Attached files

file filename
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - WEBSENSE INCdex312.htm
EX-32.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER - WEBSENSE INCdex322.htm
EX-32.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - WEBSENSE INCdex321.htm
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER - WEBSENSE INCdex311.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended March 31, 2010

OR

 

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

For the Transition Period from                      to                     

Commission File Number 000-30093

 

 

Websense, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   51-0380839
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

10240 Sorrento Valley Road

San Diego, California 92121

858-320-8000

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

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

 

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

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

The number of shares outstanding of the registrant’s Common Stock, $.01 par value, as of April 30, 2010 was 43,202,423.

 

 

 


Table of Contents

Websense, Inc.

Form 10-Q

For the Quarterly Period Ended March 31, 2010

TABLE OF CONTENTS

 

               Page

Part I. Financial Information

  
   Item 1.   

Consolidated Financial Statements (Unaudited):

  
     

Consolidated Balance Sheets as of March 31, 2010 and December 31, 2009

   3
     

Consolidated Statements of Operations for the three months ended March 31, 2010 and 2009

   4
     

Consolidated Statement of Stockholders’ Equity for the three months ended March 31, 2010

   5
     

Consolidated Statements of Cash Flows for the three months ended March 31, 2010 and 2009

   6
     

Notes to Consolidated Financial Statements

   7
   Item 2.   

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

   14
   Item 3.   

Quantitative and Qualitative Disclosures About Market Risk

   23
   Item 4.   

Controls and Procedures

   24

Part II. Other Information

  
   Item 1.   

Legal Proceedings

   24
   Item 1A.   

Risk Factors

   24
   Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

   35
   Item 3.   

Defaults upon Senior Securities

   35
   Item 4.    (Removed and Reserved)    35
   Item 5.   

Other Information

   35
   Item 6.   

Exhibits

   36

Signatures

   37

 

2


Table of Contents

Part I – Financial Information

 

Item 1. Consolidated Financial Statements (Unaudited)

Websense, Inc.

Consolidated Balance Sheets

(In thousands)

 

     March 31,
2010
    December 31,
2009
 
     (Unaudited)        

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 88,312      $ 82,862   

Cash and cash equivalents – restricted

     272        267   

Accounts receivable, net

     53,801        82,529   

Income tax receivable/prepaid income tax

     10,122        11,446   

Current portion of deferred income taxes

     36,831        36,538   

Other current assets

     13,038        11,461   
                

Total current assets

     202,376        225,103   

Cash and cash equivalents – restricted, less current portion

     414        167   

Property and equipment, net

     15,602        16,494   

Intangible assets, net

     60,938        67,563   

Goodwill

     372,445        372,445   

Deferred income taxes, less current portion

     11,821        11,795   

Deposits and other assets

     8,802        8,094   
                

Total assets

   $ 672,398      $ 701,661   
                

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable

   $ 5,168      $ 5,135   

Accrued compensation and related benefits

     20,253        21,953   

Other accrued expenses

     17,436        21,263   

Current portion of income taxes payable

     2,174        1,938   

Current portion of senior secured term loan

     11,667        12,429   

Current portion of deferred tax liability

     3,826        4,572   

Current portion of deferred revenue

     237,344        239,010   
                

Total current liabilities

     297,868        306,300   

Income taxes payable, less current portion

     16,399        15,988   

Senior secured term loan, less current portion

     63,333        74,571   

Deferred tax liability, less current portion

     918        970   

Deferred revenue, less current portion

     137,646        141,102   
                

Total liabilities

     516,164        538,931   

Stockholders’ equity:

    

Common stock

     536        529   

Additional paid-in capital

     344,547        330,451   

Treasury stock, at cost

     (216,317     (194,672

Retained earnings

     29,251        28,416   

Accumulated other comprehensive loss

     (1,783     (1,994
                

Total stockholders’ equity

     156,234        162,730   
                

Total liabilities and stockholders’ equity

   $ 672,398      $ 701,661   
                

See accompanying notes.

 

3


Table of Contents

Websense, Inc.

Consolidated Statements of Operations

(Unaudited and in thousands, except per share amounts)

 

     Three Months Ended  
     March 31,
2010
    March 31,
2009
 

Revenues

   $ 79,770      $ 77,567   

Cost of revenues:

    

Cost of revenues

     9,906        8,575   

Amortization of acquired technology

     2,245        3,256   
                

Total cost of revenues

     12,151        11,831   
                

Gross margin

     67,619        65,736   

Operating expenses:

    

Selling and marketing

     40,749        39,893   

Research and development

     14,125        12,846   

General and administrative

     9,076        11,161   
                

Total operating expenses

     63,950        63,900   
                

Income from operations

     3,669        1,836   

Interest expense

     (1,145     (2,212

Other (expense) income, net

     (744     357   
                

Income (loss) before income taxes

     1,780        (19

Provision for income taxes

     945        1,068   
                

Net income (loss)

     835        (1,087
                

Net income (loss) per share:

    

Basic net income (loss) per share

   $ 0.02      $ (0.02
                

Diluted net income (loss) per share

   $ 0.02      $ (0.02
                

Weighted average shares – basic

     43,213        44,825   
                

Weighted average shares – diluted

     44,110        44,825   
                

See accompanying notes.

 

4


Table of Contents

Websense, Inc.

Consolidated Statement of Stockholders’ Equity

(Unaudited and in thousands)

 

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

Balance at December 31, 2009

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

Issuance of common stock upon exercise of options

   458        5      7,566        —          —        —          7,571   

Issuance of common stock from restricted stock units, net

   129        2      —          (1,646     —        —          (1,644

Share-based compensation expense

   —          —        6,584        —          —        —          6,584   

Tax shortfall from share-based compensation

   —          —        (54     —          —        —          (54

Purchase of treasury stock

   (957     —        —          (19,999     —        —          (19,999

Other comprehensive income:

                

Net income

   —          —        —          —          835      —          835   

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

   —          —        —          —          —        211        211   
                      

Comprehensive income

                   1,046   
                                                    

Balance at March 31, 2010

   43,040      $ 536    $ 344,547      $ (216,317   $ 29,251    $ (1,783   $ 156,234   
                                                    

See accompanying notes.

 

5


Table of Contents

Websense, Inc.

Consolidated Statements of Cash Flows

(Unaudited and in thousands)

 

     Three Months Ended  
     March 31,
2010
    March 31,
2009
 

Operating activities:

    

Net income (loss)

   $ 835      $ (1,087

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

    

Depreciation and amortization

     9,428        12,904   

Share-based compensation

     6,584        6,157   

Deferred income taxes

     (1,250     (5,676

Unrealized gain on foreign exchange

     (268     (436

Tax shortfall from share-based compensation

     54        625   

Changes in operating assets and liabilities:

    

Accounts receivable

     29,427        33,775   

Other assets

     (2,609     (592

Accounts payable

     817        1,187   

Accrued compensation and related benefits

     (3,266     (2,841

Other liabilities

     (3,375     (998

Deferred revenue

     (5,121     (10,550

Income taxes payable and receivable/prepaid

     2,336        3,710   
                

Net cash provided by operating activities

     33,592        36,178   
                

Investing activities:

    

Change in restricted cash and cash equivalents

     (238     913   

Purchase of property and equipment

     (2,537     (3,402
                

Net cash used in investing activities

     (2,775     (2,489
                

Financing activities:

    

Principal payments on senior secured term loan

     (12,000     (15,000

Proceeds from exercise of stock options

     7,571        26   

Tax shortfall from share-based compensation

     (54     (625

Purchase of treasury stock

     (20,170     (7,027
                

Net cash used in financing activities

     (24,653     (22,626
                

Effect of exchange rate changes on cash and cash equivalents

     (714     (977

Increase in cash and cash equivalents

     5,450        10,086   

Cash and cash equivalents at beginning of period

     82,862        64,096   
                

Cash and cash equivalents at end of period

   $ 88,312      $ 74,182   
                

Supplemental disclosures of cash flow information:

    

Income taxes paid

   $ 566      $ 3,021   

Interest paid

   $ 857      $ 1,773   

(Decrease) increase in other accrued expenses for purchase of treasury stock

   $ (171   $ 473   

See accompanying notes.

 

6


Table of Contents

Websense, Inc.

Notes to Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles (“GAAP”) for interim financial statements and with the instructions to Form 10-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. In the opinion of management, the statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of our financial position and results of operations for the interim periods presented.

These financial statements should be read in conjunction with the audited consolidated financial statements and notes for the fiscal year ended December 31, 2009, included in Websense, Inc.’s (“Websense”, the “Company”, “we”, “us” or “our”) Annual Report on Form 10-K filed with the Securities and Exchange Commission. Operating results for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending December 31, 2010. The balance sheet at December 31, 2009 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. Certain prior period amounts have been reclassified to conform to the current period presentation.

2. Net Income (Loss) Per Share

Basic net income (loss) per share (“EPS”) is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted EPS is computed by dividing the net income for the period by the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares consist of dilutive stock options and restricted stock units. Dilutive stock options and dilutive restricted stock units are calculated based on the average share price for each fiscal period using the treasury stock method. If, however, the Company reports a net loss, the diluted EPS is computed in the same manner as the basic EPS.

During the three months ended March 31, 2010, the difference between the weighted average shares used in determining basic EPS versus diluted EPS related to dilutive securities totaled 897,000. As the Company reported a net loss for the three months ended March 31, 2009, basic and diluted EPS were the same. Potentially dilutive securities totaling approximately 7,330,000 and 10,372,000 shares for the three months ended March 31, 2010 and 2009, respectively, were excluded from the diluted EPS calculation because of their anti-dilutive effect.

The following is a reconciliation of the numerator and denominator used in calculating basic EPS to the numerator and denominator used in calculating diluted EPS for all periods presented:

 

     Net Income
(Loss)
(Numerator)
    Shares
(Denominator)
   Per Share
Amount
 
     (In thousands, except per share amounts)  

For the Three Months Ended:

       

March 31, 2010:

       

Basic EPS

   $ 835      43,213    $ 0.02   

Effect of dilutive securities

     —        897      —     
                     

Diluted EPS

   $ 835      44,110    $ 0.02   
                     

March 31, 2009:

       

Basic EPS

   $ (1,087   44,825    $ (0.02

Effect of dilutive securities

     —        —        —     
                     

Diluted EPS

   $ (1,087   44,825    $ (0.02
                     

 

7


Table of Contents

Websense, Inc.

