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As filed with the Securities and Exchange Commission on October 26, 2009

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

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)

 

 

CALCULATION OF REGISTRATION FEE

 

Title of Each Class of Securities to be Registered		Amount to Be Registered (1)		Proposed Maximum Offering Price Per Unit (2)		Proposed Maximum Aggregate Offering Price		Amount of Registration Fee
Common Stock par value $0.001 per share		11,500,000		$19.805		$227,757,500		$12,709

 

(1)	Includes number of shares that the underwriters have the option to purchase to cover over-allotments, if any.

(2)	Estimated solely for the purpose of calculating the registration fee in accordance with Rule 457(c) of the Securities Act of 1933, as amended, and is based upon the average of the high and low sales prices of our common stock as reported on the New York Stock Exchange on October 21, 2009.

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.

 

 

 

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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 OCTOBER 26, 2009

Prospectus

10,000,000 Shares

Common Stock

 

 

SolarWinds, Inc. is selling 1,500,000 shares of common stock. The selling stockholders identified in this prospectus are selling an additional 8,500,000 shares of common stock. We will not receive any proceeds from the sale of shares of common stock by the selling stockholders.

Our common stock is listed on the New York Stock Exchange, or NYSE, under the symbol “SWI.” On October 23, 2009, the last reported sale price of our common stock on the NYSE was $19.84  per share.

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

 

		Per Share			Total
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 10,000,000 shares of common stock, the selling stockholders have granted the underwriters an option for a period of 30 days to purchase up to 1,500,000 additional shares of common stock, at the 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		Thomas Weisel Partners LLC

FBR Capital Markets				Pacific Crest Securities

             , 2009

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TABLE OF CONTENTS

 

		Page
Prospectus Summary		1
Risk Factors		11
Special Note Regarding Forward-Looking Statements and Industry Data		26
Use of Proceeds		27
Market Price of Common Stock		27
Dividend Policy		28
Capitalization		29
Selected Consolidated Financial Data		30
Management’s Discussion and Analysis of Financial Condition and Results of Operations		34
Business		65
Management		77
Compensation Discussion and Analysis		84
Executive Compensation		92
Certain Relationships and Related Party Transactions		108
Principal and Selling Stockholders		115
Description of Capital Stock		119
Shares Eligible for Future Sale		123
Material United States Federal Income Tax Consequences to Non-U.S. Holders		126
Underwriting		130
Legal Matters		136
Experts		136
Where You Can Find More Information		136
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.

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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 and Industry

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;

 

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

 

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

 

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changes in our pricing policies or those of our competitors;

 

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

 

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the mix of our direct and indirect sales;

 

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

 

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the timing of revenue and 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;

 

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the loss of our relationship with the distributor that helps us fulfill most sales orders from the U.S. government;

 

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

 

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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.

Our actual operating results may differ significantly from our guidance.

From time to time, we may release guidance in our quarterly earnings releases, quarterly earnings conference call, or otherwise, regarding our future performance that represents our management’s estimates as of the date of release. This guidance, which includes forward-looking statements, will be based on projections

 

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prepared by our management. Neither our independent registered public accounting firm nor any other independent expert or outside party compiles or examines the projections and, accordingly, no such person expresses any opinion or any other form of assurance with respect thereto.

Projections are based upon a number of assumptions and estimates that, while presented with numerical specificity, are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control, and are also based upon specific assumptions with respect to future business decisions, some of which will change. We intend to state possible outcomes as high and low ranges, which are intended to provide a sensitivity analysis as variables are changed but are not intended to represent that actual results could not fall outside of the suggested ranges. The principal reason that we release guidance is to provide a basis for our management to discuss our business outlook with analysts and investors. We do not accept any responsibility for any projections or reports published by analysts.

Guidance is necessarily speculative in nature, and it can be expected that some or all of the assumptions underlying the guidance furnished by us will not materialize or will vary significantly from actual results. Accordingly, our guidance is only an estimate of what management believes is realizable as of the date of release. Actual results will vary from our guidance, and the variations may be material. In light of the foregoing, investors are urged not to rely upon, or otherwise consider, our guidance in making an investment decision regarding our common stock.

