00% 1.00% Consolidated Leverage Ratio <1.25:1.0 1.75% 0.75% ≥1.25:1.0 2.00% 1.00% the Company’sour assets, including pledges of stock of certain of itsour subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by itsour domestic subsidiaries. The 2010 Credit Agreement contains affirmative and negative covenants, including an obligation to maintain a certain consolidated leverage ratio and consolidated interest coverage ratio and restrictions on the Company’sour 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 Companyus to use excess cash to pay down debt.the Company’sour 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’sour representations and warranties, failure to observe covenants, defaults on any other indebtedness, entering bankruptcy, existence of a judgment or decree against the Companyus or itsour subsidiaries involving an aggregate liability of $10 million or more, the security interest or guarantee ceasing to be in full force and effect, any person becoming the beneficial owner of more than 35% of the Company’sour outstanding common stock, or the Company’sour board of directors ceasing to consist of a majority of Continuing Directors (as defined in the 2010 Credit Agreement).20112012 (in thousands): Payment Obligations by Year 2011 2012 2013 2014 2015 Thereafter Total $ — $ — $ — $ — $ 73,000 $ — $ 73,000 820 2,419 2,406 2,406 1,991 — 10,042 2,299 7,615 6,806 2,066 1,145 — 19,931 66 937 93 19 — — 1,115 $ 3,185 $ 10,971 $ 9,305 $ 4,491 $ 76,136 $ — $ 104,088 Payment Obligations by Year 2012 2013 2014 2015 2016 Thereafter Total 2010 Credit Agreement: Contractual principal payments $ — $ — $ — $ 68,000 $ — $ — $ 68,000 Estimated interest and fees 596 2,314 2,314 1,916 — — 7,140 Operating leases 1,899 6,948 2,349 823 — — 12,019 Other commitments 163 2,194 1,623 3 — — 3,983 Total $ 2,658 $ 11,456 $ 6,286 $ 70,742 $ — $ — $ 91,142 20112012 (see NoteNotes 4 and 5 to the consolidated financial statements).37%30% of our operating lease commitments are related to our corporate headquarters lease in San Diego, which extends through December 2013 and has escalating rent payments from 2011through 2013. The San Diego lease expires in December 2013; however, we have an option to 2013.extend the lease for an additional five years. The rent expense related to our worldwide office space leases areis generally recorded monthly on a straight-line basis in accordance with GAAP.Otherrepresent minimumabove are contractual commitmentscommitment obligations as of September 30, 2012 for inbound software licenses, equipment maintenance, royalty agreements and automobile leases.In addition, duethe uncertainty with respect toreasonably estimate the timing of future cash flows associated with our unrecognized tax benefits at September 30, 2011, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities. Therefore, $14.4 million of gross unrecognized tax benefitsauthorities and have beentherefore excluded this amount from the contractual payment obligations table above.4four 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 4four million shares, for a total program size of up to 8eight million shares. In July 2006, we announced that our board of directors increased the size of the stock repurchase program by an additional 4four million shares, for a total program size of up to 12twelve million shares. In January 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional 4four million shares, for a total program size of up to 16 million shares. In October 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional 8eight 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, suspendedprovides the board of directors with authority to modify, suspend or terminatedterminate the program at any time by ourtime. Effective July 17, 2012, the board of directors.our board of directors approved an increase towe 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. Repurchases areIn 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 provide for stock repurchases to be made on the open market at prevailing market prices in accordance with certain timing conditions set forth in the 2009 Repurchase Plans. Depending on market conditions and other factors, including compliance with covenants in our 2010 Credit Agreement, purchases by our agents under theconditions. The 2009 Repurchase Plans may bewere suspended at any time, or from time to time.on July 17, 2012, in connection with the suspension of the stock repurchase program. With the resumption of the stock repurchase program by the board of directors, we have resumed repurchasing stock under a 10b5-1 plan. During the first nine months ended September 30, 2011,of 2012, we repurchased 3,400,0112,268,696 shares of our common stock for an aggregate of approximately $75.0$42.9 million at an average price of $22.05$18.91 per share. As of September 30, 2011,2012, we havehad repurchased a total of 19,024,53022,680,517 shares of our common stock under this stock repurchase program, for an aggregate of $384.8$452.7 million at an average price of $20.23$19.96 per share. OurThe 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 have liquidity of at least $20 million; provided, however, if, after giving effect to any repurchase, our consolidated leverage ratio is greater than 1.75:1, such repurchase cannot exceed $10.0 million in the aggregate in any fiscal year. We intend to continue repurchasing shares during 2011. and stock repurchases, if