Notes to Consolidated Financial Statements (Unaudited)—(Continued)

 

3. Comprehensive Income (Loss)

The components of comprehensive income (loss) were as follows (in thousands):

 

     Three Months Ended  
     March 31,
2010
   March 31,
2009
 

Net income (loss)

   $ 835    $ (1,087

Net change in unrealized gain on derivative contracts, net of tax of $(133) and $(257), respectively

     211      305   
               

Comprehensive income (loss)

   $ 1,046    $ (782
               

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

 

     Three Months Ended  
     March 31,
2010
    March 31,
2009
 

Beginning balance

   $ (369   $ (1,559

Net change during the period

     211        305   
                

Ending balance

     (158     (1,254
                

4. Intangible Assets

Intangible assets subject to amortization consisted of the following as of March 31, 2010 (in thousands):

 

     Remaining
Weighted Average  Life
(years)
   Cost    Accumulated
Amortization
    Net

Technology

   2.4    $ 32,598    $ (19,950   $ 12,648

Customer relationships

   5.3      129,200      (81,088     48,112

Trade name

   1.8      510      (332     178
                        

Total

   4.7    $ 162,308    $ (101,370   $ 60,938
                        

As of March 31, 2010, remaining amortization expense is expected to be as follows (in thousands):

 

Years Ending December 31,

  

2010

   $ 19,859

2011

     15,550

2012

     8,329

2013

     5,577

2014

     4,545

Thereafter

     7,078
      

Total

   $ 60,938
      

5. Senior Secured Credit Facility

In October 2007, the Company entered into an amended and restated senior secured credit agreement, which was subsequently amended in December 2007, June 2008 and February 2010 (the “Senior Credit Agreement”). The $225 million senior secured credit facility consists of a five year $210 million senior secured term loan and a $15 million revolving credit facility. The senior secured term loan was fully funded on October 11, 2007, and the revolving line of credit remains unused. At March 31, 2010, the outstanding balance under the senior secured term loan was $75 million as a result of the Company making principal payments totaling $12 million in the three months ended March 31, 2010. The senior secured credit facility is secured by substantially all of the assets of the Company, including pledges of stock of some of its subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by the Company’s domestic subsidiaries. The senior secured term loan bears interest at a spread above LIBOR

 

8


Table of Contents

Websense, Inc.

Notes to Consolidated Financial Statements (Unaudited)—(Continued)

 

with the spread determined based upon the Company’s total leverage ratio, as defined in the Senior Credit Agreement. Based on the total leverage ratio as of December 31, 2009, the spread on the senior secured term loan was LIBOR plus 225 basis points per annum and the fee for the unused portion of the revolving credit facility was 25 basis points per annum during the quarter ended March 31, 2010. The weighted average interest rate on the senior secured term loan at March 31, 2010 was 3.6%. The Senior Credit Agreement contains financial covenants, including a consolidated leverage ratio and a consolidated interest coverage ratio, as well as affirmative and negative covenants. Among the negative covenants are restrictions on the Company’s ability to borrow money, including restrictions on (a) the incurrence of more than $15 million of new debt, including capital leases (subject to certain exceptions), (b) the incurrence of more than $7.5 million in letters of credit, (c) the incurrence of more than $50 to $75 million of new debt, depending on the Company’s leverage ratio, to finance future acquisitions or (d) the assumption of more than $15 million of new debt in connection with one or more acquisitions. Also, the Company is not permitted to pay cash dividends under the terms of the Senior Credit Agreement.

As of March 31, 2010, future remaining minimum principal payments under the senior secured term loan will be as follows (in thousands):

 

Years Ending December 31,

  

2010

   $ 8,333

2011

     13,333

2012

     53,334
      

Total

   $ 75,000
      

6. Fair Value Measurements and Derivatives

Fair Value Measurements on a Recurring Basis

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. The Company’s assessment of the significance of a particular input to the fair value measurements requires judgment, and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis as of March 31, 2010 (in thousands):

 

     Level 1  (1)    Level 2  (2)    Level 3  (3)    Total

Assets:

           

Israeli Shekel contracts designated as cash flow hedges

   —      $ 49    —      $ 49

Liabilities:

           

Interest rate swaps designated as cash flow hedges

   —        321    —        321

Foreign currency forward contracts not designated as fair value hedges

   —        200    —        200

 

(1)  –  

quoted prices in active markets for identical assets or liabilities

(2)  –  

observable inputs other than quoted prices in active markets for identical assets and liabilities

(3)  –  

no observable pricing inputs in the market

Included in Other assets and in Other accrued expenses are derivative contracts, comprised of interest rate swaps and foreign currency forward contracts that are valued using models based on readily observable market parameters for all substantial terms of the Company’s derivative contracts and thus are classified within Level 2.

The Company uses derivative financial instruments to manage foreign currency risk relating to foreign exchange rates, and to manage interest rate risk relating to the Company’s variable rate senior secured term loan. The Company does not use these instruments for speculative or trading purposes. The Company’s objective is to reduce the risk to earnings and cash flows associated with changes in foreign currency exchange rates and changes in interest rates. Derivative instruments are recognized as either assets or liabilities in the accompanying financial statements and are measured at fair value. Gains and losses resulting from changes in the fair values of those derivative instruments are recorded to earnings or other comprehensive income (loss) depending on the use of the derivative instrument and whether it qualifies for hedge accounting.

The Senior Credit Agreement provides that the Company must maintain hedge agreements so that at least 50% of the aggregate principal amount of the senior secured credit facility is subject to fixed interest rate protection for a period of not less than 2.5 years from the initial funding date of October 11, 2007. On the initial funding date, the Company entered into an interest rate swap agreement to pay a fixed rate of interest (4.85% per annum) and receive a floating rate interest payment (based on three month

 

9


Table of Contents

Websense, Inc.

Notes to Consolidated Financial Statements (Unaudited)—(Continued)

 

LIBOR) on an equivalent amount. The notional amount of the swap agreement was $27 million during the quarter ended March 31, 2010 and it amortizes down to $11 million on June 30, 2010. In addition, on October 11, 2007 the Company entered into an interest rate cap agreement to limit the maximum interest rate on a portion of its senior secured term loan to 6.5% per annum. The amount of principal protected by this agreement was $64.9 million during the quarter ended March 31, 2010 and increases up to $74.3 million on June 30, 2010. Both the interest rate swap and cap expire on September 30, 2010.

During the three months ended March 31, 2010 and 2009, 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 (expense) income, net, in the accompanying consolidated statements of operations and amounted to approximately $466,000 and $1,238,000 for the three months ended March 31, 2010 and 2009, respectively. All of the fair value hedging contracts in place as of March 31, 2010 will be settled before September 2010.

During the three months ended March 31, 2010, the Company utilized Israeli Shekel forward contracts to hedge anticipated operating expenses. All such contracts entered into were designated as cash flow hedges and were considered effective. None of the contracts were terminated prior to settlement. Net realized losses of approximately $4,000 and $19,000 related to the contracts designated as cash flow hedges during the three months ended March 31, 2010 and 2009, respectively, are included in the respective operating categories for which the Company hedges its Israeli Shekel expenditures. All of the Israeli Shekel hedging contracts in place as of March 31, 2010 will be settled before January 2011.

Notional and fair values of the Company’s foreign currency hedging positions at March 31, 2010 and 2009 are presented in the table below (in thousands):

 

     March 31, 2010    March 31, 2009
     Notional
Value
Local
Currency
   Notional
Value
USD
   Fair Value
USD
   Notional
Value
Local
Currency
   Notional
Value
USD
   Fair Value
USD

Fair Value Hedges

                 

Euro

   3,500    $ 4,751    $ 4,728    5,500    $ 7,245    $ 7,185

British Pound

   750      1,173      1,138    —        —        —  

Australian Dollar

   2,500      2,230      2,281    1,500      1,023      1,006
                                 

Total

      $ 8,154    $ 8,147       $ 8,268    $ 8,191
                                 

Cash Flow Hedges

                 

Israeli Shekel

   13,600    $ 3,624    $ 3,673    11,400    $ 2,747    $ 2,705

The effects of derivative instruments on the Company’s financial statements were as follows as of March 31, 2010 and 2009 and for the three months then ended (in thousands):

Effects of Derivative Instruments on Income and Other Comprehensive Income (“OCI”) (in thousands):

 

     Fair Value of Derivative Instruments  
     March 31, 2010     March 31, 2009  
     Balance Sheet Location    Fair Value     Balance Sheet Location    Fair Value  

Interest rate cap contract designated as cash flow hedge

   Other assets    $ —        Other assets    $ 1   

Foreign exchange contracts designated as cash flow hedges

   Other assets      49      Other accrued expenses      (42

Interest rate swap contracts designated as cash flow hedges

   Other accrued expenses      (321   Other accrued expenses      (1,999
                      

Total derivatives designated as cash flow hedges

      $ (272      $ (2,040
                      

Foreign currency forward contracts not designated as fair value hedges

   Other accrued expenses    $ (200   Other accrued expenses    $ (77
                      

Total derivatives

      $ (472      $ (2,117
                      

 

10


Table of Contents

Websense, Inc.

