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SolarWinds, Inc. – IPO: ‘S-1/A’ on 3/6/09

On:  Friday, 3/6/09, at 5:09pm ET   ·   Private-to-Public:  Document/Exhibit  –  Release Delayed   ·   Accession #:  1193125-9-47654   ·   File #:  333-149851

Previous ‘S-1’:  ‘S-1/A’ on 10/30/08   ·   Next:  ‘S-1/A’ on 4/17/09   ·   Latest:  ‘S-1/A’ on 11/5/09   ·   Referenced via Accession #:  By:  SEC – ‘UPLOAD’ on 3/25/09

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  As Of                Filer                Filing    For·On·As Docs:Size              Issuer               Agent

 3/06/09  SolarWinds, Inc.                  S-1/A¶                 8:2.2M                                   Donnelley … Solutions/FA

Initial Public Offering (IPO):  Pre-Effective Amendment to Registration Statement (General Form)   —   Form S-1
Filing Table of Contents

Document/Exhibit                   Description                      Pages   Size 

 1: S-1/A       Amendment #6 to Form S-1                            HTML   1.83M 
 8: CORRESP   ¶ Comment-Response or Other Letter to the SEC         HTML     19K 
 3: EX-10.20A   Second Amendment to Lease                           HTML     53K 
 2: EX-10.3C    Form of Restricted Stock Purchase Agreement         HTML     95K 
 4: EX-21.1     List of Subsidiaries                                HTML      5K 
 5: EX-23.1     Consent of Pricewaterhousecoopers                   HTML      6K 
 6: EX-99.1     Consent of Compass Intelligence Southwest           HTML     11K 
 7: EX-99.2     Consent of Gartner, Inc.                            HTML     14K 


‘S-1/A’   —   Amendment #6 to Form S-1
Document Table of Contents

Page (sequential)   (alphabetic) Top
 
11st Page  –  Filing Submission
"Table of Contents
"Prospectus Summary
"Risk Factors
"Special Note Regarding Forward-Looking Statements and Industry Data
"Use of Proceeds
"Dividend Policy
"Capitalization
"Dilution
"Selected Consolidated Financial Data
"Management's Discussion and Analysis of Financial Condition and Results of Operations
"Business
"Management
"Compensation Discussion and Analysis
"Executive Compensation
"Certain Relationships and Related Party Transactions
"Principal and Selling Stockholders
"Description of Capital Stock
"Shares Eligible for Future Sale
"Material United States Federal Income Tax Consequences to Non-U.S. Holders
"Underwriting
"Legal Matters
"Experts
"Where You Can Find More Information
"Index to Consolidated Financial Statements
"Index to Financial Statements
"Report of Independent Registered Public Accounting Firm
"Consolidated Balance Sheets
"Consolidated Statements of Income
"Consolidated Statements of Changes in Convertible Preferred Stock and Stockholders' Deficit
"Consolidated Statements of Cash Flows
"Notes to Consolidated Financial Statements

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  Amendment #6 to Form S-1  
Table of Contents
Index to Financial Statements

As filed with the Securities and Exchange Commission on March 6, 2009

Registration No. 333-149851

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

Amendment No. 6

to

FORM S-1

REGISTRATION STATEMENT

Under

The Securities Act of 1933

 

 

SolarWinds, Inc.

(Exact name of Registrant as specified in its charter)

 

Delaware   7372   73-1559348

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification Number)

SolarWinds, Inc.

3711 South MoPac Expressway

Building Two

Austin, Texas 78746

(512) 682.9300

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

 

 

Kevin B. Thompson

President, Chief Operating Officer

and Chief Financial Officer

SolarWinds, Inc.

3711 South MoPac Expressway

Building Two

Austin, Texas 78746

(512) 682.9300

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

Copies to:

 

Paul R. Tobias, Esq.

J. Robert Suffoletta, Esq.

Wilson Sonsini Goodrich & Rosati,

Professional Corporation

900 South Capital of Texas Highway

Las Cimas IV, Fifth Floor

Austin, Texas 78746

(512) 338.5400

 

Laird H. Simons III, Esq.

Robert A. Freedman, Esq.

Fenwick & West LLP

Silicon Valley Center

801 California Street

Mountain View, California 94041

(650) 988.8500

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 check the following box: ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨            

If this Form is a post effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ¨            

If this Form is a post effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   ¨            

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

 

Large accelerated filer  ¨   Accelerated filer  ¨   Non-accelerated filer  x    Smaller reporting company  ¨

(Do not check if a smaller reporting company)

 

 

The registrant hereby amends this registration statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the registration statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


Table of Contents
Index to Financial Statements

The information in this prospectus is not complete and may be changed. Neither we nor the selling stockholders may sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and neither we nor the selling stockholders are soliciting an offer to buy these securities, in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION, DATED MARCH 6, 2009

Prospectus

                                          Shares

LOGO

Common Stock

 

 

This is an initial public offering of shares of common stock by SolarWinds, Inc. SolarWinds is selling              shares of common stock. The selling stockholders identified in this prospectus are selling an additional              shares of common stock. We will not receive any proceeds from the sale of shares of common stock by the selling stockholders. The estimated initial public offering price is between $              and $             per share.

We have applied for a listing of our common stock on the New York Stock Exchange under the symbol “SWI.”

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 11.

 

     Per Share            Total        

Initial public offering price

   $                 $             

Underwriting discounts and commissions

   $      $  

Proceeds to SolarWinds, before expenses

   $      $  

Proceeds to the selling stockholders, before expenses

   $      $  

To the extent the underwriters sell more than          shares of common stock, we have granted the underwriters an option for a period of 30 days to purchase up to              additional shares of common stock, at the initial public offering price less the underwriting discounts and commissions.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed on the adequacy or accuracy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares against payment in New York, New York on                     , 2009.

 

 

 

J.P. Morgan   Goldman, Sachs & Co.   Morgan Stanley

 

 

 

Jefferies & Company   Pacific Crest Securities   Thomas Weisel Partners LLC

                    , 2009


Table of Contents
Index to Financial Statements

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   11

Special Note Regarding Forward-Looking Statements and Industry Data

   25

Use of Proceeds

   26

Dividend Policy

   26

Capitalization

   27

Dilution

   29

Selected Consolidated Financial Data

   30

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

   34

Business

   60

Management

   72

Compensation Discussion and Analysis

   79

Executive Compensation

   87

Certain Relationships and Related Party Transactions

   103

Principal and Selling Stockholders

   110

Description of Capital Stock

   114

Shares Eligible for Future Sale

   118

Material United States Federal Income Tax Consequences to Non-U.S. Holders

   120

Underwriting

   123

Legal Matters

   129

Experts

   129

Where You Can Find More Information

   129

Index to Consolidated Financial Statements

   F-1

 

 

You should rely only on the information contained in this prospectus or in any free writing prospectus prepared by or on behalf of us and delivered or made available to you. Neither we nor the selling stockholders have authorized anyone to provide you with information different from that contained in this prospectus. We and the selling stockholders are offering to sell, and seeking offers to buy, shares of common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock. Our business, financial condition, results of operations and prospects may have changed since that date.

No action is being taken in any jurisdiction outside the United States to permit a public offering of our common stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in a jurisdiction outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to that jurisdiction.

Until                     , 2009, all dealers that buy, sell or trade in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotment or subscriptions.


Table of Contents
Index to Financial Statements

PROSPECTUS SUMMARY

The following summary highlights information contained elsewhere in this prospectus. Before deciding whether to buy shares of our common stock, you should read this summary and the more detailed information in this prospectus, including our consolidated financial statements and related notes and the discussion of the risks of investing in our common stock in the section entitled “Risk Factors.”

SolarWinds, Inc.

We are a leading provider of powerful yet easy-to-use enterprise-class network management software designed by network professionals for network professionals. Our offerings range from individual software tools to more comprehensive software products, solve problems faced every day by network professionals and help to enable efficient and effective network management. All of our products are ready-to-use, featuring intuitive and easily customizable user interfaces and built-in workflows. Our products can be downloaded directly from our websites and installed and configured by our end-users in a matter of hours. We design our software to meet the requirements of networks and implementations of varying sizes and levels of complexity, ranging from a single device to over 100,000 installed devices.

Through December 31, 2008, over 80,000 customers within small and mid-size businesses, enterprises, including more than 400 of the Fortune 500 companies, and local, state and federal government entities had purchased one or more of our products. We have an active, loyal end-user community that is built from our customers and over one million registered end-users who have downloaded our free tools. We seek to expand, and generate loyalty from, our customer base and our end-user community by providing a variety of free tools for network professionals, by hosting our online community website, Thwack, and through other marketing programs.

As a core part of our strategy, we have developed a differentiated business model for marketing and selling high volumes of low-priced, downloadable, enterprise-class software directly to network professionals and other IT professionals. We design our Internet-based marketing programs to drive visitors to our websites in order to generate large volumes of highly qualified leads. Our inside sales force uses a disciplined, transaction-oriented process to convert these leads into paying customers at a level of productivity that is much higher than is typically achieved with a traditional direct sales force. We offer our products at compelling prices. Our average license transaction in 2007 and 2008 was less than $6,000 compared to hundreds of thousands of dollars for many competing products. Our business model allows us to support rapid growth in our business at high operating margins while offering our products at low prices.

For the years ended December 31, 2006, 2007 and 2008, we generated revenue of $38.2 million, $61.7 million and $93.1 million, respectively. In the same periods, we had operating income of $25.4 million, $30.9 million and $42.0 million and Adjusted EBITDA of $27.1 million, $35.4 million and $48.4 million, respectively. We believe Adjusted EBITDA is useful to investors in evaluating our operating performance. Our management uses Adjusted EBITDA in its management and assessment of our business, and our lender uses Adjusted EBITDA in the key operational covenants in our credit agreements. Adjusted EBITDA should not be considered as an alternative to net income, which is the most directly comparable financial measure calculated in accordance with accounting principles generally accepted in the United States, or GAAP, or any other measure of financial performance calculated in accordance with GAAP. The following table presents a reconciliation of Adjusted EBITDA to net income:

 

 

1


Table of Contents
Index to Financial Statements
     Year Ended December 31,

Reconciliation of Adjusted EBITDA to Net Income

   2006    2007    2008
                
(in thousands)     

Net income

   $ 9,591    $ 13,607    $ 22,305

Interest expense, net

     10,235      9,707      8,011

Income tax expense

     5,596      7,524      10,717

Depreciation and amortization

     124      785      1,436

Stock-based compensation expense

     1,515      3,810      5,920
                    

Adjusted EBITDA

   $ 27,061    $ 35,433    $ 48,389
                    

For further discussion regarding Adjusted EBITDA, see footnote 2 to the table in “Summary Consolidated Financial Information” included elsewhere in this prospectus.

Industry Background

Businesses, governments and other organizations of all sizes increasingly rely on data networks to execute their operations, facilitate their internal and external communications and transact business with their customers and partners, and these networks are growing in size and complexity. These factors have made network management, which includes performance monitoring, provisioning, administration and optimization, increasingly critical to the success of these organizations.

Traditionally, large organizations have deployed complex and expensive software products, called IT management frameworks, that provide centralized and unified management of entire IT systems, including networks, servers and applications. Most of these frameworks are designed for, and marketed and sold to, chief information officers, who are responsible for managing a wide variety of IT issues, rather than to the network professionals, who are responsible for the daily management of networks. As a result, frameworks are not optimized to solve the problems faced by these network professionals and often fail to address network management requirements effectively.

Limitations of existing IT management frameworks include the fact that they are:

 

   

Expensive and Difficult to Implement. Most frameworks are sold at high prices, fail to offer an affordable entry-level option and require costly professional services to deploy.

 

   

Difficult to Use, Maintain and Customize. Most frameworks require significant training to use, cannot be easily configured to end-users’ preferences and require a specialized staff to maintain.

 

   

Inflexible and Difficult to Scale. Most frameworks are highly complex software platforms that are designed for enterprise implementations. As a result, customers typically cannot start with a small or simple deployment and easily increase their capacity or add features as their networks grow and their needs expand.

 

   

Impractical for Small and Mid-Size Organizations. Because of their cost and complexity, most frameworks are impractical for small and mid-size organizations.

 

 

2


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Index to Financial Statements

Market Opportunity

There is currently a large and mature market for network management software. Gartner, Inc., a market research firm, estimates that spending on software for managing networks and the availability and performance of networks and systems will grow from $4.97 billion in 2009 to $5.55 billion in 2012.(1) We believe that a substantial portion of this spending is concentrated in enterprises and represents purchases of IT management frameworks.

We also believe there is a broader market opportunity for cost-effective, easy-to-use and scalable software offerings, such as ours, that address the day-to-day problems of network professionals in enterprises with more than 1,000 employees and small and mid-size companies with 50 to 1,000 employees, as well as in local, state and federal government entities. Many of our current enterprise customers have installed an IT management framework product, but have also purchased our products in order to address better and more directly the specific needs of the network professional. Small and mid-size companies have typically had to rely on point products to address their network management needs, but these products, unlike ours, generally do not solve a broad range of network management issues and cannot scale as networks grow or become more complex.

In a study we commissioned, Compass Intelligence Research estimated there are currently more than 35,000 enterprises and more than 1.6 million small and mid-size companies worldwide. In addition, they estimated that more than 5,000 of the largest enterprises in the world have an average of approximately ten departments that purchase as separate entities. Based on a review of our customers, their implementations of our current products and our current prices, we estimate that the average license expenditures for our current products that are generally necessary to address the needs of network professionals in small and mid-size companies, in enterprises and in the departments of the largest enterprises range from $19,000 to $190,000, respectively.

Our Solution

Our software offerings include enterprise-class network management products, entry-level network monitoring products and a wide range of software tools for network professionals. These offerings enable easy and effective network management and are:

 

   

Focused on the Needs of Network Professionals. Our products are designed by network professionals for network professionals and typically enable them to identify and solve network performance and availability issues more efficiently and effectively than with alternative products and to improve the performance and availability of their networks quickly and easily.

 

   

Easy to Find and Evaluate. We offer through our websites free, downloadable, full-featured evaluations of our software products, allowing customers to implement and use our products to manage their own networks prior to purchase.

 

   

Cost-Effective to Purchase and Install. We offer our software at prices significantly lower than those of competing framework products, and our customers can install and configure our software in a matter of hours.

 

   

Easy to Use and Maintain. Our software has intuitive user interfaces and built-in workflows and does not require significant effort or dedicated staff to maintain.

 

   

Scalable and Flexible. Our customers are able to buy only the capacity they need and expand that capacity as their networks grow. In addition, our software is flexible and extensible, allowing our customers to customize our products and to add modules and other products as their needs expand.

 

(1) Gartner, Inc. “Forecast: Enterprise Software Markets Worldwide, 2007-2012, 4Q08 Update” by Fabrizio Biscotti et al., dated December 9, 2008. See “Special Note Regarding Forward-Looking Statements and Industry Data” for information regarding the industry data used in this prospectus.

 

 

3


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Index to Financial Statements

Our Business Model

As a core part of our strategy, we utilize a differentiated business model for providing enterprise-class software to network professionals and other IT professionals within organizations of all sizes worldwide. We currently provide products for network professionals, but we believe that our model is applicable to all IT professionals, including database administrators, systems administrators, application managers, security administrators and web administrators. We designed our business model to sell high volumes of low-priced, downloadable software, and to be low cost, scalable and efficient. The key differentiating elements of our business model include:

 

   

Downloadable Enterprise-Class Software. Our software is downloadable from the Internet and can be installed and used by our customers in a self-service manner without the need for professional services or complicated installation procedures. This allows our customers to begin using our software almost immediately and enables us to pursue follow-on sales more quickly.

 

   

Customer and Community-Driven Approach. We have an active, loyal community built from our customers and over one million registered end-users who have downloaded our free tools. We believe this community promotes the usage of our software and provides us with a readily accessible pool of qualified leads for sales of current and future products and with valuable insights to help direct our product development efforts.

 

   

Compelling Pricing. We sell our software products at prices significantly lower than those of frameworks. As a result, IT professionals in large organizations generally can purchase our software with minimal internal approvals, and our software is more affordable for smaller customers.

 

   

Scalable Marketing Model. We operate a scalable marketing model that is targeted at the end-users of our products and designed to create awareness of our brand and products. This allows us to drive large numbers of potential customers to our websites and to create significant volumes of highly qualified leads, all at a low cost.

 

   

High-Volume, Transaction-Oriented Sales Model. Our inside sales model supports a high volume of predictable and repeatable “low-touch” transactions at a small average transaction size, and we sell the vast majority of our software with standard online contract terms. We believe this model reduces the length of our sales cycles and results in a higher level of sales force productivity.

 

   

Highly Efficient Product Development Process. We develop our software using distinct development teams, each dedicated to specific products, and emphasize rapid and iterative development cycles. Our approach actively involves our customers, which helps us to develop high quality products that are responsive to our customers’ needs.

 

   

Metrics-Driven Management and Culture. We have developed proprietary systems and processes that enable us to monitor and manage the results of our business. Our emphasis on specific operational and financial metrics and high activity levels instills a culture of accountability and performance measurement and helps us to achieve visibility and consistency of execution in our business.

Our Growth Strategy

Our objective is to extend our market leadership by providing network professionals and other IT professionals with enterprise-class software that solves their specific needs. The following are key elements of our growth strategy:

 

   

continue to add new customers in North America;

 

   

expand our business in international markets;

 

 

4


Table of Contents
Index to Financial Statements
   

cross-sell and up-sell existing products into our growing customer base;

 

   

selectively expand our product portfolio; and

 

   

pursue strategic acquisitions of complementary products that can be sold using our business model.

Risk Factors

Our business is subject to a number of risks that you should understand before making an investment decision. These risks are discussed more fully in the section entitled “Risk Factors” following this prospectus summary. Some of these risks are:

 

   

our operating income could continue to decline as a percentage of our revenue;

 

   

our quarterly operating results are subject to fluctuations, which could cause our stock price to decline;

 

   

if we are unable to attract new customers or to sell additional products to our existing customers, our revenue growth will be adversely affected and our net income will decrease;

 

   

if we fail to generate a sufficient volume of sales leads through our websites or through word of mouth, our revenue would decrease and our operating results would suffer;

 

   

our long-term success depends on our ability to increase sales of our products to customers located outside of the United States and our business will be susceptible to risks associated with international operations; and

 

   

our business depends on customers renewing their annual maintenance contracts and any decline in maintenance renewals would harm our future operating results.

Corporate Information

We incorporated in the State of Oklahoma in 1999 and reincorporated in the State of Delaware in 2008. Our executive offices are located at 3711 South MoPac Expressway, Building Two, Austin, Texas 78746, and our telephone number is (512) 682-9300. Our website address is www.solarwinds.com. The information on, or that can be accessed through, our website is not part of this prospectus.

In this prospectus, “we,” “us” and “our” refer to SolarWinds, Inc. and its subsidiaries.

The marks “SolarWinds®,” “ipMonitor®,” “Orion®,” “LANsurveyor®,” “Thwack®” and “SolarInk®” are our registered trademarks, and the marks “CatTools,” “Engineer’s Toolset,” “Kiwi,” “Kiwi CatTools” and “Kiwi Syslog” and our logo are our trademarks. All other trademarks and trade names appearing in this prospectus are the property of their respective owners.

 

 

5


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Index to Financial Statements

The Offering

 

Common stock offered by us

            shares

 

Common stock offered by selling stockholders

            shares

 

Over-allotment option

            shares

 

Common stock to be outstanding after this offering

            shares

 

Use of proceeds

We intend to use the net proceeds from this offering to repay a significant portion or all of our outstanding long-term indebtedness of $101.1 million as of December 31, 2008, to pay an earnout payment of up to $20.0 million to our original stockholders and for general corporate purposes, including working capital. We also may use a portion of the net proceeds to acquire complementary businesses, products, services or technologies. We will not receive any proceeds from the sale of shares by the selling stockholders.

 

Proposed symbol on the New York Stock Exchange

“SWI”

The shares of common stock to be outstanding after this offering are based on 55,166,659 shares of our common stock outstanding as of December 31, 2008 and exclude:

 

   

12,004,001 shares of our common stock issuable upon the exercise of options outstanding under our 2005 Stock Plan as of December 31, 2008, with a weighted average exercise price of $3.82 per share; and

 

   

6,029,346 shares of our common stock reserved for future issuance under our 2008 Stock Plan, which will become effective in connection with this offering (including 2,529,346 shares of common stock reserved, as of December 31, 2008, for future issuance under our 2005 Stock Plan, which shares will be added to the shares reserved under our 2008 Stock Plan upon the effectiveness of the 2008 Stock Plan).

Unless otherwise noted, the information in this prospectus reflects a 3-for-1 split of our common stock and preferred stock effected in January 2008 and assumes:

 

   

no exercise of the underwriters’ option to purchase additional shares;

 

   

the conversion of each outstanding share of preferred stock into one share of common stock upon the closing of this offering;

 

   

no exercise of options outstanding as of December 31, 2008; and

 

   

the filing of our amended and restated certificate of incorporation, which will occur immediately upon the consummation of this offering.

 

 

6


Table of Contents
Index to Financial Statements

Summary Consolidated Financial Information

We have derived the following consolidated statement of income data for the years ended December 31, 2006, 2007 and 2008 from our audited consolidated financial statements included elsewhere in this prospectus. You should read this information together with our consolidated financial statements and related notes and the information under “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our historical results are not necessarily indicative of our results to be expected in any future period.

 

Consolidated Statement of Income Data:    Year Ended December 31,  
(in thousands, except per share data)    2006      2007      2008  
                      

Revenue:

        

License

   $ 23,676      $ 39,525      $ 55,461  

Maintenance and other

     14,558        22,210        37,674  
                          

Total revenue

     38,234        61,735        93,135  

Cost of revenue (1)

     490        2,253        3,588  
                          

Gross profit

     37,744        59,482        89,547  
                          

Operating expenses:

        

Sales and marketing (1)

     3,504        12,909        22,664  

Research and development (1)

     2,341        5,899        8,452  

General and administrative (1)

     6,477        9,763        16,464  
                          

Total operating expenses

     12,322        28,571        47,580  
                          

Operating income

     25,422        30,911        41,967  
                          

Other income (expense):

        

Interest income

     447        528        528  

Interest expense

     (10,682 )      (10,235 )      (8,539 )

Foreign exchange loss

            (73 )      (934 )
                          

Total other expense

     (10,235 )      (9,780 )      (8,945 )
                          

Income before income taxes

     15,187        21,131        33,022  

Income tax expense

     5,596        7,524        10,717  
                          

Net income

     9,591        13,607        22,305  

Amount allocated to participating preferred stockholders

     (4,791 )      (6,681 )      (10,922 )
                          

Net income available to common stockholders

   $ 4,800      $ 6,926      $ 11,383  
                          

Basic earnings per share available to common stockholders

   $ 0.18      $ 0.25      $ 0.40  
                          

Diluted earnings per share available to common stockholders

   $ 0.18      $ 0.24      $ 0.35  
                          

Shares used in computation of basic earnings per share available to common stockholders

     27,014        27,969        28,137  
                          

Shares used in computation of diluted earnings per share available to common stockholders

     54,055        56,030        32,652  
                          

Pro forma earnings per share (unaudited)

        

Basic

         $ 0.40  

Diluted

         $ 0.37  

Weighted average number of shares used in pro forma computation (unaudited)

        

Basic

           55,137  

Diluted

           59,652  

Other Financial Data:

        

Adjusted EBITDA (2)

   $ 27,061      $ 35,433      $ 48,389  
                          

 

(1)    Includes stock-based compensation expense as follows:

        
(in thousands)                     

Cost of revenue

   $      $ 39      $ 63  

Sales and marketing

     334        1,213        1,593  

Research and development

     190        467        755  

General and administrative

     991        2,091        3,509  
                          
   $ 1,515      $ 3,810      $ 5,920  
                          

 

 

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(2) We anticipate that our investor and analyst presentations will include Adjusted EBITDA, which we define as net income plus net interest expense, income tax expense (benefit), depreciation and amortization, and stock-based compensation expense, and which is a financial measure that is not calculated in accordance with GAAP. The table below provides a reconciliation of this non-GAAP financial measure to the most directly comparable financial measure calculated and presented in accordance with GAAP. Adjusted EBITDA should not be considered as an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate Adjusted EBITDA in the same manner as we do. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. You are encouraged to evaluate our adjustments and the reasons we consider them appropriate.

We believe Adjusted EBITDA is useful to investors in evaluating our operating performance for the following reasons:

 

   

Adjusted EBITDA is widely used by investors to measure a company’s operating performance without regard to items, such as interest expense, income tax expense, depreciation and amortization, and stock-based compensation expense, that can vary substantially from company to company depending upon their financing and accounting methods, the book value of their assets, their capital structures and the method by which their assets were acquired;

 

   

securities analysts use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of companies;

 

   

we adopted Statement of Financial Accounting Standards, or SFAS, No. 123(R), Share-Based Payment, on January 1, 2006 and recorded stock-based compensation expense of approximately $1.5 million, $3.8 million and $5.9 million for the years ended December 31, 2006, 2007 and 2008, respectively. Prior to January 1, 2006, we accounted for stock-based compensation using the intrinsic value method under Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, which resulted in zero stock-based compensation expense. By comparing our Adjusted EBITDA in different historical periods, our investors can evaluate our operating results without the additional variations caused by stock-based compensation expense, which is not comparable from year to year due to changes in accounting treatment and is a non-cash expense that is not a key measure of our operations; and

 

   

our lenders believed Adjusted EBITDA was the appropriate performance measure for the key operational covenants in our credit agreements. These key operational covenants require us to maintain a minimum consolidated interest coverage ratio and a maximum consolidated leverage ratio as of the last day of each fiscal quarter. Each of these ratios uses Adjusted EBITDA in its calculation. The interest coverage ratio is defined to be the ratio of Adjusted EBITDA for the trailing four quarters to cash interest expense for the trailing four quarters. To be in compliance, our interest coverage ratio had to be at least 3.5 to 1.0 as of December 31, 2008 and must be at least 3.5 to 1.0 as of the last day of each fiscal quarter thereafter. The leverage ratio is defined to be the ratio of consolidated total debt to Adjusted EBITDA for the trailing four quarters. Our leverage ratio as of December 31, 2008 could not be more than 3.1 to 1.0, and this maximum ratio decreases over time to 2.1 to 1.0 as of December 31, 2011. We were in compliance with each of these key operational covenants as of December 31, 2008. We believe these are key operational covenants because the failure to comply with these covenants would be an event of default under our credit agreements that would likely result in the acceleration of our indebtedness or an unfavorable amendment to the terms of the credit agreements. This acceleration would and any such amendment might adversely affect our liquidity and financial condition.

 

 

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Our management uses Adjusted EBITDA:

 

   

as a measure of operating performance, because it does not include the impact of items not directly resulting from our core operations;

 

   

for planning purposes, including the preparation of our annual operating budget;

 

   

to allocate resources to enhance the financial performance of our business;

 

   

to evaluate the effectiveness of our business strategies; and

 

   

in communications with our board of directors concerning our financial performance.

We understand that, although Adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results of operations as reported under GAAP. Some of these limitations are:

 

   

Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or other contractual commitments;

 

   

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

 

   

Adjusted EBITDA does not reflect interest expense or interest income;

 

   

Adjusted EBITDA does not reflect cash requirements for income taxes;

 

   

although depreciation and amortization are non-cash charges, the assets being depreciated or amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for these replacements; and

 

   

other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated.

 

     Year Ended December 31,

Reconciliation of Adjusted EBITDA to Net Income

   2006    2007    2008
(in thousands)               

Net income

   $ 9,591    $ 13,607    $ 22,305

Interest expense, net

     10,235      9,707      8,011

Income tax expense

     5,596      7,524      10,717

Depreciation and amortization

     124      785      1,436

Stock-based compensation expense

     1,515      3,810      5,920
                    

Adjusted EBITDA

   $ 27,061    $ 35,433    $ 48,389
                    

 

 

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The following table presents consolidated balance sheet data as of December 31, 2008 on:

 

   

an actual basis;

 

   

a pro forma basis to reflect the conversion of all outstanding shares of our convertible preferred stock into 27,000,003 shares of our common stock upon the closing of this offering; and

 

   

a pro forma as adjusted basis to reflect (i) our receipt of the net proceeds from our sale of shares of common stock in this offering at an assumed initial public offering price of $             per share, the midpoint of the price range set forth on the front cover of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses and (ii) the application of the net proceeds from this offering as described under “Use of Proceeds.”

 

     December 31, 2008
Consolidated Balance Sheet Data:    Actual     Pro Forma     Pro Forma
As Adjusted
(in thousands)         

(unaudited)

     

Cash and cash equivalents

   $ 40,566     $ 40,566     $         

Working capital

     16,393       16,393    

Deferred revenue

     27,162       27,162    

Total assets

     86,907       86,907    

Long-term obligations and convertible preferred stock

     95,379       95,352    

Total stockholders’ deficit

     (48,555 )     (48,528 )  

 

 

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RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks described below as well as the other information contained in this prospectus before deciding to purchase any shares of our common stock. These risks could harm our business, operating results, financial condition and prospects. In addition, the trading price of our common stock could decline due to any of these risks and you might lose all or part of your investment.

Risks Related to Our Business

Our operating income and net income could continue to decline as a percentage of revenue as we make further expenditures to expand our operations in order to support additional growth in our business.

As a percentage of revenue, our operating income was 66.5%, 50.1% and 45.1% and our net income was 25.1%, 22.0% and 23.9% for the years ended December 31, 2006, 2007 and 2008, respectively. In December 2005, we converted from a Subchapter S corporation to a Subchapter C corporation. We incurred income tax expense of $5.6 million, $7.5 million and $10.7 million for the years ended December 31, 2006, 2007 and 2008, respectively. We also incurred $10.7 million, $10.2 million and $8.5 million in interest expense for the years ended December 31, 2006, 2007 and 2008, respectively, related to our outstanding debt incurred in December 2005. In addition, we incurred stock-based compensation expense of $1.5 million, $3.8 million and $5.9 million for the years ended December 31, 2006, 2007 and 2008, respectively. Since June 30, 2006, we have made significant investments in new financial and operating systems, hired substantial numbers of new sales and marketing, research and development and general and administrative personnel, invested in new facilities and expanded our operations outside the United States in order to manage and expand our business more effectively. We intend to make additional investments in systems and personnel and to continue to expand our operations to support anticipated future growth in our business. We also expect to incur additional operating costs as a public reporting company upon the completion of this offering. As a result of these factors, our operating income and net income could decline as a percentage of revenue relative to our prior periods at least through 2009.

Our quarterly revenue and operating results have fluctuated in the past and may fluctuate in the future due to a number of factors. As a result, we may fail to meet or exceed the expectations of securities analysts or investors, which could cause our stock price to decline.

We believe our quarterly revenue and operating results may vary significantly in the future. As a result, you should not rely on the results of any one quarter as an indication of future performance and period-to-period comparisons of our revenue and operating results may not be meaningful.

Our quarterly results of operations may fluctuate as a result of a variety of additional factors, including, but not limited to, those listed below, many of which are outside of our control:

 

   

occasional large customer orders, including in particular those placed by the U.S. federal government;

 

   

our inability to increase sales to existing customers and to attract new customers;

 

   

the timing and success of new product introductions by us or our competitors;

 

   

changes in our pricing policies or those of our competitors;

 

   

increasing marketing expenditures in an attempt to generate growing numbers of sales leads;

 

   

the mix of our direct and indirect sales;

 

   

the amount and timing of operating expenses and capital expenditures related to the expansion of our operations and infrastructure;

 

   

the timing of expenses related to the development or acquisition of technologies, products or businesses;

 

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potential goodwill and intangible asset impairment charges and amortization associated with acquired businesses;

 

   

the loss of our relationships with the two principal resellers that help us fulfill most sales orders from the U.S. government;

 

   

potential foreign exchange gains and losses related to expenses and sales denominated in currencies other than the functional currency of an associated entity; and

 

   

general economic, industry and market conditions that impact expenditures for network management software in the United States and other countries where we sell our software.

Fluctuations in our quarterly operating results might lead analysts to change their models for valuing our common stock. As a result, our stock price could decline rapidly and we could face costly securities class action suits or other unanticipated issues.

If we are unable to attract new customers or to sell additional products to our existing customers, our revenue growth will be adversely affected and our net income could decrease.

To increase our revenue, we must regularly add new customers or sell additional products to existing customers. We expect to incur significant additional expenses in expanding our sales and development personnel and our international operations in order to achieve revenue growth. We may be unable to maintain or increase traffic to our websites and our marketing efforts may be unsuccessful in generating evaluation downloads, resulting in fewer sales leads. We may fail to identify growth opportunities for our current products, and we may misinterpret the market for new products and technologies. If we fail to attract new customers or our new product introductions or acquisitions are not successful, we may be unable to grow our revenue and our operating results may be adversely affected.

If we are unable to generate significant volumes of sales leads from Internet search engines and marketing campaigns, traffic to our websites and our revenue may decrease.

