10-Q 1 wbsn201293010q.htm 10-Q WBSN 2012.9.30 10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
OR
o
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  ý    No  o
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  ý    No o  
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
ý
 
Accelerated Filer
o
Non-Accelerated Filer
o
(Do not check if a smaller reporting company)
Smaller reporting company
o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes  o    No  ý
The number of shares outstanding of the registrant’s Common Stock, $.01 par value, as of October 26, 2012 was 36,499,437.



Websense, Inc.
Form 10-Q
For the Quarterly Period Ended September 30, 2012
TABLE OF CONTENTS
 
 
Page
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 
 
In this report, “Websense,” “the Company,” “we,” “us” and “our” refer to Websense, Inc., and our wholly owned subsidiaries, unless the context otherwise provides.

2


Part I – Financial Information
Item 1.
Consolidated Financial Statements (Unaudited)

Websense, Inc.
Consolidated Balance Sheets
(In thousands)
 
September 30,
2012
 
December 31,
2011
 
(Unaudited)
 
 
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
57,602

 
$
76,201

Accounts receivable, net of allowance for doubtful accounts of $1,538 and $979 as of September 30, 2012 and December 31, 2011, respectively
54,436

 
80,147

Income tax receivable / prepaid income tax
2,187

 
738

Current portion of deferred income taxes
30,234

 
30,021

Other current assets
11,589

 
13,793

Total current assets
156,048

 
200,900

Cash and cash equivalents – restricted
640

 
628

Property and equipment, net
18,617

 
16,832

Intangible assets, net
20,058

 
26,412

Goodwill
372,445

 
372,445

Deferred income taxes, less current portion
8,670

 
8,599

Deposits and other assets
7,348

 
8,622

Total assets
$
583,826

 
$
634,438

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
6,404

 
$
9,026

Accrued compensation and related benefits
23,358

 
22,770

Other accrued expenses
11,722

 
16,534

Current portion of income taxes payable
1,533

 
3,187

Current portion of deferred tax liability
86

 
86

Current portion of deferred revenue
231,576

 
250,597

Total current liabilities
274,679

 
302,200

Other long term liabilities
2,256

 
2,600

Income taxes payable, less current portion
10,308

 
11,955

Secured loan
68,000

 
73,000

Deferred tax liability, less current portion
2,512

 
2,501

Deferred revenue, less current portion
139,163

 
142,437

Total liabilities
496,918

 
534,693

Stockholders’ equity:
 
 
 
Common stock
577

 
568

Additional paid-in capital
434,089

 
415,573

Treasury stock, at cost
(431,290
)
 
(385,544
)
Retained earnings
86,788

 
72,247

Accumulated other comprehensive loss
(3,256
)
 
(3,099
)
Total stockholders’ equity
86,908

 
99,745

Total liabilities and stockholders’ equity
$
583,826

 
$
634,438

See accompanying notes to consolidated financial statements

3


Websense, Inc.
Consolidated Statements of Operations
(Unaudited and in thousands, except per share amounts)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
Revenues:
 
 
 
 
 
 
 
Software and service
$
82,285

 
$
81,803

 
$
245,992

 
$
243,057

Appliance
8,078

 
10,308

 
23,769

 
28,393

Total revenues
90,363

 
92,111

 
269,761

 
271,450

Cost of revenues:
 
 
 
 
 
 
 
Software and service
11,643

 
10,234

 
33,918

 
30,993

Appliance
3,337

 
4,665

 
9,929

 
13,661

Total cost of revenues
14,980

 
14,899

 
43,847

 
44,654

Gross profit
75,383

 
77,212

 
225,914

 
226,796

Operating expenses:
 
 
 
 
 
 
 
Selling and marketing
35,661

 
38,445

 
112,226

 
121,285

Research and development
15,786

 
15,084

 
46,745

 
43,556

General and administrative
10,132

 
9,969

 
30,960

 
30,922

Total operating expenses
61,579

 
63,498

 
189,931

 
195,763

Income from operations
13,804

 
13,714

 
35,983

 
31,033

Interest expense
(644
)
 
(374
)
 
(1,943
)
 
(1,167
)
Other income (expense), net
(81
)
 
204

 
(221
)
 
1,530

Income before income taxes
13,079

 
13,544

 
33,819

 
31,396

Provision for income taxes
4,628

 
5,426

 
19,278

 
10,777

Net income
$
8,451

 
$
8,118

 
$
14,541

 
$
20,619

Net income per share:
 
 
 
 
 
 
 
Basic net income per share
$
0.23

 
$
0.21

 
$
0.39

 
$
0.51

Diluted net income per share
$
0.23

 
$
0.20

 
$
0.39

 
$
0.50

Weighted average shares — basic
36,457

 
39,575

 
37,010

 
40,081

Weighted average shares — diluted
36,782

 
40,428

 
37,590

 
41,273

See accompanying notes to consolidated financial statements

4


Websense, Inc.
Consolidated Statements of Comprehensive Income
(Unaudited and in thousands)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2012
 
September 30,
2011
 
September 30,
2012
 
September 30,
2011
Net income
$
8,451

 
$
8,118

 
$
14,541

 
$
20,619

Other comprehensive income (loss) before tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
363

 
(1,122
)
 
251

 
(2,811
)
Unrealized losses on derivative contracts, net
(144
)
 
(1,638
)
 
(613
)
 
(2,822
)
Other comprehensive income (loss) before tax
219

 
(2,760
)
 
(362
)
 
(5,633
)
Income tax benefit related to components of other comprehensive income
81

 
655

 
205

 
1,129

Other comprehensive income (loss), net of tax
300

 
(2,105
)
 
(157
)
 
(4,504
)
Comprehensive income
$
8,751

 
$
6,013

 
$
14,384

 
$
16,115

See accompanying notes to consolidated financial statements

5


Websense, Inc.
Consolidated Statement of Stockholders' Equity
(Unaudited and in thousands)
 
 
 
 
 
Additional paid-in capital
 
Treasury stock
 
Retained earnings
 
Accumulated other comprehensive loss
 
Total stockholders' equity
 
Common stock
 
 
 
 
 
 
Shares
 
Amount
 
 
 
 
 
Balance at December 31, 2011
38,048

 
$
568

 
$
415,573

 
$
(385,544
)
 
$
72,247

 
$
(3,099
)
 
$
99,745

Issuance of common stock upon exercise of options
130

 
2

 
2,075

 

 

 

 
2,077

Issuance of common stock for ESPP purchase
241

 
2

 
3,593

 

 

 

 
3,595

Issuance of common stock from restricted stock units, net
359

 
5

 

 
(2,835
)
 

 

 
(2,830
)
Share-based compensation expense

 

 
14,675

 

 

 

 
14,675

Tax shortfall from share-based compensation

 

 
(1,827
)
 

 

 

 
(1,827
)
Purchase of treasury stock
(2,269
)
 

 

 
(42,911
)
 

 

 
(42,911
)
Net income

 

 

 

 
14,541

 

 
14,541

Other comprehensive loss

 

 

 

 

 
(157
)
 
(157
)
Balance at September 30, 2012
36,509

 
$
577

 
$
434,089

 
$
(431,290
)
 
$
86,788

 
$
(3,256
)
 
$
86,908

See accompanying notes to consolidated financial statements

6


Websense, Inc.
Consolidated Statements of Cash Flows
(Unaudited and in thousands)
 
Nine Months Ended
 
September 30,
2012
 
September 30,
2011
Operating activities:
 
 
 
Net income
$
14,541

 
$
20,619

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
15,133

 
19,716

Share-based compensation
14,675

 
14,433

Deferred income taxes

 
(360
)
Unrealized loss (gain) on foreign exchange
412

 
(47
)
Excess tax benefit from share-based compensation
(532
)
 
(2,267
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
26,760

 
21,149

Other assets
2,412

 
470

Accounts payable
(3,437
)
 
2,244

Accrued compensation and related benefits
451

 
533

Other liabilities
(3,761
)
 
(3,385
)
Deferred revenue
(22,297
)
 
(24,575
)
Income taxes payable and receivable/prepaid
(6,559
)
 
8,722

Net cash provided by operating activities
37,798

 
57,252

Investing activities:
 
 
 
Change in restricted cash and cash equivalents
(20
)
 
33

Purchase of property and equipment
(9,576
)
 
(7,176
)
Purchase of intangible assets

 
(500
)
Net cash used in investing activities
(9,596
)
 
(7,643
)
Financing activities:
 
 
 
Proceeds from secured loan

 
87,000

Principal payments on secured loan
(5,000
)
 
(81,000
)
Principal payments on capital lease obligation
(587
)
 
(569
)
Proceeds from exercise of stock options
2,257

 
14,461

Proceeds from issuance of common stock for stock purchase plan
3,595

 
3,446

Excess tax benefit from share-based compensation
532

 
2,267

Tax payments related to restricted stock unit issuances
(2,830
)
 
(2,824
)
Purchase of treasury stock
(44,674
)
 
(73,998
)
Net cash used in financing activities
(46,707
)
 
(51,217
)
Effect of exchange rate changes on cash and cash equivalents
(94
)
 
(232
)
Decrease in cash and cash equivalents
(18,599
)
 
(1,840
)
Cash and cash equivalents at beginning of period
76,201

 
77,390

Cash and cash equivalents at end of period
$
57,602

 
$
75,550

Cash paid during the period for:
 
 
 
Income taxes including interest and penalties, net of refunds
$
25,385

 
$
5,045

Interest
$
1,746

 
$
968

Non-cash financing activities:
 
 
 
Change in operating assets and liabilities for unsettled purchase of treasury stock and exercise of stock options
$
(1,583
)
 
$
994

See accompanying notes to consolidated financial statements

7


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 (“SEC”). In the opinion of management, the statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of the Company’s 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, 2011, included in Websense, Inc.’s Annual Report on Form 10-K filed with the SEC. Operating results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending December 31, 2012. The balance sheet at December 31, 2011 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.
Other than the adoption of new accounting standards related to reporting comprehensive income, as discussed below, there have been no material changes to the Company’s significant accounting policies as compared with the significant accounting policies described in the Annual Report on Form 10-K for the fiscal year ended December 31, 2011.
In June 2011, the Financial Accounting Standards Board issued authoritative guidance on the presentation of other comprehensive income within the financial statements that became effective for the Company beginning January 1, 2012. Pursuant to the guidance, registrants may present total comprehensive income, the components of net income and the components of other comprehensive income in a single continuous statement or two separate but consecutive statements, but may not present other comprehensive income components as part of the consolidated statement of stockholders’ equity. As a result of this guidance, the Company has included a separate statement of comprehensive income as part of the consolidated financial statements included in this report.
2. Net Income Per Share
Basic net income per share (“EPS”) is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted 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, dilutive restricted stock units and dilutive employee stock purchase plan grants. Dilutive stock options, dilutive restricted stock units and dilutive employee stock purchase plan grants are calculated based on the average share price for each fiscal period using the treasury stock method. If, however, the Company reports a net loss, diluted EPS is computed in the same manner as basic EPS.
Potentially dilutive securities totaling approximately 5,802,000 and 4,260,000 weighted average shares for the three months ended September 30, 2012 and 2011, respectively, and approximately 5,426,000 and 3,656,000 weighted average shares for the nine months ended September 30, 2012 and 2011, respectively, were excluded from the diluted EPS calculation because of their anti-dilutive effect.

8


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
(Numerator)
 
Shares
(Denominator)
 
Per Share
Amount
 
(In thousands, except per share amounts)
For the Three Months Ended:
 
 
 
 
 
September 30, 2012:
 
 
 
 
 
Basic EPS
$
8,451

 
36,457

 
$
0.23

Effect of dilutive securities

 
325

 

Diluted EPS
$
8,451

 
36,782

 
$
0.23

September 30, 2011:
 
 
 
 
 
Basic EPS
$
8,118

 
39,575

 
$
0.21

Effect of dilutive securities

 
853

 
(0.01
)
Diluted EPS
$
8,118

 
40,428

 
$
0.20

 
Net
Income
(Numerator)
 
Shares
(Denominator)
 
Per Share
Amount
 
(In thousands, except per share amounts)
For the Nine Months Ended:
 
 
 
 
 
September 30, 2012:
 
 
 
 
 
Basic EPS
$
14,541

 
37,010

 
$
0.39

Effect of dilutive securities

 
580

 

Diluted EPS
$
14,541

 
37,590

 
$
0.39

September 30, 2011:
 
 
 
 
 
Basic EPS
$
20,619

 
40,081

 
$
0.51

Effect of dilutive securities

 
1,192

 
(0.01
)
Diluted EPS
$
20,619

 
41,273

 
$
0.50


3. Intangible Assets
Intangible assets subject to amortization consisted of the following as of September 30, 2012 (in thousands, except years):
 
Remaining
Weighted Average
Life (in years)
 
Cost
 
Accumulated
Amortization
 
Net
Technology
3.8
 
$
15,157

 
$
(13,074
)
 
$
2,083

Customer relationships
4.1
 
69,200

 
(51,225
)
 
17,975

Total
4.1
 
$
84,357

 
$
(64,299
)
 
$
20,058

Intangible assets subject to amortization consisted of the following as of December 31, 2011 (in thousands, except years):
 
Remaining
Weighted Average
Life (in years)
 
Cost
 
Accumulated
Amortization
 
Net
Technology
3.2
 
$
15,157

 
$
(11,255
)
 
$
3,902

Customer relationships
4.8
 
69,200

 
(46,690
)
 
22,510

Total
4.6
 
$
84,357

 
$
(57,945
)
 
$
26,412


9


As of September 30, 2012, remaining amortization expense is expected to be as follows (in thousands):
 
 
Years Ending December 31,
 
2012
$
2,118

2013
5,721

2014
4,689

2015
3,862

2016
3,430

Thereafter
238

Total expected amortization expense
$
20,058

 
 
4. Credit Facility
In October 2010, the Company entered into a senior credit facility (the “2010 Credit Agreement”). The 2010 Credit Agreement provides for a secured revolving credit facility that matures on October 29, 2015 with an initial maximum aggregate commitment of $120 million, including a $15 million sublimit for issuances of letters of credit and a $5 million sublimit for swing line loans. The Company may borrow and make repayments under the revolving credit facility depending on its liquidity position. During the first nine months of 2012, the Company made repayments of $5 million under this credit facility. The Company may increase the maximum aggregate commitment under the 2010 Credit Agreement to up to $200 million if certain conditions are satisfied, including that it is not in default under the 2010 Credit Agreement at the time of the increase. Loans under the 2010 Credit Agreement are designated at the Company’s election as either base rate or Eurodollar rate loans. Base rate loans bear interest at a rate equal to (i) the highest of (a) the federal funds rate plus 0.5%, (b) the Eurodollar rate plus 1.00%, and (c) Bank of America’s prime rate plus (ii) a margin set forth below. Eurodollar rate loans bear interest at a rate equal to (i) the Eurodollar rate, plus (ii) a margin set forth below. As of September 30, 2012, the Company’s weighted average interest rate was 3.11%.
The applicable margins are determined by reference to the Company’s leverage ratio, as set forth in the table below:
Consolidated Leverage Ratio
 
Eurodollar Rate
Loans
 
Base Rate
Loans
<1.25:1.0
 
1.75%
 
0.75%
≥1.25:1.0
 
2.00%
 
1.00%
For each commercial letter of credit, the Company must pay a fee equal to 0.125% per annum times the daily amount available to be drawn under such letter of credit and, for each standby letter of credit, the Company must pay a fee equal to the applicable margin for Eurodollar rate loans times the daily amount available to be drawn under such letter of credit. A quarterly commitment fee is payable to the lenders in an amount equal to 0.25% of the unused portion of the credit facility.
Indebtedness under the 2010 Credit Agreement is secured by substantially all of the Company’s assets, including pledges of stock of certain of its subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by its domestic subsidiaries. The 2010 Credit Agreement contains affirmative and negative covenants, including an obligation to maintain a certain consolidated leverage ratio and consolidated interest coverage ratio and restrictions on the Company’s ability to borrow money, to incur liens, to enter into mergers and acquisitions, to make dispositions, to pay cash dividends or repurchase capital stock, and to make investments, subject to certain exceptions. The 2010 Credit Agreement does not require the Company to use excess cash to pay down debt.
The 2010 Credit Agreement provides for acceleration of the Company’s obligations thereunder upon certain events of default. The events of default include, without limitation, failure to pay loan amounts when due, any material inaccuracy in the Company’s representations and warranties, failure to observe covenants, defaults on any other indebtedness, entering bankruptcy, existence of a judgment or decree against the Company or its subsidiaries involving an aggregate liability of $10 million or more, the security interest or guarantee ceasing to be in full force and effect, any person becoming the beneficial owner of more than 35% of the Company’s outstanding common stock, or the Company’s board of directors ceasing to consist of a majority of Continuing Directors (as defined in the 2010 Credit Agreement).