Notes to Consolidated Financial Statements (Unaudited)—(Continued)

 

     Amount of Gain (Loss)
Recognized in
Accumulated OCI on
Derivative
(Effective Portion)
   Amount and Location of Gain
(Loss) Reclassified from
Accumulated OCI into Income
(Effective Portion)
   Amount and Location of Gain
(Loss) Recognized in Income on
Derivative (Ineffective Portion and
Amount Excluded from
Effectiveness Testing)

Derivatives in Cash
Flow Hedging Relationships

   Three Months Ended
March 31, 2010
   Three Months Ended
March 31, 2010
   Three Months Ended
March 31, 2010

Interest rate swap contracts

   $ 295    $ (310   Interest expense    $ —      Interest expense

Foreign exchange contracts

     49      (4   Research and development      —      Research and development
                           

Total

   $ 344    $ (314      $ —     
                           

 

     Amount and Location of Gain (Loss)
Recognized in Income on  Derivatives

Derivatives Not Designated as Hedges

   Three Months Ended March 31, 2010

Foreign currency forward contracts

   $ 466    Other (expense) income, net

 

     Amount of Gain (Loss)
Recognized in
Accumulated OCI on
Derivative
(Effective Portion)
    Amount and Location of Gain
(Loss) Reclassified from
Accumulated OCI into Income
(Effective Portion)
   Amount and Location of Gain
(Loss) Recognized in Income on
Derivative (Ineffective Portion and
Amount Excluded from
Effectiveness Testing)

Derivatives in Cash
Flow Hedging Relationships

   Three Months Ended
March 31, 2009
    Three Months Ended
March 31, 2009
   Three Months Ended
March 31, 2009

Interest rate cap contract

   $ 1      $ —        Interest expense    $ —      Interest expense

Interest rate swap contracts

     (1,999     (644   Interest expense      —      Interest expense

Foreign exchange contracts

     (42     (19   Research and development      —      Research and development
                            

Total

   $ (2,040   $ (663      $ —     
                            

 

     Amount and Location of Gain (Loss)
Recognized in Income on Derivatives

Derivatives Not Designated as Hedges

   Three Months Ended March 31, 2009

Foreign currency forward contracts

   $ 152    Other (expense) income, net

Fair Value Measurements on a Nonrecurring Basis

During the quarter ended March 31, 2010, 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 March 31, 2010, the Company’s senior secured term loan, with a carrying value of $75 million, had an estimated fair value of $71.8 million which the Company determined using a discounted cash flow model with a discount rate of 4.8% which represents the Company’s estimated incremental borrowing rate.

 

11


Table of Contents

Websense, Inc.

Notes to Consolidated Financial Statements (Unaudited)—(Continued)

 

7. Stockholders’ Equity

Share-Based Compensation

Employee Stock Plans

The following table summarizes the Company’s restricted stock unit activity since December 31, 2009:

 

     Number of
Shares
 

Balance at December 31, 2009

   1,203,403   

Granted

   648,085   

Released

   (212,423

Cancelled

   (61,629
      

Balance at March 31, 2010

   1,577,436   
      

The following table summarizes the Company’s stock option activity since December 31, 2009:

 

     Number of
Shares
    Weighted
Average
Exercise Price

Balance at December 31, 2009

   9,775,678      $ 21.85

Granted

   200,000        20.65

Exercised

   (457,699     16.54

Cancelled

   (387,702     20.81
        

Balance at March 31, 2010

   9,130,277        22.13
        

The results of operations for the three months ended March 31, 2010 and 2009 include share-based compensation expense in the following expense categories of the consolidated statements of operations (in thousands):

 

     Three Months Ended
     March 31,
2010
   March 31,
2009

Share-based compensation in:

     

Cost of revenues

   $ 332    $ 300
             

Total share-based compensation in cost of revenues

     332      300

Selling and marketing

     1,888      1,920

Research and development

     1,490      1,098

General and administrative

     2,874      2,839
             

Total share-based compensation in operating expenses

     6,252      5,857
             

Total share-based compensation

   $ 6,584    $ 6,157
             

The Company used the following assumptions to estimate the fair value of the stock options granted:

 

     Three Months Ended  
     March 31,
2010
    March 31,
2009
 

Average expected life (years)

   3.4      3.0   

Average expected volatility factor

   42.7   44.9

Average risk-free interest rate

   1.6   1.4

Average expected dividend yield

   —        —     

Treasury Stock

The Company repurchased shares of its common stock during the first three months of 2010 as follows:

 

     Shares    Average Price
Per Share

Share repurchased through December 31, 2009

   11,534,024    $ 19.50

Shares repurchased during the three months ended March 31, 2010

   957,499      20.87
       

Total shares repurchased through March 31, 2010

   12,491,523      19.60
       

 

12


Table of Contents

Websense, Inc.

Notes to Consolidated Financial Statements (Unaudited)—(Continued)

 

The remaining number of shares authorized for repurchase under the Company’s stock repurchase program as of March 31, 2010 was 3,508,477 shares. On February 5, 2010, the Company amended its Senior Credit Agreement to increase its capacity to repurchase shares of the Company’s common stock. Under the terms of the Senior Credit Agreement, the Company is restricted from repurchasing its common stock for an aggregate purchase price that exceeds 50% of the aggregate amount of its consolidated net income, as defined in the Senior Credit Agreement, during the period from the effective date of the facility through the most recent quarter end for which quarterly financial statements have been filed. As of March 31, 2010, $30.0 million remained authorized for repurchase under the Company’s Senior Credit Agreement.

8. Tax Matters

For the three months ended March 31, 2010 the Company recognized an income tax expense of $0.9 million which represented an effective tax rate of approximately 53%. The effective tax rate variance from the statutory rate was primarily related to an increase in the valuation allowance related to net operating losses of one of the Company’s subsidiaries in the United Kingdom, the unfavorable impact on deferred tax amounts resulting from a California law change, foreign withholding taxes and non-deductible share-based payments, which offset the benefit of income taxed at lower rates in foreign jurisdictions and a favorable state tax ruling.

The Company and its subsidiaries file tax returns which are routinely examined by tax authorities in the United States and in various state and foreign jurisdictions. The Company is currently under examination by the respective tax authorities for tax years 2005 to 2007 in the United States, for 2006 to 2007 in the United Kingdom and for 2006 to 2008 in Israel. The Company has various other on-going audits in various stages of completion. In general, the tax years 2005 through 2009 could be subject to examination by U.S. federal and most state tax authorities.

During the first quarter of 2010, the Company was informed by the U.S. Internal Revenue Service (the “IRS”) that they had completed their audit for the tax years ended December 31, 2005 through December 31, 2007. Accordingly, the IRS issued the Company a 30-day letter which outlines all of their proposed audit adjustments and requires the Company to either accept the proposed adjustments, subject to future litigation, or file a formal administrative protest contesting those proposed adjustments within 30 days. The proposed adjustments relate primarily to the cost sharing arrangement between Websense, Inc. and its Irish subsidiary, including the amount of cost sharing buy-in, as well as to the Company’s claim of research and development tax credits and income tax deductions for equity compensation awarded to certain executive officers. The amount of additional tax proposed by the IRS totals approximately $19.0 million, of which $14.8 million relates to the amount of cost sharing buy-in, $2.5 million relates to research and development credits and $1.7 million relates to equity compensation awarded to certain executive officers. The total additional tax proposed excludes interest, penalties and state income taxes, each of which may be significant, and also excludes a potential reduction in tax on the Irish subsidiary. The proposed adjustments also do not include the future impact that changes in the Company’s cost sharing arrangement could have on the Company’s effective tax rate. The Company disagrees with all of the proposed adjustments and is currently in the process of completing a formal protest for timely submission to the IRS. Once the protest is submitted, the Company will seek to resolve these issues with the IRS Appeals Office. The Company intends to continue to defend its position on all of these matters, including through litigation if required. The timing of the ultimate resolution of these matters cannot be reasonably estimated at this time.

9. Litigation

The Company is involved in various legal actions in the normal course of business. Based on current information, including consultation with the Company’s attorneys, the Company believes that it has adequately reserved for any ultimate liability that may result from these actions such that any liability would not materially affect the Company’s consolidated financial position, results of operations or cash flows. The Company’s evaluation of the likely impact of these actions could change in the future and unfavorable outcomes and/or defense costs, depending upon the amount and timing, could have a material adverse effect on the Company’s results of operations or cash flows in a future period.

10. Recently Issued Accounting Standards

In October 2009, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on revenue recognition that will become effective for the Company beginning January 1, 2011, with earlier adoption permitted. Under the new guidance on arrangements that include software elements, tangible products that have software components that are essential to the functionality of the tangible product will no longer be within the scope of the software revenue recognition guidance, and software-enabled products will now be subject to other relevant revenue recognition guidance. Additionally, the FASB issued authoritative guidance on revenue arrangements with multiple deliverables that are outside the scope of the software revenue recognition guidance. Under the new guidance, when vendor specific objective evidence or third party evidence for deliverables in an arrangement cannot be determined, a best estimate of the selling price is required to separate deliverables and allocate arrangement consideration using the relative selling price method. The new guidance includes new disclosure requirements on how the application of the relative selling price method affects the timing and amount of revenue recognition. The Company is currently evaluating both the timing and the impact of the pending adoption of these standards on its consolidated financial statements.

 

13


Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the financial statements and related notes contained elsewhere in this report. See “Risk Factors” under Part II, Item 1A below regarding certain factors known to us that could cause reported financial information not to be necessarily indicative of future results.

Forward-Looking Statements

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

 

   

anticipated trends in revenue;

 

   

plans, strategies and objectives of management for future operations;

 

   

growth opportunities in domestic and international markets;

 

   

new and enhanced reliance on channels of distribution;

 

   

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

 

   

expectations regarding competitive products and pricing;

 

   

changes in domestic and international market conditions;

 

   

risks associated with fluctuations in foreign currency exchange rates;

 

   

the impact of macro-economic conditions on our customers;

 

   

expected trends in operating and other expenses;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

risks related to changes in accounting interpretations or accounting guidance;

 

   

anticipated product enhancements or releases;

 

   

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

 

   

the success of our brand development efforts.

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

Overview

We are a leading provider of information technology (“IT”) security solutions, including Web security, data security, and email security solutions. Our solutions are available as software installed on standard server hardware, as software pre-installed on optimized appliances, and as a software-as-a-service (“SaaS”) offering. Our products and services are sold to enterprises, mid-market, small and medium sized businesses (“SMB”), and Internet service providers through a network of distributors, value added resellers and original equipment manufacturer (“OEM”) arrangements. Our portfolio of real-time Web security, URL filtering, data loss prevention (“DLP”) and email anti-spam and security software allows organizations to:

 

   

dynamically categorize user-generated and other dynamic Web 2.0 content;

 

   

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

 

   

identify and remove malicious applications from incoming Web traffic;

 

   

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

 

14


Table of Contents
   

filter spam out of incoming email traffic;

 

   

filter viruses and other malicious attachments from email and instant messages;

 

   

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

 

   

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

 

   

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

Since we commenced operations in 1994, Websense has evolved from a reseller of computer security products to a leading provider of IT security software solutions, including Web security, URL filtering, DLP, email, anti-spam and messaging security solutions. Our first Web filtering software product was released in 1996 and prevented access to inappropriate Web content. Since then, we have focused on adapting our Web filtering and content classification capabilities to address changing Internet use patterns and the growing incidence of Web-based criminal activity, as well as integrating Web security with data security and email security solutions.