any, for at least the next 12 months. During the first nine months of 2011,2012, we borrowed a net totalmade principal payments of $6.0$5.0 million on our secured loan and repurchased approximately $75.0$42.9 million of our common stock, of which $1.5 million was settled in October 2011.stock. Our cash requirements may increase if, as part of our growth strategy, we make acquisitions that increase our cash requirements, or for reasons we do not currently foresee or we may make acquisitions as part of our growth strategy that increase our cash requirements.foresee. We may elect to borrow under ourthe 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.2011,2012, we did not have any off-balance sheet arrangements.ourthe 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.our variable ratethe 2010 Credit Facility. In connection with ourthe 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 three- monththe three-month LIBOR) on a principal amount of $50 million. The $50 million swap agreement becomesbecame effective on December 30, 2011 and expires on October 29, 2015.becomesbecame effective on December 30, 2011. Based on our revolving credit balance at September 30, 20112012 and taking into consideration our interest rate swap agreement, our interest expense would increase on a pre-taxpre‑tax basis by approximately $0.3$0.2 million during the next 12 months if a 100 basis point adverse move in the interest rate yield curve occurred.2011.2012. Changes in interest rates over time will, however, affect our interest income.overapproximately 130 countries, and we bill certain international customers in Euros, British Pounds, Australian Dollars, Japanese Yen 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.zero-costzero‑cost collar 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 flows associated with changes in currency exchange rates. We do not use foreign currency contracts for speculative or trading purposes.20112012 and December 31, 20102011 are presented in the table below (in thousands): September 30, 2011 December 31, 2010 Notional
Value
Local
Currency Notional
Value
USD Fair
Value
USD Notional
Value
Local
Currency Notional
Value
USD Fair
Value
USD 7,250 $ 10,264 $ 9,735 8,550 $ 11,405 $ 11,449 — — — 1,250 1,938 1,958 6,243 6,428 5,945 — — — September 30, 2012 December 31, 2011 Fair Value Hedges Euro 5,900 $ 7,335 $ 7,590 11,000 $ 14,909 $ 14,266 Australian dollar 1,500 $ 1,537 $ 1,550 — $ — $ — Cash Flow Hedges Israeli Shekel 18,666 $ 4,845 $ 4,745 — $ — $ — $1.1€5.1 million notional value decrease in our Euro hedgedhedge position at September 30, 20112012 compared towith December 31, 20102011 was primarily a result of timing differences in when assets were acquired and/or liabilities incurred. All of the Euro hedging contracts in place as of September 30, 20112012 are scheduled to be settled before January 2012.March 2013. For the nine months ended September 30, 2011,2012, less than 15% of our total billings were denominated in the Euro. We expect Euro billings to represent less than 20% of our total billings during 2011.The $1.9 million notional decrease in our British Pound hedge position at September 30, 2011 compared to December 31, 2010 was primarily due to the timing differences in when assets were acquired and/or liabilities incurred. There were no British Pound hedging contracts in place as of September 30, 2011. For the nine months ended September 30, 2011, 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 2011.$6.4AUD1.5 million notional value increase in our Australian Dollar hedge position at September 30, 20112012 compared towith December 31, 20102011 was primarily due to the incurrence of a largetwo Australian Dollar denominated obligationhedge contracts in the first nine monthsplace as of 2011 as a result of our global distribution restructuring. All of theSeptember 30, 2012. The Australian Dollar hedging contracts in place as of September 30, 20112012 are scheduled to be settled before January 2012.2013. For the nine months ended September 30, 2011, approximately2012, less than 5% of our total billings were denominated in the Australian Dollar. We expect Australian Dollar billings to represent approximatelyless than 5% of our total billings during 2011.soand 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, especially if the trend continues of international sales growing as a percentage of our total sales.dollars. Changes in currency rates also impact our future revenues under subscription contracts that are not denominated in U.S. dollars. Our revenues and deferred revenue for these foreign currencies are recorded in U.S. dollars when the 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 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.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”)) that are designed to ensure that the 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 Commission (“SEC”)SEC 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 disclosures. Our Chief Executive Officer and Chief Financial Officer evaluated our disclosure controls and procedures asdisclosure. As of the end of the period covered by this Quarterly Report.Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness and design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on theirthis evaluation, our Chief Executive OfficerCEO and Chief Financial Officer haveCFO concluded that theseour disclosure controls and procedures were effective as of the end of the period covered by this Quarterly Report.September 30, 2012.There have been noor in other factorsduring the nine months ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, including corrective actions with regard to significant deficiencies and material weaknesses, during the period covered by this Quarterly Report.the Company’sby making, using, importing, selling and/or offering for sale Websense Web Filter, Websense Web Security and Websense Web Security Gateway, the Company infringes U.S. Patent No. 6,092,194 (“194 Patent”). Since filing the complaint, Finjan Inc.withdrew its contention that Web Filter and Web Security infringes the 194 Patent. Finjan has also accused additional products of infringing the 194 Patent in response to discovery and in expert reports, namely TRITON Enterprise, TRITON Security Gateway Anywhere, Websense Web Security Gateway Anywhere, Websense Web Security Gateway Hosted and the Websense V-Series appliances. Finjan seeks an injunction from further infringement of the 194 Patent and damages. The court has set a date of January 30, 2012 forCourt held a hearing on the construction of the claims in the 194 Patent.Patent on January 30, 2012 and issued a claim construction order on February 29, 2012. The Court has set a pretrial conference for November 5, 2012 and a trial date of December 3, 2012. We deny infringing any valid claims of the 194 Patent and intend to vigorously defend the lawsuit.believe wecannot currently determine and have adequately reserved fornot accrued any ultimate liability that may result from theseany of our pending legal actions includingbecause we are unable to predict or reasonably estimate the Finjan litigation,possible losses, if any, relating to such that any liability would not materially affect our consolidated financial position, results of operations or cash flows. It is reasonably possible that the ultimate liability for these matters will be greater than the amount we have accrued for; however, management is not able to estimate any amount over what it has already accrued for at this time.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, which 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.2010,2011, as filed with the SEC on February 10, 2011.tofor our security products.* significant majority of our salesbillings for 2011the remainder of 2012 will continue to be derived from our TRITON content security solutions, including the TRITON security gateways, our data loss prevention products, related appliances and SaaS offerings sold with or without appliances. We also expect the percentage of our billings derived from our Web filtering and Web security products including our Web Security Gateway product sold with or without appliances. While we expect saleswill decline for the remainder of 2012 relative to 2011 as many of our customers transition to our TRITON unified Web, data and email security solutions, data loss prevention (“DLP”) products SaaS offerings, and otheror to lower-priced products under development to comprise a minority portion ofsold by our revenues in 2011, they should represent more than half of our sales and be a primary driver of our billings and revenue growth in 2011.competitors. Our billings and revenue growth are dependent on incremental 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 and declines in sales tosubscriptions. We also depend upon enterprise customers for a substantial portion of our OEM customers.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.forto our Web security, DLPsoftware and email securitySaaS products typicallygenerally 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 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.*end-userend user customers have caused these customers to choose shorter contract durations and/or reduce the number of seats under subscription and in some cases, have caused customers not to renew contracts at all. While the number of distressed customers appears to have stabilized, we expect this trend to continue until and unless there is a broad worldwide economic recovery and positive job growth. These trends, 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 Web filtering products and seek to sell subscriptions to our TRITON and gateway security products which may have longer durations and may depend on product mix. Credit markets may also adversely affect our resellers through whom our distributors distribute products and limit the credit value-added resellers may extend to their customers. The volatility of currency exchange rates can also significantly affect sales of our products denominated in foreign currencies. In addition, events in the global financial markets may make it difficult for us to access the credit markets or to obtain additional financing or refinancing, if needed, on satisfactory terms or at all.DLPdata loss prevention products, SaaS offerings and our V-series appliance platformplatforms are unable to achieve more widespread market acceptance our business will be seriously harmed, particularly ifas Web filtering products continue to commoditize.