10


The secured revolving credit facility under the 2010 Credit Agreement is included in the line item "Secured loan" on the Company’s consolidated balance sheets and had a balance of $68.0 million and $73.0 million as of September 30, 2012 and December 31, 2011, respectively. As of September 30, 2012, future remaining minimum principal payments under the secured loan will be due in October 2015 when the revolving credit facility matures. The unused portion of the revolving credit facility as of September 30, 2012 was $52.0 million.
5. Fair Value Measurements and Derivatives
Fair Value Measurements on a Recurring Basis
Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. The Company’s assessment of the significance of a particular input to the fair value measurements requires judgment, and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.
The following table presents the values of balance sheet accounts measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011 (in thousands):
 
September 30, 2012
 
December 31, 2011
 
Level 1
(1)
 
Level 2
(2)
 
Level 3
(3)
 
Level 1
(1)
 
Level 2
(2)
 
Level 3
(3)
Assets:
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents - money market funds
$
1,560

 
$

 
$

 
$
1,558

 
$

 
$

Foreign currency forward contracts not designated as hedges

 
10

 

 

 
643

 

Foreign currency contracts designated as cash flow hedges

 
9

 

 

 

 

Liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap

 
(2,075
)
 

 

 
(1,561
)
 

Foreign currency forward contracts not designated as hedges

 
(279
)
 

 

 

 

Foreign currency contracts designated as cash flow hedges

 
(109
)
 

 

 

 

(1) -
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 liabilities are derivative contracts, comprised of an interest rate swap contract, foreign currency forward contracts and foreign currency cash flow hedges that are valued using models based on readily observable market parameters for all substantial terms of the Company’s derivative contracts and thus are classified within Level 2.
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 secured 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 depending on the use of the derivative instrument and whether it qualifies for hedge accounting.
In connection with the 2010 Credit Agreement, the Company entered into an interest rate swap agreement to pay a fixed rate of interest (1.778% per annum) and receive a floating rate interest payment (based on the three-month LIBOR) on a principal amount of $50 million. The $50 million swap agreement became effective on December 30, 2011 and expires on October 29, 2015. The interest rate swap was designated as a cash flow hedge. Under hedge accounting, the effective portion of the derivative fair value gains or losses is deferred in accumulated other comprehensive loss.

11


During the nine months ended September 30, 2012 and 2011, the Company utilized Euro, British Pound and Australian Dollar foreign currency forward contracts to hedge anticipated foreign currency denominated net monetary assets. All such contracts entered into were designated as fair value hedges and were not required to be tested for effectiveness as hedge accounting was not elected. All of the fair value hedging contracts in place as of September 30, 2012 are scheduled to be settled before March 2013.
During the nine months ended September 30, 2012, the Company utilized Israeli Shekel foreign currency forward contracts to hedge anticipated Israeli Shekel denominated operating expenses. All such contracts were designated as cash flow hedges and were deemed effective. All Israeli Shekel hedging contracts in place as of September 30, 2012 are scheduled to be settled before August 2013.
Notional and fair values of the Company’s foreign currency hedging positions at September 30, 2012 and December 31, 2011 are presented in the table below (in thousands):
 
September 30, 2012
 
December 31, 2011
 
Notional
Value
Local
Currency
 
Notional
Value
USD
 
Fair
Value
USD
 
Notional
Value
Local
Currency
 
Notional
Value
USD
 
Fair
Value
USD
Fair Value Hedges
 
 
 
 
 
 
 
 
 
 
 
Euro
5,900

 
$
7,335

 
$
7,590

 
11,000

 
$
14,909

 
$
14,266

Australian dollar
1,500

 
$
1,537

 
$
1,550

 

 
$

 
$

Cash Flow Hedges
 
 
 
 
 
 
 
 
 
 
 
Israeli Shekel
18,666

 
$
4,845

 
$
4,745

 

 
$

 
$

The effects of derivative instruments on the Company’s financial statements were as follows as of September 30, 2012 and December 31, 2011 and for the three and nine months ended September 30, 2012 and 2011 (in thousands). There was no ineffective portion nor was any amount excluded from effectiveness testing during any of the periods presented below.
 
Fair Value of Derivatives
 
 
 
September 30,
2012
 
December 31,
2011
 
Balance Sheet Location
Interest rate contracts designated as cash flow hedges
$
(673
)
 
$
(407
)
 
Other accrued expenses
Interest rate contracts designated as cash flow hedges
(1,402
)
 
(1,154
)
 
Other long term liabilities
Currency contracts not designated as hedges
10

 
643

 
Other current assets
Currency contracts not designated as hedges
(279
)
 

 
Other accrued expenses
Foreign exchange contracts designated as cash flow hedges
9

 

 
Other current assets
Foreign exchange contracts designated as cash flow hedges
(109
)
 

 
Other accrued expenses
Total derivatives
$
(2,444
)
 
$
(918
)
 
 
Amount of Gain (Loss) Recognized in
Accumulated OCI on Derivatives (Effective Portion)
 
Location and Amount of Gain (Loss) Reclassified from
Accumulated OCI into Income (Effective Portion)
Derivatives in Cash
Flow Hedging
Relationships
 
Three Months Ended September 30,
 
Derivatives in Cash
Flow Hedging
Relationships
 
Three Months Ended September 30,
 
2012
 
2011
 
 
2012
 
2011
Interest rate contracts
 
$
(120
)
 
$
(983
)
 
Interest expense
 
$
169

 
$

Currency contracts
 
57

 

 
R&D
 
(79
)
 

Total
 
$
(63
)
 
$
(983
)
 
 
 
$
90

 
$

 
 
Location and Amount of Gain (Loss)
Recognized in Income on Derivatives
 
 
 
 
Three Months Ended September 30,
Derivatives Not Designated as Hedges
 
 
 
2012
 
2011
Currency forward contracts
 
Other income (expense), net
 
$
(232
)
 
$
155


12


Amount of Gain (Loss) Recognized in
Accumulated OCI on Derivatives (Effective Portion)
 
Location and Amount of Gain (Loss) Reclassified from
Accumulated OCI into Income (Effective Portion)
Derivatives in Cash
Flow Hedging
Relationships
 
Nine Months Ended September 30,
 
Derivatives in Cash
Flow Hedging
Relationships
 
Nine Months Ended September 30,
 
2012
 
2011
 
 
2012
 
2011
Interest rate contracts
 
$
(308
)
 
$
(1,693
)
 
Interest expense
 
$
487

 
$

Currency contracts
 
(100
)
 

 
R&D
 
(58
)
 

Total
 
$
(408
)
 
$
(1,693
)
 
 
 
$
429

 
$

 
 
Location and Amount of Gain (Loss)
Recognized in Income on Derivatives
 
 
 
 
Nine Months Ended September 30,
Derivatives Not Designated as Hedges
 
 
 
2012
 
2011
Currency forward contracts
 
Other income (expense), net
 
$
64

 
$
166

Fair Value Measurements on a Nonrecurring Basis
During the nine months ended September 30, 2012, the Company did not re-measure any nonfinancial assets and liabilities measured at fair value on a nonrecurring basis (e.g., goodwill, intangible assets, property and equipment and nonfinancial assets and liabilities initially measured at fair value in a business combination). As of September 30, 2012, the Company’s secured loan, with a carrying value of $68.0 million, had an estimated fair value of $68.1 million, which the Company determined using a discounted cash flow model with a discount rate of 2.11%, which represents the Company’s estimated incremental borrowing rate.
6. Stockholders’ Equity
Share-Based Compensation
Employee Stock Plans
The following table summarizes the Company’s restricted stock unit activity since December 31, 2011:
 
Number of
Shares
 
Weighted
Average
Fair Value
per Share
Balance at December 31, 2011
1,545,725

 
$
19.54

Granted
891,047

 
17.46

Released
(528,235
)
 
16.93

Canceled
(199,657
)
 
19.57

Balance at September 30, 2012
1,708,880

 
18.73

The following table summarizes the Company’s stock option activity since December 31, 2011:
 
Number of
Shares
 
Weighted
Average
Exercise Price
per Share
Balance at December 31, 2011
6,101,486

 
$
23.25

Granted
596,000

 
17.51

Exercised
(129,691
)
 
16.01

Canceled
(744,674
)
 
23.78

Balance at September 30, 2012
5,823,121

 
22.75



13


The results of operations for the three and nine months ended September 30, 2012 and 2011 include share-based compensation expense in the following expense categories of the consolidated statements of operations (in thousands):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Share-based compensation in:
 
 
 
 
 
 
 
Cost of revenues
$
238

 
$
276

 
$
883

 
$
829

Total share-based compensation in cost of revenues
238

 
276

 
883

 
829

Selling and marketing
1,522

 
1,333

 
5,321

 
4,311

Research and development
1,097

 
961

 
3,539

 
2,887

General and administrative
1,573

 
1,710

 
4,932

 
6,406

Total share-based compensation in operating expenses
4,192

 
4,004

 
13,792

 
13,604

Total share-based compensation
$
4,430

 
$
4,280

 
$
14,675

 
$
14,433

The Company used the following assumptions to estimate the fair value of the stock options granted:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2012
 
2011
 
2012
 
2011
Average expected life (years)
3.4

 
3.4

 
3.4

 
3.4

Average expected volatility factor
39.0
%
 
42.6
%
 
43.4
%
 
42.1
%
Average risk-free interest rate
0.5
%
 
0.5
%
 
0.5
%
 
1.1
%
Average expected dividend yield

 

 

 

Treasury Stock
The Company repurchased shares of its common stock under its stock repurchase program during the first nine months of 2012 as follows:
 
Number of
Shares
 
Average
Price Per
Share
Shares repurchased through December 31, 2011
20,411,821
 
$
20.08

Shares repurchased during the nine months ended September 30, 2012
2,268,696
 
18.91

Total shares repurchased through September 30, 2012
22,680,517
 
19.96

Effective July 17, 2012, the board of directors of the Company suspended the stock repurchase program, after repurchasing 158,700 shares of the Company's common stock for approximately $2.9 million in the third quarter of 2012. As of September 30, 2012, the remaining number of shares authorized for repurchase under the program was 1,319,483. In October 2012, the board of directors resumed the stock repurchase program and authorized management to repurchase up to $5.0 million of the Company's common stock in the fourth quarter of 2012. The 2010 Credit Agreement permits the Company to repurchase its securities so long as it is not in default under the 2010 Credit Agreement, has complied with all of its financial covenants, and has available cash and cash equivalents (including availability under the secured revolving loan) of at least $20 million; provided, however, if, after giving effect to any repurchase, the Company’s leverage ratio is greater than 1.75:1, such repurchase cannot exceed $10 million in the aggregate in any fiscal year.
7. Tax Matters
For the three months ended September 30, 2012, the Company recognized income tax expense of $4.6 million, which represents an effective tax rate of 35.4%. For the nine months ended September 30, 2012, the Company recognized income tax expense of $19.3 million, which represents an effective tax rate of 57.0%.

14


The effective tax rate variance from the U.S. federal statutory rate for the three months ended September 30, 2012 is primarily related to the favorable impact from earnings in lower tax rate jurisdictions offset by the unfavorable impact of foreign withholding taxes and non-deductible share-based payments. The effective tax rate variance from the U.S. federal statutory rate for the nine months ended September 30, 2012 is primarily related to a tax provision of $8.8 million recorded in the first quarter of 2012 resulting from an agreement in principle with the U.S. Internal Revenue Service (“IRS”) Appeals Office to settle all remaining audit issues for the 2005 through 2007 tax years, as discussed further below, as well as the unfavorable impact of foreign withholding taxes and non-deductible share-based payments, partially offset by the favorable impact from earnings in lower tax rate jurisdictions.
Open Tax Examination Periods
The Company and its subsidiaries file tax returns, which are routinely examined by tax authorities in the U.S. and in various state and foreign jurisdictions. The Company was under examination in the United States for tax years 2005 through 2007 and, as described below, settled all issues related to these years with the IRS Appeals Office in September 2012. The Company is also currently under examination for tax years 2008 and 2009 in the United States and for 2006 through 2010 in Israel. The Company has various other on-going audits in various stages of completion. In general, the tax years 2005 through 2011 could be subject to examination by U.S. federal and most state tax authorities. In significant foreign jurisdictions such as Australia, China, Ireland, Israel and the United Kingdom, the statute of limitations for tax years 2005 through 2011 is still open, and these years could be examined by the respective tax authorities.
IRS Tax Settlement
On September 20, 2012, the Company and the IRS entered into a closing agreement (the “Closing Agreement”) relating to the cost sharing arrangement between Websense, Inc. and its Irish subsidiary, including the amount of the cost sharing buy-in, as well as the Company's claim of research and development tax credits. As a result of the settlement under the Closing Agreement, the Company paid an aggregate of $14.7 million in federal and state taxes, including interest, in the third quarter of 2012, slightly lower than the Company's previously expected range of $15 to $16 million. The settlement completely resolves the buy-in issue relating to the cost sharing arrangement and precludes any additional tax liability from the buy-in for 2008 and future years. The Company expects these additional tax amounts to be offset in part by $2 million of U.S. federal tax benefits and $2.2 million of future correlative non-U.S. tax benefits related to the Company's Irish subsidiary.

As previously disclosed in the Company's periodic reports filed with the Securities and Exchange Commission, during the first quarter of 2010 the IRS completed its audit of the Company for the tax years ended December 31, 2005 through December 31, 2007 and issued the Company a letter which outlined all of its proposed audit adjustments. The adjustments related 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 initially proposed by the IRS for the audited years totaled approximately $19 million, of which $14.8 million related to the amount of the cost sharing buy-in, $2.5 million related to research and development credits and $1.7 million related to equity compensation awarded to certain executive officers. The total additional tax proposed excluded interest, penalties, state income taxes and a potential reduction in tax on the Irish subsidiary. The Company disagreed with all of the proposed adjustments and submitted a formal protest to the IRS for each matter. In the third quarter of 2011, the IRS withdrew the proposed adjustment relating to equity compensation.

In the first quarter of 2012, the Company reached an agreement in principle with the IRS Appeals Office to settle the remaining audit adjustments related to the cost sharing buy-in and research and development tax credits. Due to these negotiations, the Company recorded a tax provision of $8.8 million in the quarter ended March 31, 2012. As a result of the final settlement with the IRS under the Closing Agreement, the Company made payments in the aggregate amount of $14.7 million in the third quarter of 2012 described above, consisting of (i) $7.1 million in U.S. federal tax related to the proposed adjustments, (ii) $5.4 million in state tax and accumulated interest related to the additional federal and state taxes and (iii) $2.2 million of U.S. federal tax related to the payment of $23.4 million owed to the Company by its Irish subsidiary, which will be settled through an intercompany loan agreement.
 