During both the three months ended March 31, 2010 and 2009, we derived 51% of our revenue from international sales, with the United Kingdom comprising approximately 13% and 16% of our total revenue in the three months ended March 31, 2010 and 2009, respectively. We believe international markets continue to represent a significant growth opportunity and we are continuing to expand our international operations, particularly in selected countries in the European, Asia/Pacific and Latin American markets.

We utilize a two-tier distribution strategy in North America to sell our products, with an objective of increasing the number of value-added resellers selling our products and further extending our reach into the SMB market segment. Our distribution strategy outside North America also relies on a multi-tiered system of distributors and value-added resellers. Sales through indirect channels currently account for more than 90% of our revenue. We also have several arrangements with OEMs that grant the OEM customers the right to incorporate our products into the OEM’s products for resale to end-users.

We sell subscriptions to our products, generally in 12, 24 or 36 month contract durations, which are for a fixed number of seats or devices. As described elsewhere in this report, we recognize revenue from subscriptions to our products, including our appliances and our add-on modules, on a daily straight-line basis commencing on the day the term of the subscription begins, over the term of the subscription agreement. We recognize revenue 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 contract and are fully expensed in the period the product and/or key is delivered. Our operating expenses in the first quarter of 2010 increased slightly compared to the first quarter of 2009, primarily due to our increased headcount and the unfavorable movement of currency exchange rates partially offset by a reduction in the amortization of acquired intangible assets. Our operating expenses also increased compared to the first quarter of 2009 due to the expansion of our selling and marketing efforts, product research and development, and investments in administrative infrastructure to support subscription sales that will result in revenue recognition in subsequent periods. Given our deferred revenue as of March 31, 2010, our subscriptions up for renewal in 2010 for which we will recognize a portion of the total billing as revenue during 2010 and our forecasted operating expenses, we currently expect to report income from operations for our fiscal year 2010.

Critical Accounting Policies and Estimates

Critical accounting policies are those that may have a material impact on our financial statements and also require management to exercise significant judgment due to a high degree of uncertainty at the time the estimate is made. Our senior management has discussed the development and selection of our accounting policies, related accounting estimates and disclosures with the Audit Committee of our Board of Directors. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition. When a purchase decision is made for our products, including our appliance products, customers enter into a subscription agreement, which is generally 12, 24 or 36 months in duration and is for a fixed number of seats or devices. Other services such as upgrades/enhancements and standard post-contract technical support services are sold together with our product subscription and provided throughout the subscription term. We recognize revenue, including our appliance product revenue, 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 access codes to users, and in the case of our appliance product we ship the product with our software pre-installed on the product, and then promptly invoice customers for the full amount of their order. Payment is due for the full term of the subscription, generally within 30 to 60 days of the invoice. We record amounts billed to customers in excess of recognizable revenue as deferred revenue on our balance sheet. When we enter into a subscription agreement that is denominated and paid in a currency other than U.S.

 

15


Table of Contents

dollars, we record the subscription billing and deferred revenue in U.S. dollars based upon the currency exchange rate in effect on the last day of the previous month before the subscription agreement is effective. Changes in currency rates relative to the U.S. dollar may have a significant impact on the revenue that we will recognize under contracts that are denominated in currencies other than U.S. dollars.

For our OEM contracts, we grant our OEM customers the right to incorporate our products into their products for resale to end users. The OEM customer generally pays us a royalty fee for each resale of our product to an end user over a specified period of time. We recognize revenue associated with the OEM contracts ratably over the contractual period for which we are obligated to provide our services. The timing of the OEM revenue recognition will vary for each OEM depending on the information available, such as underlying end user subscription periods, to determine the contractual obligation period.

We record distributor marketing payments and channel rebates as an offset to revenue. We recognize distributor marketing payments as an offset to revenue as the marketing service is provided. We recognize channel rebates as an offset to revenue on a straight-line basis over the term of the subscription agreement.

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

 

   

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

 

   

identifying the intangible assets acquired;

 

   

reviewing the acquisition agreements and other relevant documents made available;

 

   

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

 

   

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

 

   

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

 

   

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

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

We review goodwill that has an indefinite useful life for impairment at least annually in our fourth fiscal quarter, or more frequently if an event occurs indicating the potential for impairment. We amortize the cost of identified intangible assets using amortization methods that reflect the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up. We review intangible assets that have finite useful lives when an event occurs indicating the potential for impairment. We review for impairment by facts or circumstances, either external or internal, indicating that we may not recover the carrying value of the asset. We measure impairment losses related to long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values. We measure fair value generally based on the estimated future cash flows. 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.

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

At March 31, 2010, there was $52.1 million of total unrecognized compensation cost related to share-based compensation arrangements granted under all equity compensation plans (excluding tax effects). That total unrecognized compensation cost will be

 

16


Table of Contents

adjusted for estimated forfeitures as well as for future changes in estimated forfeitures. We expect to recognize that cost over a weighted average period of approximately 2.3 years.

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

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

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

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

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

During the 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 outlines all of their proposed audit adjustments and requires 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 are currently in the process of completing a formal protest for timely submission to the IRS. Once the protest is submitted, we will seek to resolve these issues with the IRS Appeals Office. We intend to continue to defend our position on all of these matters, including through litigation if required. The timing of the ultimate resolution of these matters cannot be reasonably estimated at this time.

 

17


Table of Contents

Allowance for Doubtful Accounts and Other Loss Contingencies. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability or unwillingness of our customers to pay their invoices. We establish this allowance using estimates that we make based on factors such as the composition of the accounts receivable aging, historical bad debts, changes in payment patterns, changes to customer creditworthiness, current economic trends and other facts and circumstances of our existing customers. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires significant judgment by management based on the facts and circumstances of each matter.

Results of Operations

Three months ended March 31, 2010 compared with the three months ended March 31, 2009

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

 

     Three Months Ended  
     March 31,
2010
    March 31,
2009
 
     (Unaudited)  

Revenues

   100   100

Cost of revenues:

    

Cost of revenues

   12      11   

Amortization of acquired technology

   3      4   
            

Total cost of revenues

   15      15   

Gross margin

   85      85   

Operating expenses:

    

Selling and marketing

   51      52   

Research and development

   18      17   

General and administrative

   11      14   
            

Total operating expenses

   80      83   
            

Income from operations

   5      2   

Interest expense

   (2   (2

Other (expense) income, net

   (1   —     
            

Income (loss) before income taxes

   2      —     

Provision for income taxes

   1      1   
            

Net income (loss)

   1   (1 )% 
            

Revenue

Revenue increased to $79.8 million in the first quarter of 2010 from $77.6 million in the first quarter of 2009. The increase was primarily a result of incremental sales to new customers and upgrades to existing customer subscriptions (including SaaS security offerings, DLP products, Websense® V10000™ appliances and OEM contract revenue) from the first quarter of 2009 to the first quarter of 2010. Revenue from products sold in the United States accounted for $39.4 million or 49% of first quarter 2010 revenue compared to $37.9 million or 49% in the first quarter of 2009. Revenue from products sold internationally accounted for $40.4 million or 51% of first quarter 2010 revenue compared to $39.7 million or 51% in the first quarter of 2009. We had current deferred revenue of $237.3 million as of March 31, 2010, compared to $217.3 million as of March 31, 2009. For the remainder of 2010, we expect our revenue to increase over 2009 revenue levels due to the amount of current deferred revenue that will be recognized as revenue during 2010, subscriptions that are scheduled for renewal that are expected to be renewed and upgraded and expected new business for which some revenue will be recognized during 2010. Our revenue in 2010 may be impacted by the duration of contracts for renewal and new subscriptions, the timing of sales of renewal and new subscriptions, the average annual contract value and per seat price, and the effect of currency exchange rates on new and renewal subscriptions in international markets.

Cost of Revenues

Cost of revenues. Cost of revenues consists of the costs of content review, amortization of deferred costs associated with the sale of our appliance products, technical support and infrastructure costs associated with maintaining our databases and costs associated with providing our hosted security services. Cost of revenues increased to $9.9 million in the first quarter of 2010 from $8.6 million in the first quarter of 2009. The $1.3 million increase was primarily due to increased cost of sales related to our Websense V10000 appliance of $1.0 million and increased personnel costs of $0.3 million. Our full-time employee headcount in cost of revenue departments increased from an average of 241 employees during the first quarter of 2009 to an average of 276 employees during the

 

18


Table of Contents

first quarter of 2010. We allocate the costs for human resources, employee benefits, payroll taxes, information technology, facilities and fixed asset depreciation to each of our functional areas based on headcount data. As a percentage of revenue, cost of revenues increased to 12% from 11% during the first quarter of 2010 compared to 2009. We expect cost of revenues will increase in absolute dollars primarily due to increased sales of our appliance products in 2010 but as a percentage of revenue will remain relatively flat as compared to 2009. We expect cost of revenues to increase on a year over year basis because of the increased cost of sales related to our Websense V10000 appliances, the increased headcount to support the growth and maintenance of our databases and costs associated with providing our SaaS security services as well as the technical support needs of our customers.

Amortization of acquired technology. Amortization of acquired technology was $2.2 million in the first quarter of 2010 compared to $3.3 million in the first quarter of 2009. The decrease of $1.1 million in amortization of acquired technology from the first quarter of 2009 to the first quarter of 2010 was primarily due to certain acquired technology being fully amortized in 2009. As of March 31, 2010, the acquired technology is being amortized over a remaining weighted average period of 2.4 years. We expect to incur $6.7 million in amortization expense of acquired technology during the remainder of 2010 and that 2010 levels will be lower than 2009 by approximately $3.9 million.

Gross Margin

Gross margin increased to $67.6 million in the first quarter of 2010 from $65.7 million in the first quarter of 2009 primarily as a result of increased revenue. As a percentage of revenue, gross margin was 85% in the first quarters of both 2009 and 2010. We expect that gross margin as a percentage of revenue will remain in excess of 80% for the remainder of 2010.

