Websense Reports Record Second Quarter Revenues and Confirms Guidance for Billings, Revenues, Non-GAAP Earnings per Share and Cash Flow from Operations

Millions, except percentages, exchange rates, contract values, duration and DSOs

Q2'11

Q2'10

Y/Y Change

Total net billings:

$85.9

$83.7

2.6%

   Net billings to end-user customers

$85.1

$82.0

3.8%

       Incremental net end-user billings(3)

$25.3

$22.5

12.5%

       Net end-user billings from renewals

$59.9

$59.5

0.6%

OEM billings

$0.8

$1.7

-53.9%

International net billings to end-user customers

$45.6

$42.0

8.6%

As a percentage of total net billings:

   Net billings to end-user customers

99.1%

98.0%

+1.1 pts

       Incremental net end-user billings(3)

29.4%

26.8%

+2.6pts

       Net end-user billings from renewals

69.7%

71.1%

-1.4 pts

   OEM billings

0.9%

2.0%

-1.1 pts

   International net billings to end-user customers

53.6%

51.2%

+2.4 pts

Net-end user billings by product group:

    TRITON solution billings(4)

$44.4

$30.3

46.6%

    Non-TRITON solution billings(4)

$40.7

$51.7

-21.3%

As a percentage of net end-user billings:

    TRITON solution billings(4)

52.2%

37.0%

+15.2 pts

    Non-TRITON solution billings(4)

47.8%

63.0%

-15.2 pts

Appliance billings

$6.9

$4.5

53.0%

Appliance billings (as a percentage of total billings)

7.9%

5.4%

+2.5pts

Exchange rates used in FX-neutral calculations

Euro

$1.44

$1.27

+13.4%

Pound Sterling

$1.65

$1.48

+11.5%

Average annualized contract value

$10,100

$8,400

+20.2%

Average contract duration (months)

23.7

24.0

-1.3%

Cash and cash equivalents (excluding restricted)

$76.2

$82.2

-7.3%

Secured loan outstanding

$63.0

$70.0

-10.0%

Days billings outstanding (DSOs)

64

66

-2 days

Share repurchases ($)

$25.0

$20.0

25.0%

Share repurchases (shares)

1.0

0.9

0.1

1.

A detailed description of the company's non-GAAP financial measures appears under "Non-GAAP Financial Measures" and a full reconciliation of GAAP to non-GAAP results is included at the end of this news release in the tables "Reconciliation of GAAP to Non-GAAP Financial Measures."

2.

The company is reporting GAAP revenues for 2011 because the difference in GAAP and non-GAAP revenues is no longer significant. Non-GAAP revenues are provided for 2010 for purposes of historical comparison.  Non-GAAP revenues of $83.2 million in the second quarter of 2010 included approximately $1.4 million of revenue from SurfControl that would have been recognized during the second quarter of 2010 had SurfControl remained an independent operating company reporting under GAAP. This subscription revenue was included in SurfControl's deferred revenue as of the date of the acquisition, but was not recognized as revenue on a post-acquisition basis under GAAP due to a required write-down of SurfControl's deferred revenue to fair value as of the acquisition date.

3.

Incremental billings include upgrades to new products purchased by existing/renewing customers (i.e., data security, cloud-based security, and the incremental portion of Web security gateway family migrations) and new customer billings, regardless of product.

4.

TRITON solutions include the Web security gateway family of products (including WSG appliances), data security, and cloud-based security solutions.  Non-TRITON solutions include Web filtering products, including Web Security Suite (WSS) and WSS appliances, and on-premise email security.