15


8. Litigation
On July 12, 2010, Finjan, Inc. filed a complaint entitled Finjan, Inc. v. McAfee, Inc., Symantec Corp., Webroot Software, Inc., Websense, Inc. and Sophos, Inc. in the United States District Court for the District of Delaware. The complaint alleges that by making, using, importing, selling and/or offering for sale Websense Web Filter, Websense Web Security and Websense Web Security Gateway, the Company infringes U.S. Patent No. 6,092,194 (“194 Patent”). Since filing the complaint, Finjan withdrew its contention that Websense Web Filter and Websense Web Security infringes the 194 Patent. Finjan has also accused additional products of infringing the 194 Patent in response to discovery and in expert reports, namely TRITON Enterprise, TRITON Security Gateway Anywhere, Websense Web Security Gateway Anywhere, Websense Web Security Gateway Hosted and the Websense V-Series appliances. Finjan seeks an injunction from further infringement of the 194 Patent and damages. The Court held a hearing on the construction of the claims in the 194 Patent on January 30, 2012 and issued a claim construction order on February 29, 2012. The Court has set a pretrial conference for November 5, 2012 and a trial date of December 3, 2012. The Company denies infringing any valid claims of the 194 Patent and intends to defend the lawsuit vigorously.
The Company is involved in various other legal actions in the normal course of business. Based on current information, including consultation with its lawyers, the Company cannot currently determine and has not accrued any liability that may result from any of its pending legal actions because the Company is unable to predict or reasonably estimate the possible losses, if any, relating to such actions. The Company’s evaluation of the likely impact of these actions could change in the future, the Company may determine that it is required to accrue for potential liabilities in one or more legal actions and unfavorable outcomes and/or defense costs, depending upon the amount and timing, which could have a material adverse effect on its results of operations or cash flows in a future period. If the Company later determines that it is required to accrue for potential liabilities resulting from any of these legal actions, it is reasonably possible that the ultimate liability for these matters will be greater than the amount for which the Company has accrued at that time.


16


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 revenues and billings;
management’s plans, strategies and objectives for future operations;
growth opportunities in domestic and international markets;
reliance on indirect channels of distribution;
anticipated product enhancements or releases;
customer acceptance and satisfaction with our products, services and fee structures;
expectations regarding competitive products and pricing;
risks associated with launching new product offerings;
changes in domestic and international market conditions;
risks associated with fluctuations in exchange rates of the foreign currencies in which we conduct business;
the impact of macroeconomic conditions on our customers;
expected trends in expenses;
anticipated cash and intentions regarding usage of cash;
risks related to compliance with the covenants in our credit agreement;
changes in effective tax rates, laws and interpretations and statements related to tax audits;
risks related to changes in accounting interpretations or accounting guidance;
the volatile and competitive nature of the Internet and security industries; and
the success of our marketing programs and brand development efforts.
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.


17


Overview
We are a global provider of unified Web, email, mobile and data security solutions designed to protect an organization’s data and users from external and internal threats, including modern cyber-threats, advanced malware attacks, information leaks, legal liability and productivity loss. Our customers deploy our subscription software solutions on standard servers or other information technology (“IT”) hardware, including our optimized appliances, as a cloud-based service (software-as-a-service or “SaaS”) offering or in a hybrid hardware/SaaS configuration. Our products and services are sold worldwide to provide content security to enterprise customers, small and medium sized businesses, public sector entities and Internet service providers through a network of distributors, value-added resellers and original equipment manufacturers (“OEMs”). Our products use our advanced content classification, deep content inspection and policy enforcement technologies to:
prevent access to undesirable and dangerous elements on the Web, including Web pages that download viruses, spyware, keyloggers, hacking tools and an ever-increasing variety of malicious code, including Web sites that contain inappropriate content;
identify and remove malware from incoming Web content;
manage the use of social Web sites;
manage the use of non-Web Internet traffic, such as peer-to-peer communications and instant messaging;
prevent misuse of computing resources, including unauthorized downloading of high-bandwidth content;
inspect the content of encrypted Web traffic to prevent data loss, malware and access to Web sites with inappropriate content;
filter spam, viruses and malicious attachments from incoming email and instant messages;
protect against data loss by identifying and categorizing sensitive or confidential data and enforcing pre-determined policies regarding its use and transmission within and outside the organization; and
enable the secure use of mobile smartphones and tablets within an organization’s network by providing protection from Web-based malware, malicious apps, data loss and theft of intellectual property, and by providing mobile device management features that keep mobile devices secure, minimize risk and maintain compliance.
Since we commenced operations in 1994, Websense has evolved from a reseller of network security products to a leading developer and provider of IT security software solutions. Our first commercial software product was released in 1996 and controlled employee access to inappropriate Web sites. Since then, we have focused on developing our Web filtering and content classification capabilities to address changes in the Internet and the external threat environment, including the rise of Web-based social and business applications and the growing incidence of sophisticated, targeted cyber-attacks designed to steal valuable information.
During the three and nine months ended September 30, 2012 and 2011, we derived approximately 50% of our revenues from international sales. Revenues from the United Kingdom comprised approximately 11% of our total revenues in the three and nine months ended September 30, 2012 and 2011.
We utilize a multi-tiered distribution strategy globally to sell our products through indirect distributors and value-added reseller channels. Sales through indirect channels currently account for approximately 95% of our revenues, which is consistent with previous periods. We also have several arrangements with OEMs that grant them the right to incorporate our products into their products for resale to end users. Our sales force supports our channel sales by generating leads and helping close sales. We plan to increase headcount in our sales force as part of our strategy to expand our subscription business to existing customers and to grow sales to new customers.
We sell subscriptions for our software and SaaS products, generally in 12, 24 or 36 month contract durations, based on the number of seats or devices managed. As described elsewhere in this report, we recognize revenues from subscriptions for our software and SaaS products on a daily straight-line basis, commencing on the day the term of the subscription begins, over the term of the subscription agreement. We recognize revenues associated with OEM contracts ratably over the contractual period for which we are obligated to provide our services. We generally recognize the operating expenses related to these sales as they are incurred. These operating expenses include sales commissions, which are based on the total amount of the subscription agreement and are fully expensed in the period the product and/or software activation key is delivered.

18


Billings represent the amount of subscription contracts, OEM royalties and appliance sales billed to customers during the applicable period. Any excess of billings booked in a period compared with revenue recognized in that same period results in an increase in deferred revenue at the end of the period compared with the beginning of the period. Our primarily subscription-based business model operates such that subscription billings are recorded initially to our balance sheet as deferred revenue and then recognized to our statement of operations as revenue ratably over the subscription term or, in the case of OEM arrangements, over the contractual obligation period. Our billings are not a numerical measure that can be calculated in accordance with United States generally accepted accounting principles (“GAAP”). We provide this measurement (net of distributor marketing payments, channel rebates and adjustments to the allowance for doubtful accounts) in reporting financial performance because this measurement provides a consistent basis for understanding our sales activities each period. We believe the billings measurement is useful because the GAAP measurements of revenue and deferred revenue in the current period include subscription contracts commenced in prior periods.
Total billings decreased 3% to $81.5 million during the third quarter of 2012 from $84.3 million during the third quarter of 2011, primarily due to the negative impact of currency exchange rates on billings as well as fewer customer upgrades in the United States in the third quarter of 2012 compared with the third quarter of 2011. Our appliance billings decreased from $8.0 million in the third quarter of 2011 to $6.9 million in the third quarter of 2012, primarily due to reduced software billings as software sales are the general driver of our appliance sales.
Billings from our TRITON content security solutions accounted for 61% of total billings in the third quarter of 2012 and grew approximately 9% to $49.4 million, from $45.3 million in the third quarter of 2011, whereas billings from our non-TRITON solution products declined 18% to $32.1 million in the third quarter of 2012 from $39.0 million in the third quarter of 2011. The decrease in non-TRITON billings reflects the ongoing migration of existing customers to our more advanced TRITON security solutions, and to a lesser extent, customer losses to lower priced competitive solutions. Our TRITON solutions include our TRITON family of security gateways for Web, email, mobile and data security (including related appliances and technical support subscriptions), our standalone data security suite and our cloud-based security solutions. Our non-TRITON solutions include our Web filtering products, such as our Websense Web Filter, Web Security Suite, server-based email security and related hardware. We expect the proportion of billings from our TRITON solutions to increase slightly as a percentage of total billings in the fourth quarter of 2012 compared with the fourth quarter of 2011.
Our international billings represented $42.2 million, or 52% of our total billings, for the third quarter of 2012, compared with $37.1 million, or 44% of total billings, for the third quarter of 2011, reflecting our maturing and stabilized international sales force.
Our average contract duration increased to 24.1 months for the third quarter of 2012, from 23.1 months for the third quarter of 2011 with approximately 49% of our billings in 12 month contracts, 7% in 24 month contracts and 44% in contracts with durations of 36 months or more. The average contract duration increased compared with the third quarter of 2011 due to the increase in sales of TRITON solutions and sales to new customers, which tend to have longer average contract durations. The number of transactions valued at over $100,000 in the third quarter of 2012 increased by 9% from 132 transactions to 144 transactions compared with the third quarter of 2011.
Our billings depend in part on the number of subscriptions up for renewal each quarter and are affected by cyclical variations, with the highest billings occurring in the fourth quarter and the lowest billings occurring in the first quarter. As a trend, the percentage of billings from subscriptions to our TRITON content security solutions, including those pre-installed on appliances is increasing, and the percentage of billings from our legacy filtering products is declining.
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. The majority of our revenues is derived from software and SaaS products sold on a subscription basis. A subscription is generally 12, 24 or 36 months in duration and for a fixed number of seats. We recognize revenues for the software and SaaS subscriptions, including any related technical support and professional services, on a daily straight-line basis, commencing on the date the term of the subscription begins, and continuing over the term of the subscription agreement, provided the fee is fixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred and collectability is reasonably assured. Upon entering into a subscription arrangement for a fixed or determinable fee, we electronically deliver software access codes to customers and then promptly invoice customers for the full amount of their subscriptions. Payment is due for the full term of the subscription, generally within 30 to 60 days of the invoice date.

19


In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove from the scope of industry-specific software revenue recognition guidance any tangible products containing software components and non-software components that operate together to deliver the product’s essential functionality. In addition, the FASB amended the accounting standards for certain multiple element revenue arrangements to:
provide updated guidance on whether multiple elements exist, how the elements in an arrangement should be separated, and how the arrangement consideration should be allocated to the separate elements; and
require an entity to allocate arrangement consideration to each element based on a selling price hierarchy, where the selling price for an element is based on vendor-specific objective evidence (“VSOE”), if available; third-party evidence (“TPE”), if available and VSOE is not available; or the best estimate of selling price (“BESP”), if neither VSOE nor TPE is available.
We adopted the amended standards as of January 1, 2011 on a prospective basis for transactions entered into or materially modified after December 31, 2010.
A portion of our revenues is generated from the sale of appliances, which are standard server platforms optimized for our software products. These appliances contain software components, such as operating systems, that operate together with the hardware platform to provide the essential functionality of the appliance. Based on accounting standards, when sold in a multiple element arrangement that includes software deliverables, our hardware appliances are considered non-software deliverables. When appliance orders are taken, we ship the product, invoice the customer and recognize revenues when title/risk of loss passes to the buyer (typically upon delivery to a common carrier) and the other criteria of revenue recognition are met. The revenues recognized are based upon BESP, as outlined further below.
For transactions entered into prior to the adoption of amended revenue standards on January 1, 2011, all elements in a multiple element arrangement containing software were treated as a single unit of accounting as we did not have adequate support for VSOE of undelivered elements. As a result, we deferred revenue on our multiple element arrangements until only the post-contract customer support (database updates and technical support) or other services not essential to the functionality of the software remained undelivered. At that point, the revenue was amortized over the remaining life of the software subscription or estimated delivery term of the services, whichever was longer.
For transactions entered into subsequent to the adoption of the amended revenue recognition standards that are multiple element arrangements, we allocate the arrangement fee to the software-related elements and the non-software-related elements based upon the relative selling price of such element. When applying the relative selling price method, we determine the selling price for each element using BESP, because VSOE and TPE are not available. The revenues allocated to the software-related elements are recognized based on the industry-specific software revenue recognition guidance that remains unchanged. The revenues allocated to the non-software-related elements are recognized based on the nature of the element provided the fee is fixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred and collectability is reasonably assured. The manner in which we account for multiple element arrangements that contain only software and software-related elements remains unchanged.
We determine BESP for an individual element within a multiple element revenue arrangement using the same methods utilized to determine the selling price of an element sold on a standalone basis. We estimate the selling price by considering internal factors such as historical pricing practices and gross margin objectives. Consideration is also given to market conditions such as competitor pricing strategies, customer demands and geography. As there is a significant amount of judgment when determining BESP, we review all of our assumptions and inputs around BESP on a quarterly basis and maintain internal controls over the establishment and updates of these estimates.
During the three and nine months ended September 30, 2012, we recognized $8.1 million and $23.8 million, respectively, in revenues from appliance sales, of which $6.6 million and $19.0 million, respectively, represented the immediate recognition of revenue upon shipment and the remaining $1.5 million and $4.8 million, respectively, represented primarily the ratable recognition of deferred revenue from appliance sales recorded prior to the adoption of the amended revenue recognition rules. We expect to recognize revenues of $1.2 million throughout the remainder of 2012 from appliance sales made prior to 2011 that are recorded in deferred revenue as of September 30, 2012. The amended revenue recognition standards are expected to continue to affect total revenues in future periods, although the impact on the timing and pattern of revenues will vary depending on the nature and volume of new or materially modified contracts in any given period.

20


For our OEM contracts, we grant our OEM customers the right to incorporate our products into the OEMs’ products or services for resale to end users. The OEM customers generally pay us a royalty fee for each resale of our product to an end user over a specified period of time. We recognize revenues associated with the OEM contracts ratably over the contractual period for which we are obligated to provide our services to the OEMs, which will vary for each OEM depending on the information available, such as underlying end user subscription periods. To the extent we provide any custom software and engineering services in connection with an OEM arrangement, we defer recognition of all revenue until acceptance of the custom software.
We record distributor marketing payments and channel rebates as an offset to revenues, unless we receive an identifiable benefit in exchange for the consideration and we can estimate the fair value of the benefit received. We recognize distributor marketing payments as an offset to revenues in the period the marketing service is provided, and we recognize channel rebates as an offset to revenues generally on a straight-line basis over the term of the underlying subscription sale.
Income Taxes. We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes may be due. These reserves for tax contingencies are established when we believe that certain positions might be challenged despite our belief that our tax return positions are consistent with prevailing law and practice. We adjust these reserves in light of changing facts and circumstances, such as the outcome of tax audits. The provision for income taxes includes the impact of these reserves and changes to the reserves that are considered appropriate.
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.
Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the extent we believe it is more likely than not that all or a portion of the deferred tax assets will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience and expectations of future taxable income by taxing jurisdiction, the carry-forward periods available for tax reporting purposes and other relevant factors.
As previously disclosed in our periodic reports filed with the Securities and Exchange Commission, during the first quarter of 2010 the U.S. Internal Revenue Service ("IRS") completed its audit for the tax years ended December 31, 2005 through December 31, 2007 and issued us a letter which outlined all of its proposed audit adjustments. The adjustments related primarily to the cost sharing arrangement between Websense, Inc. and its Irish subsidiary, including the amount of cost sharing buy-in, as well as to our claim of research and development tax credits and income tax deductions for equity compensation awarded to certain executive officers. The amount of additional tax initially proposed by the IRS for the audited years totaled approximately $19.0 million, of which $14.8 million related to the amount of the cost sharing buy-in, $2.5 million related to research and development credits and $1.7 million related to equity compensation awarded to certain executive officers. The total additional tax proposed excluded interest, penalties, state income taxes and a potential reduction in tax on the Irish subsidiary. We disagreed with all of the proposed adjustments and submitted a formal protest to the IRS for each matter. In the third quarter of 2011, the IRS withdrew the proposed adjustment relating to equity compensation.
    