* now sell our next generation Web content gatewayTRITON security products to address emerging Web 2.0 threats, Websense Web Security Gateway, as well as our V10000V-Series and V5000X-Series appliances pre-loaded with our software. We also sell the Websense Data Security Suite, our DLPdata loss prevention offering, Websense HostedCloud Web Security and Websense HostedCloud Email Security, our SaaS offerings, and Websense Email Security, our email filtering solution. We offer our products with TRITON, our unified Web, dataemail, mobile and emaildata security solution, which combines our products into a single platform. We continue to develop and release products in accordance with our announced product roadmap. We may not be successful in achieving market acceptance of these or any new products that we develop and may be unsuccessful in obtaining incremental sales as a result. If our products fail to meet the needs of our existing and target customers, or if they do not compare favorably in price, features and performance to competing products, our operating results and our business will be significantly impaired. If we fail to continue to upgrade and diversify our products, we could lose revenues from renewal subscriptions for our Web filtering products as these products continue to suffer from commoditization.V-seriesV-Series and X-Series appliance platform exposesplatforms expose us to risks inherent with the sale of hardware to which we were not previously exposedsuch as a software company.product delays and pricing fluctuations.With the launch of*V10000 appliance in 2009 and the release of our V5000 appliance in 2010, we are selling products that are hardware-based and not solely software-based. Our V-series appliances areis primarily manufactured by a single third-party contract manufacturer, and a single third-party logistics company provides logistical services, including product configuration and shipping. Our ability to deliver our V-series appliances to our customers could be delayed if we fail to effectively manage our third-party relationships or if our contracthardware 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 manufactureassemble and deliver the V-series appliances with acceptable quality, in the required volumes, and in a cost-effective and timely manner, it could be costly to us, as well as disruptive to product shipments. In addition, supply disruptions or cost increases could increase our cost of goods sold and negatively impact our financial performance. If we are required to change our third-party hardware manufacturer and/or logistics provider, we may be unable to deliver our appliances to our customers on a timely basis which could result in loss of sales and existing or potential customers and could adversely affect our business and operating results. Our V-series appliance platforms may also face greater obsolescence risks than our pure software products.revenue isrevenues are derived almost entirely from sales through indirect channels and we depend upon these channels to create demand for our products.*Although we rely upon these indirect channels of distribution, we also depend 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 29%28% of our revenues during the first nine months of 2011. In addition, we began using Arrow Enterprise Computing Solutions as an additional broadline distributor in North America in 2010.ended September 30, 2012. Should Ingram Micro or Arrow Enterprise Computing Solutions 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 revenues 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 revenues and cash flow could be adversely affected. Our indirect sales model involves a number of additional risks, including:security-oriented offerings, our Web Security Gateway, our V-seriesX-Series appliances our DLP and email offerings, our SaaS offerings or our TRITONmobile security solutions; increase the amount of our products sold through our sales channels also depends on our ability to adequately and efficiently support these channel partners adequately and efficiently 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 existing and 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 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 properly and efficiently will result in lost sales opportunities.seasonalcyclical changes causing fluctuations in our billings, 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 seasonalcyclical 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 revenuerevenues in any quarter comes from previously deferred revenue, a meaningful portion of our revenuerevenues 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.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 manymost of the largest enterprise customers purchasing subscriptions to our products nearer to the end of the last month of each quarter. Further, an increasing portion of our billings are attributable to larger subscriptions ($1 million or more), so delays in completing agreements before the end of a quarter may cause a material failure to meet our billings guidance for the quarter.quarterly report:revenue isrevenues are recognized ratably over the subscription term.may not meetand the expectations of current or potential investors.investors may not be met. If this occurs, the price of our common stock may decline.affected, especially if international sales grow as a percentage of our total sales.revenuerevenues under subscription contracts that are not denominated in U.S. dollars as we bill certain international customers in Euros, British Pounds, Australian Dollars, Japanese Yen and Chinese Renminbi. Our revenuesrevenue 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.products and potentially