We generate many of our sales leads through visits to our websites by potential end-users interested in purchasing or downloading evaluations of our products. Many of these potential end-users find our websites by searching for network management and monitoring products through Internet search engines, such as Yahoo! and Google. A critical factor in attracting potential customers to our websites is how prominently our websites are displayed in response to search inquiries. If we are listed less prominently or fail to appear in search result listings for any reason, visits to our websites by customers and potential customers could decline significantly. We may not be able to replace this traffic and, if we attempt to replace this traffic, we may be required to increase our sales and marketing expenses, which may not be offset by additional revenue and could adversely affect our operating results.

We also generate leads through various marketing activities such as targeted email campaigns, attending networking-based trade shows and hosting webinars on network management issues. If we fail to generate a sufficient volume of leads from these activities, our revenue could decrease and our operating results could suffer.

If we fail to develop our brand cost-effectively, our financial condition and operating results might suffer.

We believe that developing and maintaining awareness and integrity of our brand in a cost-effective manner are important to achieving widespread acceptance of our existing and future products and are important elements in attracting new customers. We believe that the importance of brand recognition will increase as competition in our market further intensifies. Successful promotion of our brand will depend on the effectiveness of our marketing efforts and on our ability to provide reliable and useful products at competitive prices. We intend to increase our expenditures on brand promotion. Brand promotion activities may not yield increased revenue, and even if they do, the increased revenue may not offset the expenses we incur in building our brand. We also rely

 

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on our customer base and community of end-users in a variety of ways, including to give us feedback on our products and to provide user-based support to our other customers. If we fail to promote and maintain our brand successfully or to maintain loyalty among our customers and our end-user community, or we incur substantial expenses in an unsuccessful attempt to promote and maintain our brand, we may fail to attract new customers or retain our existing customers and our financial condition and results of operations could be harmed.

Failure to expand our sales operations effectively could harm our ability to increase our customer base and achieve broader market acceptance of our products.

Increasing our customer base and achieving broader market acceptance of our products will depend on our ability to expand our sales operations effectively. We are substantially dependent on our inside direct sales force, and to a significantly lesser extent certain resellers and distributors, to obtain new customers. We plan to continue to expand our inside direct sales force both domestically and internationally. Our ability to achieve significant growth in revenue in the future will depend on our success in recruiting, training and retaining sufficient numbers of inside direct sales personnel, and on the productivity of those personnel. Our recent and planned personnel additions may not become as productive as we would like, and we may be unable to hire or retain sufficient numbers of qualified individuals in the future in the markets where we do or plan to do business. Our operating results will be seriously harmed if these expansion efforts do not generate a corresponding significant increase in revenue.

If we are unable to enhance existing products, particularly our Orion family of products, or to develop or acquire new products that respond to rapidly changing customer requirements, technological developments or evolving industry standards, our long-term revenue growth will be harmed.

The market for our products is characterized by rapid technological advances, changes in customer requirements, changes in protocols and evolving industry standards. Our long-term growth depends on our ability to enhance and improve our existing products and to introduce or acquire new products that respond to these demands. The success of any enhancement or new product depends on a number of factors, including its timely completion, introduction and market acceptance. New products that we develop or acquire may not be introduced in a timely or cost-effective manner and may not achieve the broad market acceptance necessary to generate significant revenue. Additionally, our existing and prospective customers may develop their own competing technologies, purchase competitive products or services or engage third-party providers. If we are unable to develop or acquire enhancements to, and new features for, our existing products or acceptable new products that keep pace with rapid technological developments, our products may become obsolete, less marketable and less competitive, and our business will be harmed.

We depend significantly on our Orion family of products, which are our enterprise-class network management products. Our Orion family of products represented a majority of our revenue in 2007 and 2008. If we are unable to add products and develop enhancements to our Orion family that are satisfactory to our customers, or if our customers purchase or develop their own competing products and technologies causing a reduction in demand for our Orion family of products, our operating results will be harmed.

We depend on the U.S. federal government for a meaningful portion of our sales and fulfill most of these sales through two resellers. Any reductions in sales to the U.S. federal government as a result of the loss of these resellers or any other reason could harm our growth.

In 2008, approximately 13% of our sales was to a number of different departments of the U.S. federal government. A substantial majority of these sales were made through two of our resellers. Any factors that cause a decline in government expenditures generally or government IT expenditures in particular could cause our revenue to grow less rapidly or even to decline. Also, since in some cases we are unable to fulfill orders from the U.S. government directly, the loss of our current resellers, which are entitled under certain circumstances to terminate our contracts with them, would cause at least a temporary inability to fulfill orders from the government until we were able to find and qualify a suitable alternative. This, in turn, would cause revenue to be delayed and could cause sales to be lost.

 

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We operate in a highly competitive market, which could make it difficult for us to acquire and retain customers.

The market for network management solutions is intensely competitive. Competition in our market is based primarily on the level of difficulty in installing, using and maintaining solutions; total cost of ownership, including product price and implementation and support costs; professional services implementation; product performance, functionality, flexibility, scalability and interoperability; brand and reputation; distribution channels; vertical markets or industries; and financial resources of the vendor. We often compete to sell our products against existing products or systems that our potential customers have already made significant expenditures to install. Many of our actual and potential competitors enjoy substantial competitive advantages over us, such as greater name recognition, more comprehensive and varied products and services, and substantially greater financial, technical and other resources. In addition, many of our competitors have established marketing relationships and access to larger customer bases, and have major distribution agreements with consultants, system integrators and resellers. Given their larger size, greater resources and existing customer relationships, our competitors may be able to compete and respond more effectively than we can to new or changing opportunities, technologies, standards or customer requirements.

We face competition from both traditional, larger software vendors offering enterprise-wide software frameworks and services and smaller companies offering point solutions for specific network management issues. We also compete with network equipment vendors and systems management solution providers whose products and services address network management requirements. Our principal competitors vary depending on the product we offer and include Hewlett Packard, IBM, CA, BMC, Cisco and several smaller vendors.

Some of our competitors have made acquisitions or entered into strategic relationships with one another to offer a more comprehensive product than they individually had offered. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry and as companies enter into partnerships or are acquired. Companies and alliances resulting from these possible consolidations and partnerships may create more compelling product offerings and be able to offer more attractive pricing, making it more difficult for us to compete effectively. In addition, continued industry consolidation may adversely impact customers’ perceptions of the viability of small and medium-sized technology companies and consequently their willingness to purchase from those companies.

Competition could result in increased pricing pressure, reduced operating margins, increased sales and marketing expenses and failure to increase, or the loss of, market share, any of which would likely seriously harm our business, operating results and financial condition.

We have experienced rapid growth in recent periods. If we fail to manage our growth effectively, our financial performance may suffer.

We have substantially expanded our overall business, customer base, headcount and operations in recent periods both domestically and internationally. We increased our total number of employees from 36 as of June 30, 2006 to 254 as of December 31, 2008. In addition, during this same period, we made substantial investments in our information systems and significantly expanded our operations outside the United States, including an expansion of our sales operations in Europe, the Middle East and Africa and the establishment of a sales and support center in Cork, Ireland. In 2008, we opened a development center in the Czech Republic and an international sales and support center in Singapore. We also acquired a development center in New Zealand in 2008. We increased the number of our customers, which we define as individuals or entities, including distributors or resellers, that have purchased one or more of our products under a unique customer identification number since our inception in 1999, from over 28,000 customers as of June 30, 2006 to over 80,000 customers as of December 31, 2008. Our expansion has placed, and our expected future growth will continue to place, a significant strain on our managerial, administrative, operational, financial and other resources. If we are unable to manage our growth successfully, our operating results will suffer.

 

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Our business depends on customers renewing their annual maintenance contracts. Any decline in maintenance renewals could harm our future operating results.

We sell each of our products pursuant to a perpetual license, which includes one year of maintenance as part of the initial price. Our customers have no obligation to renew their maintenance agreements after the expiration of this one-year period, and they may not renew maintenance agreements. We may be unable to predict future customer renewal rates accurately. Our customers’ renewal rates may decline or fluctuate as a result of a number of factors, including their level of satisfaction with our products, the prices of our products, the prices of products and services offered by our competitors or reductions in our customers’ spending levels. If our customers do not renew their maintenance arrangements or if they renew them on less favorable terms, our revenue may decline and our business will suffer. A substantial portion of our quarterly maintenance revenue is attributable to maintenance agreements entered into during previous quarters. As a result, if there is a decline in renewed maintenance agreements in any one quarter, only a small portion of the decline will be reflected in our maintenance revenue recognized in that quarter and the rest will be reflected in our maintenance revenue recognized in the following four quarters.

We rely on third parties for financial and operational services essential to our ability to manage our business. A failure or disruption in these services would materially and adversely affect our ability to manage our business effectively.

Currently, we use NetSuite to manage our order management and financial processes and salesforce.com to track our sales and marketing efforts. We believe the availability of these services is particularly essential to the management of our high-volume, transaction-oriented business model. As we expand our operations and sales efforts, we expect to utilize additional systems and service providers that may also be essential to managing our business. Although the systems and services that we require are typically available from a number of providers, it is time consuming and costly to qualify and implement these relationships. Therefore, if one or more of our providers suffer an interruption in their business, or experience delays, disruptions or quality control problems in their operations, or we have to change or add additional systems and services, our ability to manage our business would suffer.

Our business model is dependent upon efficient and cost-effective product development. Failure to manage our product development efforts outside the United States effectively could harm our ability to release new products rapidly and adversely affect our revenue and operating results.

Our success depends on our ability to enhance current products and to develop new products rapidly and cost effectively. In 2008, we opened a facility in the Czech Republic for research and development activities and have expanded that facility rapidly. We also outsource a portion of the coding and testing of our products and product enhancements to two Eastern European contract development vendors. We believe that performing our research and development in our facility in the Czech Republic and supplementing these activities with our contract development vendors enhance the efficiency and cost-effectiveness of our product development. If we experience problems with our workforce or facilities in the Czech Republic, our business could be harmed while we develop our products in an alternate manner that may be less efficient and cost-effective. In addition, if our contract development vendors terminate their relationships with us or experience problems with their facilities or workforce, or if for any other reason we are unable to maintain our relationship with our contract development vendors, our business could suffer due to a delay in our product release schedules while we either hire software developers and expand our facility in the Czech Republic or find alternative contract development resources.

Because our long-term success depends on our ability to increase sales of our products to customers located outside of the United States, our business will be susceptible to risks associated with international operations.

We have international operations in the Republic of Ireland, the Czech Republic, Singapore and New Zealand, which we established or acquired in 2007 and 2008. Our limited experience in operating our business outside the United States increases the risk that our current and future international expansion efforts

 

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may not be successful. In particular, our business model may not be successful in particular countries or regions outside the United States for reasons that we currently are unable to anticipate. In addition, conducting international operations subjects us to risks that we have not generally faced in the United States. These include:

 

   

fluctuations in currency exchange rates;

 

   

unexpected changes in foreign regulatory requirements;

 

   

difficulties in managing the staffing of international operations;

 

   

potentially adverse tax consequences, including the complexities of foreign value added tax systems, restrictions on the repatriation of earnings and changes in tax rates;

 

   

dependence on resellers and distributors to increase customer acquisition;

 

   

the burdens of complying with a wide variety of foreign laws and different legal standards;

 

   

increased financial accounting and reporting burdens and complexities;

 

   

political, social and economic instability abroad;

 

   

terrorist attacks and security concerns in general; and

 

   

reduced or varied protection for intellectual property rights in some countries.

The occurrence of any one of these risks could negatively affect our international business and, consequently, our operating results. Additionally, operating in international markets requires significant management attention and financial resources. We cannot be certain that the investment and additional resources required to establish, acquire or integrate operations in other countries will produce desired levels of revenue or profitability.

We rely on our management team and need additional personnel to grow our business, and the loss of one or more key employees or our inability to attract and retain qualified personnel could harm our business.

Our success and future growth depend on the skills, working relationships and continued services of our management team. Our future success also will depend on our ability to attract, retain and motivate highly skilled product architects and sales, technical support and product development personnel in the United States and internationally. All of our employees work for us on an at-will basis. Competition for these types of personnel is intense, particularly in the software industry. As a result, we may be unable to attract or retain qualified personnel. Our inability to attract and retain the necessary personnel could adversely affect our business. We maintain key person insurance for our Chief Executive Officer and intend to obtain key person insurance for our President prior to this offering.

If we are not able to integrate future acquisitions successfully, our operating results and prospects could be harmed.

In 2007 and 2008, we acquired new technology, know-how and products through our acquisition of Neon Software, Inc. and substantially all of the assets, including technology, know-how and products, and liabilities, of IPMonitor Corporation and Trilenium Investments Limited. Our future acquisition strategy will depend on our ability to identify, negotiate, complete and integrate acquisitions and, if necessary, to obtain satisfactory debt or equity financing to fund those acquisitions. Mergers and acquisitions are inherently risky, and any mergers and acquisitions we complete may not be successful. Any mergers and acquisitions we do would involve numerous risks, including the following:

 

   

difficulties in integrating and managing the operations, technologies and products of the companies we acquire;

 

   

diversion of our management’s attention from normal daily operations of our business;

 

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our inability to maintain the key business relationships and the reputations of the businesses we acquire;

 

   

uncertainty of entry into markets in which we have limited or no prior experience and in which competitors have stronger market positions;

 

   

our dependence on unfamiliar affiliates and partners of the companies we acquire;

 

   

insufficient revenue to offset our increased expenses associated with acquisitions;

 

   

our responsibility for the liabilities of the businesses we acquire;

 

   

our inability to maintain internal standards, controls, procedures and policies; and

 

   

potential loss of key employees of the companies we acquire.

We may be unable to secure the equity or debt funding necessary to finance future acquisitions on terms that are acceptable to us. If we finance acquisitions by issuing equity or convertible debt securities, our existing stockholders will likely experience ownership dilution, and if we finance future acquisitions with debt funding, we will incur interest expense and may have to comply with financing covenants or secure that debt obligation with our assets.

Material defects or errors in our products could harm our reputation, result in significant costs to us and impair our ability to sell our products.

Software products are inherently complex and often contain defects and errors when first introduced. Any defects in our products could result in:

 

   

lost or delayed market acceptance and sales of our products;

 

   

a reduction in maintenance renewals;

 

   

diversion of development resources; and

 

   

injury to our reputation and our brand.

The costs incurred in correcting or remediating the impact of defects or errors in our products may be substantial and could adversely affect our operating results.

If a third party asserts that we are infringing its intellectual property, we could be subjected to costly and time-consuming litigation or expensive licenses, and our business might be harmed.

The software and technology industries are characterized by the existence of a large number of patents, copyrights, trademarks and trade secrets and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. We have received, and from time to time may receive, letters claiming that our products infringe or may infringe the patents or other intellectual property rights of others. As we face increasing competition, the possibility of intellectual property rights claims against us grows. Our technologies may not be able to withstand any third-party claims or rights against their use. Additionally, we have licensed from other parties proprietary technology covered by patents, and these patents may be challenged, invalidated or circumvented. These types of claims could harm our relationships with our customers, might deter future customers from acquiring our products or could expose us to litigation with respect to these claims. Even if we are not a party to any litigation between a customer and a third party, an adverse outcome in that litigation could make it more difficult for us to defend our intellectual property in any subsequent litigation in which we are a named as a party. Any of these results could harm our brand and operating results.

Any intellectual property rights claim against us or our customers, with or without merit, could be time-consuming, expensive to litigate or settle, and divert management resources and attention. As a result of any successful intellectual property rights claim against us or our customers, we might have to pay damages or stop

 

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using technology found to be in violation of a third party’s rights, which could prevent us from offering our products to our customers. We could also have to seek a license for the technology, which might not be available on reasonable terms, might significantly increase our cost of revenue or might require us to restrict our business activities in one or more respects. The technology also might not be available for license to us at all. As a result, we could also be required to develop alternative non-infringing technology, which could require significant effort and expense.

Our exposure to risks associated with the use of intellectual property may be increased as a result of acquisitions, as we have a lower level of visibility into the development process with respect to acquired technology or the care taken to safeguard against infringement risks. Third parties may make infringement and similar or related claims after we have acquired technology that had not been asserted prior to our acquisition.

The success of our business depends on our ability to protect and enforce our intellectual property rights.

We rely on a combination of copyright, trademark, trade dress, unfair competition and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights. These laws, procedures and restrictions provide only limited protection. We currently have no patents, and no patents may issue with respect to our current patent applications. Any future patents issued to us may be challenged, invalidated or circumvented, may not provide sufficiently broad protection or may not prove to be enforceable in actions against alleged infringers.

We endeavor to enter into agreements with our employees and contractors and with parties with which we do business in order to limit access to and disclosure of our proprietary information. We cannot be certain that the steps we have taken will prevent unauthorized use or reverse engineering of our technology. Moreover, others may independently develop technologies that are competitive to ours or infringe our intellectual property. The enforcement of our intellectual property rights also depends on our legal actions against these infringers being successful, but these actions may not be successful, even when our rights have been infringed.

Furthermore, effective patent, trademark, trade dress, copyright and trade secret protection may not be available in every country in which our products are available over the Internet. In addition, the legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and still evolving.

One of our former employees has sued us and our founder. An adverse outcome or protracted litigation even if we prevail could require us to pay damages and royalties and subject us to other remedies and incur significant litigation fees and expenses.

On November 26, 2007, a former employee brought a lawsuit in Oklahoma State Court asserting a number of claims against us and Donald C. Yonce, our founder and a current member of our board of directors. The former employee claims that he is a co-author and that he is, therefore, co-owner of all of our major software products, which he claims he assisted in developing while an employee of our company. The former employee makes this claim despite the fact that he signed an agreement with us which provides that we are the exclusive owner of all copyrights and other intellectual property relating to any work performed by the former employee while employed by us. He also claims that Donald C. Yonce made certain oral promises to him regarding future potential compensation at our company prior to our recapitalization in December 2005 in the event of a sale of our company, and further alleges unspecified violations of Oklahoma labor protection laws. The former employee is seeking half of the profits from sales of our software products of which he claims to be a co-author and co-owner, as well as punitive damages and unspecified other legal and equitable relief. In April 2008, Mr. Yonce requested that we indemnify him from these claims pursuant to a stock purchase agreement entered into in 2005 between Mr. Yonce, us and certain stockholders who are parties to that agreement. We have denied this request although we have agreed to pay his legal fees. Even if we prevail in the litigation, we could incur significant litigation fees and expenses. Because this lawsuit is in its initial stage, it is not possible to predict the

 

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outcome of the litigation. Although we believe we have meritorious defenses, an adverse outcome in this litigation could materially and adversely affect us, requiring us to pay damages or royalties or subjecting us to other remedies.

If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, our ability to operate our business and investor views of us.

Ensuring that we have adequate internal financial and accounting controls and procedures in place so that we can produce accurate financial statements on a timely basis is a costly and time-consuming effort that needs to be re-evaluated frequently. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with generally accepted accounting principles. We are in the process of documenting, reviewing and improving our internal controls and procedures for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, which requires annual management assessment of the effectiveness of our internal control over financial reporting and a report by our independent auditors addressing this assessment. Both we and our independent auditors will be testing our internal controls in connection with the audit of our financial statements for the year ending December 31, 2010 and, as part of that testing, identifying areas for further attention and improvement. If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, harm our ability to operate our business and reduce the trading price of our stock.

Changes in financial accounting standards or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations.

A change in accounting standards or practices can have a significant effect on our reported results and may even affect our reporting of transactions completed before the change is effective. New accounting pronouncements and varying interpretations of accounting pronouncements have occurred and may occur in the future. Changes to existing rules or the questioning of current practices may adversely affect our reported financial results or the way in which we conduct our business.

We will incur increased costs and demands upon management as a result of complying with the laws and regulations affecting public companies, which could harm our operating results.

As a public company, we will incur significant legal, accounting, investor relations and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will incur costs associated with current corporate governance requirements, including requirements under Section 404 and other provisions of the Sarbanes-Oxley Act, as well as rules implemented by the Securities and Exchange Commission, or SEC, and the New York Stock Exchange, or NYSE. The expenses incurred by public companies for reporting and corporate governance purposes have increased dramatically over the past several years. We expect these rules and regulations to increase our legal and financial compliance costs substantially and to make some activities more time-consuming and costly. We are unable currently to estimate these costs with any degree of certainty. We also expect that, as a public company, it will be more expensive for us to obtain director and officer liability insurance. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers.

We may be subject to regulation of our advertising and customer solicitation or to other newly adopted laws and regulations, which could harm our business.

As part of our product download process and during our sales process, most of our customers agree to receive emails and other communications from us. However, we may be subject to restrictions on our ability to communicate with these customers through email and phone calls. Several jurisdictions have proposed or

 

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adopted privacy-related laws that restrict or prohibit unsolicited email or “spam.” These laws may impose significant monetary penalties for violations and complex and often burdensome requirements in connection with sending commercial email. Depending on how they are interpreted, these laws may impose burdens on our email marketing practices. If any of those challenges is successful, our business may become subject to state laws and regulations that further restrict our email marketing practices. The scope of those regulations is unpredictable. Compliance with laws and regulations of different jurisdictions imposing different standards and requirements is very burdensome for businesses like ours. We offer products to customers in multiple states and foreign jurisdictions. Our business efficiencies and economies of scale depend on generally uniform product offerings and uniform treatment of customers across all jurisdictions in which we operate. Compliance requirements that vary significantly from jurisdiction to jurisdiction impose an added cost to our business and increased liability for compliance deficiencies. In addition, laws or regulations that could harm our business could be adopted, or reinterpreted so as to affect our activities, by the U.S. government, state governments, regulatory agencies or by foreign governments or agencies. Violations or new interpretations of these laws or regulations may result in penalties or damage our reputation or could increase our costs or make our products less attractive.

If we fail to protect confidential information against security breaches, or if our customers or potential customers are reluctant to use our websites because of privacy concerns, we might face additional costs and activity in our websites could decline.

Some of our customers pay for our products with credit cards. During the purchasing process and in connection with evaluations of our software, either third-party providers or we collect and use personally identifiable information, such as credit card numbers, email addresses and phone numbers. This information could be compromised or accessed as a result of misappropriation or security breaches, and we could be subject to liability as a result. Our policies concerning the collection, use and disclosure of personally identifiable information are described on our websites. We could be subject to legal claims, government action or harm to our reputation if our third-party service providers or we fail to comply or are seen as failing to comply with our policies concerning personally identifiable information or if our policies are inadequate. Concern among prospective customers regarding our use of personal information collected on our websites could keep prospective customers from purchasing our products.

Our servers and those of our third-party service providers are vulnerable to computer viruses or physical or electronic break-ins. Industry-wide incidents or incidents with respect to our websites, including misappropriation of third-party information, security breaches, or changes in industry standards, regulations or laws, could deter people from using the Internet or our websites to conduct transactions that involve the transmission of confidential information, which could harm our business.

The laws of some states and countries require businesses that maintain personal information about their residents in electronic databases to implement reasonable measures to keep that information secure. In addition, under the laws of some states and countries, if there is a breach of our computer systems and we know or suspect that unencrypted personal customer information has been stolen, we are required to inform any customers whose information was stolen, which could harm our reputation and business. Other states and countries have enacted different and often contradictory requirements for protecting personal information collected and maintained electronically. Compliance with numerous and contradictory requirements of the different states and countries is particularly difficult for an online business such as ours that collects personal information from customers in multiple jurisdictions. Failure to comply with these laws could result in legal liability. In addition, we could suffer adverse publicity and loss of consumer confidence were it known that we did not take adequate measures to assure the confidentiality of the personally identifiable information that our customers had given to us. This could result in a loss of customers and revenue that could jeopardize our success. We may not be successful in avoiding potential liability or disruption of business resulting from the failure to comply with these laws. If we were required to pay any significant amount of money in satisfaction of claims under these new laws, or any similar laws enacted by other jurisdictions, or if we were forced to cease our business operations for any length of time as a result of our inability to comply fully with any of these laws, our business, operating results and

 

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financial condition could be adversely affected. Further, complying with the applicable notice requirements in the event of a security breach could result in significant costs.

Our business and financial performance could be negatively impacted by changes in tax laws or regulations.

New sales, use or other tax laws, statutes, rules, regulations or ordinances could be enacted at any time. Those enactments could adversely affect our domestic and international business operations, and our business and financial performance. Further, existing tax laws, statutes, rules, regulations or ordinances could be interpreted, changed, modified or applied adversely to us. These events could require us or our customers to pay additional tax amounts on a prospective or retroactive basis, as well as require us or our customers to pay fines and/or penalties and interest for past amounts deemed to be due. If we raise our product and maintenance prices to offset the costs of these changes, existing customers may elect not to renew their maintenance arrangements and potential customers may elect not to purchase our products. Additionally, new, changed, modified or newly interpreted or applied tax laws could increase our customers’ and our compliance, operating and other costs, as well as the costs of our products. Further, these events could decrease the capital we have available to operate our business. Any or all of these events could adversely impact our business and financial performance.

Government regulation of the Internet and e-commerce is evolving, and unfavorable changes or our failure to comply with regulations could harm our operating results.

As Internet commerce continues to evolve, increasing regulation by federal, state or foreign agencies becomes more likely. For example, we believe increased regulation is likely in the area of data privacy, and laws and regulations applying to the solicitation, collection, processing or use of personal or consumer information could affect our customers’ ability to use and share data, potentially reducing demand for our products. In addition, taxation of products and services provided over the Internet or other charges imposed by government agencies or by private organizations for accessing the Internet may also be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in a decline in the use of the Internet and the viability of Internet-based services and product offerings, which could harm our business and operating results.

Our debt obligations contain restrictions that impact our business and expose us to risks that could adversely affect our liquidity and financial condition.

At December 31, 2008, we had approximately $101.1 million of outstanding indebtedness under our December 2005 credit facilities, and our interest expense in 2007 and 2008 was approximately $10.2 million and $8.5 million, respectively. We expect to utilize proceeds from this offering to repay a significant portion or all of these obligations. However, if we do not raise sufficient funds in connection with the offering, these credit facilities may remain outstanding.

Our credit facilities contain various covenants that will continue to be operative if our credit facilities remain outstanding. The covenants, among other things, limit our and certain of our subsidiaries’ abilities to:

 

   

incur additional indebtedness or guarantee indebtedness of others;

 

   

create additional liens on our assets;

 

   

pay dividends and make other distributions on our capital stock, and redeem and repurchase our capital stock;

 

   

make investments, including acquisitions;

 

   

make capital expenditures;

 

   

enter into mergers or consolidations or sell assets;

 

   

sell our subsidiaries;

 

   

engage in sale and leaseback transactions; and

 

   

enter into transactions with affiliates.

 

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Our credit facilities also contain numerous affirmative covenants that will remain in effect if our credit facilities remain outstanding. In addition, we are required under each of our credit facilities to continue to comply with an interest coverage ratio and a leverage ratio. Further, the obligations under our credit facilities will continue to be subject to mandatory prepayment in certain circumstances, including upon certain asset sales or receipt of condemnation proceeds, upon certain issuances of equity securities or debt, and, in the case of our senior credit facility, annually, with a portion of our excess cash flow. Even if we comply with all of the applicable covenants, the restrictions on the conduct of our business could adversely affect our business by, among other things, limiting our ability to take advantage of financings, mergers, acquisitions and other corporate opportunities that may be beneficial to the business. Even if our credit facilities are terminated, any additional debt that we incur in the future could subject us to similar or additional covenants.

If we experience a decline in cash flow due to any of the factors described in this “Risk Factors” section or otherwise, we could have difficulty paying interest and principal amounts due on our indebtedness and meeting the financial covenants set forth in our credit facilities. If we are unable to generate sufficient cash flow or otherwise to obtain the funds necessary to make required payments under our credit facilities, or if we fail to comply with the various requirements of our indebtedness, we could default under our credit facilities. Any such default that is not cured or waived could result in an acceleration of the credit facilities, an increase in the applicable interest rates under the credit facilities, and a requirement that our subsidiaries that have guaranteed the credit facilities pay the obligations in full, and would permit the lenders to exercise remedies with respect to all of the collateral that is securing the credit facilities, including substantially all of our and our subsidiary guarantors’ assets. Thus, any such default could have a material adverse effect on our liquidity and financial condition.

Risks Related to this Offering

Our common stock could trade at prices below the initial public offering price.

There has not been a public trading market for shares of our common stock prior to this offering. An active trading market may not develop or be sustained after this offering. The initial public offering price for the shares of common stock sold in this offering will be determined by negotiations among us, the selling stockholders and representatives of the underwriters. This price may not be indicative of the price at which our common stock will trade after this offering, and our common stock could easily trade below the initial public offering price.

Our stock price may be volatile, and you may be unable to sell your shares at or above the offering price.

The market price of our common stock could be subject to wide fluctuations in response to, among other things, the factors described in this “Risk Factors” section or otherwise, and other factors beyond our control, such as fluctuations in the valuations of companies perceived by investors to be comparable to us.

Furthermore, the stock markets have experienced price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market fluctuations, as well as general economic, political and market conditions, such as recessions, interest rate changes and international currency fluctuations, may negatively affect the market price of our common stock.

In the past, many companies that have experienced volatility in the market price of their stock have become subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

The concentration of our capital stock ownership with insiders upon the completion of this offering will limit your ability to influence corporate matters.

We anticipate that our executive officers, directors, current 5% or greater stockholders and entities affiliated with them will together beneficially own approximately         % of our common stock outstanding after this offering. This significant concentration of share ownership may adversely affect the trading price for our

 

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common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. Also, these stockholders, acting together, will be able to control our management and affairs and matters requiring stockholder approval, including the election of directors and the approval of significant corporate transactions, such as mergers, consolidations or the sale of substantially all of our assets. Consequently, this concentration of ownership may have the effect of delaying or preventing a change of control, including a merger, consolidation or other business combination involving us, or discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control, even if that change of control would benefit our other stockholders.

Our stock price could decline due to the large number of outstanding shares of our common stock eligible for future sale.

Sales of substantial amounts of our common stock in the public market following this offering, or the perception that these sales could occur, could cause the market price of our common stock to decline. These sales could also make it more difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate.

Upon completion of this offering, we will have              outstanding shares of common stock, assuming no exercise of the underwriters’ option to purchase additional shares and no exercise of outstanding options after                     , 2009. The shares sold in this offering will be immediately tradable without restriction. Of the remaining shares:

 

   

no shares will be eligible for sale immediately upon completion of this offering; and

 

   

             shares will be eligible for sale upon the expiration of lock-up agreements, subject in some cases to volume and other restrictions of Rule 144 and Rule 701 under the Securities Act of 1933, as amended, or the Securities Act.

The lock-up agreements expire 180 days after the date of this prospectus, except that the 180-day period may be extended in certain cases for up to 34 additional days under certain circumstances where we announce or pre-announce earnings or a material event occurs within approximately 17 days prior to, or approximately 16 days after, the termination of the 180-day period. The representatives of the underwriters may, in their sole discretion and at any time without notice, release all or any portion of the securities subject to lock-up agreements.

Following this offering, holders of substantially all of the shares of our common stock not sold in this offering will be entitled to rights with respect to the registration of these shares under the Securities Act. See “Description of Capital Stock—Registration Rights.” If we register their shares of common stock following the expiration of the lock-up agreements, these stockholders could sell those shares in the public market without being subject to the volume and other restrictions of Rule 144 and Rule 701.

After the closing of this offering, we intend to register approximately 19,200,000 shares of common stock that have been issued or reserved for future issuance under our stock incentive plans. Of these shares,              shares will be eligible for sale upon the exercise of vested options after the expiration of the lock-up agreements.

Because our initial public offering price is substantially higher than the pro forma as adjusted net tangible book value per share of our outstanding common stock, new investors will incur immediate and substantial dilution.

The initial public offering price is substantially higher than the pro forma as adjusted net tangible book value per share of our common stock based on the total value of our tangible assets less our total liabilities immediately following this offering. Therefore, if you purchase common stock in this offering, you will experience immediate and substantial dilution of approximately $             per share, the difference between the

 

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price you pay for our common stock and its pro forma as adjusted net tangible book value after completion of the offering. Furthermore, investors purchasing common stock in this offering will own only approximately         % of our shares outstanding after the offering even though they will have contributed         % of the total consideration received by us in connection with our sales of common stock. To the extent outstanding options to purchase common stock are exercised, there will be further dilution.

Our management has broad discretion in the use of the net proceeds from this offering and may not use the net proceeds effectively.

Our management will have broad discretion in the application of the net proceeds of this offering. Other than repayment of a significant portion or all of our outstanding long-term indebtedness of $101.1 million as of December 31, 2008 and an earnout payment to our original stockholders of up to $20.0 million, we cannot specify with certainty the uses to which we will apply these net proceeds. The failure by our management to apply these funds effectively could adversely affect our ability to continue to maintain and expand our business.

Our charter documents and Delaware law could prevent a takeover that stockholders consider favorable and could also reduce the market price of our stock.

Our amended and restated certificate of incorporation and our amended and restated bylaws to be effective upon the completion of this offering will contain provisions that could delay or prevent a change in control of our company. These provisions could also make it more difficult for stockholders to elect directors and take other corporate actions. These provisions include:

 

   

not providing for cumulative voting in the election of directors;

 

   

authorizing the board to issue, without stockholder approval, preferred stock with rights senior to those of our common stock;

 

   

prohibiting stockholder action by written consent; and

 

   

requiring advance notification of stockholder nominations and proposals.