Any failure to implement our operating strategy successfully or the occurrence of any of the events or circumstances set forth under “Risk Factors” in this prospectus could result in our actual operating results being different from our guidance, and those differences may be adverse and material.

Current uncertain economic conditions could adversely affect our operating results.

Current market conditions are uncertain and challenging. While current conditions seem to have improved, global economies have been in a recession as a result of a multitude of factors, including, but not limited to, turmoil in the credit and financial markets, declines in gross domestic product, increases in unemployment and volatility in commodity prices and worldwide stock markets. During these challenging and uncertain economic times, customers may reduce or delay technology purchases, including purchases of our software products. Our typically-short sales cycle may increase if purchasing decisions are delayed as a result of uncertain information technology budgets, contract negotiations become more protracted or customers institute additional internal approvals for software purchases. These economic conditions could result in reductions in sales of our products, longer sales cycles, difficulties in collecting accounts receivable or delayed payments, slower adoption of new technologies and increased price competition. Any of these events would likely harm our business, financial condition, operating results and cash flows.

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.

 

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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 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 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. We expect to continue making smaller acquisitions of these types and possibly larger acquisitions as well. The success of 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:

 

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

 

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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;

 

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

 

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

 

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insufficient revenue to offset our increased expenses associated with acquisitions;

 

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our responsibility for the liabilities of the businesses we acquire;

 

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

 

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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.

 

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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%, 45.1% and 44.2% and our net income was 25.1%, 22.0%, 23.9% and 27.5% for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2009, respectively. We incurred income tax expense of $5.6 million, $7.5 million, $10.7 million and $10.4 million for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2009, respectively. We also incurred interest expense of $10.7 million, $10.2 million, $8.5 million and $3.7 million for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2009, 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, $5.9 million and $5.6 million for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2009, 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 opened or acquired our operations outside the United States in order to expand our business. 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. As a result of these factors, our operating income and net income could decline as a percentage of revenue relative to our prior annual periods.

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 ordinarily 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 initial 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 or more.

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.

 

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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.

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 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, we may not be able to develop new products or enhance existing products in an alternate manner that may be equally or less efficient and cost-effective.

We depend significantly on our Orion family of products, which are our enterprise-class network management products. Our Orion family of products represented a substantial majority of our revenue in each of 2007, 2008 and the nine months ended September 30, 2009. 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 one distributor. Any reductions in sales to the U.S. federal government as a result of the loss of this distributor or any other reason could harm our growth.

A meaningful portion of our sales are to a number of different departments of the U.S. federal government. A substantial majority of these sales were made through one distributor. 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 this distributor, which is entitled under certain circumstances to terminate our contract with it, would cause at least a temporary inability to fulfill certain 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.

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.

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 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 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. The loss of either our Chief Executive Officer or our President could adversely affect our business. Our Chief Executive Officer underwent back surgery in 2008 that temporarily prevented him from performing his duties. He has experienced some recent complications from the surgery and will need further surgery and possibly other treatments that could prevent him from performing his duties, potentially for an extended period of time. We maintain key person insurance for our Chief Executive Officer and are in the process of obtaining key person insurance for our President. If we continue to grow as we anticipate, we may elect to supplement our management team. Any failure to integrate effectively additional members of our management team could adversely affect our operating results. Our future success also will depend on our ability

 

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to attract, retain and motivate highly skilled product architects and sales, technical support and product development personnel in the United States and internationally. Competition for these types of personnel is intense, particularly in the software industry. All of our employees work for us on an at-will basis except for some of our international employees. 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 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. In addition, during 2007, 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 our international headquarters in Cork, Ireland. In 2008, we opened and rapidly expanded a development center in the Czech Republic and an international sales and support center in Singapore. We also acquired development personnel 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 88,000 customers as of September 30, 2009. 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.

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.

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 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:

 

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fluctuations in currency exchange rates;

 

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unexpected changes in foreign regulatory requirements;

 

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difficulties in managing the staffing of international operations;

 

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

 

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dependence on resellers and distributors to increase customer acquisition;

 

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

 

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increased financial accounting and reporting burdens and complexities;

 

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political, social and economic instability abroad;

 

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terrorist attacks and security concerns in general; and

 

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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.