could result in the commoditization of these products. We depend on our more advanced security productssolutions, such as our TRITON content security solutions, to replace and grow revenues from Web filtering subscriptions that are not renewed.competitive products with their currentto 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 with no price increasemay become obsolete and unmarketable, particularly if the quality of these network security features is comparable to these currentthat 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 software and to replace any obsolete products.Our current The competitive environments in which we operate and the principal competitors include:companiesTRITON Solutions for Content Securityfiltering and Web security software solutions include companies such as Microsoft, McAfee (acquired by Intel in February 2011)Intel), Symantec, Trend Micro, Google, Webroot Software/BrightCloud, SafeNet, Actiance (formerly FaceTime Communications), EdgeWave, M86 Security, Clearswift, Check Point Software Technologies, Cisco Systems, Blue Coat Systems, Microsoft, Google, Webroot Software, SafeNet, Actiance, EdgeWave, FireEye, Trustwave, Clearswift, Sophos, Kaspersky Lab, AhnLab.,AhnLab, IBM, Panda Security, F-Secure, Commtouch, and CA Technologies, (formerly Computer Associates);Juniper Networks, Black Box Network Services and Barracuda Networks.companies integrating Web filtering into specializedEmail Security. Our principal competitors offering messaging or email security appliances,solutions include companies such as Blue CoatMcAfee, Symantec/Message Labs, Google, Cisco Systems, Cisco Systems/IronPort, McAfee, Check Point Software Technologies, EdgeWave, Barracuda Networks, SonicWALL (acquired by Dell), Trend Micro, SonicWALL,Microsoft, Axway, Sophos, IBM, PandaProofpoint, Clearswift, Commtouch, Zix, WatchGuard Technologies, Trustwave, Webroot Software, FortinetEdgeWave, Zscaler and M86 Security;DLPdata loss prevention solutions include companies such as Symantec, Verdasys, Trustwave, EMC, McAfee, IBM, Trend Micro, Proofpoint, Palisade Systems, CA Technologies, Raytheon, Intrusion, Fidelis Security Systems (acquired by General Dynamics), GTB Technologies, Workshare, Check Point Software Technologies and Code Green Networks;companies offering messaging or email security solutions, such as McAfee, Symantec/Message Labs, Google, Cisco Systems, Barracuda Networks, SonicWALL, Trend Micro, Axway, Sophos, Microsoft, Proofpoint, Clearswift, Commtouch, Zix, WatchGuard Technologies, M86 Security, Webroot Software and Fortinet;companies offering on-demand email and Web security services, such as Google, Microsoft, Symantec/Message Labs, McAfee, Webroot Software/BrightCloud, EdgeWave, Barracuda Networks, Zscaler, Trend Micro and Cisco Systems/ScanSafe;Micro; andcompaniesWeb Filtering Solutionsgatewayfiltering solutions, including through specialized security appliances, include companies such as Microsoft, Blue Coat Systems, Cisco Systems,McAfee, Symantec, Trend Micro, Check Point Software Technologies, McAfee, Juniper Networks, Symantec,Cisco Systems, Blue Coat Systems, Microsoft, Google, Webroot Software, SafeNet, Actiance, EdgeWave, FireEye, Trustwave, Clearswift, Sophos, Kaspersky Lab, AhnLab, IBM, Panda Security, Sophos, Black Box Network Services/Optinet, Safe Net, M86 Security, Clearswift,F-Secure, Commtouch, CA Technologies, ActiancePalo Alto Networks, Fortinet, Barracuda Networks and Barracuda Networks.SonicWALL.2010 Credit Agreementcredit facility restrict our financial and operational flexibility, including our ability to complete additional acquisitions and invest in new business opportunities. announced that we had entered into the 2010 Credit Agreement. Under the 2010 Credit Agreement, we can borrow up to $120 million and used the initialuse proceeds to repay our term loan and retirefund share repurchases or other corporate purposes. We may increase the 2007maximum aggregate commitment under the 2010 Credit Agreement. Agreement to 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. If we should need to increase the aggregate commitment, it may not be possible to satisfy these conditions. Ouralso requiresincluding the following:maintain specifiedsatisfy our obligations under the 2010 Credit Agreement, including certain financial ratios. Our ability to meet these financial ratios that can be affected by events beyond our control,control;cannot ensure that could be at a competitive disadvantage to competitors with less debt; andwill meet those ratios.revenue,revenues, which exposes us to risks inherent in international sales.*first nine months of 2011.ended September 30, 2012. 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:Because our products primarily manage access to uniform record locators (“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.not includedexcluded 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 termlong-term acceptance of our products.V-series appliances, content gateway products, DLPmobile device solutions, 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.Security threats to our IT infrastructure could expose us to liability, and damage our reputation and business.*It is essential to our business strategy that our technology and network infrastructure remain secure and is perceived by our customers, distributors and resellers to be secure. Despite security measures, however, any network infrastructure may be vulnerable to attacks by hackers and other security threats. As a provider 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.