These and other provisions in our amended and restated certificate of incorporation and our amended and restated bylaws to be effective upon the completion of this offering and under Delaware law could discourage potential takeover attempts, reduce the price that investors might be willing to pay in the future for shares of our common stock and result in the market price of our common stock being lower than it would be without these provisions. See “Description of Capital Stock—Preferred Stock” and “Description of Capital Stock—Anti-Takeover Effects of Delaware Law and Our Certificate of Incorporation and Bylaws.”

If securities analysts do not publish research or reports about our business or if they publish negative evaluations of our stock, the price of our stock could decline.

We expect that the trading price for our common stock will be affected by any research or reports that industry or financial analysts publish about us or our business. If one or more of the analysts who may elect to cover us downgrade their evaluations of our stock, the price of our stock could decline. If one or more of these analysts cease coverage of our company, we could lose visibility in the market for our stock, which in turn could cause our stock price to decline.

We do not anticipate paying any dividends on our common stock.

We do not anticipate paying any cash dividends on our common stock in the foreseeable future. If we do not pay cash dividends, you could receive a return on your investment in our common stock only if the market price of our common stock increases before you sell your shares. In addition, the terms of our credit facilities currently restrict our ability to pay dividends.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This prospectus contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in “Prospectus Summary,” “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Business” and “Compensation Discussion and Analysis.” Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities, potential market opportunities and the effects of competition. Forward-looking statements include all statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts, “projects,” “should,” “will,” “would” or similar expressions and the negatives of those terms.

Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. We discuss these risks in greater detail in “Risk Factors” and elsewhere in this prospectus. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this prospectus. You should read this prospectus and the documents that we have filed as exhibits to the registration statement, of which this prospectus is a part, completely and with the understanding that our actual future results may be materially different from what we expect.

Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

This prospectus also contains estimates and other information concerning our industry, including market size and growth rates, that are based on industry publications, surveys and forecasts, including those generated by Compass Intelligence Research and reports published by Gartner, Inc. This information involves a number of assumptions and limitations, and you are cautioned not to give undue weight to these estimates. Although we believe the information in these industry publications, surveys and forecasts is reliable, we have not independently verified and cannot guarantee the accuracy or completeness of the information. The industry in which we operate is subject to a high degree of uncertainty and risk due to variety of factors, including those described in “Risk Factors.”

The Gartner Report described herein represents data, research opinion or viewpoints published, as part of a syndicated subscription service available only to clients, by Gartner, Inc., a corporation organized under the laws of the State of Delaware, USA, and its subsidiaries (“Gartner”), and is not a representation of fact. The Gartner Report does not constitute a specific guide to action and you assume sole responsibility for selection of, or reliance on, the Gartner Report, or any excerpts thereof, in making any decision, including any investment decision. Although we believe the information in the Gartner Report is reliable, we have not independently verified and cannot guarantee the accuracy or completeness of the information. The Gartner Report speaks as of its original publication date (and not as of the date of this prospectus), and the opinions expressed in the Gartner Report are subject to change without notice. Gartner is not responsible, nor shall it have any liability, to us or to you for errors, omissions or inadequacies in, or for any interpretations of, or for any calculations based upon data contained in, the Gartner Report or any excerpts thereof.

 

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USE OF PROCEEDS

We estimate that the net proceeds from our sale of            shares of common stock in this offering at an assumed initial public offering price of $            per share, the midpoint of the price range set forth on the front cover of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses, will be approximately $            million, or $         million if the underwriters’ option to purchase additional shares is exercised in full. A $1.00 increase (decrease) in the assumed initial public offering price would increase (decrease) the net proceeds to us from this offering by $            million, assuming the number of shares offered by us, as set forth on the front cover of this prospectus, remains the same and after deducting the estimated underwriting discounts and commissions. We will not receive any proceeds from the sale of shares of our common stock by the selling stockholders.

We intend to use a portion of our net proceeds from this offering to repay a significant portion or all of our outstanding long-term indebtedness of $101.1 million as of December 31, 2008 under our December 2005 credit facilities and to pay an earnout payment of up to $20.0 million. See “Certain Relationships and Related Party Transactions—Redemption Agreement.” The borrowings outstanding under our December 2005 credit facilities currently have a stated maturity of December 2011. The $76.1 million of borrowings outstanding under the first lien term loan at December 31, 2008 bear interest at a per annum rate of three-month LIBOR plus a margin of 3.50%, or 7.4% at December 31, 2008, and the $25.0 million of borrowings outstanding under the second lien term loan at December 31, 2008 bear interest at a per annum rate of three-month LIBOR plus a margin of 5.25% to 6.25% depending on our leverage ratio at the time, or 9.0% at December 31, 2008, in each case payable quarterly. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations, Commitments and Contingencies.” We intend to use our remaining net proceeds from this offering for working capital and general corporate purposes. We may also use a portion of our net proceeds from this offering to acquire or license products, technologies or businesses, but we currently have no agreements or commitments relating to material acquisitions or licenses. Accordingly, our management will have broad discretion in the application of these proceeds and investors will be relying on the judgment of our management regarding their application.

Pending their use, we plan to invest our net proceeds from this offering in short-term, interest-bearing obligations, investment-grade instruments, certificates of deposit or direct or guaranteed obligations of the U.S. government.

DIVIDEND POLICY

We do not expect to pay dividends on our common stock for the foreseeable future. Instead, we anticipate that all of our earnings will be used for the operation and growth of our business. Any future determination to pay dividends on our common stock would be subject to the discretion of our board of directors and would depend upon various factors, including our results of operations, financial condition and liquidity requirements, restrictions that may be imposed by applicable law and our contracts, and other factors deemed relevant by our board of directors. In addition, the terms of our credit facilities currently restrict our ability to pay dividends.

 

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CAPITALIZATION

The following table sets forth our consolidated cash and cash equivalents and capitalization as of December 31, 2008 on:

 

   

an actual basis;

 

   

a pro forma basis to reflect the conversion of all outstanding shares of our convertible preferred stock into 27,000,003 shares of our common stock upon the closing of this offering; and

 

   

a pro forma as adjusted basis to reflect (i) our receipt of the net proceeds from our sale of shares of common stock in this offering at an assumed initial public offering price of $             per share, the midpoint of the price range set forth on the front cover of this prospectus, after deducting estimated underwriting discounts and commissions and estimated offering expenses and (ii) the application of the net proceeds from this offering as described under “Use of Proceeds.”

The information below is illustrative only and our capitalization following the completion of this offering will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing. You should read this table together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this prospectus.

 

     December 31, 2008
     Actual     Pro
Forma
    Pro Forma
As Adjusted
(in thousands)          (unaudited)      

Cash and cash equivalents

   $ 40,566     $ 40,566     $         
                      

Long-term obligations, including current portion (excluding deferred revenue)

   $ 101,306     $ 101,306     $  

Convertible preferred stock, $0.001 par value: 46,551,618 shares authorized, 27,000,003 shares issued and outstanding, actual; 46,551,618 shares authorized, no shares issued or outstanding, pro forma; no shares authorized, issued or outstanding, pro forma as adjusted

     27          

Stockholders’ equity (deficit):

      

Preferred stock, $0.001 par value: no shares authorized, issued or outstanding, actual or pro forma; 10,000,000 shares authorized, no shares issued or outstanding, pro forma as adjusted

              

Common stock, $0.001 par value: 123,000,000 shares authorized, 28,166,656 shares issued and outstanding, actual; 123,000,000 shares authorized, 55,166,659 shares issued and outstanding, pro forma; and 123,000,000 shares authorized,                  shares issued and outstanding, pro forma as adjusted

     28       55    

Additional paid-in capital

     15,166       15,166    

Accumulated other comprehensive loss

     (315 )     (315 )  

Accumulated deficit

     (63,434 )     (63,434 )  
                      

Total stockholders’ equity (deficit)

     (48,555 )     (48,528 )  
                      

Total capitalization

   $ 52,778     $ 52,778     $              
                      

 

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The numbers of pro forma and pro forma as adjusted shares of common stock shown as issued and outstanding in the table are based on the number of shares of our common stock outstanding as of December 31, 2008 and exclude:

 

   

12,004,001 shares of our common stock issuable upon exercise of options outstanding under our 2005 Stock Plan as of December 31, 2008, with a weighted average exercise price of $3.82 per share; and

 

   

6,029,346 shares of our common stock reserved for future issuance under our 2008 Stock Plan, which will become effective in connection with this offering (including 2,529,346 shares of common stock reserved, as of December 31, 2008, for future issuance under our 2005 Stock Plan, which shares will be added to the shares reserved under our 2008 Stock Plan upon the effectiveness of the 2008 Stock Plan).

A $1.00 decrease or increase in the initial public offering price would result in an approximately $            million decrease or increase in each of pro forma as adjusted cash and cash equivalents, additional paid-in capital, total stockholders’ equity (deficit) and total capitalization. If the underwriters exercise their option to purchase additional shares in full, there would be a $             increase in each of pro forma as adjusted cash and cash equivalents, additional paid-in capital, total stockholders’ equity (deficit) and total capitalization.

 

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DILUTION

At December 31, 2008, our pro forma net tangible book value (deficit) was approximately $(70.6) million, or $(1.28) per share of common stock. Our pro forma net tangible book value (deficit) per share represents the amount of our tangible assets less our liabilities, divided by the shares of common stock outstanding at December 31, 2008 after giving effect to the conversion of all outstanding shares of convertible preferred stock into 27,000,003 shares of our common stock upon completion of this offering. After giving effect to our sale of              shares of common stock in this offering at an assumed initial public offering price of $             per share, the midpoint of the price range set forth on the front cover of this prospectus, and after deducting estimated underwriting discounts and commissions and estimated offering expenses, our pro forma as adjusted net tangible book value at December 31, 2008 would have been $            , or $              per share of common stock. This represents an immediate increase in pro forma net tangible book value of $             per share to existing stockholders and an immediate dilution of $              per share to new investors.

The following table illustrates this dilution:

 

Assumed initial public offering price per share

    $             

Pro forma net tangible book value (deficit) per share as of December 31, 2008

  $ (1.28 )  

Increase per share attributable to this offering

   
         

Pro forma as adjusted net tangible book value per share after this offering

   
       

Net tangible book value dilution per share to new investors in this offering

    $  
       

If all our outstanding options had been exercised, our pro forma net tangible book value (deficit) as of December 31, 2008 would have been $(24.8) million, or $(0.37) per share, and the pro forma as adjusted net tangible book value after this offering would have been $             million, or $             per share, causing dilution to new investors of $             per share.

The following table summarizes, on a pro forma as adjusted basis as of December 31, 2008, the total number of shares of common stock purchased from us, the total consideration paid to us and the average price per share paid to us by existing stockholders and by new investors purchasing shares in this offering at the initial public offering price of $            , the midpoint of the price range set forth on the front cover of this prospectus, before deducting estimated underwriting discounts and commissions and estimated offering expenses:

 

     Shares Purchased     Total Consideration     Average Price
Per Share
     Number    Percent     Amount    Percent    

Existing stockholders

   55,166,659         %   $ 10,452,490         %   $ 0.19

New investors

            
                          

Total

      100.0 %   $      100.0 %  
                          

The foregoing calculations are based on 55,166,659 shares of our common stock outstanding as of December 31, 2008 and exclude:

 

   

12,004,001 shares of our common stock issuable upon exercise of options outstanding under our 2005 Stock Plan as of December 31, 2008, with a weighted average exercise price of $3.82 per share; and

 

   

6,029,346 shares of our common stock reserved for future issuance under our 2008 Stock Plan, which will become effective in connection with this offering (including 2,529,346 shares of common stock reserved, as of December 31, 2008, for future issuance under our 2005 Stock Plan, which shares will be added to the shares reserved under our 2008 Stock Plan upon the effectiveness of the 2008 Stock Plan).

 

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SELECTED CONSOLIDATED FINANCIAL DATA

We have derived the following consolidated statement of income data for 2006, 2007 and 2008 and consolidated balance sheet data as of December 31, 2007 and 2008 from our audited consolidated financial statements included elsewhere in this prospectus. We have derived the following consolidated statement of income data for 2004 and 2005 and consolidated balance sheet data as of December 31, 2004, 2005 and 2006 from our audited consolidated financial statements not included in this prospectus. You should read the consolidated financial data set forth below in conjunction with our consolidated financial statements and related notes and the information under “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our historical results are not necessarily indicative of our results to be expected in any future period.

 

Consolidated Statement of Income Data:   Year Ended December 31,  

(in thousands, except per share data)

  2004     2005     2006     2007     2008  

Revenue:

         

License

  $ 13,783     $ 18,400     $ 23,676     $ 39,525     $ 55,461  

Maintenance and other

    7,640       9,502       14,558       22,210       37,674  
                                       

Total revenue

    21,423       27,902       38,234       61,735       93,135  

Cost of revenue (1)

    186       257       490       2,253       3,588  
                                       

Gross profit

    21,237       27,645       37,744       59,482       89,547  
                                       

Operating expenses:

         

Sales and marketing (1)

    848       1,140       3,504       12,909       22,664  

Research and development (1)

    860       930       2,341       5,899       8,452  

General and administrative (1)

    566       973       6,477       9,763       16,464  

Recapitalization expenses (2)

          1,612                    
                                       

Total operating expenses

    2,274       4,655       12,322       28,571       47,580  
                                       

Operating income

    18,963       22,990       25,422       30,911       41,967  
                                       

Other income (expense):

         

Interest income

    2       4       447       528       528  

Interest expense

    (4 )     (474 )     (10,682 )     (10,235 )     (8,539 )

Foreign exchange loss

                      (73 )     (934 )
                                       

Total other expense

    (2 )     (470 )     (10,235 )     (9,780 )     (8,945 )
                                       

Income before income taxes

    18,961       22,520       15,187       21,131       33,022  

Income tax expense (benefit)

          (751 )     5,596       7,524       10,717  
                                       

Net income

    18,961       23,271       9,591       13,607       22,305  

Amount allocated to participating preferred stockholders

          (4,642 )     (4,791 )     (6,681 )     (10,922 )
                                       

Net income available to common stockholders

  $ 18,961     $ 18,629     $ 4,800     $ 6,926     $ 11,383  
                                       

Basic earnings per share available to common stockholders

  $ 6,320     $ 13.95     $ 0.18     $ 0.25     $ 0.40  
                                       

Diluted earnings per share available to common stockholders

  $ 6,320     $ 8.73     $ 0.18     $ 0.24     $ 0.35  
                                       

Shares used in computation of basic earnings per share available to common stockholders (3)

    3       1,335       27,014       27,969       28,137  
                                       

Shares used in computation of diluted earnings per share available to common stockholders (3)

    3       2,667       54,055       56,030       32,652  
                                       

Pro forma earnings per share (unaudited)

         

Basic

          $ 0.40  

Diluted

          $ 0.37  

Weighted average number of shares used in pro forma computation (unaudited)

         

Basic

            55,137  

Diluted

            59,652  

Other Data:

         

Adjusted EBITDA (4)

  $ 19,020     $ 23,026     $ 27,061     $ 35,433     $ 48,389  
                                       

 

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Consolidated Balance Sheet Data:    December 31,  
(in thousands)    2004     2005     2006     2007     2008  
                                

Cash and cash equivalents

   $ 137     $ 828     $ 9,342     $ 19,303     $ 40,566  

Working capital (deficit)

     (1,604 )     (631 )     1,676       5,130       16,393  

Deferred revenue

     4,416       7,531       8,353       17,092       27,162  

Total assets

     3,082       9,864       21,072       49,262       86,907  

Long-term obligations and convertible preferred stock

           110,027       102,909       101,987       95,379  

Total stockholders’ deficit

     (1,813 )     (108,822 )     (96,298 )     (78,534 )     (48,555 )

 

(1) Includes stock-based compensation expense as follows:

 

     Year Ended December 31,
     2006    2007    2008

(in thousands)

              

Cost of revenue

     $      $ 39      $ 63

Sales and marketing

     334      1,213      1,593

Research and development

     190      467      755

General and administrative

     991      2,091      3,509
                    
     $ 1,515      $ 3,810      $ 5,920
                    

 

(2) In December 2005, a group of investors led by Bain Capital Ventures and Insight Venture Partners purchased a 67.8% interest in us from our original stockholders. This transaction was accomplished through a recapitalization of the company. Costs associated with effecting the recapitalization, comprised primarily of consulting fees to certain of our stockholders and legal and accounting fees, were expensed in the 2005 consolidated statement of income.
(3) The number of shares of outstanding stock increased significantly as a result of our December 2005 recapitalization. The effect of the recapitalization was only minimally reflected in the 2005 shares used in the computation of basic and diluted earnings per share available to common stockholders due to the weighted average nature of the calculation. There was no impact of stock options in our earnings per share calculations in 2004, and there was only a minimal impact in 2005, as we had no stock option plan prior to December 2005.
(4) We anticipate that our investor and analyst presentations will include Adjusted EBITDA, which we define as net income plus net interest expense, income tax expense (benefit), depreciation and amortization, and stock-based compensation expense, and which is a financial measure that is not calculated in accordance with GAAP. The table below provides a reconciliation of this non-GAAP financial measure to the most directly comparable financial measure calculated and presented in accordance with GAAP. Adjusted EBITDA should not be considered as an alternative to net income, operating income or any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate Adjusted EBITDA in the same manner as we do. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. You are encouraged to evaluate these adjustments and the reason we consider them appropriate.

We believe Adjusted EBITDA is useful to investors in evaluating our operating performance for the following reasons:

 

   

Adjusted EBITDA is widely used by investors to measure a company’s operating performance without regard to items, such as interest expense, income tax expense, depreciation and amortization, and stock-based compensation expense, that can vary substantially from company to company depending upon their financing and accounting methods, the book value of their assets, their capital structures and the method by which their assets were acquired;

 

   

securities analysts use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of companies;

 

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we adopted SFAS No. 123(R), Share-Based Payment, on January 1, 2006 and recorded stock-based compensation expense of approximately $1.5 million, $3.8 million and $5.9 million for the years ended December 31, 2006, 2007 and 2008, respectively. Prior to January 1, 2006, we accounted for stock-based compensation using the intrinsic value method under APB Opinion No. 25, Accounting for Stock Issued to Employees, which resulted in zero stock-based compensation expense. By comparing our Adjusted EBITDA in different historical periods, our investors can evaluate our operating results without the additional variations caused by stock-based compensation expense, which is not comparable from year to year due to changes in accounting treatment and is a non-cash expense that is not a key measure of our operations; and

 

   

our lenders believed Adjusted EBITDA was the appropriate performance measure for the key operational covenants in our credit agreements. These key operational covenants require us to maintain a minimum consolidated interest coverage ratio and a maximum consolidated leverage ratio as of the last day of each fiscal quarter. Each of these ratios uses Adjusted EBITDA in its calculation. The interest coverage ratio is defined to be the ratio of Adjusted EBITDA for the trailing four quarters to cash interest expense for the trailing four quarters. To be in compliance, our interest coverage ratio had to be at least 3.5 to 1.0 as of December 31, 2008 and must be at least 3.5 to 1.0 as of the last day of each fiscal quarter thereafter. The leverage ratio is defined to be the ratio of consolidated total debt to Adjusted EBITDA for the trailing four quarters. Our leverage ratio as of December 31, 2008 could not be more than 3.1 to 1.0, and this maximum ratio decreases over time to 2.1 to 1.0 as of December 31, 2011. We were in compliance with each of these key operational covenants as of December 31, 2008. We believe these are key operational covenants because the failure to comply with these covenants would be an event of default under our credit agreements that would likely result in the acceleration of our indebtedness or an unfavorable amendment to the terms of the credit agreements. This acceleration would and any such amendment might adversely affect our liquidity and financial condition.

Our management uses Adjusted EBITDA:

 

   

as a measure of operating performance, because it does not include the impact of items not directly resulting from our core operations;

 

   

for planning purposes, including the preparation of our annual operating budget;

 

   

to allocate resources to enhance the financial performance of our business;

 

   

to evaluate the effectiveness of our business strategies; and

 

   

in communications with our board of directors concerning our financial performance.

We understand that, although Adjusted EBITDA is frequently used by investors and securities analysts in their evaluations of companies, Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results of operations as reported under GAAP. Some of these limitations are:

 

   

Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or other contractual commitments;

 

   

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

 

   

Adjusted EBITDA does not reflect interest expense or interest income;

 

   

Adjusted EBITDA does not reflect cash requirements for income taxes;

 

   

although depreciation and amortization are non-cash charges, the assets being depreciated or amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for these replacements; and

 

   

other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

 

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The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the periods indicated.

 

     Year Ended December 31,

Reconciliation of Adjusted EBITDA to Net Income

   2006    2007    2008
(in thousands)               

Net income

   $ 9,591    $ 13,607    $ 22,305

Interest expense, net

     10,235      9,707      8,011

Income tax expense

     5,596      7,524      10,717

Depreciation and amortization

     124      785      1,436

Stock-based compensation expense

     1,515      3,810      5,920
                    

Adjusted EBITDA

   $ 27,061    $ 35,433    $ 48,389
                    

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this prospectus. In addition to historical consolidated financial information, the following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include those discussed below and elsewhere in this prospectus, particularly in “Risk Factors.”

Overview

We are a leading provider of powerful yet easy-to-use enterprise-class network management software designed by network professionals for network professionals. Our offerings range from individual software tools to more comprehensive software products, solve problems faced every day by network professionals and help to enable efficient and effective network management. We design our software to meet the requirements of networks and implementations of varying sizes and levels of complexity. We currently have customers that use our software to manage networks ranging from a single device to over 100,000 installed devices. Our products are easy to find, evaluate, use and maintain.

In 1999, we were formed and introduced the first version of one of our core products, Engineer’s Toolset. Until December 2005, we were owned by our original stockholders and employed a simple business model designed to minimize expenses and maximize cash flow. We focused our marketing efforts almost exclusively on optimizing our placement in search engine listings, which we attempted to influence through changing the content on our website, and on direct email lead generation programs to the registered end-users of our software products. We did not engage in any proactive advertising, branding or lead generation programs, and thus had minimal marketing expense. By employing a “self service” model in which our software was downloaded by engineers who came to our website, we kept sales expense low as well. Our relatively small historical investment in sales and marketing and research and development allowed us to be profitable in every year since inception and to generate income before income taxes in excess of 80% of revenue from 2003 through 2005. Despite our low levels of expenditures, by 2005 we had grown our revenue to $27.9 million and had introduced a suite of software products, including our current flagship product, Orion Network Performance Monitor, as well as Orion Network Configuration Manager, formerly known as Cirrus Configuration Manager.

In 2005, our founder decided to explore alternatives in order to grow our business more rapidly than had been possible under our historical model. In December 2005, investors led by Bain Capital Ventures and Insight Venture Partners acquired an aggregate of 67.8% of our outstanding capital stock from our original stockholders and we recapitalized our company. As a result, we incurred $110.0 million of long-term debt, $101.1 million of which remained outstanding at December 31, 2008. In the second half of 2006, we hired most of our current management team. This new management team began to implement changes to our business model that were designed to accelerate the growth of our revenue. These changes included expanding our suite of products, refining our product development process, creating sales and marketing organizations, and building administrative infrastructure to manage our business.

Throughout 2007 and 2008, we continued to build and refine our business model, making significant investments in people, systems and infrastructure. We continue to embrace certain elements of our founder’s model, including providing downloadable enterprise-class software designed for network professionals, focusing on our customer base and end-user community, and offering compelling pricing. In addition, we now employ a highly efficient product development process, a scalable marketing model and a high volume, transaction-oriented inside sales model that have allowed us to drive and support rapid growth in our business at high operating margins while offering our products at prices that are typically significantly lower than those of our competitors. Our revenue grew from $38.2 million in 2006 to $61.7 million in 2007 and $93.1 million in 2008 and our operating income grew from $25.4 million in 2006 to $30.9 million in 2007 and $42.0 million in 2008. Our average transaction size

 

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for new license sales in 2007 and 2008 was less than $6,000 compared to hundreds of thousands of dollars for many competing products. We manage our business with a culture and systems that are focused on metrics and helping us to achieve a high level of visibility and consistency in our execution.

We have also sought to expand our product offerings through three acquisitions. In April 2007, we acquired ipMonitor, our entry-level network, server and application monitoring product, by purchasing substantially all of the assets and liabilities of IPMonitor Corporation, or IPMonitor. In May 2007, we acquired our LANsurveyor product and various underlying technologies by purchasing all of the outstanding stock of Neon Software, Inc., or Neon. In December 2008, we acquired our Kiwi Syslog Server and Kiwi CatTools products by purchasing substantially all of the assets and liabilities of Trilenium Investments Limited, or Trilenium. We paid $5.9 million, $3.75 million and $7.2 million, respectively, in connection with these acquisitions, resulting in the recording of purchased intangible assets and goodwill on our balance sheet, and amortization of certain of these assets in our statements of income. We anticipate making selective additional acquisitions of companies with products that complement our business model.

To increase our international sales, we have expanded international operations by building a direct sales force and contracting with resellers overseas. We established operations in Cork, Ireland in 2007 to serve as our international headquarters. We have also opened a sales and support operation in Singapore in 2008. Since we recognize the predominant portion of our international revenue through an Irish subsidiary, we have begun to reduce our tax rate below the U.S. federal statutory rate.

Through December 13, 2005, we operated as a Subchapter S corporation. As a consequence, all of our earnings were recorded on the personal tax returns of our original stockholders and we were not a tax-paying entity. Accordingly, we had no federal or state income tax expense through that date. Since December 13, 2005, we have been a Subchapter C corporation and thus have recorded income tax expense (benefit).

Key Business Metrics

We designed our business model to sell high volumes of low-priced, downloadable, enterprise-class software to our customers and to be low cost, scalable and efficient. We review a number of key business metrics to help us monitor the performance of our business model and to identify trends affecting our business. The measures that we believe are the primary indicators of our quarterly and annual performance are as follows:

Average Transaction Size for New License Sales. We focus our sales, marketing and research and development efforts on network professionals and other IT professionals in organizations of all sizes, with the goal of driving purchases of our software by these network and other IT professionals in very short sales cycles with minimal levels of approval. In addition, many of our customers make small initial purchases of our software to manage specific components of their networks and then make additional purchases over time to expand the use of the product that they purchased or to buy additional software products from us. We measure the average transaction size for new license sales on a frequent basis as an indicator of the success of these efforts and to ensure the effectiveness of our marketing and sales model.

Adjusted EBITDA. Our management uses Adjusted EBITDA to measure our performance. Because Adjusted EBITDA excludes certain non-cash expenses such as depreciation, amortization and stock-based compensation, we believe that this measure provides us with additional useful information to measure and understand our performance on a consistent basis, particularly with respect to changes in performance from period to period. We use Adjusted EBITDA in the preparation of our budgets and to measure and monitor our performance. Adjusted EBITDA is not determined in accordance with GAAP and is not a substitute for or superior to financial measures determined in accordance with GAAP. For further discussion regarding Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, see footnote 4 to the table in “Selected Consolidated Financial Data” included elsewhere in this prospectus.

 

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Revenue Growth. Beginning in the middle of 2006 with the hiring of our current executive management team, we have employed a differentiated business model for marketing and selling high volumes of enterprise- class software, which is focused on rapid revenue growth at high Adjusted EBITDA margins. We regularly review our revenue growth to measure our success.

Opportunities and Trends

Businesses, governments and other organizations are increasingly relying on data networks to execute their operations, facilitate their internal and external communications and transact business with their customers and partners, and these networks are generally growing in size and complexity. We believe that the increasing challenges of network management and the limitations of existing offerings present a market opportunity for our products. We expect our revenue to continue to grow as we capitalize on this market opportunity.

We have rapidly evolved and expanded our business since the middle of 2006. This expansion has included hiring most of our senior management team, moving our corporate headquarters to Austin, Texas and building infrastructure to support our business. This evolution has resulted in our significantly expanding our direct inside sales presence in the United States, entering into an outsourced development relationship in Eastern Europe in late 2006, creating a direct sales and support presence in Europe through establishment of our European headquarters in Cork, Ireland in the third quarter of 2007, establishing a research and development facility in the Czech Republic in 2008 and opening an international sales and support operation in Singapore in 2008. We have also expanded through three acquisitions in April and May 2007 and December 2008. These investments in and changes to our business have allowed us to accelerate our revenue growth significantly while maintaining high operating margins.

We expect to continue to invest for the foreseeable future in expanding our business as we increase our direct sales presence in the United States, Europe and Asia, enhance and expand our product offerings and pursue strategic acquisitions. We expect to continue to experience significant annual growth in our business while striving to maintain and increase Adjusted EBITDA as a percentage of revenue; however, there is a risk that the returns that we achieve on future investments in the growth of our business will not be as rapid or as high as what we have achieved in the past.

Key Components of Our Results of Operations

Sources of Revenue

Our revenue is primarily comprised of license and maintenance revenue. We license our software under perpetual licenses, which include one year of maintenance as part of the initial purchase price of the product. License revenue reflects the revenue recognized from sales of new licenses and upgrades to our software. We have experienced strong and consistent annual and quarterly growth in license revenue. Customers can renew and generally have renewed their maintenance agreements for annual periods at our standard list maintenance renewal pricing for their software products. Current customers with maintenance agreements are entitled to receive unspecified upgrades or enhancements when and if they become available. Maintenance revenue is an important source of our future revenue. We have experienced strong and consistent annual and quarterly growth in maintenance and other revenue. Based on the trend of increasing new license sales and increasing maintenance renewals during 2007 and 2008, we expect maintenance revenue to continue to increase in 2009.

Cost of Revenue

Cost of revenue primarily consists of personnel costs related to providing technical support services and amortization of acquired developed product technologies. Personnel costs include salaries, bonuses and stock- based compensation for technical support personnel, as well as an allocation of our facilities, information technology and other overhead costs and our employee benefit costs. We allocate stock-based compensation expense to personnel costs based on the expense category in which the optionholder works. We allocate

 

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overhead, such as rent, computer and other technology costs, and employee benefit costs to personnel costs in each expense category based on worldwide headcount in that category. We expect our cost of revenue to increase in absolute dollars but to remain relatively stable as a percentage of revenue in future periods.

Operating Expenses

We classify our operating expenses into three categories: sales and marketing, research and development and general and administrative.

Our operating expenses primarily consist of personnel costs, contract research and development costs, marketing program costs and legal, accounting, consulting and other professional service fees. Personnel costs for each category of operating expenses include salaries, bonuses and stock-based compensation for personnel in that category, as well as an allocation of our facilities, information technology and other overhead costs and our employee benefit costs. We allocate stock-based compensation expense resulting from the amortization of the fair value of options granted based on how we categorize the department in which the optionholder works. We allocate overhead, such as rent, computer and other technology costs and employee benefit costs, to each expense category based on worldwide headcount in that category.

Our operating expenses increased in absolute dollars and as a percentage of revenue in each of 2006, 2007 and 2008 as we have built infrastructure and added employees across all categories in order to accelerate and support our growth and to expand into international markets. We expect our operating expenses in 2009 to continue to increase in absolute dollars and to be consistent with 2008 levels as a percentage of revenue.

Sales and Marketing. Sales and marketing expenses primarily consist of personnel costs for our sales, marketing and business development employees and executives, commissions earned by our sales personnel, the cost of marketing programs such as on-line lead generation, promotional events and webinars and the cost of business development programs. During the third quarter of 2007, we began to make significant investments to expand our sales operations outside the United States, particularly in EMEA. We established a sales and support center in Cork, Ireland in July 2007 and intend to continue to add resources to this facility. We also opened an international sales and support center in Singapore in June 2008 and are rapidly expanding the operations at that center.

Research and Development. Research and development expenses primarily consist of personnel costs for our product development employees and executives and fees to our contract development vendors in Eastern Europe. We have devoted our development efforts primarily to expanding our product line and increasing the functionality and enhancing the ease-of-use of our software offerings. In 2008, we opened a development center in the Czech Republic to take advantage of low labor rates and strong technical talent and acquired research and development personnel in New Zealand as part of our acquisition of Trilenium. We expect our research and development expenses to increase in absolute dollars in 2009 as we continue to expand our Czech Republic development center.

General and Administrative. General and administrative expenses primarily consist of personnel costs for our executive, finance, legal, human resources and administrative personnel, as well as legal, accounting and other professional service fees and other corporate expenses. We expect to incur additional costs in 2009 and beyond associated with being a public company, including higher legal, corporate insurance and financial reporting expenses and the additional costs of achieving and maintaining compliance with Section 404 of the Sarbanes-Oxley Act.

Other Income (Expense)

Other income (expense) primarily consists of interest income, interest expense and foreign exchange losses. Interest income represents interest received on our cash and cash equivalents. Interest expense is associated with our outstanding long-term debt, which was $102.5 million as of December 31, 2006 and 2007 and $101.1 million

 

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as of December 31, 2008. We expect interest expense to decrease in periods subsequent to the completion of this offering as we anticipate paying down our outstanding long-term debt balance with proceeds from this offering. Foreign exchange losses relate to expenses and transactions denominated in currencies other than the functional currency of the associated company.