2011 Outlook

(as of 07/26/11)

Net billings

$357 – $374 million

Net billings to end-user customers

$354 – $371 million

OEM billings

Approximately $3 million

Appliance billings

6-7% of total net billings

GAAP revenues

$358 – $368 million

Non-GAAP gross margin

Approximately 84.5%

Non-GAAP operating expenses

Increase 9-10% y/y

Non-GAAP earnings per diluted share

$1.50 – $1.60

Estimated non-GAAP effective tax rate

Approximately 19%

Average diluted shares outstanding

40 – 41  million

Cash flow from operations

$80 – $90 million

Capital expenditures

Approximately $10 million

• Adoption of ASU 2009-13, Revenue Arrangements with Multiple Deliverables and ASU 2009-14, Certain Revenue Arrangements that Contain Software Elements

Websense was required to implement new revenue recognition rules under which revenue for sales of appliances and the related costs are recognized when sold and all other revenue recognition criteria are met. In general, this means Websense is no longer amortizing the revenue and costs for appliance sales booked in 2011 over the software subscription period. Adoption of the new rules did not change recognition of subscription software revenue or how billings are reported. The adoption of these rules, compared with the previous method of ratable appliance revenue recognition, could increase the variability in revenue and net income in any given quarter. The range of expected annual appliance billings provided for 2011 reflects this variability between quarterly reporting periods.

The new rules were not adopted retroactively and approximately $20 million in deferred revenue and approximately $9 million in deferred costs associated with pre-2011 appliance sales will be recognized ratably over the remaining subscription terms. For 2011, revenues, GAAP net income and non-GAAP net income are expected to include approximately $11.4 million in revenues(of which $6.7 million was recognized in the first half of 2011) and $5.1 million in costs (of which $3.0 million was recognized in the first half of 2011) associated with pre-2011 appliance sales, as well as revenues and costs associated with 2011 appliance billings. 2011 guidance ranges for billings and revenues assume that 2011 appliance billings will total six to seven percent of total 2011 net billings and will be recognized as revenues immediately. Based on the total net billings guidance range and recognition of $11.4 million in appliance revenues from pre-2011 appliance sales, appliances are expected to account for between 9 and 10 percent of total 2011 revenues. Accelerated recognition of appliance revenues and costs is expected to add approximately 14 cents to 2011 non-GAAP earnings per diluted share.

• International Distribution Restructuring

Effective January 1, 2011, the company restructured its international distribution operations to reduce the complexity and compliance risks associated with its global distribution activities. The new structure also was expected to reduce the company's estimated long-term non-GAAP effective tax rate by approximately six percentage points. The resulting decrease in the estimated non-GAAP effective tax rate for 2011 was expected to increase the company's non-GAAP earnings per diluted share by approximately 12 cents, compared with 2010.

• Change in Policy Used to Determine the Estimated Non-GAAP Effective Tax Rate

Beginning with the first quarter of 2011, the company's estimated non-GAAP tax rate will reflect estimated tax benefits from the company's equity-based compensation plan and other tax deductible amortization. These benefits have the effect of reducing the company's cash tax obligations and by including the estimated tax benefits in the determination of the estimated non-GAAP effective tax rate, the company's estimated non-GAAP tax provision is expected to more closely reflect the company's cash tax obligations over time. The company will continue to exclude share-based compensation expense and amortization from operating expenses when reporting its non-GAAP net income and non-GAAP earnings per fully diluted shares.    

This policy change was expected to reduce the 2011 estimated non-GAAP effective tax rate by about six percentage points and increase non-GAAP earnings per diluted share by approximately 11 cents, compared with 2010.

Websense, Inc.

Consolidated Statements of Income

(Unaudited and in thousands, except per share amounts)

Three Months Ended June 30,

Six Months Ended June 30,

2011

2010

2011

2010

Revenues:

   Software and service

$   80,950

$   79,301

$ 161,254

$ 157,236

   Appliance

9,755

2,569

18,085

4,404

      Total revenues

90,705

81,870

179,339

161,640

Cost of revenues:

   Software and service

10,333

11,395

20,759

22,475

   Appliance

4,759

1,565

8,996

2,636

      Total cost of revenues

15,092

12,960

29,755

25,111

Gross profit

75,613

68,910

149,584

136,529

Operating expenses:

   Selling and marketing

41,986

38,957

82,840

79,706

   Research and development

14,311

13,646

28,472

27,771

   General and administrative

9,789

9,241

20,953

18,317

      Total operating expenses

66,086

61,844

132,265

125,794

Income from operations

9,527

7,066

17,319

10,735

Interest expense

(366)

(898)

(793)

(2,043)

Other (expense) income, net

(139)

(146)

1,326

(890)

Income before income taxes

9,022

6,022

17,852

7,802

Provision for income taxes

4,642

2,902

5,351

3,847

Net income

$     4,380

$     3,120

$   12,501

$     3,955

Basic net income per share

$       0.11

$       0.07

$       0.31

$       0.09

Diluted net income per share

$       0.11

$       0.07

$       0.30

$       0.09

Weighted average shares - basic

40,146

42,861

40,337

43,036

Weighted average shares - diluted

41,480

43,932

41,522

44,081

Financial Data:

Total deferred revenue

$ 377,539

$ 376,806

$ 377,539

$ 376,806

Websense, Inc.

Consolidated Balance Sheets

(In thousands)

June 30, 2011

December 31, 2010

Assets

(Unaudited)

Current assets:

   Cash and cash equivalents

$         76,183

$                    77,390

   Cash and cash equivalents - restricted

-

256

   Accounts receivable, net

61,093

82,182

   Income tax receivable/prepaid income tax

151

2,760

   Current portion of deferred income taxes

36,783

36,191

   Other current assets

14,580

14,708

      Total current assets

188,790

213,487

Cash and cash equivalents - restricted, less current portion

684

434

Property and equipment, net

17,780

16,944

Intangible assets, net

34,240

41,078

Goodwill

372,445

372,445

Deferred income taxes, less current portion

7,365

6,352

Deposits and other assets

11,406

11,203

Total assets

$       632,710

$                  661,943

Liabilities and stockholders' equity

Current liabilities:

   Accounts payable

$           7,796

$                      6,858

   Accrued compensation and related benefits

21,204

22,168

   Other accrued expenses

18,496

18,704

   Current portion of income taxes payable

3,571

549

   Current portion of deferred tax liability

803

367

   Current portion of deferred revenue

243,034

251,890

      Total current liabilities

294,904

300,536

Other long term liabilities

1,508

2,388

Income taxes payable, less current portion

16,878

16,065

Secured loan

63,000

67,000

Deferred tax liability, less current portion

4,419

1,877

Deferred revenue, less current portion

134,505

142,414

   Total liabilities

515,214

530,280

Stockholders' equity:

 Common stock

561

548

 Additional paid-in capital

400,517

373,229

 Treasury stock, at cost

(334,140)

(282,570)

 Retained earnings

53,754

41,253

 Accumulated other comprehensive loss

(3,196)

(797)

   Total stockholders' equity

117,496

131,663

Total liabilities and stockholders' equity

$       632,710

$                  661,943

Websense, Inc.

Consolidated Statements of Cash Flows

(Unaudited and in thousands)

Six Months Ended June 30,

2011

2010

Operating activities:

Net income

$ 12,501

$   3,955

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

Depreciation and amortization

13,069

18,662

Share-based compensation

10,154

12,713

Deferred income taxes

20

(2,908)

Unrealized gain on foreign exchange

(148)

(553)

Excess tax benefit from share-based compensation

(1,640)

(933)

Changes in operating assets and liabilities:

Accounts receivable

20,641

22,054

Other assets

(413)

(3,497)

Accounts payable

332

3,128

Accrued compensation and related benefits

(1,822)

(2,922)

Other liabilities

(2,380)

(2,435)

Deferred revenue

(16,776)

(3,305)

Income taxes payable and receivable/prepaid

7,026

4,910

Net cash provided by operating activities

40,564

48,869

Investing activities:

Change in restricted cash and cash equivalents

35

(196)

Purchase of property and equipment

(4,710)

(3,868)

Purchase of intangible assets

(275)

-

Net cash used in investing activities

(4,950)

(4,064)

Financing activities:

Proceeds from secured loan

56,000

-

Principal payments on secured loan

(60,000)

(17,000)