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 Agreement. Under the 2010 Credit Agreement, we 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 our 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; andwe could be at a competitive disadvantage to competitors with less debt.We face risks related to customer outsourcing to system integrators.Some of our customers have outsourced the management of their IT 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 revenues and have a material adverse effect on our business.Other vendors may include products similar to ours in their hardware or software and render our products obsolete.In the future, vendors of hardware and of operating system software or other software may continue to enhance their products or bundle separate products to include functions that are currently provided primarily by network security software. If network security functions become standard features of computer hardware or of operating system software or other software, our products may become obsolete and unmarketable, particularly if the quality of these network security features is comparable to that of our products. Furthermore, even if the network security and/or management functions provided as standard features by hardware providers or operating systems or other software is more limited than that of our products, our customers might accept this limited functionality in lieu of purchasing additional software. Sales of our products would suffer materially if we were then unable to develop new Web filtering, security and DLP products to further enhance operating systems or other software and to replace any obsolete products.
Our worldwide income tax provisions and other tax accruals may be insufficient if any taxing authorities assume taxing positions that are contrary to our positions and those contrary positions are sustained.*
Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for state, federal and international income taxes together with transaction taxes such as sales tax, 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 ultimately result in changes once the arrangements are reviewed by taxing authorities. Although we believe that our approach to determining the amount of such arrangements is consistent with prevailing legislative interpretation, no assurance can be given that the final tax authority review of these matters will agree with our historical income tax provisions and other tax accruals. Such differences could have a material effect on our income tax provisions or benefits, or other tax accruals, in the period in which such determination is made, and consequently, on our results of operations for such period.
From time to time, we are also audited by various state, federal and tax authorities of other countries in which we operate. Generally, the tax years 2005 through 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, for 2005 to 2008 in the United Kingdom 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 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 reduces 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. We expect the appeals process to continue throughout the remainder of 2011. While the timing of the ultimate resolution of these remaining matters cannot be reasonably estimated at this time, we may be required to make additional payments in order to resolve these matters.
The IRS has identified and is aggressively pursuing cost sharing arrangements between 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 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.
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, we cannot assure that these agreements will not be breached or that we will have adequate remedies for any breach. 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 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, brand and future sales of our products.
We have registered our trademarks in several 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 31 patents issued in the United States and 26 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 make the inventions covered by each of our pending patent applications;
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.
difficulties in integrating operations, technologies, services and personnel of the acquired company;
potential loss of customers and OEM relationships of the acquired company;
diversion of financial and management resources from existing operations and core businesses;
risks associated with entrance into new markets;
potential loss of key employees of the acquired company;
integrating personnel with diverse business and cultural backgrounds;
preserving the development, distribution, marketing and other important relationships of the companies;
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
the continued use by acquired companies of accounting policies that differ from GAAP.
issue equity securities that would dilute our current stockholders’ percentage ownership;
assume certain liabilities, including liabilities that were not detected at the time of the acquisition;
incur additional debt, such as the debt we incurred to partially fund the acquisition of SurfControl in October 2007;
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.