In the first quarter of 2012, we reached an agreement in principle with the IRS Appeals Office to settle the remaining audit adjustments related to the cost sharing buy-in and research and development tax credits. Due to these negotiations, we recorded a tax provision of $8.8 million in the quarter ended March 31, 2012. As a result of the final settlement with the IRS under a closing agreement we entered into on September 20, 2012, we made payments in the aggregate amount of $14.7 million in the third quarter of 2012, consisting of (i) $7.1 million in U.S. federal tax related to the proposed adjustments, (ii) $5.4 million in state tax and accumulated interest related to the additional federal and state taxes and (iii) $2.2 million of U.S. federal tax related to the payment of $23.4 million owed to Websense, Inc. by its Irish subsidiary which will be settled through an intercompany loan agreement.


21


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 value of net assets acquired is recorded as goodwill.
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 for impairment by analyzing facts and circumstances, either external or internal, indicating that we may not recover the carrying value of the asset. We measure impairment losses related to long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values. We measure fair value generally based on the estimated future cash flows generated by the asset. Our analysis is based on available information and on assumptions and projections that we consider to be reasonable and supportable. If necessary, we perform subsequent calculations to measure the amount of the impairment loss based on the excess of the carrying value over the fair value of the impaired assets.
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 option valuation model. Share-based compensation expense related to restricted stock unit awards is calculated based on the market price of our common stock on the date of grant.
Performance-based restricted stock units have performance-based vesting components that vest only if performance criteria are met for each respective performance period. If the performance criteria are not met for a performance period, then the related performance awards that would have vested are forfeited. Certain performance criteria allow for different vested amounts based on the level of achievement of the performance criteria. Once the performance based vesting criteria is met, the awards are then subject to time-based vesting. Fair value is measured on the grant date and is recognized over the expected vesting period, provided we determine it is probable that the performance criteria will be met.
At September 30, 2012, there was $39.0 million of total unrecognized compensation cost related to share-based compensation arrangements granted under all equity compensation plans (excluding tax effects). This total unrecognized compensation cost will be adjusted for estimated forfeitures as well as for future changes in estimated forfeitures. We expect to recognize this cost over a weighted-average period of approximately 2.1 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 bond 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. We use historical data to estimate pre-vesting option forfeitures and record share-based expense only for those awards that are expected to vest. We may elect to use different assumptions under the Black-Scholes option valuation model in the future or select a different option valuation model altogether, which could materially affect our results of operations in the future.
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.

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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 September 30, 2012 compared with the three months ended September 30, 2011
The following table summarizes our operating results as a percentage of total revenues for each of the periods shown.
 
Three Months Ended September 30,
 
2012
 
2011
Revenues:
 
 
 
Software and service
91
%
 
89
%
Appliance
9

 
11

Total revenues
100

 
100

Cost of revenues:
 
 
 
Software and service
13

 
11

Appliance
4

 
5

Total cost of revenues
17

 
16

Gross profit
83

 
84

Operating expenses:
 
 
 
Selling and marketing
40

 
42

Research and development
17

 
16

General and administrative
11

 
11

Total operating expenses
68

 
69

Income from operations
15

 
15

Interest expense
(1
)
 

Other income (expense), net

 

Income before income taxes
14

 
15

Provision for income taxes
5

 
6

Net income
9
%
 
9
%


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Revenues
Software and service revenues. Software and service revenues increased to $82.3 million in the third quarter of 2012 from $81.8 million in the third quarter of 2011. The increase was primarily the result of year-over-year growth in billings for TRITON software and service during 2011 and the first nine months of 2012, which resulted in higher beginning current deferred software and service revenue and higher revenues recognized in the current period, compared with the third quarter of 2011. Because we recognize software and service revenues ratably over the term of the subscription, growth in software and service revenues reflects changes in current deferred revenue at the beginning of the period compared with the prior period, as well as the change in current period billings.
Software and service revenues generated in the United States accounted for $39.7 million, or 44% of third quarter 2012 revenues, compared with $40.3 million, also 44% of revenues, in the third quarter of 2011. International software and service revenues accounted for $42.6 million, or 47% of third quarter 2012 revenues, compared with $41.5 million, or 45% of revenues, in the third quarter of 2011.
Current deferred software and service revenue was $228.4 million as of September 30, 2012, compared with $231.6 million as of September 30, 2011. Total deferred software and service revenue was $364.9 million as of September 30, 2012, compared with $358.2 million as of September 30, 2011. Of the $228.4 million in current deferred software and service revenue as of September 30, 2012, $78.9 million is expected to be recognized as revenue in the fourth quarter of 2012.
We expect our software and service revenues to be relatively flat in absolute dollars and as a percentage of revenue in the fourth quarter of 2012 compared with the fourth quarter of 2011. Our software and service revenues are impacted by the duration of contracts billed, the timing of sales of renewal and new subscriptions, the average annual contract value and per seat price, the volume of OEM sales activity and the effect of currency exchange rates on new and renewal subscriptions in international markets.
Appliance revenues. Third quarter appliance revenues of $8.1 million consisted of $6.6 million in revenue from sales of appliances sold in the third quarter of 2012 and $1.5 million recognized primarily from deferred revenue for sales of appliances recorded prior to the adoption of the amended revenue recognition rules, as described above. This compares with $10.3 million in appliance revenues in the third quarter of 2011, which included $7.7 million in revenue from appliances sold in the third quarter of 2011 and $2.6 million recognized from deferred revenue. The decrease in total appliance revenue reflects reduced appliance sales of $1.1 million in the third quarter of 2012 as well as the decline in appliance revenue recognized from deferred revenue compared with the third quarter of 2011, due to the adoption of the amended revenue recognition rules related to hardware sales. As of September 30, 2012, deferred appliance revenue was $5.8 million and included $3.9 million related to appliance sales recorded prior to the adoption of the amended revenue recognition rules.
Appliance revenues generated in the United States accounted for $3.8 million, or 4% of third quarter 2012 revenues, compared with $5.6 million, or 6% of revenues, in the third quarter of 2011. Appliance revenues generated internationally accounted for $4.3 million, or 5% of third quarter 2012 revenues, compared with $4.7 million, also 5% of revenues, in the third quarter of 2011.
In the fourth quarter of 2012, we expect our appliance revenues to decrease as compared with 2011 appliance revenues primarily as a result of the decline in deferred appliance revenue to be recognized in the remainder of 2012. In the fourth quarter of 2012, we expect to recognize $1.2 million of deferred revenue for appliance sales recorded prior to January 1, 2011.
Cost of Revenues
Software and service cost of revenues. Software and service cost of revenues consists of the costs of Web content analysis, amortization of acquired technology, technical support and infrastructure costs associated with maintaining our databases and costs associated with providing our SaaS offerings. Software and service cost of revenues increased to $11.6 million in the third quarter of 2012 from $10.2 million in the third quarter of 2011. The $1.4 million increase was primarily due to increased costs of operating our infrastructure for our SaaS offerings. As a percentage of total revenues, software and service cost of revenues were 13% during the third quarter of 2012 and 11% during the third quarter of 2011. We expect software and service cost of revenues will increase in absolute dollars and as a percentage of software and service revenues in the remainder of 2012 as compared with 2011.

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Appliance cost of revenues. Appliance cost of revenues consists of the costs associated with the sale of our appliance products, primarily the cost of the hardware platform and software installation costs. Appliance cost of revenues decreased to $3.3 million in the third quarter of 2012 from $4.7 million in the third quarter of 2011. The $1.4 million decrease was primarily due to the decreased number of appliances sold as well as the decreased cost of revenues from sales prior to 2011. In appliance cost of revenues for the third quarter of 2012, we recognized $0.6 million of the ratable cost of appliances sold prior to 2011 compared with $1.1 million in the third quarter of 2011. The remaining $2.7 million represents costs of appliances sold in the third quarter of 2012. As a percentage of total revenues, appliance cost of revenues were 4% and 5% during the third quarter of 2012 and third quarter of 2011, respectively.
We expect appliance cost of revenues will remain relatively flat in absolute dollars and as a percentage of revenues in the fourth quarter of 2012 compared with the fourth quarter of 2011. In the fourth quarter of 2012, we expect to recognize $0.5 million in deferred cost of revenues recorded prior to January 1, 2011.
Gross Profit
Gross profit decreased to $75.4 million in the third quarter of 2012 from $77.2 million in the third quarter of 2011, primarily as a result of decreased appliance revenues and increased cost of revenues related to our expanding SaaS infrastructure. As a percentage of total revenues, our gross profit was 83% in the third quarter of 2012 and 84% in the third quarter of 2011. We expect that gross profit as a percentage of total revenues will remain in excess of 80% for the remainder of 2012.
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, costs related to public relations, advertising, promotions and travel, amortization of acquired customer relationships and other allocated costs. Selling and marketing expenses do not include payments to channel partners for marketing services and rebates as those are recorded as an offset to revenues.
Selling and marketing expenses were $35.7 million, or 40% of revenues, in the third quarter of 2012, compared with $38.4 million, or 42% of revenues, in the third quarter of 2011. The $2.7 million decrease in total selling and marketing expenses was primarily due to decreased amortization of acquired intangibles of $1.6 million, as certain customer relationships were fully amortized in 2011, as well as decreased travel costs.
We expect overall selling and marketing expenses to increase in absolute dollars and as a percentage of revenues for the fourth quarter of 2012 compared with the fourth quarter of 2011, as we expect to experience an increase in our selling and marketing expenses associated with increased headcount.
If our billings in the fourth quarter of 2012 exceed expectations, our sales commission expenses can be expected to exceed our forecasts and result in higher than expected selling and marketing expenses. Because commission expenses are primarily recognized in the period incurred, while a substantial portion of revenues are recognized in future periods, if our 2012 billings exceed expectations, our selling and marketing expenses as a percentage of revenues could increase in the fourth quarter of 2012 compared with 2011. Based on the existing sales and marketing related intangible assets as of September 30, 2012, we expect amortization of sales and marketing related acquired intangibles of $1.5 million for the remainder of 2012, which would be a reduction of approximately $1.6 million in comparison to the fourth quarter of 2011.
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 $15.8 million, or 17% of revenues, in the third quarter of 2012 from $15.1 million, or 16% of revenues, in the third quarter of 2011. The increase of $0.7 million in research and development expenses was primarily due to increased personnel costs. We allocate the costs for human resources, employee benefits, payroll taxes, IT, facilities and fixed asset depreciation to each of our functional areas based on headcount data. Although our headcount increased in research and development from an average of 495 employees for the third quarter of 2011 to an average of 523 employees for the third quarter of 2012, the impact of the higher headcount was partially offset by an increase in the number of employees in relatively low cost foreign locations.
We expect research and development expenses to increase in absolute dollars and as a percentage of revenue in the fourth quarter of 2012 compared with the fourth quarter of 2011 due to an expanded base of product offerings and increased average headcount to support our continued enhancements and new product developments. Fluctuations in foreign currencies may also impact our research and development expenses in 2012.

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We are managing the increase in our research and development expenses by operating research and development facilities in multiple lower cost international locations, including facilities in Beijing, China and Ra’anana, Israel. We also have research and development facilities in Los Gatos and San Diego, California and Reading, England.
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 remained consistent at $10.1 million, or 11% of revenues, in the third quarter of 2012 compared with $10.0 million, also 11% of revenues, in the third quarter of 2011.
We expect general and administrative expenses to increase in absolute dollars and as a percentage of revenue in the fourth quarter of 2012 compared with the fourth quarter of 2011 due to increased third-party professional service fees.
Interest Expense
Interest expense increased to $0.6 million in the third quarter of 2012 from $0.4 million in the third quarter of 2011, primarily due to interest expense recognized on an unfavorable interest rate swap that became effective on December 30, 2011. The average outstanding loan balance on our secured loan was $68.0 million during the third quarter of 2012 and 2011.
Under the secured loan issued pursuant to the senior credit facility which we entered into in October 2010 (the “2010 Credit Agreement” or the “2010 Credit Facility”), we made no principal payments during the third quarter of 2012 and borrowed a total of $10 million (net of principal payments) during the third quarter of 2011. We expect interest expense to remain moderately higher in 2012 compared with 2011 primarily due to an increase in the notional amount of principal subject to an unfavorable fixed rate swap agreement.
Other Income (Expense), Net
Other expense was $0.1 million in the third quarter of 2012, compared with $0.2 million other income in the third quarter of 2011.
Provision for Income Taxes
For the three months ended September 30, 2012, we recognized an income tax expense of $4.6 million compared with an income tax expense of $5.4 million for the three months ended September 30, 2011. The effective tax rates were 35.4% for the three months ended September 30, 2012 and 40.1% for the three months ended September 30, 2011. For the third quarter of 2012, the effective tax rate variance from the U.S. federal statutory rate was primarily related to the favorable impact from earnings in lower tax rate jurisdictions offset by the unfavorable impact of foreign withholding taxes and non-deductible share-based payments. For the third quarter of 2011, the effective tax rate variance from the U.S. federal statutory rate was primarily related to the unfavorable impact of foreign withholding taxes, non-deductible share-based payments and increased earnings in higher tax rate jurisdictions.
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 third quarter of 2012, specifically the expected reversal of existing taxable temporary differences and a history of generating taxable income in applicable tax jurisdictions, we believe that it is more likely than not that we will fully realize the balance of the deferred tax assets currently reflected on our consolidated balance sheets.


26


Results of Operations
Nine months ended September 30, 2012 compared with the nine months ended September 30, 2011
The following table summarizes our operating results as a percentage of total revenues for each of the periods shown.
 
Nine Months Ended September 30,
 
2012
 
2011
Revenues:
 
 
 
Software and service
91
%
 
90
%
Appliance
9

 
10

Total revenues
100

 
100

Cost of revenues:
 
 
 
Software and service
12

 
11

Appliance
4

 
5

Total cost of revenues
16

 
16

Gross profit
84

 
84

Operating expenses:
 
 
 
Selling and marketing
42

 
45

Research and development
17

 
16

General and administrative
11

 
11

Total operating expenses
70

 
72

Income from operations
14

 
12

Interest expense
(1
)
 

Other income (expense), net

 

Income before income taxes
13

 
12

Provision for income taxes
7

 
4

Net income
6
%
 
8
%

Revenues
Software and service revenues. Software and service revenues increased to $246.0 million in the first nine months of 2012 from $243.1 million in the first nine months of 2011. The increase was primarily the result of year-over-year growth in billings for TRITON software and service during 2011 and the first nine months of 2012, which resulted in higher beginning current deferred software and service revenue and higher revenues recognized in the current period, compared with the first nine months of 2011.
Software and service revenues generated in the United States accounted for $119.7 million, or 44% of the first nine months of 2012 revenues, compared with $121.1 million, or 45% of revenues, in the first nine months of 2011. International software and service revenues accounted for $126.3 million, or 47% of the first nine months of 2012 revenues, compared with $122.0 million, or 45% of revenues, in the first nine months of 2011.
Appliance revenues. The first nine months of 2012 appliance revenues of $23.8 million consisted of $19.0 million in revenue from sales of appliances sold in the first nine months of 2012 and $4.8 million recognized from deferred revenue for sales of appliances recorded prior to the adoption of the amended revenue recognition rules, as described previously. This compares with $28.4 million in appliance revenues in the first nine months of 2011, which included $19.1 million in revenue from appliances sold in the first nine months of 2011 and $9.3 million recognized from deferred revenue. The decrease in total appliance revenues was primarily the result of the decline in appliance revenue recognized from deferred revenue in the first nine months of 2012 compared with the first nine months of 2011, due to the adoption of the amended revenue recognition rules.
Appliance revenues generated in the United States accounted for $11.1 million, or 4% of the first nine months of 2012 revenues, compared with $14.6 million, or 5% of revenues, in the first nine months of 2011. Appliance revenues generated internationally accounted for $12.7 million, or 5% of the first nine months of 2012 revenues, compared with $13.8 million, also 5% of revenues, in the first nine months of 2011.