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:

 

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lost or delayed market acceptance and sales of our products;

 

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a reduction in maintenance renewals;

 

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diversion of development resources; and

 

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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 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

 

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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 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 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. We have asserted counterclaims against the former employee. We have agreed to indemnify Mr. Yonce 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. Even if we prevail in the litigation, we have incurred litigation fees and expenses and could incur significant additional litigation fees and expenses. Because this lawsuit is at an early 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.

 

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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.

Our costs and demands upon management may continue to increase as a result of complying with the laws and regulations affecting public companies, which could harm our operating results.

We have incurred significant legal, accounting, investor relations and other expenses as a public company 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 NYSE. The expenses incurred by public companies for reporting and corporate governance purposes have increased dramatically over the past several years. These rules and regulations have increased our legal and financial compliance costs substantially and have made some activities more time-consuming and costly. We are unable currently to estimate these future costs with any degree of certainty. As a public company, it is more expensive for us to obtain director and officer liability insurance.

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 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

 

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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 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 income, sales, use or other tax laws, statutes, rules, regulations or ordinances could be enacted at any time. On May 11, 2009, the United States Department of the Treasury released the General Explanations of the

 

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Administration’s Fiscal Year 2010 Revenue Proposals, or Greenbook, which contains a high-level outline of international tax proposals for fiscal year 2010. These proposals and other such 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 September 30, 2009, we had approximately $44.1 million of outstanding indebtedness under our December 2005 credit facilities, and our interest expense in 2007, 2008 and the nine months ended September 30, 2009 was approximately $10.2 million, $8.5 million and $3.7 million, respectively. We intend to use a portion of the net proceeds from this offering to repay approximately $13.8 million of our outstanding long-term indebtedness of $44.1 million as of September 30, 2009 as required by our credit facilities. Our credit facilities contain various covenants that will continue to be operative so long as 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;

 

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

 

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make investments, including acquisitions;

 

•

make capital expenditures;

 

•

enter into mergers or consolidations or sell assets;

 

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sell our subsidiaries;

 

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engage in sale and leaseback transactions; and

 

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enter into transactions with affiliates.

 

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Our credit facilities also contain numerous affirmative covenants. 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 are unable to generate sufficient cash flow or otherwise maintain or 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 the Offering and the Ownership of Our Common Stock

Our stock price may be volatile and may be less than the value of your investment.

The market price of our common stock has been and 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 continued concentration of our capital stock ownership with insiders upon 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 60.9% of our common stock after this offering. This concentration of share ownership may adversely affect the trading price for our 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.

 

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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 66,581,061 outstanding shares of common stock, assuming no exercise of outstanding options after September 30, 2009. The shares sold in our initial public offering, or IPO, and this offering will be immediately tradable without restriction, except for any shares purchased by our “affiliates” as defined in Rule 144 under the Securities Act of 1933, as amended, or the Securities Act. Of the remaining shares:

 

•

124,655 shares will be eligible for sale upon the expiration of lock-up agreements on November 15, 2009, subject in some cases to volume and other restrictions of Rule 144 under the Securities Act; and

 

•

42,431,486 shares will be eligible for sale upon the expiration of lock-up agreements 90 days after the date of this prospectus, subject in some cases to volume and other restrictions of Rule 144 under the Securities Act.

The lock-up periods may each 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 lock-up 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 a majority of the shares of our common stock 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.

In addition, we have registered 19,200,000 shares of common stock that have been issued or reserved for future issuance under our stock incentive plans. Of these shares, 7,246,219 shares were available upon the exercise of outstanding vested options as of September 30, 2009, excluding the option to purchase 219,501 shares to be exercised and sold at the closing of this offering by a selling stockholder. Approximately 1,485,119 shares and 5,761,100 shares will be eligible for sale upon the exercise of these vested options after November 15, 2009 and the expiration of the 90-day lock-up period for this offering, respectively.

In May 2009, all of our executive officers entered into stock selling plans in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and our insider trading policy. Under these plans, an aggregate of 1,806,453 shares may be sold from December 2009 through December 2010, including an aggregate of 318,487 shares that may be sold prior to the expiration of the 90-day lock-up period commencing on the date of this prospectus and further described under “Shares Eligible for Future Sale.”