Income Tax Expense

Income tax expense primarily consists of corporate income taxes related to profits resulting from the sale of our software offerings in the United States and Ireland. We expect our income tax expense to increase in absolute dollars as our profits continue to increase; however, we expect our effective tax rate to begin to decline slowly, due to the lower corporate tax rate in Ireland, as our international revenue increases as a percentage of total revenue.

Critical Accounting Policies and Estimates

We prepare our consolidated financial statements in accordance with GAAP. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require management’s judgment in its application, while in other cases management’s judgment is required in selecting among available alternative accounting standards that allow different accounting treatment for similar transactions. The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. In many instances, we could reasonably use different accounting estimates, and in some instances changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ significantly from the estimates made by our management. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates.

Impairment of Long-Lived Assets

We evaluate long-lived assets held and used for impairment whenever events or changes in circumstances indicate that their net book values may not be recoverable. We continually evaluate whether events and circumstances have occurred that indicate the balance of our property and equipment and intangible assets with finite lives may not be recoverable. This evaluation is significantly impacted by estimates and assumptions of future revenue, expenses and other factors, which are affected by changes in the business climate, legal matters and competition. If an event occurs that would cause us to revise our estimates and assumptions used in analyzing the value of our property and equipment or our intangible assets with finite lives, that revision could result in a non-cash impairment charge that could have a material impact on our financial results. When these factors and circumstances exist, we compare the projected undiscounted future cash flows associated with the related asset or group of assets over their estimated useful lives against their respective carrying amounts. We base the impairment, if any, on the excess of the carrying amount over the fair value, based on market value when available, or discounted expected cash flows of those assets, and record it in the period in which we make the determination.

Goodwill and Other Intangible Assets with Indefinite Lives

We made two acquisitions in 2007 and one acquisition in 2008 that resulted in the recognition of goodwill. We test goodwill and other intangible assets with indefinite lives for impairment on an annual basis in the fourth quarter of each year in accordance with the provisions of SFAS No. 142, Goodwill and Other Intangible Assets. Additionally, we will test goodwill and other intangible assets with indefinite lives in the interim if events and circumstances indicate that goodwill and other intangible assets with indefinite lives may be impaired. The

 

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events and circumstances that we would consider include the business climate, legal factors, operating performance indicators and competition. If an event occurs that would cause us to revise our estimates and assumptions used in analyzing the value of our goodwill and other intangible assets with indefinite lives, the revision could result in a non-cash impairment charge that could have a material impact on our financial results.

Valuation of assets and liabilities assumed in business combinations, including goodwill and other intangible assets, requires the use of management’s judgment. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future reflecting pricing, volume and expense levels, the appropriate weighted average cost of capital and appropriate discount rate. We believe that the assumptions made in this regard are comparable to those a market participant would use in making similar estimates of fair value. In arriving at this assertion, we derived future cash flows based on historical revenue growth increased by an amount we believed to be achievable by us. Expense levels were analyzed based on existing cost structures and anticipated margins. Our estimates were based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable. Management’s assumptions do not reflect unanticipated events or circumstances that may occur.

Determining the expected life of an intangible asset requires considerable management judgment and is based on an evaluation of a number of factors, including the competitive environment, our market share, customer history and macroeconomic factors. We determined that acquired product technologies and customer relationships were intangible assets that had useful lives of five and three years, respectively. These lives were based on the expected use of the existing technology and customer turnover rates. We amortized these intangible assets on a straight-line basis as we do not expect a degradation in value in any one period different from that in another period during the useful lives of the amortizable intangible assets.

Revenue Recognition

We derive substantially all of our revenue from the licensing of our software products and from the sale of maintenance agreements. We include one year of maintenance as part of the initial purchase price of each software offering and then sell annual renewals of this maintenance agreement. We recognize revenue for software, maintenance and other services in accordance with the American Institute of Certified Public Accountants’ Statement of Position, or SOP, 97-2, Software Revenue Recognition, as amended, when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable.

License Revenue. We consider delivery of our software to have occurred and recognize revenue from the sale of perpetual licenses to our software when risk of loss transfers to the customer or reseller, which is generally upon electronic transfer of the license key that provides immediate availability of the product to the purchaser.

We sell licenses to our software products through our direct inside sales force and through our distributors and other resellers. Our resellers do not carry inventory of our software; we require resellers to specify the end-user of the software at the time of the order. If the reseller does not provide end-user information, then we will generally not fulfill the order. In periods prior to October 1, 2006, on isolated occasions our resellers carried a limited amount of inventory. In those instances, we deferred revenue from the sale of those products until the software was sold by the reseller to an end-user.

We generally use a purchase order, an authorized credit card, an electronic or manually signed license agreement, or the receipt of a cash payment as evidence of an arrangement. Sales through resellers are typically evidenced by a reseller agreement, together with purchase orders or authorized credit cards on a transaction-by-transaction basis.

We account for sales incentives to customers or resellers as a reduction of revenue at the time we recognize the revenue from the related product sale. We report revenue net of any sales tax collected.

 

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Our return policy generally does not allow customers to return software offerings.

Because our software is always sold with maintenance, we calculate the amount of revenue allocated to the software license by determining the fair value of the maintenance and subtracting it from the total invoice or contract amount. We establish vendor-specific objective evidence, or VSOE, of the fair value of maintenance services by the standard published list pricing for our maintenance renewals since we generally charge list prices for our maintenance renewals.

For periods prior to October 1, 2006, we had implied post contract support services obligations because we provided free technical support and unspecified software upgrades to certain customers. Thus, for these periods, we deferred a portion of the license revenue from product sales and allocated these amounts to post contract support deferred revenue to account for the circumstances in which we provided post contract support services in excess of the customer’s contractual post contract support services period. We then recognized the deferred revenue for these implied post contract support services obligations ratably on a daily basis over the implied post contract support services period, which was typically based on the expected term of the obligation, which ranged from five months to three years. The implied post contract support services obligation for our software offerings historically ceased upon the delivery of the next major software upgrade. In October 2006, we ceased offering free upgrades and support to customers.

Maintenance and Other Revenue. We derive maintenance revenue from fees for software maintenance services and historically implied post contract support services. We recognize maintenance revenue ratably on a daily basis over the contract period. For periods prior to January 1, 2007, we recognized implied post contract support services on a daily basis over the remaining estimated term of the obligation. We had recognized all revenue related to implied post contract support services by January 1, 2007. Customers with maintenance agreements are entitled to receive unspecified upgrades or enhancements to new versions of their software products on a when-and-if-available basis. Other revenue consists of training and consulting revenue, which is recognized upon delivery of the training course or consulting services to the end customer. Training and consulting revenue is not currently significant nor do we expect it to be significant in future periods.

Stock-Based Compensation

We have granted our employees restricted stock and stock options for common stock. On January 1, 2006, we adopted the provisions of SFAS No. 123(R), Share-Based Payment. SFAS No. 123(R) requires recognizing compensation costs for all share-based payment awards made to employees based upon each award’s estimated grant date fair value. It covers employee stock options, restricted stock and employee stock purchases related to employee stock purchase plans.

We adopted SFAS No. 123(R) using the modified prospective transition method, which does not result in the revision of prior periods. Accordingly, our results of operations for 2006 and subsequent periods are not comparable to our results of operations for periods prior to 2006.

Under the modified prospective transition method, SFAS No. 123(R) applies to new equity awards and to equity awards modified, repurchased or canceled after the adoption date. Additionally, compensation cost for the portion of awards granted prior to the adoption date for which the requisite service had not been rendered as of the adoption date must be recognized as the employee renders the requisite service. The compensation cost for that portion of awards must be based on the grant-date fair value of those awards as calculated in the prior period pro forma disclosures under SFAS No. 123, Accounting for Stock-Based Compensation. The compensation cost for those earlier awards is attributed to periods beginning on or after the adoption date using the attribution method that was used under SFAS No. 123, which was the straight-line method. Instead of recognizing forfeitures only as they occur, we now estimate an expected forfeiture rate and utilize it to determine our expense.

We utilize the Black-Scholes option-pricing model to determine the fair value of our stock option awards. For stock options that contain only a service vesting feature, we recognize compensation cost on a straight-line

 

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basis over the respective vesting periods. Stock-based compensation under SFAS No. 123(R) decreased income before income taxes by $1.5 million, $3.8 million and $5.9 million in 2006, 2007 and 2008, respectively.

For periods ended after January 1, 2006, pursuant to SFAS 123(R), the income tax benefits exceeding the recorded deferred income tax benefit and any pre-adoption “as-if” deferred income tax benefit from stock-based compensation awards, or together the excess tax benefits, must be reported in net cash provided by financing activities. In 2006 and 2007, we reflected excess tax benefits from stock-based compensation awards of $0.2 million and $0.3 million as an outflow in cash flows from operating activities and an inflow in cash flows from financing activities in our consolidated statements of cash flows, resulting in no impact on cash. Excess tax benefits from stock-based compensation awards in 2008 were $83,000.

Valuation of Common Stock

In 2007, 2008 and 2009, we granted options to purchase shares of common stock with exercise prices as follows:

 

Grant Date

   Options
Granted
   Exercise Price
Per Share
   SFAS 123(R)
Fair Value

January 2007

   362,250    $ 4.06    $ 989,893

April 2007

   650,325      4.06      1,769,523

July 2007

   213,450      4.06      505,381

October 2007

   773,400      4.35      2,063,848

November 2007

   900,000      4.35      2,399,670

January 2008

   679,989      4.48      1,734,719

March 2008

   122,300      9.40      657,248

April 2008

   187,450      9.40      1,016,090

May 2008

   515,800      9.40      2,754,217

June 2008

   275,850      9.40      1,461,315

July 2008

   88,900      9.40      465,579

August 2008

   42,350      9.40      216,404

November 2008

   44,775      8.68      208,897

March 2009

   293,113      8.68      1,495,251

For all dates, we granted employees options at exercise prices equal to the fair value of the underlying common stock at the time of grant, as determined by our board of directors on a contemporaneous basis. To determine the fair value of our common stock, our board of directors considered many factors, including:

 

   

our current and historical operating performance;

 

   

our expected future operating performance;

 

   

our financial condition at the grant date;

 

   

the liquidation rights and other preferences of our preferred stock;

 

   

any recent privately negotiated sales of our securities to independent third parties;

 

   

input from management;

 

   

the lack of marketability of our common stock;

 

   

the potential future marketability of our common stock;

 

   

the business risks inherent in our business and in technology companies generally; and

 

   

the market performance of comparable public companies.

In December 2006, Austin Ventures, a venture capital firm, purchased 1,847,292 shares of our common stock and preferred stock directly from certain of our stockholders at a price per share of $4.06 in a private third-party transaction. The price per share paid by Austin Ventures for these shares and the terms of the transaction were the result of negotiations between Austin Ventures and the selling stockholders in the transaction.

 

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The stock option grants in January 2007 were made within 30 days of the sales to Austin Ventures described in the preceding paragraph. The purchase price paid by Austin Ventures was the primary factor considered by our board of directors when determining the fair value of our common stock in January 2007 as the AICPA Practice Aid, Valuation of Privately Held Company Equity Securities Issued as Compensation, indicates a third-party transaction between a willing buyer and a willing seller is the best indication of the fair value of an enterprise. Thus, we used the third-party transaction price of $4.06 per share in determining the fair value of our common stock at the time of the January 2007 stock option grants.

For the April and July 2007 stock option grants, we continued to use the $4.06 per share valuation based on the price per share paid by Austin Ventures for our common and preferred stock in December 2006. Our results of operations in the first and second quarters of 2007 were consistent with the expectations that we had provided to Austin Ventures prior to their purchase in December 2006 at $4.06 per share. Based primarily on these factors, our board of directors determined in April and July 2007 that there had been no significant change in our performance since the Austin Ventures purchase that warranted a higher valuation of our common stock.

In October 2007, we reviewed the growth in our business from the second to the third quarter of 2007 and our forecasted operating results for the fourth quarter of 2007 and for the full year 2008. During the third quarter of 2007, we sequentially increased our revenue and Adjusted EBITDA over the second quarter of 2007 by 35.4% and 60.8%, respectively. We also experienced strong sales performance across all of our territories and geographies. We expected this strong sales performance to impact our forecasted operating results positively for the fourth quarter of 2007 and for the full year 2008. In connection with our grant of options in October 2007, we considered generally accepted valuation methodologies, including the discounted cash flow method, the prior transaction method and a market approach based on the Guideline Public Company Method. We utilized and prepared a valuation of our common stock using a market approach based on the Guideline Public Company Method because we believed it produced the most reliable indicator of enterprise value in light of the stage of our company. The Guideline Public Company Method attempts to determine enterprise value based on comparisons to comparable public companies. A key assumption under the market approach is that the selected comparable companies are truly comparable. We selected companies of varying sizes engaged in similar lines of business. This peer group included software companies recently consummating initial public offerings and more mature publicly traded software companies. We concluded that enterprise value to revenue and enterprise value to Adjusted EBITDA would yield the most appropriate indications of value for us because we believed that potential investors would focus equally on our revenue growth and our ability to yield returns on their investment based on positive cash flows. We weighted these values equally when determining the fair value of our common stock. Although we believed an illiquidity discount could have been appropriate, we did not discount the derived enterprise values for illiquidity as we felt this would result in a more conservative valuation. Based on the results of this analysis, we determined that our enterprise value was $293.4 million, or $4.35 per share of common stock. We discussed this valuation with our board of directors and, based on this analysis, our board of directors determined that the fair value of our common stock should be increased to $4.35 per share of common stock in connection with the October 2007 grants. For purposes of the November 2007 stock option grants, our board determined there had been no significant change in our business or industry that would warrant a higher valuation than the fair value of our common stock of $4.35 per share in October 2007.

In January 2008, we analyzed the fair value of our common stock using a probability-weighted expected return method. Although we considered other generally accepted valuation methodologies at that time, our decision to utilize the probability-weighted expected return method was influenced by, among other things, the fact that we had begun to consider more seriously an initial public offering of our common stock, including holding our organizational meeting with our underwriters in December 2007. Under this methodology, we estimated the fair market value of our common stock based upon an analysis of future values assuming various outcomes. Share value was based upon the probability-weighted present value of the possible outcomes, as well as the rights of each class of preferred and common stock. We modeled future outcomes to include an initial public offering, a strategic acquisition and an acquisition years in the future. We used the Guideline Public Company Method based on equally-weighted enterprise value to revenue and enterprise value to Adjusted EBITDA multiples. We again selected companies engaged in similar lines of business with similar size in terms

 

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of revenue. We then applied a discount for illiquidity based upon a study of illiquidity discounts, which indicated that potential discounts of 14% to 40% would be acceptable after giving consideration to the initial public offering. Based on this study, we selected a discount of 10% due to our belief in the near-term prospects of the initial public offering. After applying this discount, we determined that our enterprise value was $389.9 million, or $4.43 per share of common stock.

In late March 2008, one of our significant stockholders negotiated an agreement with certain of our minority stockholders to have us repurchase the minority stockholders’ shares of common and preferred stock at a price of $9.40 per share. After completing that transaction, we sold an equal number of shares to a number of our existing stockholders pro rata based on the relative percentages of shares held by those stockholders that elected to participate in the transaction at the same price of $9.40 per share. For further discussion of this transaction and the parties involved, see the caption “Certain Relationships and Related Party Transactions—2008 Stock Repurchase and Sale.” We used the negotiated repurchase price of $9.40 per share in determining the fair value of our common stock in March 2008 in accordance with the guidance in the AICPA Practice Aid, Valuation of Privately Held Company Equity Securities Issued as Compensation, which states that a third-party transaction between a willing buyer and a willing seller is the best indication of fair value.

For purposes of the April, May and June 2008 stock option grants, we continued to use the $9.40 per share valuation based on the valuation established for our common stock by the March 2008 transaction described in the preceding paragraph. With respect to the April 2008 grants, our board of directors concluded that, since the date of the March 2008 stock option grants, there had been no significant change in our business or expectations of future business that would warrant a valuation higher than $9.40 per share. In connection with the May 2008 grants, we updated our January 2008 valuation based on the probability-weighted expected return method. In doing so, we increased the probability of an initial public offering while lowering the probability of an acquisition and continued to use an illiquidity discount of 10% due to our belief of the near-term prospects of the initial public offering. We also updated the enterprise value to revenue and enterprise value to Adjusted EBITDA multiples based on more recent market information and weighted the multiples 33% and 67%, respectively, in deriving an enterprise value under the Guideline Public Company Method. This updated valuation determined a fair value per share below the $9.40 per share valuation in the March 2008 transaction. After considering the updated valuation and the purchase price per share in the March 2008 transaction, our board of directors continued to use $9.40 per share as the exercise price for the May 2008 grants. In connection with our June 2008 grants, our board of directors concluded that, since the date of the March 2008 stock option grants and in light of the updated May valuation, there had been no significant change in our business or expectations of future business that would warrant a valuation higher than $9.40 per share and continued to use the $9.40 per share as the exercise price for the June 2008 grants.

In connection with the July and August 2008 grants, we updated our May 2008 valuation to derive the enterprise value to revenue and enterprise value to Adjusted EBITDA multiples based on more recent market information and the performance of our business. We applied the same weighting of the multiples, probabilities for various company scenarios and illiquidity discount as those used in the May 2008 valuation due to our continued belief in the likelihood of our initial public offering. This updated valuation determined a fair value per share below the $9.40 per share valuation in the March 2008 transaction. After again considering the updated valuation and the purchase price per share in the March 2008 transaction, our board of directors determined that there had been no significant change in our business or expectations of future business that would warrant a valuation higher than $9.40 per share and continued to use $9.40 per share as the exercise price for the July and August 2008 grants.

In connection with the November 2008 grants, we updated our July 2008 valuation to derive the enterprise value to revenue and enterprise value to Adjusted EBITDA multiples based on more recent market information. We also updated our valuation by applying the multiples for each company scenario to financial projections of additional future periods. For the initial public offering scenarios, we derived an enterprise value by applying public company multiples to revenue and Adjusted EBITDA projections for 2008 and 2009. For the strategic sale scenarios, we derived an equity value by applying transaction multiples to revenue and Adjusted EBITDA

 

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projections for 2009 and 2010. We used the same weighting of the multiples as in July 2008 because we continued to believe that our potential investors would be likely to value our business with a heavier weighting on the enterprise value to Adjusted EBITDA multiple than on the enterprise value to revenue multiple. We also did not adjust the probabilities of the company scenarios because our management believed that the fundamental strength of our business continued to make each of the company scenarios as likely as in July 2008. We applied the same illiquidity discount used in the July 2008 valuation because we had not experienced a material change in our business or prospects despite the deteriorating economic environment and we continued to believe in the near-term prospects of the offering. We derived an enterprise value of $8.68 per share of common stock. After considering this updated valuation and the passage of time since the March 2008 transaction, we determined that the fair value of our common stock was $8.68 per share.

For purposes of the March 2009 grants of stock options and restricted stock, we continued to use the $8.68 per share valuation based on the November 2008 valuation. Our board of directors concluded that, since the date of the November 2008 stock option grants, there had been no significant change in our business or expectations of future business that would warrant a valuation higher than $8.68 per share.

Income Taxes

We use the liability method of accounting for income taxes as set forth in SFAS No. 109, Accounting for Income Taxes. Under this method, we recognize deferred tax liabilities and assets for the expected future tax consequences of temporary differences between the respective carrying amounts and tax bases of our assets and liabilities.

In July 2006, the Financial Accounting Standards Board, or FASB, issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes—an Interpretation of Statement of Financial Accounting Standards 109, or FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements and prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken or expected to be taken on a tax return. We adopted FIN 48 on January 1, 2007. At the adoption, there was no liability for uncertain tax positions due to the fact that there were no material identified tax benefits that were considered uncertain tax positions. At December 31, 2008, we had $0.2 million of unrecognized tax benefits, all of which, if recognized, would affect our effective tax rate. As of December 31, 2007, we had no unrecognized tax benefits.

We accrue interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of the adoption date of FIN 48, there was no accrued interest or penalties. As of December 31, 2007 and 2008, there was no accrued interest or penalties.

In calculating our effective tax rate, we make judgments regarding certain tax positions, including the timing and amount of deductions and allocations of income among various tax jurisdictions.

The adoption of FIN 48 required us to identify, evaluate and measure all uncertain tax positions taken or to be taken on tax returns and to record liabilities for the amount of these positions that may not be sustained, or may only partially be sustained, upon examination by the relevant taxing authorities. Although we believe that our estimates and judgments were reasonable, actual results may differ from these estimates. Some or all of these judgments are subject to review by the taxing authorities.

We establish valuation allowances when necessary to reduce deferred tax assets to the amounts expected to be realized. On a quarterly basis, we evaluate the need for, and the adequacy of, valuation allowances based on the expected realization of our deferred tax assets. The factors used to assess the likelihood of realization include our latest forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets.

 

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We intend either to invest our non-U.S. earnings permanently in foreign operations or to remit these earnings to our U.S. entities in a tax-free manner. For this reason, we do not record federal income taxes on the undistributed earnings of our foreign subsidiaries.

 

Consolidated Statement of Income Data    Year Ended December 31,  
(in thousands)    2006     2007     2008  
        

Revenue:

      

License

   $ 23,676     $ 39,525     $ 55,461  

Maintenance and other

     14,558       22,210       37,674  
                        

Total revenue

     38,234       61,735       93,135  

Cost of revenue (1)

     490       2,253       3,588  
                        

Gross profit

     37,744       59,482       89,547  
                        

Operating expenses:

      

Sales and marketing (1)

     3,504       12,909       22,664  

Research and development (1)

     2,341       5,899       8,452  

General and administrative (1)

     6,477       9,763       16,464  
                        

Total operating expenses

     12,322       28,571       47,580  
                        

Operating income

     25,422       30,911       41,967  
                        

Other income (expense):

      

Interest income

     447       528       528  

Interest expense

     (10,682 )     (10,235 )     (8,539 )

Foreign exchange loss

           (73 )     (934 )
                        

Total other expense

     (10,235 )     (9,780 )     (8,945 )
                        

Income before income taxes

     15,187       21,131       33,022  

Income tax expense

     5,596       7,524       10,717  
                        

Net income

   $ 9,591     $ 13,607     $ 22,305  
                        

 

(1)    Includes stock-based compensation expense as follows:

 

      

Cost of revenue

   $     $ 39     $ 63  

Sales and marketing

     334       1,213       1,593  

Research and development

     190       467       755  

General and administrative

     991       2,091       3,509  
                        
   $ 1,515     $ 3,810     $ 5,920  
                        

 

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Comparison of the Years Ended December 31, 2007 and 2008

Revenue

 

     Year Ended December 31,
     2007     2008      

Revenue

   Amount    Percentage
of
Revenue
    Amount    Percentage
of
Revenue
    Change
(dollars in thousands)                           

License

   $ 39,525    64.0 %   $ 55,461    59.5 %   $ 15,936

Maintenance and other

     22,210    36.0       37,674    40.5       15,464
                                

Total

   $ 61,735    100.0 %   $ 93,135    100.0 %   $ 31,400
                                

Revenue was $93.1 million in 2008 compared to $61.7 million in 2007, an increase of $31.4 million, or 50.9%. This increase was comprised of a $15.9 million increase in license revenue and a $15.5 million increase in maintenance and other revenue. The increases in both license revenue and maintenance and other revenue were primarily due to the increased demand for our software products. Our average transaction size for new license sales in 2008 was approximately $5,900, which represents an increase from $5,100 in 2007. We experienced sales growth in North America, EMEA, the Asia Pacific region and Latin America during 2008 compared to 2007. Our sales growth in license revenue was primarily related to our continued efforts to add sales personnel in order to respond to the increased demand for our software products. In addition, maintenance and other revenue increased as our maintenance base continued to grow due to strong new license sales and high customer retention.

Cost of Revenue and Gross Margin

 

     Year Ended December 31,

Cost of Revenue and Gross Margin

   2007     2008     Change
(dollars in thousands)                 

Total revenue

   $ 61,735     $ 93,135     $ 31,400

Total cost of revenue

     2,253       3,588       1,335
                      

Gross profit

   $ 59,482     $ 89,547     $ 30,065
                      

Gross margin

     96.4 %     96.1 %  
                  

Cost of revenue was $3.6 million in 2008 compared to $2.3 million in 2007, an increase of $1.3 million, or 59.3%. This increase was due primarily to an increase in cost of maintenance revenue related to an increase in headcount of our North American and EMEA support organizations in 2008 compared to 2007 in order to support the increasing number of new customers we added during 2007 and 2008. Cost of license revenue also increased due to the amortization of acquired product technologies associated with two acquisitions we made in the second quarter of 2007. This non-cash amortization of acquired product technologies was $0.2 million for 2008 and was recorded in cost of license revenue. Our gross margin as a percentage of revenue was relatively consistent in 2007 and 2008 and we expect gross margin in future periods to approximate the gross margin during 2008 of 96.1%.

Operating Expenses

 

     Year Ended December 31,
     2007     2008      

Operating Expenses

   Amount    Percentage
of
Revenue
    Amount    Percentage
of
Revenue
    Change
(dollars in thousands)     

Sales and marketing

   $ 12,909    20.9 %   $ 22,664    24.3 %   $ 9,755

Research and development

     5,899    9.6       8,452    9.1       2,553

General and administrative

     9,763    15.8       16,464    17.7       6,701
                                

Total

   $ 28,571    46.3 %   $ 47,580    51.1 %   $ 19,009
                                

 

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Index to Financial Statements

Sales and Marketing. Sales and marketing expenses were $22.7 million in 2008 compared to $12.9 million in 2007, an increase of $9.8 million, or 75.6%. Increases occurred in sales and marketing expenses during 2008 as we focused on building a larger direct inside sales force in the United States and made significant investments to expand our sales operations outside the United States, by adding personnel to our sales center in Cork, Ireland and establishing a sales center in Singapore in June 2008 to support our growth in the Asia Pacific region. In addition, we have made a significant investment in business development activities in 2008, including adding a Vice President of Business Development, in order to take advantage of partnering opportunities that have the potential to expand our business. As a result of these efforts, our sales and marketing personnel costs increased by $6.8 million and stock-based compensation expense increased by $0.4 million. We also increased our spending on marketing programs and other activities in 2008 compared to 2007. Marketing program costs such as Internet search optimization expenses, trade show costs and search engine placement fees increased $1.6 million in 2008 compared to 2007. Other costs such as credit card processing fees, recruiting fees, and software licensing costs increased by $0.7 million.

Research and Development. Research and development expenses were $8.5 million in 2008 compared to $5.9 million in 2007, an increase of $2.6 million, or 43.3%. In order to support our product development strategy, we increased the size of our North American research and development organization, we opened a research and development facility in the Czech Republic in April 2008 and we established a relationship with two contract research and development vendors in Eastern Europe. In addition, we added to our research and engineering team as a result of two acquisitions that we made in the second quarter of 2007 and one acquisition that we made in the fourth quarter of 2008. Our personnel costs increased by $1.8 million and the fees we paid to our offshore contract research and development vendors increased by $0.3 million from 2007 to 2008.

General and Administrative. General and administrative expenses were $16.5 million in 2008 compared to $9.8 million in 2007, an increase of $6.7 million, or 68.6%. This increase was due primarily to a $2.4 million increase in personnel costs, a $1.4 million increase in stock-based compensation expense and a $0.5 million increase in facility and information technology costs to support our growth and international expansion. Professional fees, principally from accounting, audit and tax fees related to our initial public offering that were required to be expensed and legal fees, increased by $1.6 million.

Other Income (Expense)

 

     Year Ended December 31,  

Other Income (Expense)

       2007             2008             Change      
(in thousands)                   

Interest income

   $ 528     $ 528     $  

Interest expense

     (10,235 )     (8,539 )     (1,696 )

Foreign exchange loss

     (73 )     (934 )     861  
                        

Total

   $ (9,780 )   $ (8,945 )   $ (835 )
                        

Interest expense in 2008 decreased by $1.7 million compared to 2007 due to lower average interest rates in the 2008 period. Our total average outstanding debt balance was approximately the same during both periods. Pursuant to the terms of our credit agreements, our interest rate is reset periodically. Our effective interest rate for 2008 was 8.4% as compared to 10.0% in 2007. Foreign exchange losses related to the weakening of the British Pound Sterling and U.S. dollar against the Euro.

Income Tax Expense

Our income tax expense in 2008 increased by $3.2 million from 2007. This increase resulted from an increase in our income before income taxes of $11.9 million from 2007 to 2008 and was partially offset by a decrease in our effective tax rate from 35.6% in 2007 to 32.5% in 2008 as a result of the establishment of our European operations in July 2007.

 

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Index to Financial Statements

Comparison of the Years Ended December 31, 2006 and 2007

Revenue

 

     Year Ended December 31,
     2006     2007      

Revenue

   Amount    Percentage
of
Revenue
    Amount    Percentage
of
Revenue
    Change
(dollars in thousands)                           

License

   $ 23,676    61.9 %   $ 39,525    64.0 %   $ 15,849

Maintenance and other

     14,558    38.1       22,210    36.0       7,652
                                

Total

   $ 38,234    100.0 %   $ 61,735    100.0 %   $ 23,501
                                

Revenue was $61.7 million in 2007 compared to $38.2 million in 2006, an increase of $23.5 million, or 61.5%. This increase was comprised of a $15.8 million increase in license revenue and a $7.7 million increase in maintenance and other revenue. The increase in both license revenue and maintenance and other revenue was primarily due to an increase in sales activity in 2007 compared to 2006 to respond to increasing demand for our software products. In addition, our average transaction size for new license sales increased to approximately $5,100 in 2007 from $3,900 in 2006. We experienced sales growth in North America, EMEA and selected countries in the Asia Pacific region during 2007, with international revenue comprising 6.4% of our revenue during 2007. Our sales growth in North America was primarily due to an increase in sales of our software offerings to many different departments of the U.S. government.

Cost of Revenue and Gross Margin

 

     Year Ended December 31,

Cost of Revenue and Gross Margin

   2006     2007     Change
(dollars in thousands)                 

Total revenue

   $ 38,234     $ 61,735     $ 23,501

Total cost of revenue

     490       2,253       1,763
                      

Gross profit

   $ 37,744     $ 59,482     $ 21,738
                      

Gross margin

     98.7 %     96.4 %  
                  

Cost of revenue was $2.3 million in 2007 compared to $0.5 million in 2006, an increase of $1.8 million, or 360%. This increase was due primarily to an increase in cost of maintenance revenue related to an increase in headcount of our North American technical support organization in 2007 and the establishment of our European support center in the third quarter of 2007 in order to support the increasing number of new customers we added during 2007 and to support our international expansion that we began in July 2007. Cost of license revenue increased $0.1 million due to the amortization of acquired developed product technologies associated with our acquisitions in 2007.

Operating Expenses

 

     Year Ended December 31,
     2006     2007      

Operating Expenses

   Amount    Percentage
of
Revenue
    Amount    Percentage
of
Revenue
    Change
(dollars in thousands)                           

Sales and marketing

   $ 3,504    9.2 %   $ 12,909    20.9 %   $ 9,405

Research and development

     2,341    6.1       5,899    9.6       3,558

General and administrative

     6,477    16.9       9,763    15.8       3,286
                                

Total

   $ 12,322    32.2 %   $ 28,571    46.3 %   $ 16,249
                                

 

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Index to Financial Statements

Sales and Marketing. Sales and marketing expenses were $12.9 million in 2007 compared to $3.5 million in 2006, an increase of $9.4 million, or 268%. This increase was principally due to an increase in sales and marketing headcount during 2007. The increase in headcount was primarily to build a larger direct inside sales force in the United States as well as to make a significant investment to expand our sales operations outside the United States, particularly in EMEA, by establishing a sales and support center in Cork, Ireland. As a result of these efforts, our sales and marketing personnel costs increased by $7.1 million. We also increased our spending on marketing programs and other activities during 2007. Marketing program costs such as Internet search optimization expenses, trade show costs and pay per click fees increased $1.4 million from 2006 to 2007.

Research and Development. Research and development expenses were $5.9 million in 2007 compared to $2.3 million in 2006, an increase of $3.6 million, or 152%. In the second half of 2006, in order to support our product development strategy, we began to increase the size of our research and development organization and established a relationship with a contract development vendor in Eastern Europe. As a result, our personnel costs increased $2.0 million during 2007 and the fees we paid to our offshore contract development vendor increased $1.5 million.

General and Administrative. General and administrative expenses were $9.8 million in 2007 compared to $6.5 million in 2006, an increase of $3.3 million, or 51%. This increase was due primarily to a $4.0 million increase in personnel costs, partially offset by lower relocation, severance and other costs, as we incurred $0.9 million of costs in 2006 related to the relocation of our corporate headquarters from Tulsa, Oklahoma to Austin, Texas.

Other Income (Expense)

 

     Year Ended December 31,  

Other Income (Expense)

   2006     2007     Change  
(in thousands)                   

Interest income

   $ 447     $ 528     $ 81  

Interest expense

     (10,682 )     (10,235 )     447  

Foreign exchange loss

           (73 )     (73 )
                        

Total

   $ (10,235 )   $ (9,780 )   $ 455  
                        

Interest expense decreased by $0.4 million due to the repayment of $7.5 million of our outstanding long-term debt balance in December 2006. Our effective average interest rate decreased from 10.4% in 2006 to 10.0% in 2007.