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Cost of Revenues
Software and service cost of revenues. Software and service cost of revenues increased to $33.9 million in the first nine months of 2012 from $31.0 million in the first nine months of 2011. The $2.9 million increase was primarily due to increased costs of operating our infrastructure for our SaaS offerings. Our full-time employee headcount in cost of revenues departments averaged approximately 260 employees during the first nine months of 2012 and 2011.
Appliance cost of revenues. Appliance cost of revenues decreased to $9.9 million in the first nine months of 2012 from $13.7 million in the first nine months of 2011. The $3.8 million decrease was primarily due to decreased cost of revenues from sales prior to 2011. In appliance cost of revenues for the first nine months of 2012, we recognized $2.1 million of the ratable cost of appliances sold prior to 2011 compared with $4.2 million in the first nine months of 2011. The remaining $7.8 million represents costs of appliances sold in the first nine months of 2012 as compared with $9.5 million in the first nine months of 2011. As a percentage of total revenues, appliance cost of revenues decreased to 4% in the first nine months of 2012 from 5% during the first nine months of 2011.
Gross Profit
Gross profit decreased slightly to $225.9 million in the first nine months of 2012 from $226.8 million in the first nine months of 2011, primarily as a result of decreased appliance revenues and increased cost of revenues related to our expanding SaaS infrastructure. As a percentage of total revenues, our gross profit was 84% in the first nine months of 2012 and 2011.
Operating Expenses
Selling and marketing. Selling and marketing expenses were $112.2 million, or 42% of revenues, in the first nine months of 2012, compared with $121.3, or 45% of revenues, in the first nine months of 2011. The $9.1 million decrease in total selling and marketing expenses was primarily due to a decrease in amortization of acquired intangibles of $4.9 million, as certain customer relationships were fully amortized in 2011. The remaining decrease is related to a reduction in travel and personnelcosts.
Research and development. Research and development expenses increased to $46.7 million, or 17% of revenues, in the first nine months of 2012 from $43.6 million, or 16% of revenues, in the first nine months of 2011. The increase of $3.1 million in research and development expenses was primarily due to increased personnel costs of $2.1 million and increased allocated costs of $1.1 million. Although our headcount increased in research and development from an average of 488 employees for the first nine months of 2011 to an average of 516 employees for the first nine months of 2012, the impact of the higher headcount was partially mitigated by an increase in the number of employees in relatively low cost foreign locations.
General and administrative. General and administrative expenses remained flat in the first nine months of 2012 at $31.0 million compared with the first nine months of 2011, representing 11% of revenues in both periods.
Interest Expense
Interest expense increased to $1.9 million in the first nine months of 2012 from $1.2 million in the first nine months of 2011, primarily due to a higher average outstanding loan balance on our secured loan of $69.3 million during the first nine months of 2012 compared with an average loan balance of $66.5 million during the first nine months of 2011, as well as interest expense recognized on an unfavorable interest rate swap that became effective on December 30, 2011.
Under the secured loan made pursuant to the 2010 Credit Facility, we made $5.0 million of principal payments during the first nine months of 2012 and borrowed a total of $6.0 million (net of principal payments) during the first nine months of 2011. We expect interest expense to remain higher in 2012 compared with 2011 primarily due to higher average borrowings and an increase in the notional amount of principal subject to an unfavorable fixed rate swap agreement.
Other Income (Expense), Net    
Other expense was $0.2 million expense in the first nine months of 2012, compared with $1.5 million other income in the first nine months of 2011. Other income in the first nine months of 2011 included a non-recurring gain on foreign currency transactions of $1.4 million.

28


Provision for Income Taxes
For the nine months ended September 30, 2012, we recognized an income tax expense of $19.3 million compared with an income tax expense of $10.8 million for the nine months ended September 30, 2011. The effective tax rates were 57.0% for the nine months ended September 30, 2012 and 34.3% for the nine months ended September 30, 2011. For the first nine months of 2012, the effective tax rate variance from the U.S. federal statutory rate was primarily related to the tax provision of $8.8 million recorded in the first quarter of 2012 resulting from an agreement in principle with the IRS, as discussed previously, as well as the unfavorable impact of foreign withholding taxes and non-deductible share-based payments, partially offset by the favorable impact from earnings in lower tax rate jurisdictions. For the first nine months of 2011, the effective tax rate variance from the U.S. federal statutory rate was primarily related to the unfavorable impact of foreign withholding taxes and non-deductible share-based payments, offset by a non-recurring net discrete tax benefit of $2.8 million related primarily to our global distribution restructuring. This $2.8 million net tax benefit primarily relates to the non-recurring tax effect from the transfer of customer relationship intangible assets and the related deferred tax liabilities from a higher tax rate jurisdiction to a lower tax rate jurisdiction. The entire net tax benefit of $2.8 million was reflected in the first quarter of 2011 upon completion of our global distribution restructuring and is not expected to recur.
Liquidity and Capital Resources
As of September 30, 2012, we had cash and cash equivalents of $57.6 million and retained earnings of $86.8 million. Of the $57.6 million of cash and cash equivalents held as of September 30, 2012, $37.1 million was held by our foreign subsidiaries, and we plan to indefinitely reinvest the undistributed foreign earnings into our foreign operations. During the first nine months of 2012, we primarily used cash in excess of cash required for operations to repurchase $44.7 million of our stock and to make principal payments of $5.0 million under the 2010 Credit Agreement.
Net cash provided by operating activities was $37.8 million in the first nine months of 2012, compared with $57.3 million in the first nine months of 2011. The decrease in cash flow from operations for the first nine months of 2012 compared with the first nine months of 2011 was primarily a result of higher cash taxes in 2012 due to a settlement of certain tax obligations with the IRS related to prior years which resulted in $14.7 million in cash tax payments in the third quarter of 2012. Our operating cash flow is typically more significantly influenced by the timing of new and renewal subscriptions, accounts receivable collections and cash expenses. A decrease in sales of new and/or renewal subscriptions or accounts receivable collections, or an increase in our cash expenses, would negatively impact our operating cash flow.
Net cash used in investing activities was $9.6 million in the first nine months of 2012, compared with $7.6 million in the first nine months of 2011. The $2.0 million increase in net cash used in investing activities was primarily due to increased purchases of property and equipment during the first nine months of 2012 compared with the first nine months of 2011.
Net cash used in financing activities was $46.7 million in the first nine months of 2012, compared with $51.2 million in the first nine months of 2011. In the first nine months of 2012, we used approximately $44.7 million to repurchase our common stock and made principal payments of $5.0 million under the 2010 Credit Agreement. The $4.5 million decrease in cash used in financing activities was driven primarily by a reduction in repurchases of our common stock during the first nine months of 2012 compared with the first nine months of 2011, partially offset by a reduction in the proceeds from exercises of stock options and reduced borrowings on our secured loan during the same period.
In October 2010, we entered into the 2010 Credit Agreement. The 2010 Credit Agreement provides for a secured revolving credit facility that matures on October 29, 2015 with an initial maximum aggregate commitment of $120 million, including a $15 million sublimit for issuances of letters of credit and a $5 million sublimit for swing line loans. We may increase the maximum aggregate commitment under the 2010 Credit Agreement to up to $200 million if certain conditions are satisfied, including that we are not in default under the 2010 Credit Agreement at the time of the increase. Loans under the 2010 Credit Agreement are designated, at our election, as either base rate or Eurodollar rate loans. Base rate loans bear interest at a rate equal to (i) the highest of (a) the federal funds rate plus 0.5%, (b) the Eurodollar rate plus 1.00%, and (c) Bank of America’s prime rate, plus (ii) a margin set forth below. Eurodollar rate loans bear interest at a rate equal to (i) the Eurodollar rate, plus (ii) a margin set forth below. As of September 30, 2012, the total amount outstanding under the 2010 Credit Facility was $68.0 million and the weighted average interest rate was 3.11%.
    

29


The applicable margins are determined by reference to our leverage ratio, as set forth in the table below:
Consolidated Leverage Ratio
 
Eurodollar Rate
    Loans    
 
Base Rate
    Loans    
<1.25:1.0
 
1.75%
 
0.75%
≥1.25:1.0
 
2.00%
 
1.00%
Indebtedness under the 2010 Credit Agreement is secured by substantially all of our assets, including pledges of stock of certain of our subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by our domestic subsidiaries. The 2010 Credit Agreement contains affirmative and negative covenants, including an obligation to maintain a certain consolidated leverage ratio and consolidated interest coverage ratio and restrictions on our ability to borrow money, to incur liens, to enter into mergers and acquisitions, to make dispositions, to pay cash dividends or repurchase capital stock, and to make investments, subject to certain exceptions. The 2010 Credit Agreement does not require us to use excess cash to pay down debt.
The 2010 Credit Agreement provides for acceleration of our obligations thereunder upon certain events of default. The events of default include, without limitation, failure to pay loan amounts when due, any material inaccuracy in our representations and warranties, failure to observe covenants, defaults on any other indebtedness, entering bankruptcy, existence of a judgment or decree against us or our subsidiaries involving an aggregate liability of $10 million or more, the security interest or guarantee ceasing to be in full force and effect, any person becoming the beneficial owner of more than 35% of our outstanding common stock, or our board of directors ceasing to consist of a majority of Continuing Directors (as defined in the 2010 Credit Agreement).
Obligations and commitments. The following table summarizes our contractual payment obligations and commitments as of September 30, 2012 (in thousands):
 
Payment Obligations by Year
 
2012
 
2013
 
2014
 
2015
 
2016
 
Thereafter
 
Total
2010 Credit Agreement:
 
 
 
 
 
 
 
 
 
 
 
 
 
Contractual principal payments
$

 
$

 
$

 
$
68,000

 
$

 
$

 
$
68,000

Estimated interest and fees
596

 
2,314

 
2,314

 
1,916

 

 

 
7,140

Operating leases
1,899

 
6,948

 
2,349

 
823

 

 

 
12,019

Other commitments
163

 
2,194

 
1,623

 
3

 

 

 
3,983

Total
$
2,658

 
$
11,456

 
$
6,286

 
$
70,742

 
$

 
$

 
$
91,142

Obligations under our 2010 Credit Agreement represent the future minimum principal debt payments due under this facility. Estimated interest and fees expected to be incurred on the 2010 Credit Facility are based on known rates and scheduled principal payments, as well as the interest rate swap agreement, as of September 30, 2012 (see Notes 4 and 5 to the consolidated financial statements).
We lease our facilities under operating lease agreements that expire at various dates through 2015. Approximately 30% of our operating lease commitments are related to our corporate headquarters lease in San Diego, which has escalating rent payments through 2013. The San Diego lease expires in December 2013; however, we have an option to extend the lease for an additional five years. The rent expense related to our worldwide office space leases is generally recorded monthly on a straight-line basis in accordance with GAAP.
Included in other commitments above are contractual commitment obligations as of September 30, 2012 for inbound software licenses, equipment maintenance, royalty agreements and automobile leases.
Our total gross liability for uncertain tax positions is $10.9 million as of September 30, 2012. We are not able to reasonably estimate the timing of future cash settlement with the respective taxing authorities and have therefore excluded this amount from the contractual obligations table above.

30


In April 2003, we announced that our board of directors authorized a stock repurchase program of up to four million shares of our common stock. In August 2005, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to eight million shares. In July 2006, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to twelve million shares. In January 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to 16 million shares. In October 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional eight million shares, for a total program size of up to 24 million shares. The stock repurchase program does not have an expiration date, does not require us to purchase a specific number of shares and provides the board of directors with authority to modify, suspend or terminate the program at any time. Effective July 17, 2012, the board of directors suspended the stock repurchase program, after repurchasing approximately $2.9 million of our common stock in the third quarter of 2012, to better align with third quarter cash flow. In October 2012, the board of directors resumed the stock repurchase program and authorized management to repurchase up to $5.0 million of the Company's common stock in the fourth quarter of 2012.
In connection with the stock repurchase program, we adopted two 10b5-1 stock repurchase plans (the “2009 Repurchase Plans”) in August 2009. The 2009 Repurchase Plans initially provided for purchases of up to an aggregate of $7.5 million of our common stock per calendar quarter in open market transactions beginning in October 2009. In November 2010, we increased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $7.5 million to $25 million per calendar quarter, effective as of January 1, 2011. In October 2011, we decreased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $25 million to $20 million per calendar quarter effective as of January 1, 2012. The 2009 Repurchase Plans provide for stock repurchases to be made on the open market at prevailing market prices in accordance with certain timing conditions. The 2009 Repurchase Plans were suspended on July 17, 2012, in connection with the suspension of the stock repurchase program. With the resumption of the stock repurchase program by the board of directors, we have resumed repurchasing stock under a 10b5-1 plan. During the first nine months of 2012, we repurchased 2,268,696 shares of our common stock for an aggregate of approximately $42.9 million at an average price of $18.91 per share. As of September 30, 2012, we had repurchased a total of 22,680,517 shares of our common stock under this stock repurchase program, for an aggregate of $452.7 million at an average price of $19.96 per share. The 2010 Credit Agreement permits us to repurchase our securities so long as we are not in default under the 2010 Credit Agreement, have complied with all of our financial covenants, and have liquidity of at least $20 million; provided, however, if, after giving effect to any repurchase, our consolidated leverage ratio is greater than 1.75:1, such repurchase cannot exceed $10.0 million in the aggregate in any fiscal year.
We 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 and debt repayment obligations, if any, for at least the next 12 months. During the first nine months of 2012, we made principal payments of $5.0 million on our secured loan and repurchased approximately $42.9 million of our common stock. Our cash requirements may increase if, as part of our growth strategy, we make acquisitions that increase our cash requirements, or for reasons we do not currently foresee. We may elect to borrow under the 2010 Credit Agreement, raise funds for these purposes or reduce our cost of capital through capital markets transactions or debt or private equity transactions as appropriate. We intend to continue to invest our cash in excess of current operating and capital requirements in interest-bearing, investment-grade money market funds.
Off-Balance Sheet Arrangements
As of September 30, 2012, we did not have any off-balance sheet arrangements.