Principal payments on capital lease obligation

(569)

(532)

Proceeds from exercise of stock options

12,540

11,075

Proceeds from issuance of common stock for stock purchase plan

3,446

3,131

Excess tax benefit from share-based compensation

1,640

933

Tax payments related to restricted stock unit issuances

(1,568)

(1,702)

Purchase of treasury stock

(48,940)

(39,996)

Net cash used in financing activities

(37,451)

(44,091)

Effect of exchange rate changes on cash and cash equivalents

630

(1,357)

Decrease in cash and cash equivalents

(1,207)

(643)

Cash and cash equivalents at beginning of period

77,390

82,862

Cash and cash equivalents at end of period

$ 76,183

$ 82,219

   Income taxes paid, net of refunds

$   1,694

$   2,501

Websense, Inc.

Reconciliation of GAAP to Non-GAAP Financial Measures

(Unaudited and in thousands, except per share amounts)

Three Months Ended June 30,

2011

2010

GAAP Revenues

$ 90,705

$        81,870

  Deferred revenue related to SurfControl acquisition (1)

-

1,376

Non-GAAP Revenues

$ 90,705

$        83,246

GAAP Gross profit

$ 75,613

$        68,910

  Deferred revenue related to SurfControl acquisition (1)

-

1,376

  Amortization of acquired technology (3)

646

2,124

  Share-based compensation (2)

268

364

    Gross profit adjustment

914

3,864

Non-GAAP Gross profit

$ 76,527

$        72,774

GAAP Operating expenses

$ 66,086

$        61,844

  Amortization of other intangible assets (3)

(3,160)

(4,381)

  Share-based compensation (2)

(4,381)

(5,765)

    Operating expense adjustment

(7,541)

(10,146)

Non-GAAP Operating expenses

$ 58,545

$        51,698

GAAP Income from operations

$   9,527

$          7,066

    Gross profit adjustment

914

3,864

    Operating expense adjustment

7,541

10,146

Non-GAAP Income from operations

$ 17,982

$        21,076

GAAP Provision for income taxes

$   4,642

$          2,902

    Amortization of acquired intangible and other assets (4)

401

Not available

    Benefit for share-based compensation (5)

(374)

Not available

    Items relating to our global distribution restructuring (6)

(1,519)

Not available

       Provision for income taxes adjustment

(1,492)

3,608

Non-GAAP Provision for income taxes (7)

$   3,150

$          6,510

GAAP Net income

$   4,380

$          3,120

    Gross profit adjustment

914

3,864

    Operating expense adjustment

7,541

10,146

    Amortization of deferred financing fees (8)

59

167

    Provision for income tax adjustment

1,492

(3,608)

Non-GAAP Net income

$ 14,386

$        13,689

GAAP Net income per share

$     0.11

$            0.07

  Non-GAAP adjustments as described above per share,
     net of tax (1-8)

0.24

0.24

Non-GAAP Net income per share

$     0.35

$            0.31

Websense, Inc.

Reconciliation of GAAP to Non-GAAP Financial Measures

(Unaudited and in thousands, except per share amounts)

Six Months Ended June 30,

2011

2010

GAAP Revenues

$ 179,339

$      161,640

  Deferred revenue related to SurfControl acquisition (1)

-

3,423

Non-GAAP Revenues

$ 179,339

$      165,063

GAAP Gross profit

$ 149,584

$      136,529

  Deferred revenue related to SurfControl acquisition (1)

-

3,423

  Amortization of acquired technology (3)

1,291

4,249

  Share-based compensation (2)

553

696

    Gross profit adjustment

1,844

8,368

Non-GAAP Gross profit

$ 151,428

$      144,897

GAAP Operating expenses

$ 132,265

$      125,794

  Amortization of other intangible assets (3)

(6,320)

(8,761)

  Share-based compensation (2)

(9,601)

(12,017)

    Operating expense adjustment

(15,921)

(20,778)