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. 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. * Period July 1 - July 31, 2011 August 1 - August 31, 2011 September 1 - September 30, 2011 Total As we have publicly announced, our former Chief Financial Officer, Arthur S. Locke III, resigned in September 2011 and we are in the process of recruiting a new Chief Financial Officer who would assume those duties from our current General Counsel and Chief Administrative Officer, Michael A. Newman, who is now 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 our executive officers, key management or development personnel that would prevent them from terminating their employment with us at any 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.**hashad been remediated as of December 31, 2010.* have restated our consolidated financial statements and related disclosures for fiscal years ended December 31, 2007,2009, 2008 and 2009.2007. 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.resource-intensiveresource 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 NasdaqNASDAQ Stock Market, Inc. (“NASDAQ”) regarding our restated financial statements or matters relating thereto.implementation of two-tier distribution, international expansion, introduction of new products, leveraging our multi-tier distribution channels and expansion of our product sales to the SMB segment.international expansion. Each of these initiatives requires an investment of our 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.Agreement acceleratesFacility accelerate and becomesborrowings become 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.our seniorthe 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 ourthe 2010 Credit Facility.(a) Not applicable. (b) Not applicable. (c) Issuer Purchases of Equity Securities Total
Number of
Shares
Purchased (1) Average Price
Paid per Share Total
Number of Shares
Purchased as Part
of Publicly
Announced Plans
or Programs Maximum Number
of Shares that May
be Purchased
Under the Plans
or Programs (2) 320,500 $ 26.04 18,168,186 5,831,814 400,000 $ 20.48 18,568,186 5,431,814 456,344 $ 18.50 19,024,530 4,975,470 1,176,844 $ 21.23 19,024,530 4,975,470 Month July 1 - July 31, 2012 158,700 $ 18.37 22,680,517 1,319,483 August 1 - August 31, 2012 — — 22,680,517 1,319,483 September 1 - September 30, 2012 — — 22,680,517 1,319,483 Total 158,700 $ 18.37 22,680,517 1,319,483 1. 10b5-1 stock repurchase plans.2009 Repurchase Plans.2. In April 2003, we announced that our board of directors authorized a stock repurchase program of up to 4four 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 4four million shares, for a total program size of up to 8eight million shares. In July 2006, we announced that our board of directors increased the size of the stock repurchase program by an additional 4four million shares, for a total program size of up to 12 million shares. In January 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional 4four million shares, for a total program size of up to 16 million shares. In October 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional 8eight 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, suspendedprovides the board of directors the authority to modify, suspend or terminatedterminate the program at any time by ourtime. Effective July 17, 2012, the board of directors. In connection withdirectors suspended 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 $7.5after repurchasing approximately $2.9 million of our common stock per calendarin the third quarter in open market transactions beginning inof 2012, to better align with third quarter cash flow. In October 2009. In November 2010, our2012 the board of directors approved an increase toresumed 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. Depending on market conditions and other factors, including compliance with covenants in our 2010 Credit Agreement, purchases by our agents under the 2009 Repurchase Plans may be suspended at any time, or from time to time. The remaining shares authorized for repurchase under our stock repurchase program asand authorized management to repurchase up to $5.0 million of September 30, 2011 was 4,975,470.our common stock in the fourth quarter of 2012.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(3) Separation Agreement, dated September 6, 2011, by and between Websense, Inc. and Arthur S. Locke III.31.1 Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a). 31.2 Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a). 32.1 Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350). 32.2 Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350). 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 Extension Label Linkbase Document 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document (1) Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on June 19, 2009.2009 and incorporated herein by reference.(2) Filed as an exhibit to our Registration Statement on Form S-1/A (No 333-95619)S-1 filed with the SEC on March 23, 2000.2000 (Commission File No. 333-95619) and incorporated herein by reference.(3)Filed as exhibit to our Current Report on Form 8-K filed on September 6, 2011.
WEBSENSE, INC.Date: November 4, 2011 WEBSENSE, INC. Date: October 31, 2012 By: s/S/ GENE HODGES Gene Hodges Chief Executive Officer Gene HodgesChief Executive OfficerDate: October 31, 2012 By: s/S/ MICHAEL A. NEWMANDate: November 4, 2011 Michael A. Newman Michael A. NewmanChief Financial Officer 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(3) Separation Agreement, dated September 6, 2011, by and between Websense, Inc. and Arthur S. Locke III.31.1 Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a). 31.2 Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a). 32.1 Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350). 32.2 Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350). 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 Extension Label Linkbase Document 101.PRE XBRL Taxonomy Extension Presentation Linkbase Document (1) Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on June 19, 2009.2009 and incorporated herein by reference.(2) Filed as an exhibit to our Registration Statement on Form S-1/A (No 333-95619)S-1 filed with the SEC on March 23, 2000.2000 (Commission File No. 333-95619) and incorporated herein by reference.(3)Filed as exhibit to our Current Report on Form 8-K filed on September 6, 2011.
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