31



Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk
Our market risk exposures are related to our cash and cash equivalents and the 2010 Credit Facility. We invest our excess cash in highly liquid short-term investments such as money market funds. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and the interest expense incurred on our secured loan and therefore impact our cash flows and results of operations.
We are exposed to changes in interest rates primarily from our money market funds and from our borrowings at variable rates under the 2010 Credit Facility. In connection with the 2010 Credit Agreement, we entered into an interest rate swap agreement to pay a fixed rate of interest (1.778% per annum) and receive a floating rate interest payment (based on the three-month LIBOR) on a principal amount of $50 million. The $50 million swap agreement became effective on December 30, 2011 and expires on October 29, 2015.
A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would materially affect our interest expense. However, the impact of this type of adverse movement would be partially mitigated by our interest rate swap agreement that became effective on December 30, 2011. Based on our revolving credit balance at September 30, 2012 and taking into consideration our interest rate swap agreement, our interest expense would increase on a pre‑tax basis by approximately $0.2 million during the next 12 months if a 100 basis point adverse move in the interest rate yield curve occurred.
A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive investments at September 30, 2012. Changes in interest rates over time will, however, affect our interest income.
Foreign Currency Exchange Rate Risk
We sell our products through a distribution network in approximately 130 countries, and we bill certain international customers in Euros, British Pounds, Australian Dollars, Japanese Yen and Chinese Renminbi. Additionally, a significant portion of our foreign subsidiaries’ operating expenses are incurred in foreign currencies. As a result, our financial results could be significantly affected by factors such as changes in foreign currency exchange rates or weak economic conditions in the foreign markets in which we sell our products. We hedged our Israeli Shekel denominated operating expenses during the third quarter of 2012 due to the increased volatility of the Israeli Shekel. All of the Israeli Shekel hedging contracts in place as of September 30, 2012 will be settled before August 2013.
To mitigate the effect of changes in currency exchange rates, we utilize foreign currency forward contracts and zero‑cost collar contracts to hedge foreign currency market exposures of underlying assets, liabilities and expenses. We also keep working funds necessary to facilitate the short-term operations of our subsidiaries in the local currencies in which they do business. As exchange rate fluctuations can significantly vary our sales and expense results when converted to U.S. dollars, our objective is to reduce the risk to earnings and cash flows associated with changes in currency exchange rates. We do not use foreign currency contracts for speculative or trading purposes.
Notional and fair values of our hedging positions at September 30, 2012 and December 31, 2011 are presented in the table below (in thousands):
 
September 30, 2012
 
December 31, 2011
 
Notional
Value
Local
Currency
 
Notional
Value
USD
 
Fair
Value
USD
 
Notional
Value
Local
Currency
 
Notional
Value
USD
 
Fair
Value
USD
Fair Value Hedges
 
 
 
 
 
 
 
 
 
 
 
Euro
5,900

 
$
7,335

 
$
7,590

 
11,000

 
$
14,909

 
$
14,266

Australian dollar
1,500

 
$
1,537

 
$
1,550

 

 
$

 
$

Cash Flow Hedges
 
 
 
 
 
 
 
 
 
 
 
Israeli Shekel
18,666

 
$
4,845

 
$
4,745

 

 
$

 
$


32


The €5.1 million notional value decrease in our Euro hedge position at September 30, 2012 compared with December 31, 2011 was primarily a result of timing differences in when assets were acquired and/or liabilities incurred. All of the Euro hedging contracts in place as of September 30, 2012 are scheduled to be settled before March 2013. For the nine months ended September 30, 2012, less than 15% of our total billings were denominated in the Euro. We expect Euro billings to represent less than 15% of our total billings during 2012.
The AUD1.5 million notional value increase in our Australian Dollar hedge position at September 30, 2012 compared with December 31, 2011 was due to the incurrence of two Australian Dollar hedge contracts in place as of September 30, 2012. The Australian Dollar hedging contracts in place as of September 30, 2012 are scheduled to be settled before January 2013. For the nine months ended September 30, 2012, less than 5% of our total billings were denominated in the Australian Dollar. We expect Australian Dollar billings to represent less than 5% of our total billings during 2012.
During the nine months ended September 30, 2012, we utilized Israeli Shekel foreign currency forward contracts to hedge anticipated Israeli Shekel denominated operating expenses. All such contracts were designated as cash flow hedges and were considered effective. None of the contracts were terminated prior to settlement. Net unrealized losses of approximately $100,000 related to the contracts designated as cash flow hedges during the nine months ended September 30, 2012 and are included in comprehensive income as of September 30, 2012. All Israeli Shekel hedging contracts in place as of September 30, 2012 are scheduled to be settled before August 2013.
A significant portion of our foreign subsidiaries’ operating expenses are incurred in foreign currencies and if the U.S. dollar weakens, our consolidated operating expenses would increase. Should the U.S. dollar strengthen, our products may become more expensive for our international customers with subscription contracts denominated in U.S. dollars. Changes in currency rates also impact our future revenues under subscription contracts that are not denominated in U.S. dollars. Our revenues and deferred revenue for these foreign currencies are recorded in U.S. dollars when the 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”)) that are designed to ensure that the information required to be disclosed in the reports we file or submit under the Exchange Act is (a) recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and (b) accumulated and communicated to management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosure. As of the end of the period covered by this Quarterly Report on Form 10-Q, we carried out an evaluation, under the supervision and with the participation of our management, including our CEO and CFO, of the effectiveness and design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were effective as of September 30, 2012.
Changes In Internal Control over Financial Reporting
An evaluation was also performed under the supervision and with the participation of our management, including our CEO and CFO, of any change in our internal control over financial reporting that occurred during our last fiscal quarter. That evaluation did not identify any changes in our internal control over financial reporting during the nine months ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


33


Part II – Other Information

Item 1.
Legal Proceedings
On July 12, 2010, Finjan, Inc. filed a complaint entitled Finjan, Inc. v. McAfee, Inc., Symantec Corp., Webroot Software, Inc., Websense, Inc. and Sophos, Inc. in the United States District Court for the District of Delaware. The complaint alleges that by making, using, importing, selling and/or offering for sale Websense Web Filter, Websense Web Security and Websense Web Security Gateway, the Company infringes U.S. Patent No. 6,092,194 (“194 Patent”). Since filing the complaint, Finjan withdrew its contention that Web Filter and Web Security infringes the 194 Patent. Finjan has also accused additional products of infringing the 194 Patent in response to discovery and in expert reports, namely TRITON Enterprise, TRITON Security Gateway Anywhere, Websense Web Security Gateway Anywhere, Websense Web Security Gateway Hosted and the Websense V-Series appliances. Finjan seeks an injunction from further infringement of the 194 Patent and damages. The Court held a hearing on the construction of the claims in the 194 Patent on January 30, 2012 and issued a claim construction order on February 29, 2012. The Court has set a pretrial conference for November 5, 2012 and a trial date of December 3, 2012. We deny infringing any valid claims of the 194 Patent and intend to defend the lawsuit vigorously.
We are involved in various other legal actions in the normal course of business. Based on current information, including consultation with our lawyers, we cannot currently determine and have not accrued any liability that may result from any of our pending legal actions because we are unable to predict or reasonably estimate the possible losses, if any, relating to such actions. Our evaluation of the likely impact of these actions could change in the future, we may determine that we are required to accrue for potential liabilities in one or more legal actions and unfavorable outcomes and/or defense costs, depending upon the amount and timing, which could have a material adverse effect on our results of operations or cash flows in a future period. If we later determine that we are required to accrue for potential liabilities resulting from any of these legal actions, it is reasonably possible that the ultimate liability for these matters will be greater than the amount for which we have accrued at that time.
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 addition to other 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, financial condition, results of operations, and cash flows may be adversely affected, the trading price of our common stock could decline, and you may lose all or part of your investment in Websense.
We have marked with an asterisk (*) those risk factors that reflect material changes from the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC on February 23, 2012.
Our future success depends on our ability to sell new, renewal and upgraded subscriptions for our security products.*
We expect that a majority of our billings for the remainder of 2012 will be derived from our TRITON content security solutions, including the TRITON security gateways, our data loss prevention products, related appliances and SaaS offerings sold with or without appliances. We also expect the percentage of our billings derived from our Web filtering products will decline for the remainder of 2012 relative to 2011 as many of our customers transition to our TRITON products or to lower-priced products sold by our competitors. Our billings and revenue growth are dependent on sales of security products to new customers and to customers who upgrade products upon renewal, which must also offset declines in sales from the renewals of Web filtering subscriptions. We also depend upon enterprise customers for a substantial portion of our sales. If we cannot sufficiently increase our customer base with the addition of new customers and upgrade subscriptions for additional product offerings from existing customers or renew a sufficient number of customers, we will not be able to grow our business to meet expectations.

34


Subscriptions to our software and SaaS products generally have durations of 12, 24 or 36 months. Our billings and revenues depend upon maintaining a high rate of sales of renewal subscriptions and adding additional product offerings to existing customers as well as new customer sales. Our customers have no obligation to renew their subscriptions upon expiration, and if they renew, they may elect to renew for a shorter duration than the previous subscription period. As a result of macroeconomic conditions, our customers may elect to renew subscriptions for shorter durations and may reduce their subscribed products due to contractions of work forces of their respective organizations. This may require increasingly costly sales efforts targeting senior management and other management personnel associated with our customers’ Internet and security infrastructure. We may not be able to maintain or continue to generate increasing revenues from existing customers.
Volatility in the global economy and macroeconomic conditions may adversely impact our business, results of operations, financial condition or liquidity.
The global economy has experienced a period of unprecedented volatility characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from governments and regulatory agencies worldwide. We believe that financial distress and associated headcount reductions implemented by certain of our end user customers have caused these customers to choose shorter contract durations and/or reduce the number of seats under subscription and in some cases, have caused customers not to renew contracts at all. While the number of distressed customers appears to have stabilized, we expect this trend to continue until and unless there is a broad worldwide economic recovery and positive job growth. These trends, most recently in continental Europe, have negatively impacted the duration and scope of contract renewals in certain countries or regions in the world and, in some cases, resulted in customer losses. Our average contract duration may be volatile as we seek contract renewals without eroding our average contract price for our products and seek to sell subscriptions to our TRITON and gateway security products which may have longer durations and may depend on product mix. Credit markets may also adversely affect our resellers through whom our distributors distribute products and limit the credit value-added resellers may extend to their customers. The volatility of currency exchange rates can also significantly affect sales of our products denominated in foreign currencies. In addition, events in the global financial markets may make it difficult for us to access the credit markets or to obtain additional financing or refinancing, if needed, on satisfactory terms or at all.
If our security gateway products, data loss prevention products, SaaS offerings and our appliance platforms are unable to achieve more widespread market acceptance our business will be seriously harmed, particularly as Web filtering products continue to commoditize.*
Our ability to generate revenue growth depends on our ability to continue to diversify our offerings by successfully developing, introducing and gaining customer acceptance of our new products and services, particularly our TRITON security gateway offerings as our Web filtering products have become more of a commodity. Recently, we extended the TRITON security platform to include our mobile security products, which propagate web and data security policies to mobile devices. We sell our TRITON security products to address emerging Web threats, Websense Web Security Gateway, as well as our V-Series and X-Series appliances pre-loaded with our software. We also sell the Websense Data Security Suite, our data loss prevention offering, Websense Cloud Web Security and Websense Cloud Email Security, our SaaS offerings, and Websense Email Security, our email filtering solution. We offer our products with TRITON, our unified Web, email, mobile and data security solution, which combines our products into a single platform. We may not be successful in achieving market acceptance of these or any new products that we develop and may be unsuccessful in obtaining incremental sales as a result. If our products fail to meet the needs of our existing and target customers, or if they do not compare favorably in price, features and performance to competing products, our operating results and our business will be significantly impaired. If we fail to continue to upgrade and diversify our products, we could lose revenues from renewal subscriptions for our Web filtering products as these products continue to suffer from commoditization.
Our V-Series and X-Series appliance platforms expose us to risks inherent with the sale of hardware such as product delays and pricing fluctuations.*
The hardware for our appliances is primarily manufactured by a single third-party manufacturer, and a single third-party logistics company provides logistical services, including product configuration and shipping. Our ability to deliver our appliances to our customers could be delayed if we fail to effectively manage our third-party relationships or if our hardware manufacturer or logistics provider experiences delays, disruptions or quality control problems in manufacturing, configuring or shipping the appliances. If our third-party providers fail for any reason to assemble and deliver the appliances with acceptable quality, in the required volumes, and in a cost-effective and timely manner, it could be costly to us, as well as disruptive to product shipments. In addition, supply disruptions or cost increases could increase our cost of goods sold and negatively impact our financial performance. If we are required to change our third-party hardware manufacturer and/or logistics provider, we may be unable to deliver our appliances to our customers on a timely basis which could result in loss of sales and existing or potential customers and could adversely affect our business and operating results. Our appliance platforms may also face greater obsolescence risks than our pure software products.

35


Our revenues are derived almost entirely from sales through indirect channels and we depend upon these channels to create demand for our products.*
Our revenues have been derived almost entirely from sales through multi-tiered indirect channels, including value-added resellers, distributors and OEM customers that sell our products to end users, providers of managed Internet services and other resellers. Ingram Micro, one of our broad-line distributors in North America, accounted for approximately 28% of our revenues during the nine months ended September 30, 2012. Should Ingram Micro or any of our other distributors experience financial difficulties, difficulties in collecting their accounts receivable or otherwise delay or prevent our collection of accounts receivable from them, our revenues and cash flow would be adversely affected. Also, should our resellers be subject to credit limits or have financial difficulties that limit financing terms available to them, our revenues and cash flow could be adversely affected. Our indirect sales model involves a number of additional risks, including:
our resellers and distributors are not subject to minimum sales requirements or any obligation to market our products to their customers;
we cannot control the level of effort our resellers and distributors expend or the extent to which any of them will be successful in marketing and selling our products;
we cannot ensure that our channel partners will market and sell our newer product offerings such as our X-Series appliances or our mobile security solutions;
providers of networking hardware, OEM customers and other value-added resellers that incorporate our products into, or bundle our products with, their products may fail to provide, or restrict us from providing, adequate support services to end users of these integrated product offerings, harming our reputation and brand, or may decide to develop or sell competing products instead of our products;
our reseller and distributor agreements are generally nonexclusive and may be terminated at any time without cause; and
our resellers and distributors frequently market and distribute competing products and may, from time to time, place greater emphasis on the sale of these products due to pricing, promotions and other terms offered by our competitors.
Our ability to increase meaningfully the amount of our products sold through our sales channels also depends on our ability to support these channel partners adequately and efficiently with, among other things, appropriate financial incentives to encourage pre-sales investment and development of sales tools, such as sales training, technical training and product materials needed to support their existing and prospective customers. The diversity and sophistication of our product offerings have required us to focus on additional sales and technical training, and we are making increased investments in this area. Additionally, we are continually evaluating the changes to our internal ordering and partner management systems in order to effectively execute our multi-tiered distribution strategy. Any failure to support our sales channels properly and efficiently will result in lost sales opportunities.
We also depend significantly upon our corporate sales force to generate sales leads and assist in the sale of products through the reseller network. Our ability to grow our revenues from sales of TRITON solutions to new and renewing customers will depend on the success of our sales team in executing on new customer opportunities while upgrading our renewing customer base to TRITON solutions with higher subscription values. In order to execute successfully on our strategy, we have to recruit and retain qualified sales personnel who can sell our sophisticated security solutions in organizations with complex information technology infrastructures. Our failure to recruit or retain sales personnel may adversely affect our sales to new customers and our sales for renewals and upgrades within our existing customer base.


36


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. Many of these variations come from macroeconomic and cyclical changes causing fluctuations in our billings, revenues, operating expenses and tax provisions. Our billings depend in part on the number of subscriptions up for renewal each quarter and are affected by cyclical variations, with the fourth quarter generally being our strongest quarter in billings, and the first quarter generally being our lowest quarter for billings each fiscal year. Although a significant portion of our revenues in any quarter comes from previously deferred revenue, a meaningful portion of our revenues in any quarter depends on the number, size and length of subscriptions to our products that are sold in that quarter as well as our appliance sales which are, following January 1, 2011, fully recognized in the quarter in which they are sold. In addition, we have become increasingly dependent upon large orders which have a significant effect on our operating results during the quarter in which we receive them. The timing of such orders or the loss of an order is difficult to predict and sales expected in a quarter may not be completed until a subsequent quarter. The unpredictability of quarterly fluctuations is further increased by the fact that a significant portion of our quarterly sales have historically been generated during the last month of each fiscal quarter, with most of the largest enterprise customers purchasing subscriptions to our products nearer to the end of the last month of each quarter.
Our operating expenses may increase in the future if we expand our selling and marketing activities, increase our research and development efforts or hire additional personnel which could impact our margins. In addition, our operating expenses historically have fluctuated, and may continue to fluctuate in the future, as the result of the factors described below and elsewhere in this report:
changes in currency exchange rates impacting our international operating expenses;
timing of marketing expenses for activities such as trade shows and advertising campaigns;
quarterly variations in general and administrative expenses, such as recruiting expenses and professional services fees;
increased research and development costs prior to new or enhanced product launches; and
fluctuations in expenses associated with commissions paid on sales of subscriptions to our products which generally increase with billings growth in the short term because such expenses are recognized immediately upon sales of subscriptions while revenues are recognized ratably over the subscription term.
Consequently, these factors limit our ability to accurately predict our results of operations and the expectations of current or potential investors may not be met. If this occurs, the price of our common stock may decline.
Our worldwide income tax provisions and other tax accruals may be insufficient if any taxing authorities assume taxing positions that are contrary to our positions and those contrary positions are sustained.*
Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for state, federal and international income taxes together with transaction taxes such as sales tax, value added tax and goods and services tax. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of intercompany arrangements to share revenues and costs. In such arrangements there are uncertainties about the amount and manner of such sharing, which could 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 audited by various federal, state and non- U.S. tax authorities. Generally, the tax years 2005 through 2011 could be subject to examination by U.S. federal and most state tax authorities. We are currently under examination for tax years 2008 and 2009 in the United States and for 2006 through 2010 in Israel. We also have various other on-going audits in various stages of completion. No outcome for a particular audit can be determined with certainty prior to the conclusion of the audit and any appeals process.