Income Tax Expense

Our income tax expense increased by $1.9 million from 2006 to 2007. This increase resulted from an increase in our income before income taxes of $5.9 million from 2006 to 2007, partially offset by a decrease in our effective tax rate to 35.6% in 2007 from 36.8% in 2006 as a result of the establishment of our European operations in July 2007.

 

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Index to Financial Statements

Quarterly Results of Operations

The following tables set forth unaudited quarterly consolidated statement of income data for 2007 and 2008, as well as the percentage that each line item represented of our revenue. We have prepared the statement of income for each of these quarters on the same basis as the audited consolidated financial statements included elsewhere in this prospectus and, in the opinion of the management, each statement of income includes all adjustments, consisting solely of normal recurring adjustments, necessary for the fair statement of the results of operations for these periods. This information should be read in conjunction with the audited consolidated financial statements and related notes included elsewhere in this prospectus. These quarterly operating results are not necessarily indicative of our operating results for any future period.

 

            Three Months Ended  
    March 31,
2007
    June 30,
2007
    September 30,
2007
    December 31,
2007
    March 31,
2008
    June 30,
2008
    September 30,
2008
    December 31,
2008
 
(in thousands, except per share
data)
 

        (unaudited)

 

Revenue

  $ 12,773     $ 12,784     $ 17,311     $ 18,867     $ 20,396     $ 21,677     $ 26,165     $ 24,897  

Cost of revenue

    429       573       611       640       819       847       940       982  
                                                               

Gross profit

    12,344       12,211       16,700       18,227       19,577       20,830       25,225       23,915  
                                                               

Operating expenses:

               

Sales and marketing

    2,559       3,022       3,452       3,876       4,538       5,138       6,522       6,466  

Research and development

    1,229       1,529       1,522       1,619       1,920       1,990       2,339       2,203  

General and administrative

    1,889       2,268       2,566       3,040       4,172       3,787       4,527       3,978  
                                                               

Total operating expenses

    5,677       6,819       7,540       8,535       10,630       10,915       13,388       12,647  
                                                               

Operating income

    6,667       5,392       9,160       9,692       8,947       9,915       11,837       11,268  
                                                               

Other income (expense):

               

Interest income

    140       109       106       173       150       110       140       128  

Interest expense

    (2,530 )     (2,560 )     (2,590 )     (2,555 )     (2,681 )     (1,858 )     (1,896 )     (2,104 )

Foreign exchange gain (loss)

          (26 )     9       (56 )     (133 )     6       84       (891 )
                                                               

Total other expense

    (2,390 )     (2,477 )     (2,475 )     (2,438 )     (2,664 )     (1,742 )     (1,672 )     (2,867 )
                                                               

Income before income taxes

    4,277       2,915       6,685       7,254       6,283       8,173       10,165       8,401  

Income tax expense

    1,553       1,059       2,326       2,586       2,133       2,945       2,878       2,761  
                                                               

Net income

    2,724       1,856       4,359       4,668       4,150       5,228       7,287       5,640  

Amount allocated to participating preferred stockholders

    (1,348 )     (910 )     (2,136 )     (2,287 )     (2,034 )     (2,560 )     (3,567 )     (2,761 )
                                                               

Net income available to common stockholders

  $ 1,376     $ 946     $ 2,223     $ 2,381     $ 2,116     $ 2,668     $ 3,720     $ 2,879  
                                                               

Basic earnings per share available to common stockholders

  $ 0.05     $ 0.03     $ 0.08     $ 0.08     $ 0.08     $ 0.09     $ 0.13     $ 0.10  
                                                               

Diluted earnings per share available to common stockholders

  $ 0.05     $ 0.03     $ 0.08     $ 0.08     $ 0.07     $ 0.08     $ 0.11     $ 0.09  
                                                               

Shares used in computation of basic earnings per share available to common stockholders

    27,581       28,097       28,097       28,097       28,097       28,141       28,153       28,157  
                                                               

Shares used in computation of diluted earnings per share available to common stockholders

    55,249       55,567       55,810       56,158       57,788       33,035       33,407       33,380  
                                                               

Other data:

               

Adjusted EBITDA

  $ 7,573     $ 6,449     $ 10,371     $ 11,041     $ 10,396     $ 11,692     $ 13,933     $ 12,368  
                                                               

 

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Index to Financial Statements
            Three Months Ended  
    March 31,
2007
    June 30,
2007
    September 30,
2007
    December 31,
2007
    March 31,
2008
    June 30,
2008
    September 30,
2008
    December 31,
2008
 
   

        (unaudited)

 

Revenue

  100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Cost of revenue

  3.4     4.5     3.5     3.4     4.0     3.9     3.6     3.9  
                                               

Gross margin

  96.6     95.5     96.5     96.6     96.0     96.1     96.4     96.1  
                                               

Operating expenses:

               

Sales and marketing

  20.0     23.6     20.0     20.5     22.2     23.7     24.9     26.0  

Research and development

  9.6     12.0     8.8     8.6     9.4     9.2     8.9     8.8  

General and administrative

  14.8     17.7     14.8     16.1     20.5     17.5     17.3     16.0  
                                               

Total operating expenses

  44.4     53.3     43.6     45.2     52.1     50.4     51.1     50.8  
                                               

Operating income

  52.2     42.2     52.9     51.4     43.9     45.7     45.3     45.3  
                                               

Other income (expense):

               

Interest income

  1.1     0.9     0.6     0.9     0.7     0.5     0.5     0.5  

Interest expense

  (19.8 )   (20.0 )   (15.0 )   (13.5 )   (13.1 )   (8.6 )   (7.2 )   (8.5 )

Foreign exchange gain (loss)

      (0.2 )   0.1     (0.3 )   (0.7 )   0.1     0.3     (3.6 )
                                               

Total other expense

  (18.7 )   (19.4 )   (14.3 )   (12.9 )   (13.1 )   (8.0 )   (6.4 )   (11.5 )
                                               

Income before income taxes

  33.5     22.8     38.6     38.4     30.8     37.7     38.9     33.7  

Income tax expense

  12.2     8.3     13.4     13.7     10.5     13.6     11.0     11.1  
                                               

Net income

  21.3 %   14.5 %   25.2 %   24.7 %   20.3 %   24.1 %   27.9
%
  22.7 %
                                               

Other data:

               

Adjusted EBITDA

  59.3 %   50.4 %   60.0 %   58.5 %   51.0 %   53.9 %   53.3 %   49.7 %
                                               

Quarterly Revenue Trend

Our quarterly revenue increased 94.9% from the first quarter of 2007 to the fourth quarter of 2008 as a result of our increase in marketing and sales activity during 2007 and 2008. Our business model is based on a high volume of sales transactions at relatively low average transaction values. Our average license transaction in 2007 and 2008 was less than $6,000, but individual license transactions varied in size from under $1,000 to over $2.0 million.

In the first quarter of 2007, we grew our sales and revenue significantly over the prior quarter. We exceeded our sales, revenue and net income targets in the first quarter to a large extent as a result of two license transactions with a single customer in the U.S. government that totaled $2.0 million and resulted in the recognition of $1.5 million of license revenue in this quarter. Our average transaction size for new license sales, including the impact of the large U.S. government transactions, was approximately $5,700 in the first quarter of 2007.

In the second quarter of 2007, although we experienced strong sales, revenue and profitability, we had no individual sales transaction greater than $0.5 million. As a result, our average transaction size for new license sales decreased to approximately $3,800 for the second quarter of 2007. Thus, revenue for the second quarter of 2007, while in line with our expectations, increased only slightly from the first quarter of 2007.

In the third quarter of 2007, we experienced strong sales performance across all of our territories and geographies. In addition to growth in the number of transactions and the average transaction size for new license sales, we closed two license transactions with the same customer in the U.S. government that totaled $2.9 million and resulted in the recognition of $2.3 million of license revenue. Our average transaction size for new license sales, including the impact of the large U.S. government transactions, increased to approximately $5,600 in the third quarter of 2007.

 

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Index to Financial Statements

In the fourth quarter of 2007, we had strong sequential sales growth in EMEA, Asia Pacific and in our North American commercial business. This sequential sales growth was driven entirely by increases in the number of sales transactions we closed since our average transaction size for new license sales remained constant at approximately $5,600, despite the fact that we had no individual sales transaction greater than $0.5 million in the fourth quarter of 2007.

In the first quarter of 2008, we grew our revenue by $1.5 million, or 8.1%, from the fourth quarter of 2007. This growth was the result of strong sales performance in North America and EMEA. Despite the fact that we had no individual sales transaction greater than $0.5 million in the first quarter 2008, our average transaction size for new license sales increased slightly over the fourth quarter 2007 to approximately $5,700.

In the second quarter of 2008, we increased revenue by $1.3 million, or 6.3%, from the first quarter of 2008. This growth was the result of continued growth in North America and additional sales into the Asia Pacific region with the opening of our sales and support office in Singapore. Our average transaction size for new license sales was approximately $5,400 in the second quarter of 2008.

In the third quarter of 2008, we increased revenue by $4.5 million, or 20.7%, from the second quarter of 2008. This growth was driven by higher sales to North American commercial customers, the U.S. federal government and customers in EMEA. In addition, our average transaction size for new license sales increased to $6,500 in the third quarter of 2008.

In the fourth quarter of 2008, our revenue decreased by $1.3 million, or 4.8%, from the third quarter of 2008. Our average transaction size for new license sales was approximately $5,900 in the fourth quarter of 2008. We experienced sequential sales growth in Latin America, Asia Pacific and EMEA and in our North American commercial business. Our sales to the U.S. federal government declined as the U.S. federal government’s largest purchasing quarter is typically the third calendar quarter of the year.

We expect to continue to make occasional larger sales transactions; however, we do not expect nor do we plan for these transactions in any individual quarter. In quarters in which we close individual transactions greater than $0.5 million, it is likely that this will impact the quarterly linearity of our revenue and net income growth.

Quarterly Cost of Revenue Trend

Cost of revenue increased sequentially each quarter of 2007 and 2008 as we increased our technical support headcount in order to keep up with our sales growth. Our gross margin percentage fluctuated slightly over the four quarters in 2007 and the four quarters of 2008. We expect our quarterly gross margin percentages in 2009 to approximate our 2008 gross margin of 96.1%.

Quarterly Operating Expense Trend

Our operating expenses increased sequentially each quarter of 2007 due to growth in our sales and marketing, research and development and general and administrative headcount to support the growth in our business. The largest quarter-to-quarter increase in operating expenses in 2007 was in the second quarter of 2007 when we incurred certain start-up expenses in connection with the opening of our international headquarters in Cork, Ireland in the third quarter of 2007, and closed the acquisitions of IPMonitor and Neon, which resulted in a significant increase in our headcount. We also had significant sequential quarterly increases in stock-based compensation during 2007 and 2008 related to our increases in headcount across all operating categories. Our operating expenses, while consistent with our expectations, increased by $2.1 million in the first quarter of 2008 from the fourth quarter of 2007. The increase in operating expenses was the result of an increase in total personnel costs of approximately $0.9 million, an increase of $0.3 million primarily in accounting and tax fees incurred related to this offering, an increase of approximately $0.2 million in legal fees primarily related to pending litigation and an increase in stock-based compensation expense of approximately $0.1 million.

 

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Index to Financial Statements

Operating expenses in the second quarter of 2008 increased slightly over our expenses in the first quarter of 2008 due to a $0.6 million increase in sales and marketing expenses offset by a $0.4 million decrease in general and administrative expenses. The increase in sales and marketing expenses was primarily attributable to an increase in sales and marketing headcount. The decrease in general and administrative expenses was attributable to a reduction in professional fees primarily related to this offering offset by an increase in personnel costs related to increased headcount. Operating expenses in the third quarter of 2008 increased over our expenses in the second quarter. The increase is primarily related to our investment in our Asia Pacific operations, the rapid growth of our Czech Republic development center, growth of North America sales and marketing activities and ongoing legal fees related to our pending litigation. Operating expenses decreased in the fourth quarter of 2008 versus the third quarter of 2008 due to lower sales commissions, bonuses and legal fees.

Our Adjusted EBITDA for the first, second, third and fourth quarters of 2008 was $10.4 million, $11.7 million, $13.9 million and $12.4 million or 51.0%, 53.9%, 53.3% and 49.7% of total revenue, respectively. We expect our Adjusted EBITDA for 2009 to increase in absolute dollars and to be consistent with our Adjusted EBITDA during 2008 as a percentage of revenue.

Reconciliation of Quarterly Non-GAAP Financial Measures

We anticipate that our investor and analyst presentations will include Adjusted EBITDA, which we define as net income plus net interest expense, income tax expense (benefit), depreciation and amortization, and stock-based compensation expense and which is a financial measure that is not calculated in accordance with GAAP. The table below provides a reconciliation of this non-GAAP financial measure to the most recent directly comparable financial measure calculated and presented in accordance with GAAP. Adjusted EBITDA should not be considered as an alternative to net income, operating income and any other measure of financial performance calculated and presented in accordance with GAAP. Our Adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate Adjusted EBITDA in the same manner as we do. We prepare Adjusted EBITDA to eliminate the impact of items that we do not consider indicative of our core operating performance. You are encouraged to evaluate these adjustments and the reason we consider them appropriate.

We believe Adjusted EBITDA is useful to investors in evaluating our operating performance for the following reasons:

 

   

Adjusted EBITDA is widely used by investors to measure a company’s operating performance without regard to items, such as interest expense, income tax expense, depreciation and amortization, and stock-based compensation, that can vary substantially from company to company depending upon their financing and accounting methods, the book value of their assets, their capital structures and the method by which their assets were acquired;

 

   

securities analysts use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of companies;

 

   

we adopted SFAS No. 123(R), Share-Based Payment, on January 1, 2006 and recorded approximately $0.8 million, $0.9 million, $1.0 million, $1.1 million, 1.2 million, $1.4 million, $1.6 million and $1.7 million in stock-based compensation expense in the three months ended March 31, June 30, September 30 and December 31, 2007 and March 31, June 30, September 30 and December 31, 2008, respectively. Prior to January 1, 2006, we accounted for stock-based compensation using the intrinsic value method under APB Opinion No. 25, Accounting for Stock Issued to Employees, which resulted in zero stock-based compensation expense. By comparing our Adjusted EBITDA in different historical periods, our investors can evaluate our operating results without the additional variations of stock-based compensation expense, which is not comparable from year to year due to changes in accounting treatment and is a non-cash expense that is not a key measure of our operations; and

 

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our lenders believed Adjusted EBITDA was the appropriate performance measure for the key operational covenants in our credit agreements. These key operational covenants require us to maintain a minimum consolidated interest coverage ratio and a maximum consolidated leverage ratio as of the last day of each fiscal quarter. Each of these ratios uses Adjusted EBITDA in its calculation. The interest coverage ratio is defined to be the ratio of Adjusted EBITDA for the trailing four quarters to cash interest expense for the trailing four quarters. To be in compliance, our interest coverage ratio had to be at least 3.5 to 1.0 as of December 31, 2008 and must be at least 3.5 to 1.0 as of the last day of each fiscal quarter thereafter. The leverage ratio is defined to be the ratio of consolidated total debt to Adjusted EBITDA for the trailing four quarters. Our leverage ratio as of December 31, 2008 could not be more than 3.1 to 1.0, and this maximum ratio decreases over time to 2.1 to 1.0 as of December 31, 2011. We were in compliance with each of these key operational covenants as of December 31, 2008. We believe these are key operational covenants because the failure to comply with these covenants would be an event of default under our credit agreements that would likely result in the acceleration of our indebtedness or an unfavorable amendment to the terms of the credit agreements. This acceleration would and any such amendment might adversely affect our liquidity and financial condition.

Our management uses Adjusted EBITDA:

 

   

as a measure of operating performance, because it does not include the impact of items not directly resulting from our core operations;

 

   

for planning purposes, including the preparation of our annual operating budget;

 

   

to allocate resources to enhance the financial performance of our business;

 

   

to evaluate the effectiveness of our business strategies; and

 

   

in communications with our board of directors concerning our financial performance.

We understand that, although Adjusted EBITDA is frequently used by investors and securities analysts in their evaluation of companies, Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results of operations as reported under GAAP. Some of these limitations are:

 

   

Adjusted EBITDA does not reflect our cash expenditures or future requirements for capital expenditures or other contractual commitments;

 

   

Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs;

 

   

Adjusted EBITDA does not reflect interest expense or interest income;

 

   

Adjusted EBITDA does not reflect cash requirements for income taxes;

 

   

although depreciation and amortization are non-cash charges, the assets being depreciated or amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for these replacements; and

 

   

other companies in our industry may calculate Adjusted EBITDA differently than we do, limiting its usefulness as a comparative measure.

 

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The following table presents a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measure, for each of the three-month periods indicated:

 

                Three Months Ended

Reconciliation of Adjusted
EBITDA to Net Income

  March 31,
2007
  June 30,
2007
  September 30,
2007
  December 31,
2007
  March 31,
2008
  June 30,
2008
  September 30,
2008
  December 31,
2008
(in thousands)  

(unaudited)

Net income

  $ 2,724   $ 1,856   $ 4,359   $ 4,668   $ 4,150   $ 5,228   $ 7,287   $ 5,640

Interest expense, net

    2,390     2,451     2,484     2,382     2,531     1,748     1,756     1,976

Income tax expense

    1,553     1,059     2,326     2,586     2,133     2,945     2,878     2,761

Depreciation and amortization

    92     168     226     300     348    
349
   
365
    374

Stock-based compensation expense

    814     915     976     1,105     1,234     1,422     1,647     1,617
                                               

Adjusted EBITDA

  $ 7,573   $ 6,449   $ 10,371   $ 11,041   $ 10,396   $ 11,692   $ 13,933   $ 12,368
                                               

Acquisitions

In April 2007, we acquired certain assets and liabilities from IPMonitor for $5.9 million.

In May 2007, we acquired all of the issued and outstanding shares of Neon for $3.75 million. In May 2008, we paid an additional $0.8 million upon the achievement of the first of two development milestones. In September 2008, we paid an additional $0.5 million upon the achievement of the second development milestone.

In December 2008, we acquired substantially all of the assets and liabilities of Trilenium for $7.2 million in cash. We have included the operating results of this acquisition in our consolidated results from the effective date of the acquisition.

We accounted for each of those acquisitions using the purchase method of accounting. In each case, we allocated the purchase price to the assets acquired, including intangible assets, and liabilities assumed, based on estimated fair values at the date of the acquisition. We derived the value of intangible assets of $1.8 million in the aggregate for the IPMonitor and Neon acquisitions and $2.1 million for the Trilenium acquisition from the present value of estimated future benefits from the various intangible assets acquired. At the time of the acquisitions, we recorded goodwill of $9.1 million in the aggregate for the IPMonitor and Neon acquisitions and $5.0 million for the Trilenium acquisition, representing in each case the excess of the purchase price over the aggregate fair values of the net identifiable assets acquired. Since the date of the IPMonitor and Neon acquisitions, we have recorded additional goodwill of $1.7 million related to additional acquisition costs.

Liquidity and Capital Resources

In December 2005, a group of investors led by Bain Capital Ventures and Insight Venture Partners purchased a 67.8% ownership interest in us from our original stockholders. This purchase was part of a series of transactions to recapitalize our company, including:

 

   

our issuance of 41,901 shares of common stock and 41,901 shares of convertible preferred stock for each outstanding share of common stock, all of which was held by our original stockholders.

 

   

our incurrence of $110.0 million in long-term debt, approximately $105.0 million of which was utilized to purchase and retire 19,551,615 shares of common stock and 19,551,615 shares of convertible preferred stock held by our original stockholders.

 

   

the sale by our original stockholders to investors led by Bain Capital Ventures and Insight Venture Partners of 18,310,347 shares of common stock and 18,310,347 shares of convertible preferred stock.

 

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Because the group of investors did not acquire ownership of substantially all of our equity, our recapitalization did not affect the historical bases of our assets and liabilities for financial reporting purposes. In accordance with Statement of Financial Accounting Standards, or SFAS, No. 141, Business Combinations, we expensed approximately $1.6 million of costs associated with effecting the recapitalization, which were primarily comprised of consulting fees to the original stockholders and legal and accounting fees, in our 2005 consolidated statement of income.

Net Cash Provided by Operating Activities

Net cash provided by operating activities was $17.1 million, $22.1 million and $35.2 million in 2006, 2007 and 2008, respectively. Cash provided by operating activities is driven by sales of our software offerings. Collection of accounts receivable from the sales of our software offerings is a significant component of our cash flows from operating activities, as is the change in deferred revenue related to these sales. Net cash provided by operating activities was reduced by interest and income tax payments of $8.1 million and $5.4 million, respectively, in 2006, $10.1 million and $6.6 million, respectively, in 2007, and $8.6 million and $12.9 million, respectively, in 2008.

Net Cash Used in Investing Activities

Net cash used in investing activities was $2.6 million, $12.2 million and $11.0 million in 2006, 2007 and 2008, respectively. Cash used in investing activities in 2006 was primarily for leasehold improvements and purchase of computers and equipment. During 2007, we acquired Neon and certain assets and liabilities of IPMonitor for an aggregate of $9.8 million in cash. In addition, we made capital expenditures for software licenses, computer equipment, leasehold improvements and furniture and fixtures as we expanded our infrastructure and work force. We relocated our corporate headquarters from Tulsa, Oklahoma to Austin, Texas in late 2006 and we opened our international headquarters in Cork, Ireland in the third quarter of 2007. In 2008, we incurred additional costs primarily consisting of payments in an aggregate amount of $1.3 million upon the achievement of two development milestones related to the Neon acquisition in 2007 and costs associated with the relocation of our corporate headquarters and opening of our Czech Republic development center. We also acquired certain assets and liabilities in December 2008 of Trilenium for an aggregate of $7.2 million in cash.

Net Cash Provided by (Used in) Financing Activities

Net cash used in financing activities was $6.1 million in 2006. Net cash provided by financing activities was $0.2 million in 2007. Net cash used in financing activities was $1.5 million in 2008. The net cash used in financing activities in 2006 was primarily related to repayment of $7.5 million of our long-term debt, partially offset by proceeds of $1.2 million from the exercise of stock options. The net cash used in financing activities in 2008 resulted from payments of $2.1 million for offering costs and the repayment of $1.4 million of our long-term debt offset by the receipt of a $1.7 million repayment of a note receivable issued to us by a stockholder.

Capital Resources

To date, we have financed our operations primarily through internally generated funds. The recapitalization in December 2005 resulted in our issuing the $110.0 million in long-term debt discussed below, which was immediately used to repurchase and retire preferred and common stock from our original stockholders and to pay a portion of the distributions to our original stockholders of $25.3 million. We repaid $7.5 million and $1.4 million of our outstanding long-term debt in December 2006 and April 2008, respectively.

As of December 31, 2008, we had $40.6 million of cash and cash equivalents and $16.4 million of working capital. Our long-term debt, which had an outstanding balance of $101.1 million at December 31, 2008, matures in December 2011, but we expect to prepay a significant portion or all of the outstanding balance from the proceeds of this offering. We estimate our capital expenditures for 2009 will be approximately $3.0 million, comprised primarily of additional leasehold improvements and furniture and computer equipment. We believe

 

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that our existing cash and cash equivalents and our cash flow from operations will be sufficient to fund our operations and our capital expenditures and pay our debt service for at least the next 12 months. Our future capital requirements will depend on many factors, including our rate of revenue growth, the expansion of our sales and marketing activities, the timing and extent of spending to support product development efforts and expansion into new territories, the timing of introductions of new software products and enhancements to existing software products, and the continuing market acceptance of our software offerings. Although we are not currently a party to any agreement or letter of intent regarding potential investments in, or acquisitions of, complementary businesses, applications or technologies, we may enter into these types of arrangements, which could require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us or at all.

Contractual Obligations and Commitments

We generally do not enter into long-term minimum purchase commitments. Our principal commitments, in addition to those related to our long-term debt discussed below, consist of obligations under facility leases for office space in Austin, Texas; Tulsa, Oklahoma; the Republic of Ireland; New Zealand; Singapore and the Czech Republic.

The following table summarizes our outstanding contractual obligations as of December 31, 2008:

 

     Payments Due by Period
     Total    Less Than
1 Year
   1-3
Years
   3-5
Years
   More Than
5 Years
(in thousands)     

Long-term debt obligations (1)

   $ 101,083    $ 7,161    $ 93,922    $    $

Capital lease obligations

     35      25      10          

Operating lease obligations (2)

     13,452      2,466      4,570      3,222      3,194

Purchase obligations (3)

     1,024      977      47          
                                  

Total contractual obligations (4)

   $ 115,594    $ 10,629    $ 98,549    $ 3,222    $ 3,194
                                  

 

(1)

On December 13, 2005, we entered into credit agreements with an investment management firm pursuant to which we borrowed $85.0 million under a first lien note and $25.0 million under a second lien note. The first lien note bears interest at the three-month LIBOR rate plus 3.5% (7.4% at December 31, 2008) and the second lien note bears interest at the three-month LIBOR rate plus 5.25% to 6.25%, based on certain factors defined by the second lien credit agreement (9.0% at December 31, 2008). Both notes are due and payable on December 13, 2011. The first lien credit agreement allows the lender to elect to receive earlier repayment of amounts due under the first lien credit agreement, based on annual calculations of our excess cash flow as defined in the agreement. The agreement bases this payment upon a specified percentage of our calculated excess cash flow. We must offer to prepay the loans no later than 120 days after the end of the fiscal year for which we have calculated our excess cash flow. We paid $7.5 million and $1.4 million in principal on the notes in December 2006 and April 2008, respectively. Thus, the total outstanding balance on the notes was $102.5 million at December 31, 2006 and 2007 and $101.1 million at December 31, 2008. The borrowings are secured by substantially all of our North American assets. The credit agreements contain financial covenants placing a limit on our annual capital expenditures and requiring us to maintain a minimum consolidated interest coverage ratio and a maximum consolidated leverage ratio as of the last day of each fiscal quarter. The interest coverage ratio is defined to be the ratio of Adjusted EBITDA for the trailing four quarters to cash interest expense for the trailing four quarters. To be in compliance, our interest coverage ratio had to be at least 3.5 to 1.0 as of December 31, 2008 and must be at least 3.5 to 1.0 as of the last day of each fiscal quarter thereafter. The leverage ratio is defined to be the ratio of consolidated total debt to Adjusted EBITDA for the trailing four quarters. Our leverage ratio as of September 30, 2008 could not be more than 3.1 to 1.0, and this maximum ratio decreases over time to 2.1 to 1.0 as of December 31, 2011. We were in compliance with each of these key operational covenants as of December 31, 2008. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quarterly

 

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Results of Operations—Reconciliation of Quarterly Non-GAAP Financial Measures” above for a more detailed discussion of Adjusted EBITDA. In March and September 2008, we amended our credit agreements. These amendments clarified certain provisions of the credit agreements related to the structure of the lenders’ security interest and amended and permanently waived the default of certain covenants under the credit agreements. We intend to repay a significant portion or all of our long-term debt obligations from the proceeds of this offering. The amount of long-term debt obligations shown in the table above does not include any interest payments.

 

(2) In March 2009, we amended our lease for our corporate headquarters in Austin, Texas to, among other things, acquire additional space to accommodate our growth. The lease amendment becomes effective on July 1, 2009. The increase in our total operating lease obligations resulting from the lease amendment is presented below.

 

     Payments Due by Period
     Total    Less Than
1 Year
   1-3
Years
   3-5
Years
   More Than
5 Years
(in thousands)     

Operating lease obligations

   $ 5,555    $ 402    $ 1,606    $ 1,606    $ 1,941

 

(3) Purchase obligations represent obligations under issued purchase orders for software license and support fees, marketing activities, and computer hardware and software.

 

(4) We have excluded long-term tax liabilities of $0.2 million related to uncertain tax positions from the amounts presented as the amounts that will be settled in cash are not known.

Off-Balance Sheet Arrangements

During 2006, 2007 and 2008, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Recent Accounting Pronouncements

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and is intended to be applied prospectively, except in the case of a limited number of financial instruments that require retrospective application. In February 2008, the FASB concluded that it should defer the effective date of SFAS No. 157 for one year for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. We adopted SFAS No. 157 on January 1, 2008 for our financial assets and financial liabilities, which did not have a material impact on our results of operations or financial position. We adopted SFAS No. 157 for our non-financial assets and liabilities on January 1, 2009.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—including an amendment of SFAS 115. SFAS No. 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. We adopted SFAS No. 159 on January 1, 2008, and we are not electing the fair value option for any of our eligible financial instruments and other items that are not already measured at fair value under existing standards.

 

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In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations. SFAS No. 141(R) requires that, upon a business combination, the acquired assets, assumed liabilities, contractual contingencies and contingent liabilities be recognized and measured at their fair value at the acquisition date. SFAS No. 141(R) also requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred. In addition, SFAS No. 141(R) requires that acquired in-process research and development be measured at fair value and capitalized as an indefinite-lived intangible asset, and it is therefore not subject to amortization until the project is completed or abandoned. Moreover, SFAS No. 141(R) requires changes in deferred tax asset valuation allowances and acquired income tax uncertainties that are recognized after the measurement period be recognized in income tax expense. SFAS No. 141(R) is to be applied prospectively and is effective for fiscal years beginning on or after December 15, 2008. We are currently evaluating the potential impact of SFAS No. 141(R) on our financial position and results of operations.

In April 2008, the FASB issued FSP No. FAS 142-3, Determination of the Useful Life of Intangible Assets, which amends the factors that should be considered in developing renewal of extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, Goodwill and Other Intangible Assets. This position is effective for fiscal years beginning after December 15, 2008 and only applies prospectively to intangible assets acquired after the effective date. Early adoption is not permitted. We are currently evaluating the impact this statement will have on our results of operations and financial position.

Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

We had cash and cash equivalents of $19.3 million at December 31, 2007 and $40.6 million at December 31, 2008. We held these amounts primarily in cash or money market funds.

We hold cash and cash equivalents for working capital purposes. We do not have material exposure to market risk with respect to investments, as our investments consist primarily of highly liquid investments purchased with original maturities of three months or less. We do not use derivative financial instruments for speculative or trading purposes; however, we may adopt specific hedging strategies in the future. Any declines in interest rates, however, will reduce future interest income.

We had total outstanding debt of $102.5 million at December 31, 2007 and $101.1 million at December 31, 2008. The interest rate on this debt is variable and adjusts periodically based on the three-month LIBOR rate. If the LIBOR rate changes by 1%, our annual interest expense would change by approximately $1.0 million.

Foreign Currency Risk

Our results of operations and cash flows will be subject to fluctuations because of changes in foreign currency exchange rates, particularly changes in exchange rates between the U.S. dollar and the Euro and British Pound Sterling. Our historical revenue has generally been denominated in U.S. dollars, and a significant majority of our current revenue continues to be denominated in U.S. dollars; however, we expect an increasing portion of our future revenue to be denominated in currencies other than the U.S. dollar, primarily the Euro and the British Pound Sterling. Our expenses are generally denominated in the currencies of the countries in which our operations are located, primarily the United States, Ireland, the Czech Republic and Singapore. We do not currently enter into forward exchange contracts to hedge exposure denominated in foreign currencies or any derivative financial instruments for trading or speculative purposes, although we may do so in the future. Thus, fluctuations in currency exchange rates could harm our business in the future.

 

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BUSINESS

Overview

We are a leading provider of powerful yet easy-to-use enterprise-class network management software designed by network professionals for network professionals. Our offerings range from individual software tools to more comprehensive software products, solve problems faced every day by network professionals and help to enable efficient and effective network management. All of our products are ready-to-use, featuring intuitive and easily customizable user interfaces and built-in workflows. Our products can be downloaded directly from our websites and installed and configured by our end-users in a matter of hours. We design our software to meet the requirements of networks and implementations of varying sizes and levels of complexity, ranging from a single device to over 100,000 installed devices.

Through December 31, 2008, over 80,000 customers within small and mid-size businesses, enterprises, including more than 400 of the Fortune 500 companies, and local, state and federal government entities had purchased one or more of our products. We have an active, loyal end-user community that is built from our customers and over one million registered end-users who have downloaded our free tools. We seek to expand, and generate loyalty from, our customer base and our end-user community by providing a variety of free tools for network professionals, by hosting our online community website, Thwack, and through other marketing programs.

As a core part of our strategy, we have developed a differentiated business model for marketing and selling high volumes of low-priced, downloadable, enterprise-class software directly to network professionals and other IT professionals. We design our Internet-based marketing programs to drive visitors to our websites in order to generate large volumes of highly qualified leads. Our inside sales force uses a disciplined, transaction-oriented process to convert these leads into paying customers at a level of productivity that is much higher than is typically achieved with a traditional direct sales force. We offer our products at compelling prices. Our average license transaction in 2007 and 2008 was less than $6,000 compared to hundreds of thousands of dollars for many competing products. Our business model allows us to support rapid growth in our business at high operating margins while offering our products at lower prices.