Operating Expenses

Selling and marketing. Selling and marketing expenses consist primarily of salaries, commissions and benefits related to personnel engaged in selling, marketing and customer support functions, including costs related to public relations, advertising, promotions and travel, amortization of acquired customer relationships as well as allocated costs. Selling and marketing expenses do not include payments to channel partners for marketing services and rebates as those are recorded as an offset to revenue. Selling and marketing expenses were $40.7 million, or 51% of revenue, in the first quarter of 2010, compared to $39.9 million, or 52% of revenue, in the first quarter of 2009. The $0.8 million increase in total selling and marketing expenses was primarily due to our increased personnel costs (including the unfavorable movements in the U.S. currency rates relative to the foreign currencies in which certain of our international expenses were incurred), offset by a reduction in the amortization of acquired intangibles (customer relationships) of approximately $2.2 million. As of March 31, 2010, the acquired customer relationships intangible assets are being amortized over a remaining weighted average period of approximately 5.3 years. Our headcount in sales and marketing increased from an average of 580 employees during the first quarter of 2009 to an average of 593 employees for the first quarter of 2010 and headcount is expected to remain relatively flat for the remainder of 2010. Our personnel costs were higher by $2.7 million due to the higher average headcount and the unfavorable movement in the currency exchange rates as approximately one-half of our sales and marketing personnel are based in international locations. We expect overall selling and marketing expenses to decrease in absolute dollars and as a percentage of revenue for the remainder of 2010 as compared to 2009 primarily due to a reduction of amortization of acquired intangibles from the SurfControl acquisition due to the accelerated nature of the amortization partially offset by having additional sales and marketing personnel to support our expanding selling and marketing efforts worldwide and increased sales resulting in higher overall sales commission expenses. If our sales exceed expectations, our sales commission expenses would also exceed our expectations and result in higher than expected selling and marketing expenses in 2010 while revenue from the higher sales would be recognized in future periods. We also expect that selling and marketing expenses as a percentage of revenue will decrease in 2010 compared to 2009 due to the expected increase in revenue and expected decrease in selling and marketing expenses. Based on the existing sales and marketing related intangible assets as of March 31, 2010, we expect amortization of acquired intangibles of $13.1 million for the remainder of 2010, which would be a reduction of approximately $6.6 million from 2009.

Research and development. Research and development expenses consist primarily of salaries and benefits for software developers and allocated costs. Research and development expenses increased to $14.1 million, or 18% of revenue, in the first quarter of 2010 from $12.8 million, or 17% of revenue, in the first quarter of 2009. The increase of $1.3 million in research and development expenses was primarily due to increased personnel costs of $1.5 million offset by reduced allocated costs of $0.2 million. Our headcount increased in research and development from an average of 385 employees for the first quarter of 2009 to an average of 439 employees for the first quarter of 2010. We expect headcount to remain relatively flat for the remainder of 2010. We expect research and development expenses to increase in absolute dollars for the remainder of 2010 as compared to 2009 due to an expanded base of product offerings and increased headcount compared to 2009 to support our continued enhancements and new products. We are managing the increase in our absolute research and development expenses by operating research and development facilities in multiple international locations, including a facility in Beijing, China, that have lower costs than our operations in the United States. We also have research and development facilities in Ra’anana, Israel, 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 2010, we expect that research and development expenses as a percentage of revenue will remain relatively flat in 2010 compared to 2009 due to the expected increase in revenue.

 

19


Table of Contents

General and administrative. General and administrative expenses consist primarily of salaries, benefits and related expenses for our executive, finance and administrative personnel, third party professional service fees and allocated costs. General and administrative expenses decreased to $9.1 million, or 11% of revenue, in the first quarter of 2010 from $11.2 million, or 14% of revenue, in the first quarter of 2009. The $2.1 million decrease in general and administrative expenses was primarily due to a reduction in third party professional service fees of $1.8 million primarily related to SurfControl integration matters and reduced allocated costs of $0.4 million. Our headcount increased in general and administrative departments from an average of 121 employees during the first quarter of 2009 to an average of 132 employees for the first quarter of 2010. We expect general and administrative expenses to increase in absolute dollars due to the higher headcount but remain relatively flat as a percentage of revenue for the remainder of 2010 as compared to 2009 due to the expected increase in revenue.

Interest Expense

Interest expense decreased to $1.1 million in the first quarter of 2010 from $2.2 million in the first quarter of 2009. The decrease was primarily due to a lower average outstanding loan balance on our senior secured term loan of $81 million during the first quarter of 2010 compared to an average loan balance of $118 million during the first quarter of 2009. In addition, the marginal interest rates were lower in the first quarter of 2010 compared to 2009. Included in the interest expense for the first quarter of 2010 and 2009 is $0.3 million and $0.4 million, respectively, of amortization of deferred financing fees that were capitalized as part of the senior secured credit facility. We made principal payments on the senior secured term loan totaling $12 million and $15 million during the first quarter of 2010 and 2009, respectively. As a result of reductions in the LIBOR interest rate and reductions in the notional amount of principal subject to the fixed rate swap agreement, our weighted average interest rate decreased from 5.7% at March 31, 2009 to 3.6% at March 31, 2010. Interest expense should decline in the remaining quarters of 2010 as compared to 2009 due to the lower outstanding principal amount, the expected lower marginal interest rate from the reduction in the notional amount of principal subject to the fixed rate swap agreement and the expiration of the swap agreement on September 30, 2010.

Other (Expense) Income, Net

Other (expense) income, net went from a net other income of $0.4 million in the first quarter of 2009 to a net other expense of $0.7 million in the first quarter of 2010. The change was due primarily to foreign exchange related losses of $0.8 million in the first quarter of 2010 compared to gains of $0.3 million in the first quarter of 2009 due to unfavorable movements in the foreign exchange rates during the first quarter of 2010, and slightly reduced interest income as a result of lower interest rates realized on our balances of cash and cash equivalents. Due to a lower interest rate environment, we expect our net other income for the remainder of 2010 will be less than 2009 levels.

Provision for Income Taxes

For the three months ended March 31, 2010 we recognized an income tax expense of $0.9 million compared to an income tax expense of $1.1 million for the three months ended March 31, 2009. The effective tax rates reflect a tax expense of approximately 53% for the three months ended March 31, 2010 and a tax expense of 5,600% for the three months ended March 31, 2009. For the first quarter of 2010, the effective tax rate variance from the statutory rate was primarily related to an increase in the valuation allowance related to net operating losses of one of the Company’s subsidiaries in the United Kingdom, the unfavorable impact on deferred tax amounts resulting from a California law change, foreign withholding taxes and non-deductible share-based payments, which offset the benefit of income taxed at lower rates in foreign jurisdictions and a favorable state tax ruling. For the first quarter of 2009, the effective tax rate variance from the statutory rate was primarily attributed to non-deductible items, including share-based payments, an increase in the valuation allowance related to net operating losses of one of our subsidiaries in the United Kingdom and foreign withholding taxes, which offset the benefit of income taxed at lower rates in foreign jurisdictions and the favorable impact on deferred tax amounts resulting from a California law change.

Our effective tax rate may change in future periods due to differences in the composition of taxable income between domestic and international operations along with the potential changes or interpretations in tax rules and legislation, or corresponding accounting rules.

We assess, on a quarterly basis, the ultimate realization of our deferred income tax assets. Realization of deferred income tax assets is dependent upon taxable income in prior carryback years, estimates of future taxable income, tax planning strategies and reversals of existing taxable temporary differences. Based on our assessment of these items during the first quarter of 2010, we believe that it is more likely than not that we will fully realize the balance of the deferred tax assets currently reflected on our consolidated balance sheet.

Liquidity and Capital Resources

As of March 31, 2010, we had cash and cash equivalents of $88.3 million and retained earnings of $29.3 million. During the first three months of 2010, we used our cash and cash equivalents primarily to pay down $12 million on our senior secured term loan as principal payments and for stock repurchases of approximately $20.2 million.

 

20


Table of Contents

Net cash provided by operating activities was $33.6 million in the first three months of 2010 compared with $36.2 million in the first three months of 2009. Although our cash collections increased by approximately $2.9 million in the first quarter of 2010 compared to the first quarter of 2009, our overall net cash provided by operating activities decreased primarily as a result of increased cash expenses of approximately $1.2 million and a reduction in accrued liabilities in the first quarter of 2010 compared to 2009. Our operating cash flow is significantly influenced by 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.

Net cash used in investing activities was $2.8 million in the first three months of 2010 compared with $2.5 million in the first three months of 2009. The $0.3 million increase in net cash used in investing activities was due to the $1.2 million change in restricted cash and cash equivalents offset by a $0.9 million reduction in the purchases of property and equipment.

Net cash used in financing activities was $24.7 million in the first three months of 2010 compared with $22.6 million in the first three months of 2009. The $2.1 million increase in net cash used in financing activities was primarily due to an increase in stock repurchases of $13.1 million in the first three months of 2010 compared to the first three months of 2009, offset by increased proceeds from exercises of stock options of $7.5 million and a reduction in principal payments on our senior secured term loan of $3.0 million.

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 outlines all of their proposed audit adjustments and requires 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 are currently in the process of completing a formal protest for timely submission to the IRS. Once the protest is submitted, we will seek to resolve these issues with the IRS Appeals Office. We intend to continue to defend our position on all of these matters, including through litigation if required. The timing of the ultimate resolution of these matters cannot be reasonably estimated at this time.

In October 2007, we entered into the Senior Credit Agreement. The $225 million senior secured credit facility consists of a five year $210 million senior secured term loan and a $15 million revolving credit facility. The senior secured term loan was fully funded on October 11, 2007, and the revolving line of credit remains unused. At March 31, 2010, the outstanding balance under our senior secured term loan was $75 million as a result of making principal payments totaling $12 million during the first quarter of 2010. The senior secured credit facility is secured by substantially all of our assets, including pledges of stock of some of our subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by our domestic subsidiaries. The senior secured term loan bears interest at a spread above LIBOR with the spread determined based upon our total leverage ratio, as defined in the Senior Credit Agreement. Based on the total leverage ratio as of December 31, 2009, the spread on the senior secured term loan was LIBOR plus 225 basis points per annum and the fee for the unused portion of the revolving credit facility was 25 basis points per annum during the quarter ended March 31, 2010. The weighted average interest rate on the senior secured term loan at March 31, 2010 was 3.6%.