Non-GAAP Operating expenses

$ 116,344

$      105,016

GAAP Income from operations

$   17,319

$        10,735

    Gross profit adjustment

1,844

8,368

    Operating expense adjustment

15,921

20,778

Non-GAAP Income from operations

$   35,084

$        39,881

GAAP Provision for income taxes

$     5,351

$          3,847

    Amortization of acquired intangible and other assets (4)

851

Not available

    Benefit for share-based compensation (5)

259

Not available

    Items relating to our global distribution restructuring (6)

329

Not available

       Provision for income taxes adjustment

1,439

8,272

Non-GAAP Provision for income taxes (7)

$     6,790

$        12,119

GAAP Net income

$   12,501

$          3,955

    Gross profit adjustment

1,844

8,368

    Operating expense adjustment

15,921

20,778

    Amortization of deferred financing fees (8)

119

455

    Provision for income tax adjustment

(1,439)

(8,272)

Non-GAAP Net income

$   28,946

$        25,284

GAAP Net income per share

$       0.30

$            0.09

  Non-GAAP adjustments as described above per share,
     net of tax (1-8)

0.40

0.48

Non-GAAP Net income per share

$       0.70

$            0.57

The non-GAAP financial measures included in the tables above are non-GAAP revenues, non-GAAP gross profit, non-GAAP operating expenses, non-GAAP income from operations, non-GAAP provision for income taxes, non-GAAP net income and non-GAAP net income per share, which adjust for the following items: acquisition related adjustments, share-based compensation expense, amortization of intangible assets and certain other items. We believe the presentation of these non-GAAP financial measures, when taken together with the corresponding GAAP financial measures, provides meaningful supplemental information regarding the Company's operating performance for the reasons discussed below. Our management uses these non-GAAP financial measures in assessing the Company's operating results, as well as when planning, forecasting and analyzing future periods. The annual operating plan approved by our Board of Directors is based upon non-GAAP financial measures and our management incentive plans also use non-GAAP financial measures as performance objectives. We believe that these non-GAAP financial measures also facilitate comparisons of the Company's performance to prior periods and to our peers and that investors benefit from an understanding of these non-financial measures.

(1) Deferred revenue related to SurfControl. We completed our acquisition of SurfControl in October 2007. At the time of the acquisition, SurfControl had recorded deferred revenue related to subscriptions commenced in the past for which revenue would be recognized in future periods (during the term of the subscriptions) as revenue recognition criteria are satisfied. The purchase accounting rules required us to write down a significant portion of this deferred revenue to its then current fair value. Consequently, in post acquisition periods, we do not recognize the full amount of this deferred revenue. When measuring the performance of our business, however, we add back non-GAAP revenues associated with the SurfControl deferred revenue that would have been recognized during the relevant accounting period that was excluded as a result of these purchase accounting adjustments, as we believe this provides information about the impact on operations of the acquired business in a manner consistent with the revenue recognition for our pre-existing services. We further believe that the inclusion of non-GAAP revenues enables investors to better understand the impact of the acquisition on the baseline revenues of the combined company and provides useful information to investors on revenue trends impacting the combined business. As of December 31, 2010, we removed the remaining balance of the deferred revenue related to SurfControl acquisition as it was no longer significant nor meaningful as the acquisition of SurfControl occurred in 2007.

(2) Share-based compensation. Consists of non-cash expenses for employee stock options, restricted stock units and our employee stock purchase plan determined in accordance with the fair value method of accounting for share-based compensation. When evaluating the performance of our business and developing short and long-term plans, we do not consider share-based compensation charges. Although share-based compensation is necessary to attract and retain quality employees, our consideration of share-based compensation places its primary emphasis on overall shareholder dilution rather than the accounting charges associated with such grants. Because of varying available valuation methodologies, subjective assumptions and the variety of award types, we believe that the exclusion of share-based compensation allows for more accurate comparison of our financial results to previous periods. In addition, we believe it is useful to investors to understand the specific impact of the application of the fair value method of accounting for share-based compensation on our operating results.