For the years ended December 31, 2006, 2007 and 2008, our revenue was $38.2 million, $61.7 million and $93.1 million, respectively. In the same periods, we generated operating income of $25.4 million, $30.9 million and $42.0 million and Adjusted EBITDA of $27.1 million, $35.4 million and $48.4 million, respectively. We believe Adjusted EBITDA is useful to investors in evaluating our operating performance. Our management uses Adjusted EBITDA in its management and assessment of our business, and our lender uses Adjusted EBITDA in the key operational covenants in our credit agreements. Adjusted EBITDA should not be considered as an alternative to net income, which is the most directly comparable financial measure calculated in accordance with GAAP, or any other measure of financial performance calculated in accordance with GAAP. The following table presents a reconciliation of Adjusted EBITDA to net income:

 

     Year Ended December 31,

Reconciliation of Adjusted EBITDA to Net Income

   2006    2007    2008
                
(in thousands)               

Net income

   $ 9,591    $ 13,607    $ 22,305

Interest expense, net

     10,235      9,707      8,011

Income tax expense

     5,596      7,524      10,717

Depreciation and amortization

     124      785      1,436

Stock-based compensation expense

     1,515      3,810      5,920
                    

Adjusted EBITDA

   $ 27,061    $ 35,433    $ 48,389
                    

For further discussion regarding Adjusted EBITDA, see footnote 4 to the table in “Selected Consolidated Financial Data” included elsewhere in this prospectus.

 

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Industry Background

Network Management Challenges

Businesses, governments and other organizations of all sizes increasingly rely on data networks to execute their operations, facilitate their internal and external communications and transact business with their customers and partners, and these networks are growing in size and complexity. These factors have made network management, which includes performance monitoring, provisioning, administration and optimization, increasingly critical to the success of these organizations.

Certain trends have made it more important and challenging to manage networks effectively, including:

 

   

Increasing Reliance on Networks for Business Operations and Applications. Organizations are moving a greater proportion of their critical operations online and are increasingly dependent on websites, email, business software applications and other technologies to conduct their daily business, thus expanding their reliance on their networks.

 

   

Growing Complexity of Constantly Changing Networks. The increasing number of devices, applications and end-users on most networks has led to significantly greater network complexity. Networks constantly change as organizations routinely add, upgrade or modify devices and applications on their networks, requiring continuous monitoring and management.

 

   

Expanding Use of Networks to Deliver New Services and Technologies. The adoption of wireless local area networks; voice-over-IP, or VoIP; software as a service, or SaaS, applications; and other next-generation applications changes the nature of issues that must be managed in connection with the network, elevates the importance of managing network performance and further increases network complexity.

 

   

Increasing Globalization of Organizations and Their Operations. The size and complexity of networks have increased as organizations become more geographically dispersed across countries and time zones, target a broader set of customers and trade with an increasingly global base of suppliers and partners.

 

   

Heightened Importance of Compliance and Regulatory Requirements. Sarbanes-Oxley, HIPAA, PCI and other regulations require organizations to implement and certify controls for network security, access and configuration. Implementing these controls and reporting on their effectiveness add further complexity to network management.

Limitations of Existing Network Management Software

Traditionally, large businesses, governments and other organizations have deployed complex and expensive software products, called IT management frameworks, that provide centralized and unified management of entire IT systems, including networks, servers and applications. Most of these frameworks are designed for and marketed and sold to chief information officers, who are responsible for managing a wide variety of IT issues, rather than to network professionals, who are responsible for the daily management of networks. As a result, frameworks have not been optimized to solve the problems faced by these network professionals and often fail to address network management requirements effectively.

Limitations of existing IT management frameworks include the fact that they are:

 

   

Expensive and Difficult to Implement. Most frameworks are sold at high prices and do not offer an affordable entry-level option. Due to their complexity, these frameworks require costly professional services to deploy and take months before they are usable by the customer.

 

   

Difficult to Use, Maintain and Customize. Most frameworks require significant training to use, cannot be easily configured to end-users’ preferences and require a specialized staff to maintain, which is difficult to attract and retain.

 

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Inflexible and Difficult to Scale. Most frameworks are highly complex software platforms that are designed for enterprise implementations. As a result, customers typically cannot start with a small or simple deployment and easily increase their capacity or add features as their networks grow and their needs expand.

 

   

Impractical for Small and Mid-Size Organizations. Because of their cost and complexity, most frameworks are impractical for small and mid-size organizations.

The Network Management Market Opportunity

There is currently a large and mature market for network management software. Gartner Inc., a market research firm, estimates that spending on software for managing networks and the availability and performance of networks and systems will grow from $4.97 billion in 2009 to $5.55 billion in 2012.(1) We believe that a substantial portion of this spending is concentrated in enterprises and represents purchases of IT management frameworks.

Given the increasing challenges of network management and the limitations of existing offerings, we believe there is a broader market opportunity for products that directly address the needs of network professionals and that are cost effective; easy to find, evaluate, use and maintain; and scalable and flexible. We believe that our software addresses this opportunity, particularly in enterprises with more than 1,000 employees and small and mid-size companies with 50 to 1,000 employees, as well as in local, state and federal government entities.

Many of our current enterprise customers have installed an IT management framework product, but have also purchased our products in order to address better and more directly the specific needs of the network professional. We believe that a substantial opportunity exists to continue to sell our products to enterprise customers, even those that have purchased framework products.

Small and mid-size companies have typically had to rely on point products to address their network management needs, but these products, unlike ours, generally do not solve a broad range of network management issues and cannot scale as networks grow or become more complex.

In a study we commissioned, Compass Intelligence Research estimated there are currently more than 35,000 enterprises and more than 1.6 million small and mid-size companies worldwide. In addition, they estimated that more than 5,000 of the largest enterprises in the world have an average of approximately ten departments that purchase as separate entities. Based on a review of our customers, their implementations of our products and our current prices, we estimate that the average license expenditures for our products that are generally necessary to address the needs of network professionals in small and mid-size companies, in enterprises and in the departments of the largest enterprises range from $19,000 to $190,000.

Our Solution

Our software offerings include enterprise-class network management products, entry-level network monitoring products and a wide range of software tools for network professionals. These offerings enable easy and effective network management. We design our software to meet the requirements of networks and implementations of varying sizes and levels of complexity, ranging from a single device to over 100,000 installed devices.

 

(1) Gartner, Inc. “Forecast: Enterprise Software Markets Worldwide, 2007-2012, 4Q08 Update” by Fabrizio Biscotti et al., dated December 9, 2008. See “Special Note Regarding Forward-Looking Statements and Industry Data” for information regarding the industry data used in this prospectus.

 

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Our software is:

 

   

Focused on the Needs of Network Professionals. Since our inception, we have focused on the specific needs of network professionals, who use, and typically make the decision to purchase, our software. Our products are designed by network professionals for network professionals and provide end-users with graphical user interfaces, architecture and built-in workflows that demonstrate an in-depth understanding of the daily tasks of the network professional. We believe that our customers prefer our software to alternative offerings because it typically enables them to identify and solve network performance and availability issues more efficiently and effectively and to improve the performance and availability of their networks quickly and easily.

 

   

Easy to Find and Evaluate. Network professionals can find our products easily through our websites, Internet search engines, partner websites and a broad network of corporate resellers. We offer through our websites free, downloadable, full-featured evaluations of our software products, generally for up to 30 days, which allows customers to implement and use our products to manage their own networks prior to purchase. We believe that these evaluations generally help build trust in our products and goodwill for our brand prior to the time of purchase, which expedites the sales transaction cycle for many of our customers while at the same time helping to establish a large and loyal customer base and end-user community.

 

   

Cost-Effective to Purchase and Install. We offer our software at prices significantly lower than those of competing framework products. All of our products are downloadable via our websites and can be installed, configured and ready to use in a matter of hours, without using professional implementation services, which are costly and time-consuming.

 

   

Easy to Use and Maintain. Our software is Windows-based and each has an intuitive user interface, allowing most of our customers to begin using our products the day they are purchased. Once installed, our software is easy for most customers to modify because each user interface can be customized with drop-down menus. Our software does not require significant effort or dedicated staff to maintain.

 

   

Scalable and Flexible. We generally offer our products at different prices reflecting a range of capacities that allow our customers to buy only the capacity they need and to expand their capacity as their networks grow. In addition, our software is flexible and extensible, allowing our customers to customize our products and to begin with our network management tools or monitoring products, and then purchase additional modules and products, such as configuration management, VoIP monitoring, application monitoring or wireless network monitoring, as their needs expand.

Our Business Model

As a core part of our strategy, we utilize a differentiated business model for providing enterprise-class software to network professionals and other IT professionals within organizations of all sizes worldwide. We currently provide products for network professionals, but we believe that our model is applicable to all IT professionals, including database administrators, systems administrators, application managers, security administrators and web administrators. We designed our business model to sell high volumes of low-priced, downloadable software, and to be low cost, scalable and efficient.

The key differentiating elements of our business model include:

 

   

Downloadable Enterprise-Class Software. We provide ready-to-use enterprise-class software that customers can install and configure in a matter of hours. We offer free, downloadable, full-featured evaluations of our software products, generally for up to 30 days, which allows customers to implement and use our products to manage their own networks prior to purchase. All of our software can be installed and used by our customers in a self-service manner without the need for professional services or complicated installation procedures. This allows our customers to begin using our software almost immediately and enables us to pursue follow-on sales more quickly.

 

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Customer and Community-Driven Approach. We have an active, loyal end-user community built from our customers and over one million registered end-users who have downloaded our free tools. We currently build loyalty in and expand our community by providing a variety of free tools for network professionals, publishing a monthly newsletter and online tutorials, conducting various webcasts and hosting our community website, Thwack. We believe this community provides us with significant competitive advantages, including a readily accessible pool of qualified leads for sales of current and future products and a loyal network of practitioners who promote the usage of our software and provide valuable insights to help direct our product development efforts and improve our existing software products.

 

   

Compelling Pricing. We sell our software products at prices significantly lower than those of frameworks. For example, our average transaction size for new license sales in each of 2007 and 2008 was less than $6,000, a price that typically requires minimal internal approvals and is much less than the hundreds of thousands of dollars for frameworks. In addition, because we offer our products at different prices reflecting a range of capacities, IT professionals in large organizations and smaller customers generally can purchase our software without making the large expenditures typically required to purchase frameworks. Because of our low prices, our software is frequently purchased by first-time customers to solve specific problems and not as part of a strategic technology purchasing decision. However, because our software is powerful, easy to use and maintain, and solves a range of network management problems, these initial purchases often drive further adoption of our software within the customers’ organizations and lead to further sales of our products.

 

   

Scalable Marketing Model. We operate a scalable marketing model that is targeted at the end-users of our products and designed to create awareness of our brand and products. This allows us to drive significant numbers of potential customers to our websites and to create a substantial volume of highly qualified leads, all at a low cost. We maintain an extensive database of potential customers and create targeted email campaigns to a broad universe of network professionals to drive additional traffic to our websites in order to inform them about our products and to allow them to download our software. We believe our marketing approach provides us with a cost-efficient and highly effective means of targeting a large number of potential end-users and generating highly qualified sales leads.

 

   

High-Volume, Transaction-Oriented Sales Model. Our inside sales force uses a disciplined process to target these highly qualified leads, primarily network professionals who have downloaded and installed evaluations of our software on a self-service basis. We designed our sales model to support a high volume of predictable and repeatable “low-touch” transactions, and we sell the vast majority of our software with standard online contract terms and at a small average transaction size, which reduces our process time and costs. We believe this model reduces the length of our sales cycles and results in a higher level of sales force productivity.

 

   

Highly Efficient Product Development Process. We develop our software using distinct development teams, each dedicated to specific products, and emphasize rapid and iterative development cycles. Each team is able to complete the full development cycle for a new product release in approximately four months, enabling multiple releases for our products each year. Our development process actively involves our customers to determine new functional requirements and to test the ease-of-use and quality of each new product release. This helps us to develop high quality products that are responsive to our customers’ needs.

 

   

Metrics-Driven Management and Culture. We have developed proprietary systems and processes that enable us to monitor and manage the results of our business. Our emphasis on specific operational and financial metrics and high activity levels instills a culture of accountability and performance measurement to help us to achieve visibility and consistency of execution in our business.

 

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Our Growth Strategy

Our objective is to extend our market leadership by providing network professionals and other IT professionals with enterprise-class software that solves their specific needs. The following are key elements of our growth strategy:

 

   

Continue to Add New Customers in North America. We believe that the network management market in North America remains significantly under-penetrated and represents a significant opportunity to continue our growth. We intend to penetrate this market further by leveraging our customer base and end-user community and using our strategic marketing programs to identify and obtain new customers.

 

   

Expand Our Business in International Markets. We believe a substantial opportunity exists for sales of our software in Europe and Asia, and we intend to increase our sales, marketing and support operations significantly in these regions. In 2007 and 2008, we established our international headquarters in Cork, Ireland, from which we will manage our international operations, and a sales and support operation in Asia. In addition, we plan to continue to scale and develop our existing group of international distributors and resellers.

 

   

Cross-Sell and Up-Sell Existing Products into Our Growing Customer Base. We have more than 80,000 customers that have purchased our software to manage aspects of their networks. We believe our customers are highly satisfied users of our products and that there is a significant opportunity for follow-on sales of both incremental capacity and additional products and modules to these customers.

 

   

Selectively Expand Our Product Portfolio. We plan to continue to develop new software products and modules that enhance and expand our current network management offerings. We also intend to expand our product offerings into adjacent areas of infrastructure management software in which we can provide differentiated, easy-to-use enterprise-class software products that are marketed and sold directly to IT professionals, such as database administrators, systems administrators, application managers, security administrators and web administrators.

 

   

Pursue Strategic Acquisitions of Complementary Products that Can Be Sold Using Our Business Model. We expect to pursue acquisitions that will enable us either to bring new product offerings to market more quickly than we can develop them or to enter new markets or segments of markets we currently serve.

Our differentiated business model of providing low-cost, intuitive software marketed and sold directly to network professionals and other IT professionals through a highly productive and efficient inside sales force is the core of our strategy. We evaluate all of our strategic opportunities to ensure that they are compatible with our model for providing cost-efficient, downloadable enterprise-class software that can be marketed and sold through a high volume, transaction-oriented model.

Our Products

We offer a broad portfolio of products for network management. Our products fit into one of the following four categories:

Free Tools

Our free tools are desktop or server-based applications designed for use by individual network professionals, and typically focused on a single network management task or technology. We use free tools primarily to drive awareness of our brand and our products within the broader network management community and to expand and build loyalty among our customers and our end-user community.

 

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Tools for Engineers

Our tools are desktop-based and laptop-based applications designed for individual network professionals who need specific solutions for routine and complicated tasks. Our tools for engineers include individual tools and toolsets that combine many powerful tools together into a single package. We price our tools and toolsets so that an individual network engineer or administrator can purchase them with one level of or, in some cases, no management approval. We believe that broad awareness and usage of our tools create positive relationships and loyalty with network professionals, who in turn influence the purchase of our other products.

Our current tools for engineers are:

 

   

Standard Toolset. Our Standard Toolset, which builds on our free offerings, is a small collection of fundamental tools that allow network professionals to diagnose network issues, collect and analyze network data and maintain network health. This toolset is designed for network professionals who need only a very basic set of network management capabilities.

 

   

Engineer’s Toolset. Our Engineer’s Toolset is a broad collection of desktop tools that enable network professionals to address a range of network engineering and management tasks, including configuration management, network discovery and mapping, fault management, and bandwidth and network performance monitoring. This toolset is designed for more advanced network professionals and the situations they encounter day to day.

 

   

Kiwi Syslog Server. Kiwi Syslog Server is a server-based application that receives syslog-formatted messages from any network device, and allows network professionals to display, filter, export and alert on those messages. We also offer a free version of the Kiwi Syslog Server with limited features.

 

   

Kiwi CatTools. Kiwi CatTools is a desktop application that allows a network professional to automate most network configuration tasks. Using Kiwi CatTools, network professionals can create scripts for specific device configuration activities and have those tasks automated for one or many devices. We also offer a free version of Kiwi CatTools that restricts a network professional to configuring a small number of devices.

 

 

 

LANsurveyor. LANsurveyor automatically discovers the devices connected to a network, collects inventory and configuration information about those devices and produces comprehensive network maps that can be exported into Microsoft Office® Visio® . LANsurveyor continuously scans the network, detects new devices on the network and dynamically updates the network map.

Entry-Level Network Monitoring Product

Our entry-level network monitoring product is designed for network professionals and IT teams who need only basic network monitoring functionality and who prioritize simplicity and affordability above other features. Many IT teams lack detailed expertise required for more complex network management or simply do not need more than basic monitoring of network resources. We price and design our entry-level monitoring product to meet the combination of features, simplicity and affordability needed by these organizations.

Our current entry-level network monitoring product is:

 

   

ipMonitor. ipMonitor is a server-based network, server and application monitoring system for basic up/down monitoring. It features a simple installation and configuration process, basic web interface and an intuitive operations console for displaying the up/down status of network resources. ipMonitor provides monitoring for network devices, servers and common applications such as Microsoft Exchange, Active Directory and SQL Server and includes a built-in database and web server, further simplifying installation and enabling all components of the product to run on a single server.

 

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Enterprise-Class Network Management Products

Our enterprise-class network management products are used by network professionals and IT teams of companies of all sizes to configure, monitor and report on network equipment, servers and applications to determine the overall health and performance of the network and to automate the processes of network change, compliance and inventory. These products provide advanced network management functionality and are capable of scaling from a few to several thousand network devices. Our enterprise-class network management products are represented by our Orion family of products, and most share integrated components, including databases, web servers and user administration. The Orion family of products is designed to operate seamlessly together, while still allowing network professionals to purchase and deploy only the products they need.

Our current enterprise-class network management products are:

 

   

Orion Network Performance Monitor. Our flagship product, Orion Network Performance Monitor, or Orion NPM, is a server-based fault and performance management platform designed to minimize network downtime. Orion NPM monitors and analyzes real-time, in-depth network performance metrics for routers, switches, servers and other Simple Network Management Protocol, or SNMP, enabled devices to provide both current and historical views into the availability and performance of a network and all devices attached to it. Orion NPM is modular and has the ability to scale with the growth of a network. It can also be expanded through the use of add-on modules and polling engines. End-users can configure Orion NPM to alert network professionals of network events, including thresholds, correlated events, sustained conditions and complex combinations of device states. Orion NPM drives follow-on sales of our other products and, together with its related modules, currently generates a majority of our revenue.

 

   

Orion Modules. Our Orion modules are a series of add-ons to Orion NPM that extend its network management capabilities to network traffic analysis, application performance monitoring, VoIP performance monitoring and wireless LAN monitoring. Orion modules are purchased separately and are fully integrated with Orion NPM’s web console and database. Our current Orion modules are:

 

   

Orion NetFlow Traffic Analyzer. NetFlow Traffic Analyzer utilizes Cisco Systems’ NetFlow protocol and other similar protocols to extract data from network devices to provide an in-depth view of which end-users, protocols and applications are consuming network bandwidth.

 

   

Orion Application Performance Monitor. Application Performance Monitor extends Orion NPM’s management capabilities to application performance, by monitoring application-specific server processes, performance counters, network ports, end-user transactions and external scripts.

 

   

Orion VoIP Monitor. VoIP Monitor proactively analyzes VoIP quality across wide area network links and monitors the underlying systems and protocols relied upon by VoIP service.

 

   

Orion Wireless Network Monitor. Wireless Network Monitor extends Orion NPM’s monitoring capabilities to wireless access points and associated wireless devices and sessions.

 

   

Orion Network Configuration Manager. Orion Network Configuration Manager, or Orion NCM, is a server-based product that automates the processes of network device discovery, network inventory management and network change management. Compliance with internal controls and regulatory standards is growing in importance to companies of all sizes, and network configuration and device configuration changes impact network availability, access and security controls that are critical to ensuring up-time and compliance. Orion NCM automates many device configuration management tasks, including bulk network configuration changes, real-time detection and alerts of network configuration problems and rolling back configuration changes on demand. These capabilities help avoid network downtime and are essential to meeting compliance objectives. Orion NCM provides an audit mechanism for tracking changes to network devices and helps organizations achieve continuous compliance with operational, security and regulatory policies.

 

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Orion Polling Engine. Polling engines increase the scale of Orion NPM’s monitoring capabilities to a larger number of devices by distributing the polling load across additional servers.

 

   

Orion Enterprise Operations Console. Enterprise Operations Console is a server-based product that provides summarized web-based views of multiple Orion instances, enabling flexible deployment architectures for large or distributed environments.

Maintenance and Support

Our customers receive one year of software maintenance and support as part of their initial purchase of our products and have the option to renew their maintenance agreements. These annual maintenance agreements provide customers the right to receive unspecified software updates, maintenance releases and patches, when and if they became available, and unlimited access to our internal support representatives.

Our typical customers are network professionals who are sophisticated users of software and related technologies. We devote significant resources to designing software products that are easy to install, configure and use, and to developing extensive, easy-to-understand instruction manuals and online tutorials for our products. We also utilize our community website, Thwack, as a forum for our end-users to share information, tips, tools and other valuable resources. Through this online community of over 20,000 registered members, users of our software are able to find answers for many technical problems, discover new uses for our software, and provide suggestions or feedback to our product development teams. As a result of all these efforts, our customers are able to resolve most technical issues without having to contact our support representatives, which significantly reduces our total support expenses. Our support organization operates from offices in Austin, Texas; Cork, Ireland; and Singapore.

Research and Development

Our research and development organization is responsible for the design, development and testing of our software. Our current research and development efforts are focused on new releases of existing products as well as new products and modules.

We work closely with our customers in developing our products and have designed a product development process that is responsive to customer feedback throughout the process. Our customers and end-user community provide extensive input regarding a wide variety of use cases that we incorporate into our product definitions and requirements. A subset of customers participates in our product testing, helping us to identify issues prior to product release. Our research and development organization regularly assists customer support personnel with customer inquiries, which provides another mechanism for customer feedback into the development process.

We utilize small development teams, each dedicated to specific products, that work according to a structured and repeatable, iterative process. These teams apply a standard architecture to their individual products, and are managed centrally to ensure standardization, efficiency and interoperability. We use a hybrid onshore and offshore development model, wherein product requirements definition and technical design are performed in the United States, and our U.S. technical staff work closely with development teams in our Czech Republic and New Zealand facilities and in two contract development vendors in Eastern Europe that write code and do testing and quality assurance. We opened our Czech Republic facility in April 2008 and intend to continue to expand this facility rapidly. We acquired our New Zealand development facility in December 2008. We currently outsource a portion of this development to contract development vendors. We believe we have developed a differentiated process that allows us to release new software rapidly and cost effectively. Using our development model, we made 35 product releases in 2007 and 56 product releases in 2008.

Our research and development expenses were $2.3 million, $5.9 million and $8.5 million in 2006, 2007 and 2008, respectively.

 

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Marketing and Sales

We have designed our marketing and sales model to be efficient for very high volumes of low-price transactions. Our marketing efforts focus on driving traffic to our websites and on generating high quality sales leads, primarily consisting of end-users who download a free evaluation of our software. Our sales efforts focus on converting these leads into paying customers through a high volume, short duration, inside sales process that we measure and manage frequently.

Marketing

We use a variety of online marketing programs for lead generation, as well as more traditional direct marketing and indirect channel partner marketing programs to drive traffic to our websites. These efforts leverage the ubiquity of Internet search engines through search engine marketing and optimization programs. In addition, we send a series of targeted emails to end-users who have downloaded free evaluations of one or more of our software products or received our corporate communications or public relations material. Once we drive traffic to our websites, we have a well-defined process that allows us automatically to track visitors’ activities, communicate with potential customers, encourage downloads of our software and provide highly qualified leads to our sales organization.

Our historical marketing approach, which continues to be important to us, was based on word of mouth. It allowed us to build a substantial customer base and community of network engineers who use our products and act as advocates for them. We continue to build our customer base and this community through marketing of relevant web-based content and online communications. Examples of our initiatives include Thwack, a community website designed for network professionals that provides our end-users and the broader networking community with information, tools and valuable resources; Geek Speak, a blog in which we provide perspectives and information relevant to network management, network engineering, systems management, security and other technical topics; and monthly newsletters designed to inform, and keep us connected to, our end-user base and other prospective customers.

In addition, we attend networking-based trade shows, communicate with industry analysts and host webinars on network management issues to create awareness of our brand and software products.

Sales

We primarily sell our software directly to our customers. Our direct sales are made exclusively through a low-cost inside sales force that is devoted to turning highly qualified leads into purchasers of our software. The substantial majority of our leads come from potential customers who have downloaded our software and are using it during a trial period or from our existing customer base. As a result, our inside sales team typically is calling potential buyers who are already informed on the use and value of our products and do not require a lengthy sales cycle. We also utilize a reseller channel that supplements our inside sales force and helps us fulfill sales orders from state, local and federal governments and those commercial customers that prefer to make purchases through a particular reseller.

Our sales approach focuses on driving a high volume of standard transactions. We implement our approach through a disciplined sales process that provides clear guidelines for our sales force, and we actively measure and manage our sales results. We offer our products at low prices using standardized online contract terms. We enable our customers to buy our products in a manner convenient to them, whether by purchase order, online with a credit card or through our channel partners. Because of our approach, our average transaction size is much smaller than is typical for the enterprise software industry and we make more frequent sales of our products.

We believe we have built a sales process and culture that is unique in the software industry, and that our sales force is able to achieve and maintain a higher level of productivity at a lower cost than other enterprise software companies. Because our sales personnel do not need a professional software sales background, we are able to keep our personnel costs low and can expand our sales force quickly and easily.

 

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Customers

As of December 31, 2008, we had over 80,000 customers in more than 170 countries, including small businesses, governments and more than 400 of the Fortune 500 companies. We define customers as individuals or entities, including distributors or resellers, that have purchased one or more of our products under a unique customer identification number since our inception in 1999. No customer represented 10% or more of our revenue in 2006 or 2007. In 2008, we had one distributor that represented 14.9% of our revenue from sales to various end-users. We do not believe, however, that our business is substantially dependent on this distributor or that the loss of this distribution relationship would have a material adverse effect on our business.

See Note 14 of the notes to our consolidated financial statements for further information regarding measurement of our international revenue and location of our long-lived assets.

Intellectual Property

We rely on a combination of copyright, trademark, trade dress and trade secret laws, as well as confidentiality procedures and contractual restrictions, to establish and protect our proprietary rights. These laws, procedures and restrictions provide only limited protection. We currently have no patents. We have filed patent applications, but no patents may issue with respect to our current patent applications in a manner that gives us the protection that we seek or at all. Any future patents issued to us may be challenged, invalidated or circumvented. Any patents that may issue in the future with respect to pending or future patent applications may not provide sufficiently broad protection or may not prove to be enforceable in actions against alleged infringers.

We endeavor to enter into agreements with our employees and contractors and with parties with which we do business in order to limit access to and disclosure of our proprietary information. We cannot be certain that the steps we have taken will prevent unauthorized use or reverse engineering of our technology. Moreover, others may independently develop technologies that are competitive with ours or that infringe our intellectual property. The enforcement of our intellectual property rights also depends on any legal actions against these infringers being successful, but these actions may not be successful, even when our rights have been infringed.

Furthermore, effective patent, trademark, trade dress, copyright and trade secret protection may not be available in every country in which our products are available over the Internet. In addition, the legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain and still evolving.

Competition

We face competition from both traditional, larger software vendors offering enterprise-wide software frameworks and services and smaller companies offering point solutions for network management. We also compete with network equipment vendors and systems management product providers whose products and services also address network management requirements. Our principal competitors vary depending on the product we offer and include Hewlett Packard, IBM, CA, BMC, Cisco and several smaller vendors.

Competition in our market is based primarily on level of difficulty in using, maintaining and installing solutions; total cost of ownership, including product price and implementation and support costs; professional services implementation; product performance, functionality, flexibility, scalability and interoperability; brand and reputation; distribution channels; vertical markets or industries; and financial resources of the vendor. We generally compete favorably with respect to these factors; however, many of our actual and potential competitors enjoy substantial competitive advantages over us, such as greater name recognition, more comprehensive and varied products and services and substantially greater financial, technical and other resources.

 

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Employees

As of December 31, 2008, we had 254 employees. We consider our current relationship with our employees to be good. None of our employees is represented by a labor union or is a party to a collective bargaining agreement.

Facilities

We currently lease approximately 65,437 square feet of space for our corporate headquarters in Austin, Texas under a lease agreement that expires on June 1, 2016. We also lease space in Tulsa, Oklahoma. Our foreign subsidiaries lease office space for their operations, including local sales, support and development personnel. We believe our current and planned facilities will be adequate for the foreseeable future.

Legal Proceedings

On November 26, 2007, a former employee brought a lawsuit in Oklahoma State Court asserting a number of claims against us and Donald C. Yonce, our founder and a current member of our board of directors. The former employee claims that he is a co-author and that he is, therefore, co-owner of all of our major software products, which he claims he assisted in developing while an employee of our company. The former employee makes this claim despite the fact that he signed an agreement with us which provides that we are the exclusive owner of all copyrights and other intellectual property relating to any work performed by the former employee while employed by us. He also claims that Donald C. Yonce made certain oral promises to him regarding future potential compensation at our company prior to our recapitalization in December 2005 in the event of a sale of our company, and further alleges unspecified violations of Oklahoma labor protection laws. The former employee is seeking half of the profits from sales of our software products of which he claims to be a co-author and co-owner, as well as punitive damages and unspecified other legal and equitable relief. In April 2008, Mr. Yonce requested that we indemnify him from these claims pursuant to a stock purchase agreement entered into in 2005 between Mr. Yonce, us and certain stockholders who are parties to that agreement. We have denied this request although we have agreed to pay his legal fees. Even if we prevail in the litigation, we could incur significant litigation fees and expenses. Because this lawsuit is in its initial stage, it is not possible to predict the outcome of the litigation. Although we believe we have meritorious defenses, an adverse outcome in this litigation could materially and adversely affect us, requiring us to pay damages or royalties or subjecting us to other remedies.

From time to time, we have been and may be involved in various legal proceedings arising from our ordinary course of business. We currently have no other material legal proceedings pending.

 

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MANAGEMENT

Executive Officers and Directors

The following table sets forth the names, ages and positions of our executive officers and directors as of January 1, 2009:

 

Name

   Age   

Position

Michael S. Bennett

   56   

Chief Executive Officer, Director and Chairman of the Board

Kevin B. Thompson

   43   

President, Chief Operating Officer, Chief Financial Officer and Treasurer

Douglas G. Hibberd

   44    Senior Vice President, Product Development

J. Barton Kalsu

   41    Chief Accountant and Vice President, Finance

David Owens

   37    Vice President, Finance and Operations, EMEA

Rita J. Selvaggi

   53    Senior Vice President, Marketing

Bryan A. Sims

   40    Vice President, General Counsel and Secretary

Paul Strelzick

   45    Senior Vice President, Worldwide Sales

Garry D. Strop

   62   

Vice President, Human Resources and Corporate Infrastructure

Kenny L. Van Zant

   38   

Senior Vice President and Chief Product Strategist

Karen L. White

   46   

Vice President, Corporate and Business Development

Steven M. Cakebread (1) (2)

   57    Lead Independent Director

Jeffrey L. Horing (2)

   44    Director

Bob L. Martin (1) (3)

   60    Director

J. Benjamin Nye (2)

   43    Director

Ellen F. Siminoff (1) (3)

   41    Director

John D. Thornton (3)

   43    Director

Donald C. Yonce

   45    Director

 

(1) Member of the audit committee
(2) Member of the compensation committee
(3) Member of the nominating and governance committee

Michael S. Bennett has served as our Chief Executive Officer and a member of our board of directors since June 2006. He was appointed Chairman of the Board in October 2007 and served as President from June 2006 to January 2009. From April 2004 until March 2006, Mr. Bennett served as Chief Executive Officer of Permeo Technologies, Inc., a network security software company. From November 2001 until April 2004, Mr. Bennett was a venture partner at Austin Ventures, a venture capital firm. In May 1998, Mr. Bennett was appointed President, Chief Executive Officer and a member of the board of directors of Mission Critical Software, and in February 1999 he was also appointed Chairman of its Board of Directors. Mr. Bennett held those positions with Mission Critical Software until its acquisition by NetIQ Corporation in 2000. From August 1996 until April 1998, he served as President and Chief Executive Officer of Learmonth & Burchett Management Systems plc, a provider of process management tools for software development. Prior to joining Learmonth & Burchett in August 1996, Mr. Bennett served as President and Chief Executive Officer of Summagraphics from June 1993 until its July 1996 acquisition by Lockheed Martin’s CalComp subsidiary. Prior to joining Summagraphics, Mr. Bennett served as a senior executive with Dell Computer Corporation and as chief executive officer of several other technology organizations.