37


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.
Fluctuations in foreign currency exchange rates could materially affect our financial results.*
A significant portion of our foreign subsidiaries’ operating expenses are incurred in foreign currencies, so if the U.S. dollar weakens, our consolidated operating expenses would increase. Conversely, our operating expenses would be lower if the U.S. dollar strengthens. These currency changes have the opposite impact on our revenues from international sales. Should the U.S. dollar strengthen, our products may become more expensive for our international customers with subscription contracts denominated in U.S. dollars, and as a result, our results of operations and net cash flows from international operations may be adversely affected.
Changes in currency rates also impact our future revenues under subscription contracts that are not denominated in U.S. dollars as we bill certain international customers in Euros, British Pounds, Australian Dollars, Japanese Yen and Chinese Renminbi. Our revenue and deferred revenue for these currencies are recorded in U.S. dollars when the subscription begins based upon currency exchange rates in effect on the last day of the previous month before the subscription agreement is entered into. This accounting policy increases our risks associated with fluctuations in currency exchange rates since we cannot be assured of receiving the same U.S. dollar equivalent as when we bill exclusively in U.S. dollars. If there is a strong U.S. dollar at the time a subscription begins, we experience a reduction in subscription amounts as recorded in U.S. dollars relative to the foreign currency in which the subscription was priced to the customer. As a result, the strengthening of the U.S. dollar for current sales would reduce our future revenues from these contracts, even though these foreign currencies may strengthen during the term of these subscriptions. Because currency exchange rates remain volatile, our future revenues could be adversely affected by currency fluctuations.
We engage in currency hedging activities with the intent of limiting the risk of exchange rate fluctuations, but our foreign exchange hedging activities also involve inherent risks that could result in an unforeseen loss. If we fail to properly forecast our billings, expenses and currency exchange rates these hedging activities could have a negative impact.
We face increasing competition from much larger software and hardware companies, which places pressure on our pricing and which could prevent us from increasing our revenues. In addition, as we increase our emphasis on our security-oriented products, we face competition from better-established security companies that have significantly greater resources.*
The market for our products is intensely competitive and is likely to become even more so in the future. Our current principal Web filtering competitors frequently offer their products at a significantly lower price than our products, which has resulted in pricing pressures on sales of our basic Web filtering products and email filtering products. We depend on our more advanced security solutions, such as our TRITON content security solutions, to replace and grow revenues from Web filtering subscriptions that are not renewed.
We also face current and potential competition from vendors of Internet servers, operating systems and networking hardware, many of which now, or may in the future, enhance, develop and/or bundle products to include functions that are currently provided primarily by network security software. If network security functions become standard features of computer hardware or of operating system software or other software, our products may become obsolete and unmarketable, particularly if the quality of these network security features is comparable to that of our products. Furthermore, even if the network security and/or management functions provided as standard features by hardware providers or operating systems or other software is more limited than that of our products, our customers might accept this limited functionality in lieu of purchasing additional software. Sales of our products would suffer materially if we were then unable to develop new Web filtering, security and data loss prevention products to further enhance operating systems or other software and to replace any obsolete products.

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Increased competition may also cause price reductions or a loss of market share, either of which could have a material adverse effect on our business, results of operations and financial condition. If we are unable to maintain the current pricing on sales of our products or increase our pricing in the future, our results of operations could be negatively impacted. Even if our products provide greater functionality and are more effective than certain other competitive products, potential customers might accept this limited functionality. In addition, our own indirect sales channels may decide to develop or sell competing products instead of our products. Pricing pressures and increased competition generally could result in reduced sales, reduced margins or the failure of our products to achieve or maintain widespread market acceptance, any of which could have a material adverse effect on our business, results of operations and financial condition. The competitive environments in which we operate and the principal competitors within each environment are described below.
TRITON Solutions for Content Security
Web Security. Our principal competitors offering Web security software solutions include companies such as McAfee (acquired by Intel), Symantec, Trend Micro, Check Point Software Technologies, Cisco Systems, Blue Coat Systems, Microsoft, Google, Webroot Software, SafeNet, Actiance, EdgeWave, FireEye, Trustwave, Clearswift, Sophos, Kaspersky Lab, AhnLab, IBM, Panda Security, F-Secure, Commtouch, CA Technologies, Juniper Networks, Black Box Network Services and Barracuda Networks.
Email Security. Our principal competitors offering messaging or email security solutions include companies such as McAfee, Symantec/Message Labs, Google, Cisco Systems, Barracuda Networks, SonicWALL (acquired by Dell), Trend Micro, Microsoft, Axway, Sophos, Proofpoint, Clearswift, Commtouch, Zix, WatchGuard Technologies, Trustwave, Webroot Software, EdgeWave, Zscaler and Fortinet.
Mobile Security. Our principal competitors offering mobile security solutions include companies such as Symantec, McAfee, AirWatch, Good Technology and MobileIron.
Data Security. Our principal competitors offering data loss prevention solutions include companies such as Symantec, Verdasys, Trustwave, EMC, McAfee, IBM, Trend Micro, Proofpoint, Palisade Systems, CA Technologies, Raytheon, Intrusion, Fidelis Security Systems (acquired by General Dynamics), GTB Technologies, Workshare, Check Point Software Technologies and Code Green Networks; and companies offering desktop security solutions, such as Check Point Software Technologies, Cisco Systems, McAfee, Microsoft, Symantec, CA Technologies, Sophos, Webroot Software, IBM and Trend Micro.
Web Filtering Solutions
Our principal competitors offering Web filtering solutions, including through specialized security appliances, include companies such as McAfee, Symantec, Trend Micro, Check Point Software Technologies, Cisco Systems, Blue Coat Systems, Microsoft, Google, Webroot Software, SafeNet, Actiance, EdgeWave, FireEye, Trustwave, Clearswift, Sophos, Kaspersky Lab, AhnLab, IBM, Panda Security, F-Secure, Commtouch, CA Technologies, Palo Alto Networks, Fortinet, Barracuda Networks and SonicWALL.
As we develop and market our products with an increasing security-oriented emphasis, we also face growing competition from security solutions providers. Many of our competitors within the Web security market, such as Symantec, McAfee, Trend Micro, Cisco Systems, Check Point Software Technologies, Google and Microsoft enjoy substantial competitive advantages, including:
greater name recognition and larger marketing budgets and resources;
established marketing relationships and access to larger customer bases; and
substantially greater financial, technical and other resources.

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As a result, we may be unable to gain sufficient traction as a provider of advanced content security solutions, and our competitors may be able to respond more quickly and effectively than we can to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, marketing, promotion and sale of their products than we can. Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the functionality and market acceptance of their products or may be acquired by a corporation with significantly greater resources. In addition, our competitors may be able to replicate our products, make more attractive offers to existing and potential employees and strategic partners, develop new products or enhance existing products and services more quickly. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, many of our competitors made recent acquisitions in some of our product areas, and, we expect competition to increase as a result of this industry consolidation. Through an acquisition, a competitor could bundle separate products to include functions that are currently provided primarily by our Web, email, mobile and data security solutions and sell the combined product at a lower cost which could essentially include, at no additional cost, the functionality of our stand-alone solutions. For all of the foregoing reasons, we may not be able to compete successfully against our current and future competitors.
The covenants in our credit facility restrict our financial and operational flexibility, including our ability to complete additional acquisitions and invest in new business opportunities.*
In October 2010, we entered into the 2010 Credit Agreement. Under the 2010 Credit Agreement, we can borrow up to $120 million and use proceeds to fund share repurchases or other corporate purposes. We may increase the maximum aggregate commitment under the 2010 Credit Agreement to up to $200 million if certain conditions are satisfied, including that we are not in default under the 2010 Credit Agreement at the time of the increase. If we should need to increase the aggregate commitment, it may not be possible to satisfy these conditions.
The 2010 Credit Agreement contains affirmative and negative covenants, including an obligation to maintain a certain consolidated leverage ratio and consolidated interest coverage ratio and restrictions on our ability to borrow money, to incur liens, to enter into mergers and acquisitions, to make dispositions, to pay cash dividends or repurchase capital stock, and to make investments, subject to certain exceptions. An event of default under the 2010 Credit Agreement could allow the lenders to declare all amounts outstanding with respect to the agreement to be immediately due and payable. The 2010 Credit Agreement is secured by substantially all of our assets, including pledges of stock of certain of our subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by our domestic subsidiaries. If the amount outstanding under the 2010 Credit Agreement is accelerated, the lenders could proceed against those assets and stock. Any event of default, therefore, could have a material adverse effect on our business.
In addition to the risk of default, we face certain other risks as a result of entering into the 2010 Credit Agreement, including the following:
it may be difficult for us to satisfy our obligations under the 2010 Credit Agreement, including certain financial ratios that can be affected by events beyond our control;
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 the covenants under the 2010 Credit Agreement;
our vulnerability to general adverse economic and industry conditions could be increased;
we could be at a competitive disadvantage to competitors with less debt; and
we may be unable to repurchase our securities due to certain financial ratios set forth in the 2010 Credit Agreement.


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Our international operations involve risks that could increase our expenses, adversely affect our operating results and require increased time and attention of our management.
We have significant operations outside of the United States, including research and development, sales and customer support. We have engineering operations in Reading, England; Beijing, China and Ra’anana, Israel.
We plan to continue to expand our international operations, but such expansion is contingent upon the financial performance of our existing international operations as well as our identification of growth opportunities. Our international operations are subject to risks in addition to those faced by our domestic operations, including:
difficulties associated with managing a distributed organization located on multiple continents in greatly varying time zones;
potential loss of proprietary information due to misappropriation or foreign laws that may be less protective of our intellectual property rights;
requirements of foreign laws and other governmental controls, including trade and labor restrictions and related laws that reduce the flexibility of our business operations;
potential failures of our foreign employees or partners to comply with U.S. and foreign laws, including antitrust laws, trade regulations and anti-bribery and corruption laws;
political unrest, war or terrorism, particularly in areas in which we have facilities;
difficulties in staffing, managing, and operating our international operations, including difficulties related to administering our stock plans in some foreign countries;
difficulties in coordinating the activities of our geographically dispersed and culturally diverse operations;
restrictions on our ability to repatriate cash from our international subsidiaries or to exchange cash in international subsidiaries into cash available for use in the United States; and
costs and delays associated with developing software in multiple languages.
Sales to customers outside the United States have accounted for a significant portion of our revenues, which exposes us to risks inherent in international sales.*
We market and sell our products outside the United States through value-added resellers, distributors and other resellers. International sales represented approximately 50% of our total revenues generated during the nine months ended September 30, 2012. As a key component of our business strategy to generate new business sales, we intend to continue to expand our international sales, but success cannot be assured. In addition to the risks associated with our domestic sales, our international sales are subject to the following risks:
our ability to adapt to sales and marketing practices and customer requirements in different cultures;
our ability to successfully localize software products for a significant number of international markets;
laws in foreign countries may not adequately protect our intellectual property rights;
the significant presence of some of our competitors in some international markets;
laws and business practices favoring local competitors;
dependence on foreign distributors and their sales channels;
longer payment cycles for sales in foreign countries and difficulties in collecting accounts receivable;
compliance with multiple, conflicting and changing governmental laws and regulations, including tax laws and regulations and consumer protection and privacy laws; and
regional economic and political conditions, including civil unrest and adverse economic conditions in emerging markets with significant growth potential.
These factors could have a material adverse effect on our international sales. Any reduction in international sales, or our failure to further develop our international distribution channels, could have a material adverse effect on our business, results of operations and financial condition.

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Security threats to our IT infrastructure could expose us to liability, and damage our reputation and business.
It is essential to our business strategy that our technology and network infrastructure remain secure and is perceived by our customers, distributors and resellers to be secure. Despite security measures, however, any network infrastructure may be vulnerable to cyber-attacks by hackers and other security threats. As a provider of security solutions designed to provide content security by protecting an organization’s data and users, we may face cyber-attacks that attempt to penetrate our network security, including our data centers, to sabotage or otherwise disable our products and services, misappropriate our or our customers’ proprietary information, which may include personally identifiable information, or cause interruptions of our internal systems and services. If successful, any of these attacks could negatively affect our reputation as a provider of security solutions, damage our network infrastructure and our ability to deploy our products and services, harm our relationship with customers that are affected and expose us to financial liability.
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 need to continuously modify and enhance our products to keep pace with changes in Internet-related hardware (including mobile devices), 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.
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 excluded in specific categories of our databases. In addition, it is possible that our filtering processes may place objectionable or security risk material in categories that are generally unrestricted by our users’ Internet and computer access policies, which could result in such material not being blocked from the network. Any errors in categorization could result in customer dissatisfaction and harm our reputation. Any failure to effectively categorize and filter URLs and executable files according to our customers’ expectations could impair the growth of our business. Our databases and database technologies may not be able to keep pace with the growth in the number of URLs and executable files, especially the growing amount of content utilizing foreign languages and the increasing sophistication of malicious code and the delivery mechanisms associated with spyware, phishing and other hazards associated with the Internet. The success of our dynamic Web categorization capabilities may be critical to our customers’ long-term acceptance of our products.
We may spend significant time and money on research and development to enhance our TRITON management console, appliances, content gateway products, mobile device solutions, data loss prevention products and our SaaS offerings. If these products fail to achieve broad market acceptance in our target markets, we may be unable to generate significant revenues from our research and development efforts. As a result, our business, results of operations and financial condition would be adversely impacted.
Because our products primarily manage access to URLs and executable files included in our databases, if our databases do not contain a meaningful portion of relevant content, the effectiveness of our Web filtering products will be significantly diminished. Any failure of our databases to keep pace with the rapid growth and technological change of the Internet, such as the increasing amount of multimedia content on the Internet that is not easily classified, will impair the market acceptance of our products.
If we fail to maintain adequate operations infrastructure, we may experience disruptions of our SaaS offerings.
Any disruption to our technology infrastructure or the Internet could harm our operations and our reputation among our customers. Our technology and network infrastructure is extensive and complex, and could result in inefficiencies or operational failures. These potential inefficiencies or operational failures could diminish the quality of our products, services, and user experience, resulting in damage to our reputation and loss of current and potential subscribers, and could harm our operating results and financial condition. Any disruption to our computer systems could adversely impact the performance of our SaaS offerings and hybrid service offerings, our customer service, our delivery of products or our operations and result in increased costs and lost opportunities for business.

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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 world. Our products may have errors or defects that users identify after deployment, which could harm our reputation and our business. In addition, products as complex as ours frequently contain undetected errors when first introduced or when new versions or enhancements are released. We have from time to time found errors in versions of our products, and we expect to find such errors in the future. Because customers rely on our products to manage employee behavior to protect against security risks and prevent the loss of sensitive data, including confidential and proprietary information, any significant defects or errors in our products may result in negative publicity or legal claims. For example, an actual or perceived breach of network or computer security at one of our customers, regardless of whether the breach is attributable to our products, could adversely affect the market’s perception of our security products. Moreover, any actual security breach could result in product liability and related claims. Our subscription agreements with our customers typically contain provisions designed to limit our exposure to potential product liability claims, however, it is possible, that such provisions may not be effective under the laws of certain jurisdictions, particularly in circumstances involving subscriptions without signed agreements from our customers.
In addition to the risks above, parties whose Web sites or executable files are placed in security-risk categories or other categories with negative connotations may seek redress against us for falsely labeling them or for interfering with their business. The occurrence of errors could adversely affect sales of our products, divert the attention of engineering personnel from our product development efforts and cause significant customer relations or legal problems.
Our products may also be misused or abused by customers or non-customer third parties who obtain access to our products. These situations may arise where an organization uses our products in a manner that impacts their end users’ or employees’ privacy or where our products are misappropriated to censor private access to the Internet. Any of these situations could result in negative press coverage and negatively affect our reputation.
Third parties claiming that we infringe their proprietary rights could cause us to incur significant legal expenses that reduce our operating margins and/or prevent us from selling our products.
The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of patent infringement or other violations of intellectual property rights. As we expand our product offerings in the data loss and security area where larger companies with large patent portfolios compete, the possibility of an intellectual property claim against us grows. We may receive claims that we have infringed the intellectual property rights of others, including claims regarding patents, copyrights and trademarks. For example, on July 12, 2010, Finjan, Inc. filed a complaint entitled Finjan, Inc. v. McAfee, Inc., Symantec Corp., Webroot Software, Inc., Websense, Inc. and Sophos, Inc. in the United States District Court for the District of Delaware. The complaint alleges that our Web filtering and Web Security Gateway products infringe a patent owned by Finjan and seeks damages and injunctive relief. Any such claim, including Finjan’s claim, with or without merit, could result in costly litigation and distract management from day-to-day operations and may result in us deciding to enter into license agreements to avoid ongoing patent litigation costs. If we are not successful in defending such claims, we could be required to stop selling our products, redesign our products, pay monetary amounts as damages, enter into royalty or licensing arrangements, or satisfy indemnification obligations that we have with some of our customers. Such arrangements may cause our operating margins to decline.
We face risks related to customer outsourcing to system integrators.
Some of our customers have outsourced the management of their IT departments to large system integrators. If this trend continues, our established customer relationships could be disrupted and our products could be displaced by alternative system and network protection solutions offered by system integrators. Significant product displacements could impact our revenues and have a material adverse effect on our business.
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. While we require employees, collaborators and consultants to enter into confidentiality agreements and include provisions in our subscription agreements with customers that prohibit the unauthorized reproduction or transfer of our products, we cannot ensure that these agreements will not be breached or that we will have adequate remedies for any breach.