The Senior Credit agreement contains financial covenants, including a consolidated leverage ratio and a consolidated interest coverage ratio, as well as affirmative and negative covenants. Among the negative covenants are restrictions on our ability to borrow money, including restrictions on (a) the incurrence of more than $15 million of new debt, including capital leases (subject to certain exceptions), (b) the incurrence of more than $7.5 million in letters of credit, (c) the incurrence of more than $50 to $75 million of new debt, depending on our leverage ratio, to finance future acquisitions or (d) the assumption of more than $15 million of new debt in connection with one or more acquisitions.

The Senior Credit Agreement provides that we must maintain hedge agreements so that at least 50% of the aggregate principal amount of the senior secured credit facility is subject to fixed interest rate protection for a period of not less than 2.5 years from the initial funding date of October 11, 2007. On the initial funding date, we entered into an interest rate swap agreement to pay a fixed rate of interest (4.85% per annum) and receive a floating rate interest payment (based on three month LIBOR) on an equivalent amount. The notional amount of the swap agreement was $27 million during the quarter ended March 31, 2010 and it amortizes each quarter down to $11 million on June 30, 2010. In addition, on October 11, 2007 we entered into an interest rate cap agreement to limit the maximum interest rate on a portion of our senior secured term loan to 6.5% per annum. The amount of principal protected by this agreement was $64.9 million during the quarter ended March 31, 2010 and increases up to $74.3 million on June 30, 2010. Both the interest rate swap and cap expire on September 30, 2010.

 

21


Table of Contents

Obligations and commitments. The following table summarizes our contractual payment obligations and commitments as of March 31, 2010 (in thousands):

 

     Payment Obligations by Year
     2010    2011    2012    2013    2014    Thereafter    Total

Senior Credit Agreement:

                    

Scheduled principal payments

   $ 8,333    $ 13,333    $ 53,334    $ —      $ —      $ —      $ 75,000

Estimated interest and fees

     1,786      1,680      944      —        —        —        4,410

Operating leases

     5,316      5,395      4,634      4,726      1,047      447      21,565

Other commitments

     202      192      69      10      —        —        473
                                                

Total

   $ 15,637    $ 20,600    $ 58,981    $ 4,736    $ 1,047    $ 447    $ 101,448
                                                

Obligations under our Senior Credit Agreement represent the future minimum principal debt payments due under the senior secured term loan. Estimated interest and fees represent interest and fees expected to be incurred under the Senior Credit Agreement based on known rates and scheduled principal payments as of March 31, 2010 (see Note 5 to the financial statements).

We lease our facilities under operating lease agreements that expire at various dates through 2015. Over 40% 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 2010 to 2013. The rent expense related to our worldwide office space leases are generally recorded monthly on a straight-line basis in accordance with GAAP.

Other commitments represent minimum contractual commitments for automobile leases.

In addition, due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at March 31, 2010, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities. Therefore, $14.2 million of gross unrecognized tax benefits have been excluded from the contractual payment obligations table above.

In 2003, we announced that our Board of Directors authorized a stock repurchase program of up to 4 million shares of our common stock. In 2005, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 8 million shares. In 2006, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 12 million shares. On January 31, 2010, our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 16 million shares. Repurchases may be made from time to time on the open market at prevailing market prices or in privately negotiated transactions. In January 2008, we adopted a 10b5-1 plan that provides for quarterly purchases of our common stock in open market transactions. Depending on market conditions and other factors, purchases by our agent under this program may be commenced or suspended at any time, or from time to time, without prior notice to us. On February 5, 2010, we amended our Senior Credit Agreement to increase our capacity to repurchase shares of our common stock. During the three months ended March 31, 2010, we repurchased 957,499 shares of our common stock for an aggregate of approximately $20.0 million at an average price of $20.87 per share. As of March 31, 2010, we have repurchased a total of 12,491,523 shares of our common stock under this program, for an aggregate of $244.9 million at an average price of $19.60 per share. Under the terms of the Senior Credit Agreement, we are restricted from repurchasing our common stock for an aggregate purchase price that exceeds 50% of the aggregate amount of our consolidated net income, as defined in our Senior Credit Agreement, during the period from the effective date of the facility through the most recent quarter end for which we have filed quarterly financial statements. As of March 31, 2010, we can repurchase up to $30.0 million of our common stock under our Senior Credit Agreement. We intend to repurchase shares during the remainder of 2010.

We believe that our cash and cash equivalents balances, accounts receivable, revolving credit balances and our ongoing cash flow from operations will be sufficient to satisfy our cash requirements, including our capital expenditures, debt repayment obligations and stock repurchases, if any, for at least the next 12 months. During the first three months of 2010, we made principal payments on our senior secured term loan of $12 million and repurchased approximately $20 million of our common stock. Our cash requirements may increase for reasons we do not currently foresee or we may make acquisitions as part of our growth strategy that increase our cash requirements. We may elect to raise funds for these purposes or to reduce our cost of capital through capital markets transactions or debt or private equity transactions as appropriate. We intend to continue to invest our cash in excess of current operating and capital requirements in interest-bearing, investment-grade money market funds.

Off-Balance Sheet Arrangements

As of March 31, 2010, we did not have any off-balance sheet arrangements.

 

22


Table of Contents
Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

We are exposed to changes in interest rates primarily from our money market funds and from our borrowings under our variable rate senior secured term loan. Our Senior Credit Agreement provides that we must maintain hedge agreements so that at least 50% of the aggregate principal amount of the senior secured term loan is subject to fixed interest rate protection for a period of not less than 2.5 years from the date of the initial funding of the loan.

A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would materially affect our interest expense. Based on our outstanding senior secured term loan balance at March 31, 2010 and taking into consideration our interest rate swap and cap, our interest expense would increase on a pre-tax basis by approximately $509,000 during the next 12 months if there were a 100 basis point adverse move in the interest rate yield curve.

A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive investments at March 31, 2010. Changes in interest rates over time will, however, affect our interest income.

We utilize foreign currency forward contracts to hedge foreign currency market exposures of underlying assets, liabilities and expenses. We bill certain international customers in Euros, British Pounds, Australian Dollars, Chinese Renminbi and Japanese Yen. We also keep working funds necessary to facilitate the short-term operations of our subsidiaries in the local currencies in which they do business. Our objective is to reduce the risk to earnings and cash flows associated with changes in currency exchange rates. We do not use foreign currency contracts for speculative or trading purposes.

Notional and fair values of our hedging positions at March 31, 2010 and 2009 are presented in the table below (in thousands):

 

     March 31, 2010    March 31, 2009
     Notional
Value
Local
Currency
   Notional
Value
USD
   Fair Value
USD
   Notional
Value
Local
Currency
   Notional
Value
USD
   Fair Value
USD

Fair Value Hedges

                 

Euro

   3,500    $ 4,751    $ 4,728    5,500    $ 7,245    $ 7,185

British Pound

   750      1,173      1,138    —        —        —  

Australian Dollar

   2,500      2,230      2,281    1,500      1,023      1,006
                                 

Total

      $ 8,154    $ 8,147       $ 8,268    $ 8,191
                                 

Cash Flow Hedges

                 

Israeli Shekel

   13,600    $ 3,624    $ 3,673    11,400    $ 2,747    $ 2,705

The $2.5 million notional decrease in our Euro hedged position at March 31, 2010 compared to March 31, 2009 was primarily a result of an increase in natural hedges and the occurrence of more timing differences in when assets were acquired or liabilities incurred. All of the Euro hedging contracts in place as of March 31, 2010 will be settled before September 2010. For the three months ended March 31, 2010, 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 2010.

The $1.2 million notional increase in our British Pound hedge position at March 31, 2010 compared to March 31, 2009 was primarily due to the timing differences in when assets were acquired and/or liabilities incurred. All of the British Pound hedging contracts in place as of March 31, 2010 will be settled before June 2010. For the three months ended March 31, 2010, less than 15% of our total billings were denominated in the British Pound. We expect British Pound billings to represent less than 15% of our total billings during 2010.

The $1.2 million notional increase in our Australian Dollar hedge position at March 31, 2010 compared to March 31, 2009 was primarily due to the timing differences in when assets were acquired and/or liabilities incurred. All of the Australian Dollar hedging contracts in place as of March 31, 2010 will be settled before July 2010. We expect Australian Dollar billings to represent less than 5% of our total billings during 2010.

 

23


Table of Contents

The $0.9 million notional increase in our Israeli Shekel hedge position at March 31, 2010 compared to March 31, 2009 was primarily due to an increased effort to further reduce currency volatility associated with our Israeli Shekel denominated expenditures. All of the Israeli Shekel hedging contracts in place as of March 31, 2010 will be settled before January 2011.

A significant portion of our foreign subsidiaries’ operating expenses are incurred in foreign currencies so if the U.S. dollar weakens, our consolidated operating expenses would increase. Should the U.S. dollar strengthen, our products may become more expensive for our international customers with subscription contracts denominated in U.S. dollars, especially if the trend continues of international sales growing as a percentage of our total sales. Changes in currency rates also impact our future revenue under subscription contracts that are not denominated in U.S. dollars. Our revenue 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.

 

Item 4. Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) 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 and (b) accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Our Chief Executive Officer and Chief Financial Officer evaluated our disclosure controls and procedures as of the end of the period covered by this report. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures are effective as of the end of the period covered by this Quarterly Report.

Changes In Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting or in other factors 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.

Part II - Other Information

 

Item 1. Legal Proceedings

We are involved in various legal actions in the normal course of business. Based on current information, including consultation with our lawyers, we believe we have adequately reserved for any ultimate liability that may result from these actions such that any liability would not materially affect our consolidated financial position, results of operations or cash flows. Our evaluation of the likely impact of these actions could change in the future and unfavorable outcomes and/or defense costs, depending upon the amount and timing, could have a material adverse effect on our results of operations or cash flows in a future period.