Kevin B. Thompson has served as our Chief Financial Officer and Treasurer since July 2006 and assumed the title and responsibilities of Chief Operating Officer in July 2007 and President in January 2009. Prior to joining SolarWinds, Mr. Thompson was Chief Financial Officer of Surgient, Inc., a software company, from November 2005 until March 2006 and was Senior Vice President and Chief Financial Officer at SAS Institute, a business intelligence software company, from September 2004 until November 2005. From October 2000 until

 

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August 2004, Mr. Thompson served as Executive Vice President and Chief Financial Officer of Red Hat, Inc., an enterprise software company. Mr. Thompson holds a B.B.A. from the University of Oklahoma. He also serves on the board of directors of NetSuite Inc.

Douglas G. Hibberd has served as our Senior Vice President, Product Development since January 2009. Mr. Hibberd served as our Vice President, Product Development from August 2006 until January 2009. Prior to joining SolarWinds, Mr. Hibberd was Vice President, Engineering at RealVue Simulation Technologies, Inc., a provider of custom simulation software to the commercial, industrial and manufacturing sectors, from September 2004 until May 2006. Mr. Hibberd was Vice President, Engineering at ForwardVue Technologies Inc., a provider of supply chain risk management software and services, from November 2001 until September 2004. He holds a degree as a technician in mechanical engineering from Sydney Technical College and a degree in electronics engineering from North Sydney Technical College in Australia and has received fundamentals of engineering certification from the National Council of Examiners for Engineering.

J. Barton Kalsu has served as our Chief Accountant and Vice President, Finance since August 2007. Prior to joining SolarWinds, Mr. Kalsu worked for JPMorgan Chase Bank as Vice President, Commercial Banking from June 2005 until August 2007. From April 2002 until June 2005, Mr. Kalsu worked for Red Hat, Inc., an enterprise software company, as Senior Director of Finance. He holds a B.S. in Accounting from Oklahoma State University.

David Owens has served as our Vice President, Finance and Operations, EMEA since April 2007. Prior to joining SolarWinds, Mr. Owens worked for Red Hat, Inc., an enterprise software company, for over seven years, where he served initially as Director of Global Logistics and Production and then as Senior Director of Finance-EMEA. Mr. Owens qualified as a chartered accountant with Ernst & Young and is a member of the Institute of Chartered Accountants in Ireland.

Rita J. Selvaggi has served as our Senior Vice President, Marketing since January 2009. Ms. Selvaggi served as our Vice President, Marketing from August 2006 until January 2009. Prior to joining SolarWinds, Ms. Selvaggi was Vice President, Corporate Development at Blue Coat Systems, a provider of hardware proxy appliances for corporate networks, from March 2006 until June 2006. She was Vice President, Marketing and Business Development at Permeo Technologies, Inc., a network security software company, from January 2004 until its acquisition by Blue Coat Systems in March 2006. From January 2003 until January 2004, Ms. Selvaggi was an independent business development consultant. She holds a B.A. in Spanish with a minor in Business Administration from the University of Delaware and an M.B.A. from the University of Texas at Austin.

Bryan A. Sims has served as our Vice President, General Counsel and Secretary since March 2007. From July 2005 until March 2007, Mr. Sims was Of Counsel at Squire Sanders and Dempsey, where he was head of the Open Source Software Group and focused on intellectual property, corporate mergers and acquisitions and commercial transactions. From September 2000 until August 2005, Mr. Sims served as a Vice President at Red Hat, Inc., an enterprise software company. Mr. Sims holds a B.A. in English with a minor in Business Administration/Finance from Howard University and a J.D. from The Ohio State University College of Law.

Paul Strelzick has served as our Senior Vice President, Worldwide Sales since January 2009. Mr. Strelzick served as our Vice President, Worldwide Sales from January 2008 until January 2009 and as our Vice President, North American Sales from July 2007 until January 2008. Prior to joining SolarWinds, Mr. Strelzick served as Vice President, Sales for various technology companies, including Uplogix, Inc., a provider of remote network management solutions, from March 2006 until April 2007, MessageOne, Inc., a provider of managed services for email archiving, management and business continuity, from September 2004 until February 2006, Permeo Technologies, Inc., a network security software company, from October 2003 until June 2004 and NetIQ Corporation, a provider of systems and security management solutions, from July 1999 to October 2003. He holds a B.A. in History from the State University of New York (Albany).

 

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Garry D. Strop has served as our Vice President, Human Resources and Corporate Infrastructure since June 2008. From November 2004 until June 2008, Mr. Strop served as Director, Americas Supply Chain, at Symantec Corporation, an infrastructure software company. From January 2004 until November 2004, Mr. Strop was Senior Manager, Operations for Procket Networks. From December 2002 until January 2004, Mr. Strop was General Manager for Exel, Inc., a logistics company. Mr. Strop holds a B.S. in Business Administration from Arizona State University.

Kenny L. Van Zant has served as our Chief Product Strategist since September 2006 and as a Senior Vice President since January 2009. Prior to joining SolarWinds, Mr. Van Zant served as Executive Vice President, Products and Marketing at Motive, Inc., a provider of broadband management software, from January 2003 until May 2006. He holds a B.S. in Electrical Engineering from the University of Texas at Austin.

Karen L. White has served as our Vice President, Corporate and Business Development since May 2008. From May 2006 to May 2008, Ms. White was on sabbatical pursuing philanthropic interests. From September 2000 to April 2006, Ms. White was a Managing Director at Pequot Ventures, a venture capital firm, where she focused on investments in information technology and was instrumental in opening the firm’s Silicon Valley office. While in this position, Ms. White served on the boards of directors of and as a lead investor at several private companies.

Steven M. Cakebread has served on our board of directors since January 2008. Mr. Cakebread is currently the Senior Vice President, Chief Accounting Officer and Chief Financial Officer of XACTly Corporation, a sales performance management software company, which he joined in February 2009. Prior to joining XACTly Corporation, he served as President and Chief Strategy Officer of salesforce.com, inc. from March 2008 to February 2009. From 2002 until February 2008, Mr. Cakebread was Executive Vice President and Chief Financial Officer of salesforce.com. From April 1997 to April 2002, Mr. Cakebread served as Senior Vice President and Chief Financial Officer of Autodesk, Inc., a software company. Mr. Cakebread received a B.S. from the University of California at Berkeley and an M.B.A. from Indiana University. Mr. Cakebread also serves on the board of directors of eHealth, Inc.

Jeffrey L. Horing has served on our board of directors since December 2005. Mr. Horing is the Managing Director and Co-Founder of Insight Venture Partners, a private equity and venture capital firm he co-founded in 1995. Prior to founding Insight, Mr. Horing held various positions at Warburg, Pincus and Goldman, Sachs & Co. Mr. Horing received a B.S. and a B.A. from the University of Pennsylvania’s Moore School of Engineering and Wharton School and received an M.B.A. from the M.I.T. Sloan School of Management. He also serves on the boards of directors of a number of private companies.

Bob L. Martin has served on our board of directors since July 2006. Mr. Martin is currently the Chief Executive Officer of Mcon Management Services, Ltd., a consulting company, which he joined in June 1999. Prior to joining Mcon Management Services, Ltd., he was the President and Chief Executive Officer of the International Division of Wal-Mart Stores, Inc. He also serves on the boards of directors of The Gap, Inc., Furniture Brands International, Inc. and Conn’s, Inc.

J. Benjamin Nye has served on our board of directors since December 2005. Mr. Nye is a Managing Director of Bain Capital Venture Partners, LLC, which he joined in October 2004. From June 2003 until October 2004, Mr. Nye was a Senior Vice President at VERITAS Software Corporation, a software company. He was Chief Operating Officer and Chief Financial Officer of Precise Software Solutions, Ltd., a network management software company, from January 2000 until its sale to VERITAS Software in June 2003. Mr. Nye received a B.A. from Harvard College and an M.B.A. from Harvard Business School. He also serves on the boards of directors of various private companies.

Ellen F. Siminoff has served on our board of directors since June 2008. Since March 2008, Ms. Siminoff has served as President and Chief Executive Officer of Shmoop University, an educational website. Ms. Siminoff is also Chairman of Efficient Frontier, Inc., a pioneer of dynamic search engine marketing management services. From March 2004 to March 2008, Ms. Siminoff served as President and Chief Executive Officer of Efficient

 

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Frontier, Inc. From 1996 to 2002, Ms. Siminoff served in various capacities at Yahoo!, including as Vice President of Business Development and Planning, Senior Vice President of Entertainment and Small Business and Senior Vice President of Corporate Development. She has received an A.B. from Princeton University in Economics and an M.B.A. from the Stanford Graduate School of Business. She also serves on the board of directors of U.S. Auto Parts Networks, Inc., Journal Communications, Inc., Glu Mobile Inc. and various private companies.

John D. Thornton has served on our board of directors since January 2008. Mr. Thornton is a general partner of Austin Ventures, a venture capital firm, which he joined in 1991. He has worked with a number of public companies, including Active Power, Dazel, Metasolv, Mission Critical Software, Motive, Pentasafe, TechRepublic, Tivoli, Vignette and Waveset. Mr. Thornton holds a B.A. from Trinity University and an M.B.A from the Stanford Graduate School of Business. He also serves on the boards of directors of various private companies.

Donald C. Yonce is our founder and has served on our board of directors since our inception in 1999. From February 1999 until December 2006, Mr. Yonce held the position of Founder and Chief Architect. Prior to founding our company, Mr. Yonce held the position of Principal Consultant at International Network Services until its merger with Lucent Technologies, Inc. Earlier in his career, Mr. Yonce served as Senior Strategy Architect for Wal-Mart Stores, Inc. and was a member of its Advanced Technology Group.

Board Composition

Our board of directors is currently composed of eight members. Six of our directors are independent within the meaning of the independent director guidelines of the NYSE. At each annual meeting of stockholders, our directors will be elected for a one-year term and until their successors are elected and qualified, or until their earlier resignation or removal. Our amended and restated certificate of incorporation and our amended and restated bylaws to be effective upon the completion of this offering will provide that the number of our directors, which is currently fixed at eight members, shall be fixed from time to time by a resolution of a majority of our board of directors.

In addition, pursuant to our stockholders agreement, as amended in March 2008, we have agreed, from the date of this offering until the date of the first annual meeting of our stockholders following this offering, to nominate and use our best efforts to have elected to our board of directors one individual designated by any of Bain Capital Ventures, Insight Venture Partners and the Yonces and reasonably acceptable to us, for so long as that investor or investor group owns beneficially at least 10% of our outstanding capital stock held by the parties to the stockholders agreement other than us (on an as-converted to common stock basis, including any options, warrants or other convertible securities held by any party to the stockholders agreement other than us). This obligation will terminate prior to the first annual stockholders meeting if, within 60 days prior to the earlier of the meeting or the proposed date of the meeting as specified in our proxy statement, the average closing price for a share of our common stock on the NYSE equals or exceeds $10.68, as adjusted for stock splits, stock dividends, recapitalizations or other similar transactions.

Board Committees

As of the closing of this offering, our board of directors will have an audit committee, a compensation committee and a nominating and governance committee, each of which will have the composition and responsibilities described below.

Audit Committee

The audit committee oversees our corporate accounting and financial reporting processes. The audit committee will also:

 

   

evaluate our independent auditors’ qualifications, independence and performance;

 

   

determine the engagement of our independent auditors;

 

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approve the retention of our independent auditors to perform any proposed permissible non-audit services;

 

   

monitor the rotation of partners of our independent auditors on our engagement team;

 

   

review our financial statements and review our critical accounting policies and estimates; and

 

   

review and discuss with management and our independent auditors the results of the annual audit and the quarterly reviews of our financial statements.

The current members of the audit committee are Messrs. Cakebread and Martin and Ms. Siminoff. Messrs. Cakebread and Martin and Ms. Siminoff are financial experts as contemplated by the rules of the SEC implementing Section 407 of the Sarbanes Oxley Act of 2002. Mr. Cakebread has been appointed to serve as the chairman of the audit committee. We believe that the composition of the audit committee meets the requirements for independence under current NYSE and SEC rules and regulations. Our board of directors has adopted an audit committee charter to be effective prior to the closing of this offering. We believe that the audit committee’s charter and functioning comply with the applicable requirements of NYSE and SEC rules and regulations. We intend to comply with future requirements to the extent they become applicable to us.

Following the completion of this offering, copies of the charter for our audit committee will be available without charge, upon request in writing to SolarWinds, Inc., 3711 South MoPac Expressway, Building Two, Austin, Texas 78746, Attn: General Counsel or on the investor relations portion of our website, www.solarwinds.com.

Compensation Committee

The compensation committee oversees our corporate compensation and benefit programs and has the responsibilities described in “Compensation Discussion and Analysis” below.

The members of the compensation committee are Messrs. Cakebread, Horing and Nye, each of whom our board of directors has determined is independent within the meaning of the independent director guidelines of the NYSE. Mr. Nye has been appointed to serve as the chairman of the compensation committee. We believe that the composition of the compensation committee meets the requirements for independence under current NYSE and SEC rules and regulations. Our board of directors has adopted a compensation committee charter to be effective prior to the closing of this offering. We believe that the compensation committee charter and the functioning of the compensation committee will comply with the applicable requirements of NYSE and SEC rules and regulations. We intend to comply with future requirements to the extent they become applicable to us.

Following the completion of this offering, copies of the charter for our compensation committee will be available without charge, upon request in writing to SolarWinds, Inc., 3711 South MoPac Expressway, Building Two, Austin, Texas 78746, Attn: General Counsel or on the investor relations portion of our website, www.solarwinds.com.

Nominating and Governance Committee

The nominating and governance committee oversees and assists our board of directors in reviewing and recommending nominees for election as directors. The nominating and governance committee will also:

 

   

assess the performance of the members of our board of directors;

 

   

oversee guidelines for the composition of our board of directors; and

 

   

review and administer our corporate governance principles.

The current members of the nominating and governance committee are Messrs. Martin and Thornton and Ms. Siminoff, each of whom our board of directors has determined is independent within the meaning of the independent director guidelines of the NYSE. Mr. Martin has been appointed to serve as the chairman of the

 

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nominating and governance committee. We believe that the composition of the nominating and governance committee meets the requirements for independence under current NYSE and SEC rules and regulations. Our board of directors has adopted a nominating and governance committee charter to be effective prior to the closing of this offering. We believe that the nominating and governance committee charter and the functioning of the nominating and governance committee will comply with the applicable requirements of NYSE and SEC rules and regulations. We intend to comply with future requirements to the extent they become applicable to us.

Following the completion of this offering, copies of the charter for our nominating and governance committee will be available without charge, upon request in writing to SolarWinds, Inc., 3711 South MoPac Expressway, Building Two, Austin, Texas 78746, Attn: General Counsel or on the investor relations portion of our website, www.solarwinds.com.

Our board of directors may from time to time establish other committees.

Director Compensation

In 2008, our board of directors approved the following compensation package for our non-employee directors not affiliated with any of our major stockholders based on the recommendation of our Chief Executive Officer and the compensation committee of our board of directors.

 

Annual retainer

   $35,000

Board meeting fees

   $1,250 per meeting

Lead independent director retainer

   $10,000

Audit committee chair retainer

   $15,000

Compensation committee chair retainer

   $10,000

Nominating and governance committee chair retainer

   $7,500

Initial equity grant

   stock options to purchase 30,000 shares of our common stock vesting over three years (1)

Annual equity grant

   $100,000 (75% stock options and 25% restricted stock) (2)

Lead independent director equity grant

   stock options to purchase 5,000 shares of our common stock vesting over three years

 

(1) One-third of the options will vest on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 24 months, subject to continued service through each applicable date.
(2) Value of the stock options to be determined as of the date of grant using the Black-Scholes option-pricing model. Each option will become fully exercisable and the forfeiture provision of each restricted stock award will lapse on the earlier of the date of the next year’s annual stockholder meeting and December 31 of the calendar year following the calendar year in which the award is granted, provided the director remains a director on that date.

The following table sets forth the compensation paid or accrued by us to our directors during 2008.

Director Compensation Table for Year Ended December 31, 2008

 

Name

   Fees Earned
or Paid

in Cash
   Option
Awards (1)
    Total

Michael S. Bennett

               

Steven M. Cakebread

   $ 66,250    $ 24,733 (2)   $ 90,983

Jeffrey L. Horing

               

Bob L. Martin

     46,875      17,673 (3)     64,548

J. Benjamin Nye

               

Ellen F. Siminoff

     20,000      29,469 (4)     49,469

John D. Thornton

               

Donald C. Yonce

               

 

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(1) The value reported above in the “Option Awards” column is the amount we expensed during 2008 for each director’s option award calculated in accordance with SFAS No. 123(R). All awards were granted under the 2005 Stock Plan.
(2) Mr. Cakebread was granted an option to purchase 30,000 shares of our common stock on January 23, 2008 and an option to purchase 5,000 shares of our common stock on March 9, 2008. The grant date fair values of these option awards calculated pursuant to SFAS No. 123(R) was $75,093 and $26,026, respectively.
(3) Mr. Martin was granted an option to purchase 30,000 shares of our common stock on January 23, 2008. The grant date fair value of this option award calculated pursuant to SFAS No. 123(R) was $75,093.
(4) Ms. Siminoff was granted an option to purchase 30,000 shares of our common stock on June 20, 2008. The grant date fair value of this option award calculated pursuant to SFAS No. 123(R) was $153,276.

On March 5, 2009, we granted to each of Mr. Cakebread and Mr. Martin 2,880 shares of restricted stock and an option to purchase 15,369 shares of common stock at an exercise price of $8.68 per share. These grants represent the annual equity awards under our director compensation policy. The stock options become fully exercisable and the forfeiture provision of each restricted stock award will lapse on the earlier of the date of the 2010 annual stockholder meeting and December 31, 2010, provided the director remains a director on that date.

Compensation Committee Interlocks and Insider Participation

Jeffrey L. Horing, J. Benjamin Nye and Donald C. Yonce served as members of the compensation committee in 2008. Mr. Yonce is our founder, has served on our board of directors since our inception and held the positions of Founder and Chief Architect from February 1999 until December 2006. For a discussion of certain transactions we entered into with Mr. Yonce, see “Certain Relationships and Related Party Transactions.” In January 2008, Mr. Yonce resigned from the compensation committee and the board of directors appointed Steven M. Cakebread to fill the vacancy on the committee. Thus, the current members of the compensation committee are Steven M. Cakebread, Jeffrey L. Horing and J. Benjamin Nye. None of the current members of the compensation committee has at any time been one of our officers or employees. None of our executive officers serves, or in the past year has served, as a member of the board of directors or compensation committee of any entity that has one or more executive officers who serve on our board of directors or compensation committee.

Executive Officers

Our executive officers are elected by, and serve at the discretion of, our board of directors. There are no familial relationships among our directors and officers.

Code of Business Ethics and Conduct

In January 2008, our board of directors adopted a code of business ethics and conduct for all employees, officers and directors. The code of business ethics and conduct will be available on our website at www.solarwinds.com. We expect that any amendments to the code of business ethics and conduct, or any waiver of its requirements, will be disclosed on our website.

 

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COMPENSATION DISCUSSION AND ANALYSIS

The following discussion and analysis of compensation arrangements of our named executive officers, or NEOs, for 2008 and 2009 should be read together with the compensation tables and related disclosures set forth below under “Executive Compensation.” This discussion contains forward-looking statements that are based on our current plans, considerations, expectations and determinations regarding future compensation programs.

Overview of Compensation Program

Our compensation and benefits programs seek to attract and retain talented, qualified senior executives to manage and lead our company and to motivate them to pursue our corporate objectives. Our current and proposed compensation programs reflect a mix of cash and equity elements to focus senior executives on not only short-term results, but also long-term success. Our compensation programs are designed to:

 

   

reflect our compensation philosophy to pay competitively at the market median for achieving target levels of performance, with a significant upside opportunity to earn additional compensation for achieving superior results;

 

   

align the interests of management and stockholders; and

 

   

encourage effective use of resources to achieve corporate objectives.

The current compensation program consists of base salary, short-term incentives and a long-term equity component, historically in the form of stock options. We have discussed each element of the compensation program in more detail in the subsection titled “—Components of Our Compensation Program.”

Compensation Philosophy

In January 2008, our management and board of directors, based on the recommendation of the compensation committee, adopted the following compensation philosophy to guide compensation decision-making and program design. We expect to review our compensation philosophy at least annually.

 

 

 

The total compensation package is targeted at competitive market median levels with the opportunity to earn up to the market 75th percentile for superior performance.

 

   

The elements of the total compensation package are designed to reward the executive management team for achieving our company objectives, with significant upside opportunity for exceeding the performance objectives.

 

   

The compensation package balances achievement of short-term performance objectives with long-term strategic goals.

 

   

The compensation package is designed to align the interests of our management with those of our stockholders by paying a significant portion of each executive officer’s total compensation in the form of stock options and/or restricted stock.

 

   

Our total compensation program is designed to provide compensation opportunities that are competitive with those companies with which we compete for executive talent.

Compensation Decision Making

In December 2007, our management retained Ernst & Young LLP, or E&Y, to review the current executive compensation programs and make recommendations for strengthening the programs. We believe E&Y is independent because we are unaware of relationships that could affect their independence and because the compensation committee was able to communicate directly with E&Y and assess the results of E&Y’s review. Although we have no current engagements with E&Y, we anticipate utilizing their compensation services in the future.

 

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E&Y conducted a review of total compensation for our top seven executive officers comparing them in compensation to similar positions at publicly traded companies of similar size in the technology industry. The top seven executive officers were identified by our Chief Executive Officer and Chief Operating Officer based on their respective levels of responsibility. Our Chief Executive Officer and the compensation committee of our board of directors utilized the results and recommendations from the E&Y study in making recommendations to our board of directors for changes to the compensation programs for 2008.

In addition, E&Y reviewed typical compositions and structures of boards of directors as well as competitive compensation programs for outside members of boards of directors. Our Chief Executive Officer, Chief Operating Officer and General Counsel evaluated this information in January 2008 in proposing to the compensation committee and the board of directors the structure of our board of directors and the design of the outside director compensation program in preparation for this offering.

In October 2008, our management engaged E&Y to conduct another review of our executive compensation program and to make recommendations for 2009 compensation for our top ten executive officers. Our Chief Executive Officer, Chief Operating Officer, General Counsel and Vice President, Corporate Infrastructure reviewed this report in November 2008 and our Chief Executive Officer presented this report along with other information to the compensation committee.

Compensation Committee

In January 2007, our board of directors established a compensation committee of the board of directors. Currently, our compensation committee consists of J. Benjamin Nye, the Chairman of the compensation committee, Jeffrey L. Horing and Steven M. Cakebread. Each member was determined to be, and remains, an “outside director” for purposes of Section 162(m) of the Internal Revenue Code of 1986, as amended, or the Code, and a “non-employee director” for purposes of Rule 16b-3 under the Securities Exchange Act of 1934, as amended, or the Exchange Act. The compensation committee oversees the compensation and benefit programs for our executive officers. In 2008 and 2009, our Chief Executive Officer made recommendations to the compensation committee regarding each executive officer’s compensation. With respect to 2008 compensation, the compensation committee recommended compensation for each executive officer, which was adopted by our board of directors in January 2008. In 2009, the compensation committee determined the compensation of each member of the senior leadership group based, in part, on the recommendations of our Chief Executive Officer. The compensation committee will be responsible for ensuring that our compensation policies and practices support the successful recruitment, development and retention of the executive officer talent required for us to achieve our business objectives.

The compensation committee is responsible for the following:

 

   

reviewing and recommending policies relating to compensation and benefits of our executive officers and employees;

 

   

reviewing and approving corporate goals and objectives relevant to compensation of our Chief Executive Officer and other executive officers;

 

   

evaluating the performance of our executive officers in light of established goals and objectives;

 

   

setting compensation of our executive officers based on its evaluations; and

 

   

reviewing and evaluating, at least annually, its own performance and that of its members, including compliance with the committee charter.

The compensation committee has the authority to retain a compensation consultant to assist them in evaluating the compensation of our Chief Executive Officer and our other executive officers and to approve the consultant’s fees and engagement terms. The compensation committee also has the authority to retain other advisors to assist them in fulfilling their responsibilities.

 

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Participation of Management in Compensation Decisions

We believe that the best way to align executive and stockholder interests is through a compensation program designed with input from our Chief Executive Officer in an ongoing dialogue with the compensation committee and, as appropriate, external advisors regarding internal, external, cultural and business challenges and opportunities facing our company and our executive officers. Our Chief Executive Officer provides recommendations to the compensation committee with respect to individual performance and related compensation decisions for our executive officers for the compensation committee’s review and approval. To date, our Chief Executive Officer, Chief Operating Officer and General Counsel have attended certain meetings of the compensation committee, but have not been present during the portion of any meeting when their own compensation was discussed.

In 2008 and 2009, the compensation committee sought the input of our Chief Executive Officer when evaluating his performance and establishing recommendations for his compensation. In the future, the compensation committee intends to make all decisions with regard to our Chief Executive Officer’s performance and compensation based, in part, on guidance from the Chief Executive Officer. However, our Chief Executive Officer will not be permitted to be present during deliberations or voting by the compensation committee regarding the Chief Executive Officer’s compensation goals and objectives, performance evaluation or compensation level approval.

Competitive Market

Our post-initial public offering executive compensation program is designed so that total short-term and long-term compensation are competitive with comparable positions at comparable companies. In setting 2008 compensation, our Chief Executive Officer, Chief Operating Officer and General Counsel selected the following publicly-traded companies, or the Peer Group, to be utilized for compensation comparisons. They considered the members of the Peer Group to be appropriate companies to compare against our company based on their industry focus, size, scope, growth rate and complexity of operations.

 

•     Acme Packet

  

•     NetSuite

•     Akamai Technologies

  

•     Omniture

•     Ansys

  

•     Quest Software

•     Aruba Networks

  

•     Red Hat

•     Bankrate

  

•     Riverbed Technology

•     BladeLogic

  

•     salesforce.com

•     Blue Coat Systems

  

•     Sourcefire

•     NetScout Systems

  

•     Tibco Software

 

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In setting 2009 compensation, our Chief Executive Officer, Chief Operating Officer and General Counsel reviewed the Peer Group and amended the list of companies in order to select more appropriate companies after the impact of changed economic events and the changed industry focus, size, scope, growth rate or complexity of operations of the members. We used the following Peer Group, or the 2009 Peer Group, for 2009 compensation comparison:

 

•     Akamai Technologies

  

•     NetSuite

•     Ariba

  

•     Omniture

•     Aruba Networks

  

•     Opsware

•     Concur Technologies

  

•     Red Hat

•     Data Domain

  

•     Riverbed Technology

•     DemandTec

  

•     salesforce.com

•     Kenexa

  

•     SuccessFactors

•     NetScout Systems

  

•     VMware

In addition to the Peer Group and 2009 Peer Group analyses, management reviewed information from a proprietary database created by Culpepper and Associates, Inc., a compensation advisory firm focused on technology companies. The Culpepper database consisted of compensation data from numerous companies presented in consolidated form such that individual peer companies were not identified. Management also reviewed benchmarks developed by E&Y based on published surveys of nationally recognized human resources consulting firms available to E&Y. These surveys consisted of compensation data from companies operating in all industries and of all revenue sizes, including compensation data not disclosed in public documents of the Peer Group or the 2009 Peer Group. E&Y selected data of companies in the technology industry with revenue comparable to our anticipated revenue after this offering and matched the duties and responsibilities of each of our officers to those in the survey data to develop appropriate benchmarks.

Total Compensation Review

In December 2007, our management engaged E&Y to conduct a total compensation review for our top seven executive officers in setting their 2008 compensation. The review consisted of a proxy statement analysis of the Peer Group listed above as well as published survey analyses, including the Culpepper database. Management informed E&Y that we intended to pursue a public offering and instructed E&Y to review and evaluate our compensation programs assuming we would consummate a public offering in 2008. The results of the review were used to position the current compensation programs to be competitive with other publicly traded companies as we prepared for this offering in 2008. E&Y initially made recommendations to our Chief Executive Officer, who modified them and presented them to the compensation committee. In January 2008, the compensation committee recommended and our board of directors approved modifications to the current compensation programs to establish a total compensation package targeted at competitive market median levels with the opportunity to earn up to the market 75th percentile for superior performance based on the Peer Group. Specific modifications included increasing annual incentive targets to median market levels and implementing equity grant guidelines. These changes were implemented effective as of February 1, 2008.

In October 2008, our management engaged E&Y to conduct another review of our executive compensation program for setting 2009 compensation of our top ten executive officers. The review consisted of a proxy statement analysis of the 2009 Peer Group as well as published survey analyses, including the Culpepper database. E&Y initially presented the report to our Chief Executive Officer, Chief Operating Officer, General Counsel and Vice President, Corporate Infrastructure, who modified them and our Chief Executive Officer presented them to the compensation committee. In February 2009, the compensation committee approved modifications to the compensation programs to establish a total compensation package targeted at competitive market median levels with the opportunity to earn up to the market 75th percentile for superior performance

 

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based on the 2009 Peer Group. Specific modifications included increasing annual incentive targets to median market levels and implementing equity grant guidelines. These changes were implemented effective as of January 1, 2009.

Components of Our Compensation Program

Our compensation program after this offering will consist of base salary, cash bonuses based on achievement of short-term objectives, long-term incentives, and benefits. Each of the components is designed to motivate our executive officers to achieve the overall corporate goals and objectives and to drive the success of our company. The overall corporate objectives include:

 

   

increasing market penetration in key areas;

 

   

encouraging new product development;

 

   

increasing bookings/revenue;

 

   

controlling operating expenses; and

 

   

generating high Adjusted EBITDA margins relative to peers.

The compensation committee recommended and our board of directors selected these objectives based on their determination that they represent the key indicators of success for our business. We expect to review them at least annually.

We believe that our compensation programs are designed to support these objectives because the total compensation program places a significant amount of each executive officer’s total potential compensation “at risk” based on corporate performance. Base salary and benefits represent less than half of each executive officer’s potential total compensation at target performance levels for each of 2008 and 2009. Each component is described in more detail below.

We evaluate these components on an aggregate basis and, as a result, each component affects decisions regarding the other components. We consider every component of compensation, both potential and realized, when determining the amount of each component of compensation. We do not currently have any policies regarding the adjustment or recovery of awards or payments in the event the relevant performance measures upon which the awards or payments are based are restated or otherwise adjusted in a manner that would decrease the size of an award or payment.

Base Salary

We pay an annual base salary to our executive officers in order to provide them with a fixed rate of cash compensation during the year. Prior to 2008, base salaries of our executive officers were negotiated individually with several factors considered, including the individual’s base salary at his/her previous employer and unique skills and/or knowledge that we required. In 2008, the compensation committee established a formal review process for base salaries of our executive officers based upon a number of factors, including overall performance against our financial and strategic plan; overall functional unit expense controls; assessment of professional effectiveness, consisting of competencies such as leadership, commitment, creativity and team accomplishment; the underlying scope of their responsibilities; their individual performance; their experience; internal equity; competitive market compensation; and retention concerns. Achievement of these factors will be measured as a whole.

 

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In relation to a potential initial public offering, the compensation committee recommended and our board of directors approved increasing base salaries of the executive officers for 2008 to market median levels based on E&Y’s review of the Peer Group. Effective February 1, 2008, we have reviewed the base salaries of our NEOs on an annual basis and make adjustments to reflect performance-based factors, as well as competitive conditions. The compensation committee reviews competitive market data, business conditions and internal factors annually to determine appropriate base salary adjustments. The table below shows base salaries for our NEOs before and from and after January 1, 2009.

 

Officer

  

Title

   Prior Base Salary    Current Base Salary Rate    % Increase  

Michael S. Bennett

   CEO    $ 375,000    $ 400,000    6.7 %

Kevin B. Thompson

  

President, COO, CFO and Treasurer

     275,000      300,000    9.1  

Karen L. White

  

VP, Corporate and Business Development

     220,000      220,000     

Kenny L. Van Zant

  

SVP and Chief Product Strategist

     225,000      250,000    11.1  

Douglas G. Hibberd

   VP, Product Development      215,000      250,000    16.3  

Bonuses

We pay cash bonuses to our NEOs based on the achievement of our company objectives in order to incent management to achieve these objectives. These objectives have historically been determined by our Chief Executive Officer based on input from our Chief Operating Officer and reviewed and approved by our board of directors. Our 2008 and 2009 objectives were determined by our Chief Executive Officer in conjunction with the compensation committee and based on input from our Chief Operating Officer, with final review and approval by the compensation committee. For 2010, the compensation committee will set the bonus objectives for our NEOs based on recommendations by our Chief Executive Officer. These objectives may change from year to year as we continue to evolve and establish different priorities, but will remain subject to the review and approval of the compensation committee.

In 2008, the objective under our Executive Bonus Plan was for us to achieve quarterly sales targets. Our Chief Executive Officer and Chief Operating Officer recommended targets and our board of directors made the final determination. With the exception of our Vice President, Worldwide Sales, who participates in a commission plan, all executive officers participate in the Executive Bonus Plan. Under the 2008 Executive Bonus Plan, participants were required to achieve a minimum of 85% of the quarterly sales target to be eligible for a bonus. For each additional percentage point of the quarterly sales target achieved between 85% and 100%, the executive earned 6.67% of the quarterly target bonus. In addition, the executive officer group was eligible for an “excess bonus” to the extent that quarterly sales targets were exceeded. When a quarterly sales target was exceeded, 5% of the excess sales was placed into a bonus pool to be distributed among the executive officer group. Under the Executive Bonus Plan, deductions were made from the bonus pool to the extent that actual operating expenses exceeded budgeted operating expenses. The bonus pool was reduced by 5% of the excess of actual operating expenses, excluding commission expenses on quarterly sales in excess of target, over budgeted operating expenses. The operating expense deduction was limited to 50% of the total quarterly bonus pool resulting from excess sales.