(3) Amortization of acquired technology and other intangible assets. When conducting internal development of intangible assets (including developed technology, customer relationships, trade-marks, etc.), GAAP accounting rules require that we expense the costs as incurred. In the case of acquired businesses, however, we are required to allocate a portion of the purchase price to the accounting value assigned to intangible assets acquired and amortize this amount over the estimated useful lives of the acquired intangibles. The acquired company, in most cases, has itself previously expensed the costs incurred to develop the acquired intangible assets, and the purchase price allocated to these assets is not necessarily reflective of the cost we would incur in developing the intangible asset. We eliminate these amortization charges from our non-GAAP operating results to provide better comparability of pre- and post-acquisition operating results and comparability to results of businesses utilizing internally developed intangible assets.

(4) Amortization of acquired intangibles and other assets. These amounts relate to the tax effect on amortization of acquired intangible assets and deferred financing fees.  The amortization is excluded from our non-GAAP pre-tax earnings which results in an increase to our Non-GAAP tax provision.  These items have no net impact on our GAAP tax provision primarily because deferred tax liabilities were established for the tax effect of the amortization of the acquired intangibles on the purchase date.    

(5) Benefit for share-based compensation.  These amounts represent the net tax benefit from the estimated tax deductions for share-based compensation (e.g., stock option exercises, restricted stock releases and employee stock purchase plan issuances) of $2.0 million and $3.9 million for Q2 and year-to-date Q2 2011, respectively, less the estimated increase in income tax expense from excluding the GAAP share-based compensation expense of $1.7 million and $4.1 million for Q2 and year-to-date Q2 2011, respectively, from our pre-tax non-GAAP earnings

(6) Items related to our global distribution restructuring.  These items relate to our global distribution restructuring which was completed in the first quarter of 2011.  The amount for Q2 2011 relates primarily to a $1.5 million reduction in non-GAAP tax expense as a result of excluding certain intangible property buy-in amounts from our pre-tax non-GAAP earnings, offset by other small discrete items that were recorded in Q2.  The amount for year-to-date Q2 2011 relates primarily to a $2.8 million reduction in non-GAAP tax expense as a result of excluding the intangible buy-in amounts mentioned above from pre-tax non-GAAP earnings, offset by the exclusion of approximately $3.1 million of Q1 2011 discrete tax benefits from our non-GAAP tax expense. Approximately $3.0 million of the Q1 discrete tax benefit relates to the tax effect of 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 in the first quarter of 2011.  The tax effect from the transfer of the customer relationship intangible assets was reflected in the first quarter of 2011 upon the completion of our global distribution restructuring and is not expected to recur.

(7) The company’s annual non-GAAP effective tax rate is calculated by dividing the company’s estimated annual non-GAAP tax expense by its estimated annual non-GAAP taxable income. The company’s estimated non-GAAP taxable income is determined by adjusting its estimated GAAP taxable income for its non-GAAP adjustments on a country-by-country basis. The company determines its annual estimated non-GAAP tax expense by adding together the estimated non-GAAP tax expense for each country based on each country's applicable tax rate.  The company determines its interim non-GAAP effective tax expense in accordance with the general principles of ASC 740, Accounting for Income Taxes.

(8) Amortization of deferred financing fees. This is a non-cash charge that is disregarded by the Company's management when evaluating our ongoing performance and/or predicting our earnings trends, and excluded by us when presenting our non-GAAP financial measures. Further, we believe it is useful to investors to understand the specific impact of this charge on our operating results.

Websense, Inc.

Rollforward of Deferred Revenue

(Unaudited and in thousands)

Deferred revenue balance at March 31, 2011

$ 382,334

Net billings during second quarter 2011

85,903

Less revenue recognized during second quarter 2011

(90,705)

Translation adjustment

7

Deferred revenue balance at June 30, 2011

$ 377,539

INVESTOR CONTACT:

MEDIA CONTACT:

Kate Patterson

Patricia Hogan

Websense, Inc.

Websense, Inc.

(858) 320-8072

(858) 320-9393

[email protected]

[email protected]