 

Item 1A. Risk Factors

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

We have marked with an asterisk (*) those risk factors that reflect material changes from the risk factors included in our Annual Report for the fiscal year ending December 31, 2009 on Form 10-K filed with the Securities and Exchange Commission on February 25, 2010.

Recent volatility in the global economy may adversely impact our business, results of operations, financial condition or liquidity.

The global economy has been experiencing a period of unprecedented volatility characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from governments and regulatory agencies worldwide. We believe that financial distress and associated headcount reductions implemented by certain of our end user customers have caused these customers to choose shorter contract durations and/or reduce the number of seats under subscription and in some cases, have caused customers not to renew contracts at all. While the number of distressed customers appears to have stabilized, we

 

24


Table of Contents

expect this trend to continue until there is a broad worldwide economic recovery and positive job growth. These trends may negatively impact the duration and scope of contract renewals and, in some cases, may result in customer losses. 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 financing or refinancing, if needed, on satisfactory terms or at all.

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

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

Subscriptions for our Web security, data security and email security products typically have durations of 12, 24 or 36 months. Our revenue depends upon maintaining a high rate of sales of renewal subscriptions and adding additional product offerings to existing customers as well as new customer sales. Our customers have no obligation to renew their subscriptions upon expiration, and if they renew, they may elect to renew for a shorter duration than the previous subscription period. As a result of macroeconomic conditions, our customers may elect to renew subscriptions for shorter durations and may reduce their subscribed products due to contractions of work forces of their respective organizations. This may require increasingly costly sales efforts targeting senior management and other management personnel associated with our customers’ Internet and security infrastructure. We may not be able to maintain or continue to generate increasing revenue from existing customers.

Failure of our security products, including our security gateway products, DLP products, SaaS security solutions and our V-series appliance platform, to achieve more widespread market acceptance will seriously harm our business.

Our ability to generate revenue growth depends on our ability to diversify our offerings by successfully developing, introducing and gaining customer acceptance of our new products and services, particularly our security gateway offerings. We now sell our next generation Web content gateway to address emerging Web 2.0 threats, Websense Web Security Gateway, as well as our V10000 appliance pre-loaded with our software. We also sell the Websense Data Security Suite, our DLP offering for the data security market, Websense Hosted Web Security and Websense Hosted Email Security, our SaaS offerings, and Websense Email Security, our email filtering solution. In February 2010, we introduced our Triton unified Web, data and email security solution, which combines our products into a single platform, and during 2010 we will also release our V5000TM appliance. 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 we fail to continue to upgrade and diversify our products, we could lose revenue from renewal subscriptions for our Web filtering products as these products become more of a commodity.

Our V-series appliance platform exposes us to risks inherent with the sale of hardware, to which we were not previously exposed as a software company.

With the launch of our V10000 appliance in 2009 and the scheduled release of our V5000 appliance in 2010, we are now selling a product that is hardware-based and not solely software-based. Our V-series appliances are manufactured by a third-party contract manufacturer, and a third-party logistics company is providing 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 contract manufacturer or logistics provider experiences delays, disruptions or quality control problems in manufacturing, configuring or shipping the appliance. If our third-party providers fail for any reason to manufacture and deliver the V-series appliances with acceptable quality, in the required volumes, and in a cost-effective and timely manner, it could be costly to us, as well as disruptive to product shipments. In addition, supply disruptions or cost increases could increase our cost of goods sold and negatively impact our financial performance. Our V-series appliance platform may also face greater obsolescence risks than our pure software products.

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

Our revenue has been derived almost entirely from sales through indirect channels, including value-added resellers, distributors that sell our products to end-users, providers of managed Internet services and other resellers. 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 32% of our revenue during

 

25


Table of Contents

the quarter ended March 31, 2010. Should Ingram Micro experience financial difficulties, difficulties in collecting their accounts receivable or otherwise delay or prevent our collection of accounts receivable from them, our revenue 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 revenue and cash flow could be adversely affected. Our indirect sales model involves a number of additional risks, including:

 

   

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

 

   

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

 

   

we cannot assure that our channel partners will market and sell our newer product offerings such as our security-oriented offerings, our Web Security Gateway, our V-series appliances, our DLP offerings or our SaaS security products;

 

   

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

 

   

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

Our ability to meaningfully increase the amount of our products sold through our sales channels also depends on our ability to adequately and efficiently support these channel partners with, among other things, appropriate financial incentives to encourage pre-sales investment and sales tools, such as sales training, technical training and product materials needed to support their customers and prospects. 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-tier distribution strategy. Any failure to properly and efficiently support our sales channels will result in lost sales opportunities.

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

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

In our annual and quarterly reports (as amended) for the periods from December 31, 2008 through September 30, 2009, we reported material weaknesses in our internal control over financial reporting which related to our revenue recognition under OEM contracts and our computation of our income tax benefit for the year ended December 31, 2008. We have taken a number of actions to remediate these material weaknesses, which included reviewing and designing enhancements to certain of our controls and processes relating to revenue recognition and the computation of the income tax provision as well as conducting additional training in these areas. Based upon these remediation actions, management concluded that the material weaknesses described above were remediated as of December 31, 2009.

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

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

The market for our products is intensely competitive and is likely to become even more so in the future. Our current principal Web filtering competitors frequently offer their products at a significantly lower price than our products, which has resulted in pricing pressures on sales of our products and potentially could result in the commoditization of products in our space. We also face current and potential competition from vendors of Internet servers, operating systems and networking hardware, many of which now, or may in the future, develop and/or bundle Web filtering or other competitive products with their current products with no price increase to these current products. Increased competition may cause price reductions or a loss of market share, either of which could have a material adverse effect on our business, results of operations and financial condition. If we are unable to maintain the current pricing on sales of our products or increase our pricing in the future, our results of operations could be negatively impacted. Even if our products provide greater functionality and are more effective than certain other competitive products, potential customers might accept this limited functionality. In addition, our own indirect sales channels may decide to develop or sell competing products instead of our

 

26


Table of Contents

products. Pricing pressures and increased competition generally could result in reduced sales, reduced margins or the failure of our products to achieve or maintain widespread market acceptance, any of which could have a material adverse effect on our business, results of operations and financial condition.

Our current principal competitors include:

 

   

companies offering Web filtering and Web security solutions, such as Microsoft, Symantec/Message Labs, McAfee, Cisco Systems, Juniper Networks, Trend Micro, Google, BrightCloud, Cisco Systems/ScanSafe, Blue Coat Systems, Aladdin, FaceTime, St. Bernard Software, M86 Security/Finjan, Clearswift, Sophos, Barracuda Networks, Digital Arts, RuleSpace, Commtouch and Computer Associates;

 

   

companies integrating Web filtering into specialized security appliances, such as Blue Coat Systems, Cisco Systems, McAfee, WatchGuard, Check Point Software, St. Bernard Software, Barracuda Networks, Juniper Networks, Trend Micro, SonicWALL, Sophos, Network Box and M86 Security/Finjan;

 

   

companies offering DLP solutions, such as Symantec, Verdasys, Trustwave, EMC, McAfee, IBM, Trend Micro, Proofpoint, Palisade Systems, Computer Associates, Raytheon, Intrusion, Fidelis, GTB Technologies, Workshare, Check Point Software and Code Green Networks;

 

   

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

 

   

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

 

   

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

 

   

companies offering Web gateway solutions such as Microsoft, Blue Coat Systems, Cisco Systems, Trend Micro, Check Point Software, McAfee and Juniper Networks.

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

 

   

greater name recognition and larger marketing budgets and resources;

 

   

established marketing relationships and access to larger customer bases; and

 

   

substantially greater financial, technical and other resources.

As a result, we may be unable to gain sufficient traction as a provider of Web security solutions, and our competitors may be able to respond more quickly and effectively than we can to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, marketing, promotion and sale of their products than we can. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the functionality and market acceptance of their products. In addition, our competitors may be able to replicate our products, make more attractive offers to existing and potential employees and strategic partners, develop new products or enhance existing products and services more quickly. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, many of our competitors made recent acquisitions in some of our product areas, and, we expect competition to increase as a result of this industry consolidation. Through an acquisition, a competitor could bundle separate products to include functions that are currently provided primarily by our Web and data security solutions and sell the combined product at a lower cost than our stand-alone solutions. For all of the foregoing reasons, we may not be able to compete successfully against our current and future competitors.

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

In connection with our acquisition of SurfControl in October 2007, we entered into an amended and restated senior secured credit facility to provide financing for a substantial portion of the acquisition purchase price. Our senior secured credit facility contains covenants that restrict, among other things, our ability to borrow money, make particular types of investments, including investments in our subsidiaries, make other restricted payments, pay down subordinated debt, swap or sell assets, merge or consolidate or make acquisitions. An event of default under our senior secured credit facility could allow the lenders to declare all amounts outstanding with respect to the senior secured credit facility to be immediately due and payable. As collateral for the loan, we pledged substantially all of our consolidated assets and the stock of some of our subsidiaries (subject to limitations with respect to foreign subsidiaries) to secure the debt under our senior secured credit facility. If the amounts outstanding under the senior secured credit facility were accelerated, the lenders could proceed against those consolidated assets and the stock of our subsidiaries. Any event of

 

27


Table of Contents

default, therefore, could have a material adverse effect on our business. Our senior secured credit facility also requires us to maintain specified financial ratios. Our ability to meet these financial ratios can be affected by events beyond our control, and we cannot assure that we will meet those ratios.

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

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

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

 

   

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

 

   

potential loss of proprietary information due to misappropriation or 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;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

costs and delays associated with developing software in multiple languages.