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We rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable and protect the source code of our products as trade secrets and as unpublished copyrighted works. We may not be able to adequately protect our trade secrets or other proprietary information in the event of any unauthorized use or disclosure, or the lawful development by others of such information. Any unauthorized disclosure of our source code or other trade secrets could result in the loss of future trade secret protection for those items. Additionally, any intentional disruption and/or the unauthorized use or publication of our trade secrets and other confidential business information, via theft or a cyber-attack, could adversely affect our competitive position, reputation, brands and future sales of our products.
We have registered our trademarks in various countries and have registrations for the Websense trademark pending in several 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 39 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 conceive the inventions covered by each of our pending patent applications;
we were the first to file patent applications for these inventions;
any of our pending patent applications are not obvious or anticipated such that they will not result in issued patents or if issued, will not be nullified when challenged for being obvious;
others will not independently develop similar or alternative technologies or duplicate any of our technologies;
any patents issued to us will provide us with any competitive advantages or will not be challenged by third parties;
we will develop additional proprietary technologies that are patentable; or
the patents of others will not have a negative effect on our ability to do business.
Our patents and claims in pending patent applications cover features or technology used in certain of our products but do not cover all of the technology utilized in any such product or preclude our competitors from offering competing products. Furthermore, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and can change over time. Effective patent, trademark, copyright and trade secret protection may not be available to us in every country in which our products are available. The laws of some foreign countries may not be as protective of intellectual property rights as U.S. laws, and mechanisms for enforcement of intellectual property rights may be inadequate. As a result our means of protecting our proprietary technology and brands may not be adequate. Furthermore, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property, including the misappropriation or misuse of the content of our proprietary databases of URLs and executable files, and our ability to police that misappropriation or infringement is uncertain, particularly in countries outside of the United States. Any such infringement or misappropriation could have a material adverse effect on our business, results of operations and financial condition.
Because we recognize revenues from subscriptions for our software products ratably over the term of the subscription, downturns in software subscription sales may not be immediately reflected in our revenues.
Most of our revenues come from the sale of subscriptions to our software products, including our SaaS offerings. Upon execution of a subscription agreement or receipt of royalty reports from OEM customers, we invoice our customers for the full term of the subscription agreement or for the period covered by the royalty report from OEM customers. We then recognize revenue from customers daily over the terms of their subscription agreements, or performance period under the OEM contract, as applicable, which, in the case of subscriptions, typically have durations of 12, 24 or 36 months. Even though new revenue recognition rules require us to recognize revenue from hardware sales in the current period that the sale is concluded, a majority of the revenues we report in each quarter will continue to be derived from deferred revenue from subscription agreements and OEM contracts entered into and paid for during previous quarters. Because of this financial model, the revenues 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.

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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;
risks associated with entrance into new markets;
potential loss of key employees of the acquired company;
integrating personnel with diverse business and cultural backgrounds;
preserving the development, distribution, marketing and other important relationships of the companies;
assuming liabilities of the acquired company, including debt and litigation;
inability to generate sufficient revenues from newly acquired products and/or cost savings needed to offset acquisition related costs; and
the continued use by acquired companies of accounting policies that differ from GAAP.
Acquisitions may also cause us to:
issue equity securities that would dilute our current stockholders’ percentage ownership;
assume certain liabilities, including liabilities that were not detected at the time of the acquisition;
incur additional debt;
make large and immediate one-time write-offs for restructuring and other related expenses;
become subject to intellectual property or other litigation; and
create goodwill and other intangible assets that could result in significant impairment charges and/or amortization expense.
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.

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In addition, the market price of our common stock could be subject to wide fluctuations in response to:
announcements of technological innovations or new products or services by us;
changes in our pricing policies; and
quarterly variations in our revenues and operating expenses.
Further, the stock market has experienced significant price and volume fluctuations that have particularly affected the market price of the stock of many Internet-related companies, and that often have been unrelated or disproportionate to the operating performance of these companies. 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 our executive officers, key management or development personnel that would prevent them from terminating their employment with us at any time. We do not maintain key person life insurance policies on any of our employees. The loss of one or more of our key employees could seriously harm our business, results of operations and financial condition. In such an event we may be unable to recruit personnel to replace these individuals in a timely manner, or at all, on acceptable terms.
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 and 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 revenues may be negatively impacted and our business and future growth prospects could be severely harmed.
If our internal controls are not effective, current and potential stockholders could lose confidence in our financial reporting.
Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to conduct a comprehensive evaluation of their internal control over financial reporting. To comply with this statute, we are required to document and test our internal control over financial reporting; our management is required to assess and issue a report concerning our internal control over financial reporting; and our independent registered public accounting firm is required to attest to and report on the effectiveness of internal control over financial reporting.
In our annual and quarterly reports (as amended) for the periods from December 31, 2008 through September 30, 2009, we reported material weaknesses in our internal control over financial reporting which related to our revenue recognition under OEM contracts and our computation of our income tax benefit for the year ended December 31, 2008. We took a number of actions to remediate these material weaknesses. As a result of an error in identifying a variance in our deferred tax assets in the fourth quarter of 2010, we reassessed the effectiveness of our disclosure controls and procedures for the year ended December 31, 2009 and the period from January 1, 2010 through September 30, 2010 and concluded that we continued to have a material weakness in the internal controls over the computation of our income tax provision. In the fourth quarter of 2010, we took additional remediation measures and concluded that the material weakness described above had been remediated as of December 31, 2010.

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Although we believe we have taken appropriate actions to remediate the material weaknesses, we cannot assure you that we will not discover other material weaknesses applicable to both future and past reporting periods. The existence of one or more material weaknesses could result in errors in our financial statements, and substantial costs and resources may be required to rectify these or other internal control deficiencies. If we cannot produce reliable financial reports, investors could lose confidence in our reported financial information, the market price of our common stock could decline significantly, and our business and financial condition could be harmed.
The restatement of our historical financial statements may affect stockholder confidence, may consume a significant amount of our time and resources and may have a material adverse effect on our business and stock price.
We restated our consolidated financial statements and related disclosures for fiscal years ended December 31, 2009, 2008 and 2007. We cannot be certain that the measures we have taken since we completed the restatement process will ensure that restatements will not occur in the future. A restatement may affect investor confidence in the accuracy of our financial disclosures and may result in a decline in stock price and stockholder lawsuits related to the restatement. We cannot guarantee that we will not be affected in this way.
The restatement process was also highly time and resource intensive and involved substantial attention from management and significant legal and accounting costs. Although we have now completed the restatement, we cannot guarantee that we will not receive inquiries from the SEC or the NASDAQ Stock Market, Inc. (“NASDAQ”) regarding our restated financial statements or matters relating thereto.
Any future inquiries from the SEC or NASDAQ as a result of the restatement of our historical financial statements will, regardless of the outcome, likely consume a significant amount of our resources in addition to those resources already consumed in connection with the restatement itself.
Compliance with regulations relating to corporate governance, accounting principles and public disclosure may result in additional expenses.
Compliance with laws, regulations and standards relating to corporate governance, accounting principles and public disclosure, including the Sarbanes-Oxley Act of 2002, Dodd-Frank Wall Street Reform and Consumer Protection Act, and NASDAQ listing rules, have caused us to incur higher compliance costs and we expect to continue to incur higher compliance costs as a result of our increased global reach and obligation to ensure compliance with these laws as well as local laws in the jurisdictions where we do business. These laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity and, as a result, their application in practice may evolve over time. Further guidance by regulatory and governing bodies can result in continuing uncertainty regarding compliance matters and higher costs related to the ongoing revisions to accounting, disclosure and governance practices. Our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.
If we cannot effectively manage our internal growth, our business revenues, results of operations and prospects may suffer.
If we fail to manage our internal growth in a manner that minimizes strains on our resources, we could experience disruptions in our operations that could negatively affect our revenues, billings and results of operations. We are pursuing a strategy of organic growth through introduction of new products, leveraging our multi-tier distribution channels and international expansion. Each of these initiatives requires an investment of our financial and employee resources and involves risks that may result in a lower return on our investments than we expect. These initiatives also may limit the opportunities we pursue or investments we would otherwise make, which may in turn impact our prospects.

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It may be difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.
Some provisions of our amended and restated certificate of incorporation and amended and restated bylaws, as well as some provisions of Delaware law, may discourage, delay or prevent third parties from acquiring us, even if doing so would be beneficial to our stockholders. For example, our amended and restated certificate of incorporation provides that stockholders may not call stockholder meetings or act by written consent. Our amended and restated bylaws provide that stockholders may not fill board of director vacancies and further provide that advance written notice is required prior to stockholder proposals. Each of these provisions makes it more difficult for stockholders to obtain control of our board of directors or initiate actions that are opposed by the then current board of directors. Additionally, we have authorized preferred stock that is undesignated, making it possible for the board of directors to issue up to 5,000,000 shares of preferred stock with voting or other rights and preferences that could impede the success of any attempted change of control. Delaware law also could make it more difficult for a third party to acquire us. Section 203 of the Delaware General Corporation Law has an anti-takeover effect with respect to transactions not approved in advance by our board of directors, including discouraging attempts that might result in a premium over the market price of the shares of common stock held by our stockholders.
Our repayment obligations under the 2010 Credit Facility accelerate and borrowings become payable in full upon a change of control, which is defined generally as a person or group acquiring 35% of our voting securities or a proxy contest that results in changing a majority of our board of directors. These consequences may discourage third parties from attempting to acquire us.
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 and pay down the 2010 Credit Facility, 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 the 2010 Credit Facility.

48


Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
(a)
Not applicable.
(b)
Not applicable.
(c)
Issuer Purchases of Equity Securities
The following table sets forth information about purchases of our common stock during the quarter ended September 30, 2012:
Month
Total Number
of Shares
Purchased
During Month (1)
 
Average Price
Paid per Share
 
Cumulative
Number of Shares
Purchased as Part of
Publicly Announced
Plan (2)
 
Number of Shares
that May Be
Purchased Under
the Plan (2)
July 1 - July 31, 2012
158,700

 
$
18.37

 
22,680,517

 
1,319,483

August 1 - August 31, 2012

 

 
22,680,517

 
1,319,483

September 1 - September 30, 2012

 

 
22,680,517

 
1,319,483

Total
158,700

 
$
18.37

 
22,680,517

 
1,319,483

1.
All share purchases were made in open market transactions under our 2009 Repurchase Plans. 
2.
In April 2003, we announced that our board of directors authorized a stock repurchase program of up to four million shares of our common stock. In August 2005, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to eight million shares. In July 2006, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to 12 million shares. In January 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional four million shares, for a total program size of up to 16 million shares. In October 2010, we announced that our board of directors increased the size of the stock repurchase program by an additional eight million shares, for a total program size of up to 24 million shares. The stock repurchase program does not have an expiration date, does not require us to purchase a specific number of shares and provides the board of directors the authority to modify, suspend or terminate the program at any time. Effective July 17, 2012, the board of directors suspended the stock repurchase program, after repurchasing approximately $2.9 million of our common stock in the third quarter of 2012, to better align with third quarter cash flow. In October 2012 the board of directors resumed the stock repurchase program and authorized management to repurchase up to $5.0 million of our common stock in the fourth quarter of 2012.
In connection with the stock repurchase program, we adopted the 2009 Repurchase Plans in August 2009. The 2009 Repurchase Plans initially provided for purchases of up to an aggregate of $7.5 million of our common stock per calendar quarter in open market transactions beginning in October 2009. In November 2010, we increased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $7.5 million to $25 million per calendar quarter effective as of January 1, 2011. In October 2011, we decreased the value of shares to be repurchased under the 2009 Repurchase Plans from an aggregate of $25 million to $20 million per calendar quarter effective as of January 1, 2012. Depending on market conditions and other factors, including compliance with covenants in the 2010 Credit Agreement, purchases by our agents under the 2009 Repurchase Plans may be suspended at any time, or from time to time. The 2009 Repurchase Plans were suspended on July 17, 2012, in connection with the suspension of the stock repurchase program. With the resumption of the stock repurchase program by the board of directors, we have resumed repurchasing stock under a 10b5-1 plan. As of September 30, 2012 the remaining number of shares authorized for repurchase under the program was 1,319,483.


49


Item 3.
Defaults upon Senior Securities
None.
Item 4.
Mine Safety Disclosures
Not applicable.
Item 5.
Other Information
None.

50


Item 6.
Exhibits
Exhibit Number
 
Description of Document
3.1(1)
 
Amended and Restated Certificate of Incorporation.
 
 
3.2(1)
 
Amended and Restated Bylaws.
 
 
4.1(2)
 
Specimen Stock Certificate of Websense, Inc.
 
 
31.1
 
Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).
 
 
31.2
 
Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).
 
 
32.1
 
Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).
 
 
32.2
 
Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).
 
 
101.INS
 
XBRL Instance Document
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Document
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 

(1)
Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on June 19, 2009 and incorporated herein by reference.
(2)
Filed as an exhibit to our Registration Statement on Form S-1 filed with the SEC on March 23, 2000 (Commission File No. 333-95619) and incorporated herein by reference.

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K have a Commission File No. of 000-30093.

51


SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
 
 
 
WEBSENSE, INC.
 
 
 
Date: October 31, 2012
By:
 
/S/    GENE HODGES        
 
 
 
Gene Hodges
 
 
 
Chief Executive Officer
 
 
 
Date: October 31, 2012
By:
 
/S/    MICHAEL A. NEWMAN        
 
 
 
Michael A. Newman
 
 
 
Chief Financial Officer

52


EXHIBIT INDEX
Exhibit Number
 
Description of Document
3.1(1)
 
Amended and Restated Certificate of Incorporation.
 
 
3.2(1)
 
Amended and Restated Bylaws.
 
 
4.1(2)
 
Specimen Stock Certificate of Websense, Inc.
 
 
31.1
 
Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).
 
 
31.2
 
Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).
 
 
32.1
 
Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).
 
 
32.2
 
Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).
 
 
101.INS
 
XBRL Instance Document
 
 
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
101.DEF
 
XBRL Taxonomy Extension Definition Document
 
 
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
 
 
 
 
(1)
Filed as an exhibit to our Current Report on Form 8-K filed with the SEC on June 19, 2009 and incorporated herein by reference.
(2)
Filed as an exhibit to our Registration Statement on Form S-1 filed with the SEC on March 23, 2000 (Commission File No. 333-95619) and incorporated herein by reference.

The Company’s Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K have a Commission File No. of 000-30093.

53