In 2008, we met our sales and expense goals resulting in bonus payouts approximately equal to the target levels. When we established our 2008 target levels, we believed they were challenging but achievable for the executive group with excellent execution of our 2008 plan. We have adopted a 2009 Executive Bonus Plan based on the same structure utilized in 2008. We have set sales and expense goals for 2009 that we believe are challenging, but achievable for the executive group with excellent execution of our plan. We must outperform our annual operating plan in order for an executive to earn 100% of the target bonus amount under the Executive Bonus Plan.

 

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In 2008, annual target bonus levels for our NEOs ranged from $50,000 to $275,000. Actual target bonus amounts for 2008 are shown below under “Executive Compensation—Grants of Plan-Based Awards in 2008.” Actual bonuses earned in 2008 are shown below under “Executive Compensation—2007 and 2008 Summary Compensation Table.”

As a result of the E&Y study, the compensation committee recommended and our board of directors approved an increase to the target bonus awards for the executive officer group for 2009. These increases to the target bonus awards were effective January 1, 2009 and reflect competitive market levels for the 2009 Peer Group. Bonuses will be determined based on the achievement of revenue targets. The table below shows the annual target bonuses for our NEOs for 2009.

 

Officer

   Target Bonus    Annual Target as % of
2008 Base Salary
 

Michael S. Bennett

   $ 300,000    75 %

Kevin B. Thompson

     250,000    83  

Karen L. White

     100,000    45  

Kenny L. Van Zant

     75,000    30  

Douglas G. Hibberd

     75,000    30  

In addition to the 2009 Executive Bonus Plan, executive officers are eligible to receive an additional 15% of the quarterly target bonus amount for achieving sales consistency goals throughout the quarter. Each of the monthly sales consistency goals must be met to receive the additional bonus amount for the quarter. Our Chief Executive Officer and Chief Operating Officer recommended these goals to the compensation committee, which, in turn, recommended them to our board of directors. Our board of directors approved these goals. We believe it is necessary to maintain consistent sales performance during each month of each quarter in order to improve the likelihood that we will achieve our quarterly targets. If our NEOs earn their maximum quarterly bonus, including the maximum additional amounts upon achievement of their sales consistency goals, their aggregate compensation will be in the 75th percentile of the Peer Group.

Long-Term Incentives

We utilize long-term equity-based incentives to align the interests of our executive officers with those of our stockholders and to promote a longer term performance perspective and progress toward achieving our long-term strategy. In addition, equity-based awards provide an important retention tool for us because they historically have been subject to vesting based on continued service. We have historically granted stock options to each of our executive officers upon hire under our 2005 Stock Plan that was approved on December 14, 2005 and amended and restated on March 3, 2008. The size and terms of the initial option grant made to each NEO upon joining our company are primarily based on competitive conditions applicable to the NEO’s specific position, as well as the new executive officer’s experience and compensation requirements relative to our executive officers then employed. The plan allows for the grant of stock options, restricted stock and other stock-based awards. We have chosen to grant only stock options to our executive officers prior to this offering. In November 2007, we made an annual grant of stock options to all of our NEOs employed by us at the time. Our board of directors determined the aggregate amount of all option grants to our NEOs in November 2007 based on its assessment of the then-current size of the option plan and management’s performance. Our board of directors allocated this aggregate amount of stock options to the NEOs based on their overall performance, organization level, ability to impact our results that drive stockholder value and potential to take on roles of increasing responsibility. Our board of directors made its determinations based on a qualitative rather than a quantitative analysis of these factors. All of these stock options and all stock options we have granted to date have an exercise price equal to or greater than fair market value of our common stock on the date of grant. Ms. White received a stock option grant to purchase 500,000 shares of common stock upon her hire in May 2008. Other than this grant, we did not grant any equity awards to our NEOs in 2008.

 

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The compensation committee and our board of directors have approved the implementation of NEO equity grant guidelines, which will be effective after this offering. The guidelines were developed based on the December 2007 competitive market analysis of E&Y’s compensation review of the Peer Group. We expect to award equity-based incentives to retain our NEOs in amounts we believe to be appropriate based on our evaluation of equity awards received by executive officers at similar organization levels in comparable companies. In addition, we will evaluate each NEO’s overall performance by evaluating company performance factors such as achievement of our financial and strategic plan and other business objectives, as well as the NEO’s organization level, ability to impact our results that drive stockholder value and potential to take on roles of increasing responsibility. The target grant levels are designed to achieve total compensation levels for our executive officers that approximate the market median of the Peer Group with maximum grant levels reflecting the market 75th percentile of the Peer Group. We have not yet approved a target and maximum grant level for Ms. White. The chart below shows the target and maximum grant guidelines for each of our other NEOs.

 

Officer

   Target Value (1)    Maximum Value (1)

Michael S. Bennett

   $ 700,000    $ 1,400,000

Kevin B. Thompson

     450,000      900,000

Kenny L. Van Zant

     250,000      500,000

Douglas G. Hibberd

     250,000      500,000

 

(1) Value to be determined as of the date of grant using the Black-Scholes option-pricing model.

After this offering, we plan to make annual equity awards to our executive officers in October of each year. The awards are expected to consist of 75% stock options and 25% restricted stock. These equity grants are designed to reward past performance and, to a greater extent, to foster retention of our NEOs. We plan to grant awards according to the above guidelines while also taking into consideration our overall performance, market conditions and our options granted and available for issuance and the rate at which we have granted and expect to grant options relative to comparable companies in the 2009 Peer Group. All stock options will be granted with an exercise price equal to the fair market value on the date of grant.

Benefits

Our executive officers are eligible to participate in standard employee benefit plans, including medical, dental, vision, life, accidental death and disability, long-term disability, short-term disability, and any other employee benefit or insurance plan made available to employees. We maintain a 401(k) plan, which is intended to be a tax-qualified defined contribution plan under Section 401(k) of the Code. In general, all of our U.S. employees are eligible to participate in this plan. The 401(k) plan includes a salary deferral arrangement pursuant to which participants may elect to reduce their current compensation by up to 90% or the statutory limit, $16,500 in 2009, whichever is less, and have the amount of the reduction contributed to the 401(k) plan. Beginning in 2008, we began to match a certain percentage of contributions made by all employees, including our NEOs.

We maintain similar benefit programs for employees outside of the United States.

We believe these benefits are consistent with or better than those offered by companies with which we compete for employees.

Stock Ownership Guidelines

We do not currently have stock ownership guidelines.

 

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EXECUTIVE COMPENSATION

2007 and 2008 Summary Compensation Table

The following table provides information regarding the compensation earned in 2007 and 2008 by our principal executive officer, principal financial officer and each of the next three most highly compensated executive officers in 2008.

 

Name and Principal Position

   Year    Salary     Option
Awards (1)
   Non-Equity
Incentive Plan
Compensation
   All Other
Compensation
    Total (2)

Michael S. Bennett

Chief Executive Officer and Chairman of the Board

   2008

2007

   $

 

372,917

350,000

(3)

 

  $

 

1,546,949

1,372,878

   $

 

263,245

165,863

   $

 


 

 

  $

 

2,183,111

1,888,741

Kevin B. Thompson

President, Chief Operating Officer, Chief Financial Officer and Treasurer (4)

   2008

2007

    

 

272,917

250,000

(5)

 

   

 

518,070

382,197

    

 

204,292

96,575

    

 


 

 

   

 

995,279

728,772

Karen L. White (6)

Vice President, Corporate and Business Development

   2008

2007

    

 

128,333

 

 

   

 

425,251

    

 

60,026

    

 

105,484

(7)

 

   

 

719,094

Kenny L. Van Zant

Chief Product Strategist

   2008

2007

    

 

225,000

225,000

 

 

   

 

384,378

340,867

    

 

99,646

62,288

    

 


 

 

   

 

709,024

628,155

Douglas G. Hibberd

Senior Vice President, Product Development

   2008

2007

    

 

213,333

189,166

(8)

 

   

 

319,150

216,467

    

 

99,643

62,705

    

 

358

 

 

   

 

632,484

468,338

 

(1) Reflects the compensation expense we reported in the period presented for option awards in accordance with SFAS No. 123(R) (disregarding an estimate of forfeitures related to service-based vesting conditions) as discussed in Note 9 to our consolidated financial statements included elsewhere in this prospectus, and thus may include amounts for awards granted in and prior to the period presented.
(2) We do not have any pension or deferred compensation plans.
(3) Mr. Bennett’s salary increased to $375,000 in February 2008.
(4) Mr. Thompson assumed the title and responsibilities of President in January 2009.
(5) Mr. Thompson’s salary increased to $275,000 in February 2008.
(6) Ms. White joined our company on May 5, 2008 and her 2008 compensation represents the amount earned from May 5, 2008 through December 31, 2008.
(7) Represents a $100,000 relocation payment earned and paid in 2008 and $5,484 of employer contributions to 401(k) plan.
(8) Mr. Hibberd’s salary increased to $215,000 in February 2008.

Grants of Plan-Based Awards in 2008

The following table provides information regarding grants of plan-based awards to each of our NEOs in 2008.

 

     Grant
Date
   Estimated Payouts
Under Non-Equity
Incentive Plan
Awards Target (1)
   All Other
Option
Awards
   Per-Share
Exercise

Price
   Grant Date
Fair Value
of Stock
and Option
Awards (3)

Name

              

Michael S. Bennett

   1/1/2008    $ 275,000             

Kevin B. Thompson

   1/1/2008      200,000             

Karen L. White

   5/5/2008      100,000             
   5/14/2008         500,000    $ 9.40    $ 2,669,800

Kenny L. Van Zant

   1/1/2008      100,000             

Douglas G. Hibberd

   1/1/2008      100,000             

 

(1) Represents the formulaic awards under the Executive Bonus Plan. We did not set threshold or maximum amounts for awards under the Executive Bonus Plan.

 

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(2) Stock options vest 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date.
(3) Represents the grant date fair value of stock option awards granted during the year computed using a Black-Scholes option-pricing model in accordance with SFAS No. 123(R) that we estimate will be recognized ratably over the award’s vesting period. Refer to Note 9 to our consolidated financial statements included elsewhere in this prospectus for assumptions used in calculating this amount.

Outstanding Equity Awards at December 31, 2008

The following table presents certain information concerning outstanding equity awards held by each of our NEOs at December 31, 2008.

 

     Option Awards

Name

   Number of
Securities
Underlying
Unexercised
Options

Exercisable (1)
    Number of
Securities
Underlying
Unexercised
Options

Unexercisable
   Option Exercise
Price
   Option
Expiration Date

Michael S. Bennett

   300,000 *      $4.35    11/14/2017
   96,146     52,726    2.69    7/26/2016
   2,851,128 *      2.69    7/26/2016

Kevin B. Thompson

   56,875     153,125    4.35    11/14/2017
   29,687     45,313    4.06    7/26/2017
   84,375     65,625    2.69    10/2/2016
   451,128 *      2.69    7/26/2016
   89,943     58,929    2.69    7/26/2016

Karen L. White

       500,000    9.40    5/14/2018

Kenny L. Van Zant

   20,312     54,688    4.35    11/14/2017
   421,875     328,125    2.69    10/2/2016

Douglas G. Hibberd

   48,750     131,250    4.35    11/14/2017
   301,128 *      2.69    8/8/2016
   86,842     62,030    2.69    8/8/2016

 

(1) The options granted to Messrs. Bennett, Thompson, Van Zant and Hibberd and to Ms. White vest at the rate of 25% of the total number of shares on the first anniversary of the vesting commencement date, with the remainder of the shares vesting ratably over the next 36 months, subject to continued service through each applicable date.
 * Grants subject to right of early exercise prior to vesting and a right of repurchase that lapses in accordance with the vesting schedule.

Option Exercises During 2008

None of our NEOs exercised stock options during 2008.

Accounting and Tax Considerations

Section 162(m) of the Code limits to $1.0 million the amount of compensation paid to our Chief Executive Officer and to each of our three most highly compensated executive officers that may be deducted by us for federal income tax purposes in any fiscal year. “Performance-based” compensation that has been approved by our stockholders is not subject to the $1.0 million deduction limit. Although the compensation committee cannot predict how the deductibility limit may impact our compensation program in future years, the compensation committee intends to maintain an approach to executive compensation that strongly links pay to performance. In addition, although the compensation committee has not adopted a formal policy regarding tax deductibility of compensation paid to our named executive officers, the compensation committee intends to consider tax deductibility under Rule 162(m) as a factor in compensation decisions.

 

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Employment Agreements

Employment Agreement with Michael S. Bennett

We entered into an employment agreement with Michael S. Bennett, our Chief Executive Officer, on May 11, 2006. Under the agreement, Mr. Bennett’s base salary was $350,000 per year with a target bonus of $150,000 annually. Mr. Bennett’s current base salary and target bonus are $400,000 and $300,000, respectively. In addition, Mr. Bennett received a signing bonus of $75,000 upon his first day of employment. On July 26, 2006, in accordance with the terms of his employment agreement, Mr. Bennett was granted an option to purchase 3,000,000 shares of our common stock at an exercise price of $2.69. The stock option vests 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Bennett is also eligible to participate in all employee benefit plans and vacation programs, will be reimbursed for all reasonable business expenses, and was reimbursed for all temporary living expenses during the period in 2006 when our headquarters were in Tulsa, Oklahoma prior to relocating to Austin, Texas. As part of his employment agreement, Mr. Bennett is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with Kevin B. Thompson

We entered into an employment agreement with Kevin B. Thompson, our President, Chief Operating Officer, Chief Financial Officer and Treasurer, on June 28, 2006. Under the agreement, Mr. Thompson’s base salary was $225,000 per year with a target bonus of $50,000 annually; Mr. Thompson’s base salary and target bonus were subsequently increased to $250,000 and $100,000, respectively. Mr. Thompson’s current base salary and target bonus are $300,000 and $250,000, respectively. On July 26, 2006, in accordance with the terms of his employment agreement, Mr. Thompson was granted an option to purchase 600,000 shares of our common stock at an exercise price of $2.69. Mr. Thompson was subsequently granted an option to purchase an additional 150,000 shares of our common stock in 2006 at an exercise price of $2.69. Each stock option vests 25% on the first anniversary of the vesting commencement date with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Thompson is also eligible to participate in all employee benefit plans and vacation programs, will be reimbursed for all reasonable business expenses, and was reimbursed for all temporary living expenses during the period in 2006 when our headquarters were in Tulsa, Oklahoma prior to relocating to Austin, Texas. As part of his employment agreement, Mr. Thompson is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with Karen L. White

We entered into an employment agreement with Karen L. White, our Vice President, Corporate and Business Development, on May 5, 2008. Under the agreement, Ms. White’s annual base salary is $220,000 with an annual target bonus of $100,000 that is paid quarterly. Ms. White’s current base salary and target bonus are $220,000 and $100,000, respectively. In addition, Ms. White received a one-time relocation payment of $100,000 upon her relocation to Austin, Texas. On May 14, 2008, in accordance with the terms of her employment agreement, Ms. White was granted an option to purchase 500,000 shares of common stock. The stock option vests 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Ms. White is also eligible to participate in all employee benefit plans and vacation programs. As part of her employment agreement, Ms. White is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with Kenny L. Van Zant

We entered into an employment agreement with Kenny L. Van Zant, our Senior Vice President and Chief Product Strategist, on September 25, 2006. Under the agreement, Mr. Van Zant’s base salary was $225,000 per

 

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year with a target bonus of $50,000 annually. Mr. Van Zant’s current base salary and target bonus are $250,000 and $75,000, respectively. On October 2, 2006, in accordance with the terms of his employment agreement, Mr. Van Zant was granted an option to purchase 750,000 shares of our common stock at an exercise price of $2.69. The stock option vests 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Van Zant is also eligible to participate in all employee benefit plans and vacation programs and will be reimbursed for all reasonable business expenses. As part of his employment agreement, Mr. Van Zant is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with Douglas G. Hibberd

We entered into an employment agreement with Douglas G. Hibberd, our Senior Vice President, Product Development, on August 7, 2006. Under the agreement, Mr. Hibberd’s base salary was $185,000 per year with a target bonus of $42,000 annually; Mr. Hibberd’s base salary and target bonus were subsequently increased to $195,000 and $50,000, respectively. Mr. Hibberd’s current base salary and target bonus are $250,000 and $75,000, respectively. On August 8, 2006, in accordance with the terms of his employment agreement, Mr. Hibberd was granted an option to purchase 450,000 shares of our common stock at an exercise price of $2.69. The stock option vests 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Hibberd is also eligible to participate in all employee benefit plans and vacation programs, will be reimbursed for all reasonable business expenses, and was reimbursed for all temporary living expenses during the period in 2006 when our headquarters were in Tulsa, Oklahoma prior to relocating to Austin, Texas. As part of his employment agreement, Mr. Hibberd is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with J. Barton Kalsu

We entered into an employment agreement with J. Barton Kalsu, our Chief Accountant and Vice President, Finance, on August 1, 2007. Under the agreement, Mr. Kalsu’s base salary was $160,000 per year with a target bonus of $40,000 annually. He will also receive a one-time relocation payment of $95,000 upon his relocation to Austin, Texas. On October 25, 2007, in accordance with the terms of his employment agreement, Mr. Kalsu was granted an option to purchase 186,000 shares of our common stock at an exercise price of $4.35. The stock option vests 25% on the first anniversary of the vesting commencement date with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Kalsu is also eligible to participate in all employee benefit plans and vacation programs. As a part of his employment agreement, Mr. Kalsu is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with David Owens

We entered into an employment agreement with David Owens, our Vice President, Finance and Operations, EMEA, on March 23, 2007. Under the agreement, Mr. Owens’ base salary was €130,000 with a target bonus of €19,500 annually. On April 26, 2007, in accordance with the terms of his employment agreement, Mr. Owens was granted an option to purchase 90,000 shares of our common stock at an exercise price of $4.06. The stock option vests 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Owens is also eligible to participate in all employee benefit plans and vacation programs. As a part of his employment agreement, Mr. Owens is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

 

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Employment Agreement with Rita J. Selvaggi

We entered into an employment agreement with Rita J. Selvaggi, our Senior Vice President, Marketing, in July 2006. Under the agreement, Ms. Selvaggi’s base salary was $195,000 per year with a target bonus of $50,000 annually. In addition, Ms. Selvaggi received a signing bonus of $150,000 payable over the first six months of employment to replace compensation that she otherwise would have received from her prior employer. On August 8, 2006, in accordance with the terms of her employment agreement, Ms. Selvaggi was granted an option to purchase 450,000 shares of our common stock at an exercise price of $2.69. The stock option vests 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Ms. Selvaggi is also eligible to participate in all employee benefit plans and vacation programs and will be reimbursed for all reasonable business expenses and was reimbursed temporary living expenses. As part of her employment agreement, Ms. Selvaggi is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with Bryan A. Sims

We entered into an employment agreement with Bryan A. Sims, our Vice President, General Counsel and Secretary, on April 1, 2007. Under the agreement, Mr. Sims’ base salary was $175,000 with a target bonus of $45,000 annually. In addition, Mr. Sims received a one-time relocation payment of $80,000 upon his relocation to Austin, Texas. On April 26, 2007, in accordance with the terms of his employment agreement, Mr. Sims was granted an option to purchase 240,000 shares of our common stock at an exercise price of $4.06. The stock option vests 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Sims is also eligible to participate in all employee benefit plans and vacation programs. As a part of his employment agreement, Mr. Sims is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with Paul Strelzick

We entered into an employment agreement with Paul Strelzick, our Senior Vice President, Worldwide Sales, on July 24, 2007. Under the agreement, Mr. Strelzick’s base salary was $150,000 per year with a target bonus of $150,000 annually. On October 25, 2007, Mr. Strelzick was granted an option to purchase 180,000 shares of our common stock at an exercise price of $4.35; his employment agreement provided for an option to purchase 150,000 shares of common stock, which was increased to 180,000 shares by our board of directors. The stock option vests 25% on the first anniversary of the vesting commencement date, with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Strelzick is also eligible to participate in all employee benefit plans and vacation programs. As a part of his employment agreement, Mr. Strelzick is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Employment Agreement with Garry D. Strop

We entered into an employment agreement with Garry D. Strop, our Vice President, Human Resources and Corporate Infrastructure, on June 2, 2008. Under the agreement, Mr. Strop’s base salary is $190,000 per year with a target bonus of $60,000 annually. In addition, we have agreed to pay Mr. Strop a minimum bonus of $30,000 for the first six months of his employment. Mr. Strop received a relocation payment of $50,000 and will receive an additional relocation payment of $25,000 in each of the first and second quarters of 2009. On June 20, 2008, in accordance with the terms of his employment agreement, Mr. Strop was granted an option to purchase 225,000 shares of our common stock. The stock option vests 25% on the first anniversary of the vesting commencement date with the remainder vesting ratably over the next 36 months, subject to continued service through each applicable date. Mr. Strop is also eligible to participate in all employee benefit plans and vacation

 

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programs. As a part of his employment agreement, Mr. Strop is entitled to severance benefits upon termination of employment as described below under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Potential Payments upon Termination or Change of Control

We have entered into employment agreements, described immediately above, that require specific payments and benefits to be provided to our executive officers in the event of termination of employment. To attract talented, qualified senior executive officers, we believe we must pay severance upon termination without “cause” and upon resignation for “good reason.” The description and tables that follow describe the payments and benefits that we would owe to each of our executive officers upon his or her termination.

Arrangements with Messrs. Bennett, Hibberd, Thompson and Van Zant and Ms. Selvaggi

Pursuant to the employment agreements with Messrs. Bennett, Hibberd, Thompson and Van Zant and Ms. Selvaggi, if the executive’s employment is terminated due to death or a disability leaving the executive unable to return to work after 12 weeks, leading us to terminate the executive, the executive is entitled to additional vesting with respect to any stock options held by the executive for a period of 12 months from the termination date, to be effected through the acceleration of vesting of those shares effective as of the date of termination.

The employment agreements with each of these individuals provide that, if we terminate the executive’s employment for “cause” or if the executive terminates his or her employment other than for “good reason,” we must pay the executive any base salary earned but not paid through the date of the executive’s termination, any earned but unpaid bonus, and any pay for vacation time accrued but not used.

In addition, these agreements state that, if we terminate the executive’s employment other than for “cause” or the executive terminates his or her employment for “good reason,” we must provide (i) a lump sum cash severance amount equal to 50% of the executive’s then annual base salary, (ii) any earned but unpaid bonus payment, (iii) reimbursement of health and dental care premiums for the executive and the executive’s dependents incurred to continue health and dental insurance coverage for 12 months after termination, to the extent the executive is eligible for and elects such continued coverage under COBRA, and (iv) any accrued and unused vacation pay payable within 21 days of termination. Our obligations to provide these severance payments following termination of employment are conditioned upon the executive’s signing a release of claims within 21 days of notice of termination and not later revoking the release of claims, which we agreed would include a mutual release of any claims we may have against the executive.

Furthermore, pursuant to these agreements, if we terminate the executive’s employment without “cause” or the executive resigns for “good reason” during the 12-month period after the effective date of a “change of control,” we agreed that any then-outstanding equity awards held by the executive would fully vest. In addition, under these circumstances, we are obligated to pay any accrued but unpaid salary, vacation or bonus payment, and to provide (i) a lump sum cash severance amount equal to 50% of the executive’s then annual base salary, (ii) reimbursement of health and dental care premiums for the executive and the executive’s dependents incurred to continue health and dental insurance coverage for 12 months after termination, to the extent the executive is eligible for and elects such continued coverage under COBRA. In addition to this compensation, we are obligated to pay an additional cash severance payment in the amount of $350,000 to Mr. Bennett, $185,000 to Mr. Hibberd, $185,000 to Ms. Selvaggi, $225,000 to Mr. Thompson and $225,000 to Mr. Van Zant.

 

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The following definition of “change of control” applies to all our employment agreements. A “change of control” occurs when a transaction, or series of transactions, occurs where our stockholders immediately preceding the transaction own, following the transaction, less than 50% of our voting securities. However, a firmly underwritten public offering of our common stock is not be considered a “change of control,” and therefore this offering will not constitute a “change of control” for purposes of any of the employment agreements.

A termination for “cause” occurs under our employment agreement with Mr. Bennett if we terminate his employment for any of the following reasons:

(i) substantial and continuous violations of his employment duties or willful disregard of reasonable directives from our board of directors;

(ii) moral turpitude, dishonesty or gross misconduct in the performance of the duties of the position or that has materially and demonstrably injured our finances or future business;

(iii) material breach of the employment agreement; or

(iv) conviction of, or confession or plea of no contest to, any felony or any other act of fraud, misappropriation, embezzlement or the like involving our property.

However, the events in (i) and (iii) will not constitute “cause” if fully cured by Mr. Bennett within 30 days of Mr. Bennett’s receiving notice from us.

A termination for “cause” occurs under our employment agreements with Messrs. Hibberd, Thompson and Van Zant and Ms. Selvaggi if we terminate the executive’s employment for any of the following reasons:

(i) substantial and continual violations of the executive’s employment duties or willful disregard of reasonable directives from our Chief Executive Officer or our board of directors;

(ii) moral turpitude, dishonesty or gross misconduct in the performance of the duties of the position or that has materially and demonstrably injured our finances or future business;

(iii) material breach of the employment agreement; or

(iv) conviction of, or confession or plea of no contest to, any felony or any other act of fraud, misappropriation, embezzlement or the like involving our property.

However, the events in (i) and (iii) will not constitute “cause” if fully cured by the executive within 30 days of the executive’s receiving notice from us.

Pursuant to the employment agreement with Mr. Bennett, “good reason” for his termination of his employment with us results from implementation of any of the following directives by our board of directors without Mr. Bennett’s prior written consent:

(i) assignment of duties to Mr. Bennett that are materially inconsistent with his status as President and Chief Executive Officer or a materially adverse alteration in the nature of his duties or responsibilities, reporting obligations or authority; or

(ii) removal of Mr. Bennett from our board of directors;

(iii) our failure to provide directors’ and officers’ liability insurance coverage for Mr. Bennett; or

(iv) our failure to set up a corporate office in Austin, Texas within 90 days of the date of his employment agreement.

However, no act or event under (i)-(iii) will constitute “good reason” if we fully cure that act or event within 30 days of receiving notice from Mr. Bennett.

 

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Pursuant to the employment agreement with Mr. Thompson, “good reason” for his termination of his employment with us results from implementation of any of the following directives by our board of directors without Mr. Thompson’s prior written consent:

(i) assignment of duties to Mr. Thompson that are materially inconsistent with his status as Chief Financial Officer or a materially adverse alteration in the nature of his duties or responsibilities, reporting obligations or authority;

(ii) our failure to provide directors’ and officers’ liability insurance coverage for Mr. Thompson; or

(iii) our failure to set up a corporate office in Austin, Texas within 90 days of the date of his employment agreement.

However, no act or event under (i) will constitute “good reason” if we fully cure that act or event within 30 days of receiving notice from Mr. Thompson.

The definition of “good reason” in the employment agreements with Mr. Hibberd and Ms. Selvaggi is essentially identical to the definition of “good reason” in Mr. Thompson’s employment agreement.

Pursuant to the employment agreement with Mr. Van Zant, “good reason” for his termination of his employment with us results from implementation of any of the following directives by our board of directors without Mr. Van Zant’s prior written consent:

(i) assignment of duties to Mr. Van Zant that are materially inconsistent with his status as Chief Product Strategist or a materially adverse alteration in the nature of his duties or responsibilities, reporting obligations or authority; or

(ii) our failure to provide directors’ and officers’ liability insurance coverage for Mr. Van Zant.

However, no act or event under (i) will constitute “good reason” if we fully cure that act or event within 30 days of receiving notice from Mr. Van Zant.

Arrangements with Messrs. Kalsu, Sims, Strelzick, Strop and Rogers and Ms. White

The employment agreements with Messrs. Kalsu, Sims, Strop and Strelzick and Ms. White state that, if we terminate the executive due to a disability that prevents the executive from returning to work or from performing substantially all of the executive’s duties and responsibilities for 12 consecutive weeks, we are not obligated to provide severance pay or other separation benefits.

In addition, pursuant to these employment agreements, if the executive’s employment is terminated due to death, we must pay to the executive’s beneficiaries any accrued base salary, any bonus compensation earned, any vested deferred compensation or stock options, any benefits under any of our plans in which the executive participates to the full extent of the executive’s rights under that plan, any accrued vacation pay and any appropriate business expenses incurred in connection with the executive’s duties.

Pursuant to these agreements, if we terminate the executive for “cause” or if the executive resigns, the executive will receive any base salary earned, but not paid, through the date of the executive’s termination, any earned but unpaid incentive compensation, and any pay for vacation time accrued but not used.

Furthermore, these employment agreements state that, if we terminate the executive’s employment other than for “cause,” the executive is entitled to (i) any earned but unpaid incentive compensation payments, (ii) reimbursement of health and dental care premiums for the executive and the executive’s dependents incurred to continue health and dental insurance coverage for three months after termination (or six months in the case of Mr. Strop), to the extent the executive is eligible for and elects that continued coverage under COBRA, and

 

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(iii) any accrued and unused vacation pay payable within 21 days of termination. In addition to this compensation, Mr. Kalsu is entitled to a lump sum cash severance amount equal to four months of his then annual base salary, Messrs. Sims, Strop and Strelzick are each entitled to a lump sum cash severance amount equal to three months of his then annual base salary and Ms. White is entitled to a lump sum cash severance amount equal to six months of her then annual base salary. Our obligations to provide these severance payments to Messrs. Kalsu, Sims, Strop and Strelzick and Ms. White following termination of employment are conditioned upon the executive’s signing a release of claims within 21 days of notice of termination and not later revoking that release of claims. In addition, our obligation to provide severance payments and benefits to Messrs. Sims and Strop are conditioned further on the executive’s having been employed for six months (or 180 days in the case of Mr. Strop) prior to termination. Finally, our obligation to Ms. White is further conditioned on her having been employed for 90 days prior to termination.

These agreements also provide that, if the executive is terminated or constructively terminated without “cause” during the 12-month period after the effective date of a “change of control,” we are obligated to pay the executive (i) any accrued but unpaid salary, vacation or bonus payment, and (ii) reimbursement of health and dental care premiums for the executive and the executive’s dependents incurred to continue health and dental insurance coverage for three months after termination, to the extent the executive is eligible for and elects that continued coverage under COBRA. In addition to this compensation, Mr. Kalsu is entitled to a lump sum cash severance amount equal to four months of his then annual base salary, Messrs. Sims, Strop and Strelzick are each entitled to a lump sum cash severance amount equal to three months of his then annual base salary and Ms. White is entitled to a lump sum cash severance amount equal to six months of her then annual base salary. We are further obligated to pay Messrs. Sims and Strop and Ms. White an additional cash severance amount equal to three months of their respective then annual base salaries.

Pursuant to the employment agreements with Messrs. Kalsu, Sims, Strop and Strelzick, if the executive is terminated or constructively terminated within 12 months following the closing date of a transaction that results in a “change of control,” an amount equal to 50% of the executive’s original stock option grant to purchase shares of our common stock will fully vest as of the termination date in addition to any options already vested. Pursuant to the employment agreement with Ms. White, all of her original stock option grant will fully vest as of her termination date in the event of her termination or constructive termination within 12 months of a “change of control.” In each case, the executive will have 90 days from termination to exercise any vested stock options.

The arrangements with Mr. Rogers are substantially similar to the arrangements with our NEOs, except that (i) his additional cash payment severance amount is $150,000, (ii) “good reason” is defined differently, as explained below, (iii) if we terminate his employment other than for “cause” or he terminates his employment for “good reason,” then within 12 months of his termination, Mr. Rogers may exercise any options that were vested as of his termination, and (iv) if we terminate his employment without “cause” or he resigns for “good reason” during the 12-month period after the effective date of a “change of control,” then Mr. Rogers will not be entitled to full vesting of all then-outstanding equity awards as is the case with the NEOs, but he may, within 12 months of his termination, exercise any options that were vested as of his termination.

The definition of “change of control” for purposes of the employment agreements with Messrs. Kalsu, Sims, Strop, Strelzick and Rogers and Ms. White is the same as in the employment agreements of our NEOs.

A termination for “cause” occurs under our employment agreements with Messrs. Kalsu, Sims, Strelzick and Rogers and Ms. White if we terminate his employment for any of the following reasons:

(i) substantial and continual violations of the duties of the position or willful disregard of commercially reasonable and lawful directives from the member of our management team to whom the executive reports;

(ii) moral turpitude, dishonesty or gross misconduct in the performance of the duties of the position or that has materially and demonstrably injured our finances or future business;

 

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