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

We market and sell our products outside the United States through value-added resellers, distributors and other resellers. International sales represented 51% of our total revenue generated during the quarters ended March 31, 2010 and March 31, 2009. As a key component of our business strategy to generate new business sales, we intend to continue to expand our international sales, but success cannot be assured. In addition to the risks associated with our domestic sales, our international sales are subject to the following risks:

 

   

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

 

   

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

 

   

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

 

   

laws and business practices favoring local competitors;

 

   

dependence on foreign distributors and their sales channels;

 

   

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

 

   

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

 

   

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

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

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

A significant portion of our foreign subsidiaries’ operating expenses are incurred in foreign currencies so if the U.S. dollar weakens, our consolidated operating expenses would increase. Should the U.S. dollar strengthen, our products may become more

 

28


Table of Contents

expensive for our international customers with subscription contracts denominated in U.S. dollars, and as a result, our results of operations and net cash flows from international operations may be adversely affected, especially if the trend continues of international sales growing as a percentage of our total sales. Changes in currency rates also impact our future revenue under subscription contracts that are not denominated in U.S. dollars as we bill certain international customers in Euros, British Pounds, Australian Dollars, Chinese Renminbi and Japanese Yen. Our revenue and deferred revenue for these 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. This increases our risks associated with fluctuations in currency exchange rates since we cannot be assured of receiving the same U.S. dollar equivalent as when we bill exclusively in U.S. dollars. During the first three quarters of 2009, due to the strengthening of the U.S. dollar, we experienced a reduction in subscription amounts as recorded in U.S. dollars relative to the foreign currency in which the subscription was priced to the customer. As a result, the strengthening of the U.S. dollar for current sales has reduced our future revenue from these contracts, even though these foreign currencies may strengthen during the term of these subscriptions. This trend reversed itself during the fourth quarter of 2009 and the first quarter of 2010 but currency exchange rates remain volatile and our future revenue could be adversely affected by currency fluctuations. We engage in currency hedging activities with the intent of limiting the risk of exchange rate fluctuations, but our foreign exchange hedging activities also involve inherent risks that could result in an unforeseen loss. If we fail to properly forecast our billings, expenses and currency exchange rates these hedging activities could have a negative impact.

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

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

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

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

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

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

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

 

29


Table of Contents

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

Our products are complex, are deployed in a wide variety of network environments and manage content in a dramatically changing Web 2.0 world. Our products may have errors or defects that users identify after deployment, which could harm our reputation and our business. In addition, products as complex as ours frequently contain undetected errors when first introduced or when new versions or enhancements are released. We have from time to time found errors in versions of our products, and we expect to find such errors in the future. Because customers rely on our products to manage employee behavior to protect against security risks and prevent the loss of sensitive data, 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, parties whose Web sites or executable files are placed in security-risk categories or other categories with negative connotations may seek redress against us for falsely labeling them or for interfering with their business. The occurrence of errors could adversely affect sales of our products, divert the attention of engineering personnel from our product development efforts and cause significant customer relations or legal problems.

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

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

In October 2007, we borrowed $210 million under the Senior Credit Agreement and $75 million remained outstanding as of March 31, 2010. As a result, we are incurring interest expense for the amounts we borrowed under the senior secured term loan, and our income from our cash, cash equivalents and marketable securities has declined as we used a significant portion of our cash and marketable securities to fund a portion of the acquisition cost and have continued to use cash from operations to pay down debt and repurchase our common stock. This debt and the limitations our senior secured credit facility impose on us could have important consequences, including:

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

We face risks related to customer outsourcing to system integrators.

Some of our customers have outsourced the management of their information technology 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 revenue and have a material adverse effect on our business.

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

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

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

Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for state, federal and international income taxes together with transaction taxes such as sales tax, VAT and GST. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. Some of these uncertainties arise as a

 

30


Table of Contents

consequence of intercompany arrangements to share revenue and costs. In such arrangements there are uncertainties about the amount and manner of such sharing, which could ultimately result in changes once the arrangements are reviewed by taxing authorities. Although we believe that our approach to determining the amount of such arrangements is consistent with prevailing legislative interpretation, no assurance can be given that the final tax authority review of these matters will agree with our historical income tax provisions and other tax accruals. Such differences could have a material effect on our income tax provisions or benefits, or other tax accruals, in the period in which such determination is made, and consequently, on our results of operations for such period.

From time to time, we are also audited by various state, federal and tax authorities of other countries in which we operate. Generally, the tax years 2005 through 2009 could be subject to examination by U.S. federal and most state tax authorities. In significant foreign jurisdictions, tax years 2004 through 2009 could be subject to examination by the respective tax authorities. We are currently under examination by the respective tax authorities for tax years 2005 to 2007 in the United States, for 2006 to 2007 in the United Kingdom and for 2006 to 2008 in Israel. Our audits are in various stages of completion; however, no outcome for a particular audit can be determined with certainty prior to the conclusion of the audit and any appeals process.

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

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

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

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

Intellectual property is critical to our success, and we rely upon patent, trademark, copyright and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology and our Websense brands. We rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. While we require employees, collaborators and consultants to enter into confidentiality agreements, 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.

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 22 patents issued in the United States and 28 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;

 

31


Table of Contents
   

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.

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

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

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

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

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

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

We may acquire additional companies, services and technologies in the future as part of our efforts to expand and diversify our business. Although we review the records of companies or businesses we are interested in acquiring, even an in-depth review may not reveal existing or potential problems or permit us to become familiar enough with a business to assess fully its capabilities and deficiencies. Integration of acquired companies may disrupt or slow the momentum of the activities of our business. As a result, if we fail to properly evaluate, execute and integrate future acquisitions, our business and prospects may be seriously harmed.

Acquisitions involve numerous risks, including:

 

   

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

 

   

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

 

   

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

 

   

risk of entering new markets;

 

32


Table of Contents
   

potential loss of key employees of the acquired company;

 

   

integrating personnel with diverse business and cultural backgrounds;

 

   

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

 

   

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

 

   

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

 

   

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

Acquisitions may also cause us to:

 

   

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

 

   

assume certain liabilities, 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;

 

   

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

 

   

become subject to intellectual property or other litigation; and

 

   

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

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

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

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

 

   

changes in currency exchange rates impacting our international operating expenses;

 

   

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

 

   

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

 

   

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

 

   

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

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

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

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

 

   

deteriorating or fluctuating world economic conditions;

 

   

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

 

   

demand for our products, including fluctuations in subscription renewals;

 

   

changes in the pricing policies of our competitors; and

 

   

changes in government regulations.

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

 

   

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

 

33


Table of Contents
   

changes in our pricing policies; and

 

   

quarterly variations in our revenues and operating expenses.

Further, the stock market has experienced significant price and volume fluctuations that have particularly affected the market price of the stock of many Internet-related companies, and that often have been unrelated or disproportionate to the operating performance of these companies. A number of publicly traded Internet-related companies have current market prices below their initial public offering prices. Market fluctuations such as these may seriously harm the market price of our common stock. In the past, securities class action suits have been filed following periods of market volatility in the price of a company’s securities. If such an action were instituted, we would incur substantial costs and a diversion of management attention and resources, which would seriously harm our business, results of operations and financial condition.

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

Our success depends largely upon the continued services of our executive officers and other key management personnel and our ability to recruit new personnel to executive and key management positions. We are also substantially dependent on the continued service of our existing engineering personnel because of the complexity of our products and technologies. We do not have employment agreements with a majority of our executive officers, key management or development personnel and, therefore, they could terminate their employment with us at any time without penalty. We do not maintain key person life insurance policies on any of our employees. The loss of one or more of our key employees could seriously harm our business, results of operations and financial condition. In such an event we may be unable to recruit personnel to replace these individuals in a timely manner, or at all, on acceptable terms.

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

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

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

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

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

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

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

Some provisions of our certificate of incorporation and bylaws, as well as some provisions of Delaware law, may discourage, delay or prevent third parties from acquiring us, even if doing so would be beneficial to our stockholders. For example, our certificate

 

34


Table of Contents

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

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

We do not intend to pay dividends.

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

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

(a) Not applicable.

 

(b) Not applicable.

 

(c) Issuer Purchases of Equity Securities

 

Period

   Total
Number of
Shares
Purchased
   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
Yet Purchased Under
the Plans or Programs

January 1, 2010 to January 31, 2010

   130,000    $ 18.97    11,664,024    4,335,976

February 1, 2010 to February 28, 2010

   539,200      20.27    12,203,224    3,796,776

March 1, 2010 to March 31, 2010

   288,299      22.84    12,491,523    3,508,477
             

Total

   957,499      20.87    12,491,523    3,508,477
             

 

1. The purchases were made in open-market transactions.
2. In April 2003, we announced that our Board of Directors authorized a stock repurchase program of up to 4 million shares of our common stock. In August 2005, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 8 million shares. In July 2006, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 12 million shares. In January 2008, we adopted a 10b5-1 plan that provides for quarterly purchases of our common stock in open market transactions. In January 2010, Websense’s Board of Directors increased the size of its stock repurchase program by an additional 4 million shares, for a total program size of up to 16 million shares. The remaining shares authorized for repurchase under our stock repurchase program as of March 31, 2010 was 3,508,477

 

Item 3. Defaults upon Senior Securities

None.

 

Item 4. (Removed and Reserved)

 

Item 5. Other Information

None.

 

35


Table of Contents
Item 6. Exhibits

Exhibits

 

  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)    2010 Bonus Program
10.2(3)    2010 EVP of Worldwide Sales Bonus Program
10.3(4)    Board of Directors Compensation Plan
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).

 

(1) Filed as an exhibit to our Current Report on Form 8-K filed on June 19, 2009.
(2) Filed as an exhibit to our Registration Statement on Form S-1/A (No 333-95619) filed on March 23, 2000.
(3) Filed as an exhibit to our Current Report on Form 8-K filed on February 24, 2010.
(4) Filed as an exhibit to our Form 10-K for the period ended December 31, 2009 filed on February 25, 2010.

 

36


Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    WEBSENSE, INC.
Date: May 6, 2010     By:   /s/    GENE HODGES        
      Gene Hodges
      Chief Executive Officer
Date: May 6, 2010     By:   /s/    ARTHUR S. LOCKE III        
      Arthur S. Locke III
      Chief Financial Officer

 

37


Table of Contents

EXHIBIT INDEX

Exhibits

 

  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)    2010 Bonus Program
10.2(3)    2010 EVP of Worldwide Sales Bonus Program
10.3(4)    Board of Directors Compensation Plan
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).

 

(1) Filed as an exhibit to our Current Report on Form 8-K filed on June 19, 2009.
(2) Filed as an exhibit to our Registration Statement on Form S-1/A (No 333-95619) filed on March 23, 2000.
(3) Filed as an exhibit to our Current Report on Form 8-K filed on February 24, 2010.
(4) Filed as an exhibit to our Form 10-K for the period ended December 31, 2009 filed on February 25, 2010.

 

38