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 a mandatory repayment of approximately $13.8 million of our outstanding long-term indebtedness of $44.1 million as of September 30, 2009, 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.

 

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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 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:

 

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a classified board of directors with three-year staggered terms;

 

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not providing for cumulative voting in the election of directors;

 

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

 

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prohibiting stockholder action by written consent; and

 

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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 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 continue to publish research or reports about our business or if they publish negative evaluations of our stock, the price of our stock could decline.

We believe that the trading price for our common stock will be affected by 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 intend to pay dividends on our common stock.

We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS AND INDUSTRY DATA

This prospectus contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. Forward-looking statements 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, IDC 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 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 (the “Gartner Report”) represents data, research opinion or viewpoints published, as part of a syndicated subscription service, by Gartner, Inc., that are not representations of fact. 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.

 

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USE OF PROCEEDS

We estimate that the net proceeds from our sale of 1,500,000 shares of common stock in this offering at an assumed offering price of $19.84 per share, the last reported sale price of our common stock on the NYSE on October 23, 2009, after deducting estimated underwriting discounts and commissions and estimated offering expenses, will be approximately $27.6 million. A $1.00 increase (decrease) in the assumed offering price would increase (decrease) the net proceeds to us from this offering by approximately $1.4 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.

The primary purposes of this offering are to provide liquidity for the selling stockholders and to raise additional capital. We intend to use a portion of our net proceeds from this offering to repay part of our outstanding long-term indebtedness of $44.1 million as of September 30, 2009 as required by our December 2005 credit facilities. The borrowings outstanding under our December 2005 credit facilities currently have a stated maturity of December 2011. The $19.1 million of borrowings outstanding at September 30, 2009 under the first lien term loan bear interest at a per annum rate of three-month LIBOR plus a margin of 3.50%, or 4.1% at September 30, 2009, and the $25.0 million of borrowings outstanding at September 30, 2009 under the second lien term loan 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 5.8% at September 30, 2009, in each case payable quarterly. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual Obligations, Commitments and Contingencies.” Pursuant to the terms of our credit facilities, we will be required to repay a portion of the outstanding principal amount under our first lien term loan based on our leverage ratio for the 12 months immediately preceding the receipt of the net proceeds from this offering. We expect this repayment to be $13.8 million based on our expected leverage ratio and the amount of the net proceeds from this offering at the assumed offering price. We currently do not intend to prepay with the proceeds from this offering any additional outstanding indebtedness under our December 2005 credit facilities. 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.

MARKET PRICE OF COMMON STOCK

Our common stock has been listed on the NYSE under the symbol “SWI” since May 20, 2009. Prior to that date, there was no public trading market for our common stock. Our IPO was priced at $12.50 per share on May 19, 2009. The following table sets forth for the periods indicated the high and low sales prices per share of our common stock as reported on the NYSE:

 

		Low			High
Year ending December 31, 2009
Second Quarter (beginning May 20, 2009)		$	12.70		$	16.82
Third Quarter		$	14.75		$	24.25
Fourth Quarter (through October 23, 2009)		$	18.79		$	23.62

On October 23, 2009, the last reported sale price of our common stock on the NYSE was $19.84 per share and, as of September 30, 2009, there were approximately 29 holders of record of our common stock.

 

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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 September 30, 2009 on:

 

•

an actual basis; and

 

•

a pro forma basis to give further effect to (i) our receipt of the net proceeds from our sale of shares of common stock in this offering, at an assumed offering price of $19.84 per share, the last reported sale price of our common stock on the NYSE on October 23, 2009, after deducting estimated underwriting discounts and commissions and estimated offering expenses, (ii) the application of approximately $13.8 million of the proceeds of this offering to repay a portion of our indebtedness and (iii) an adjustment to debt issuance costs.

The information below is illustrative only and our capitalization following the completion of this offering will be adjusted based on the actual 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.

 

		September 30, 2009
		Actual				Pro Forma
(in thousands)						(unaudited)
Cash and cash equivalents		$	125,805			$	139,616
Long-term obligations, including current portion (excluding deferred revenue)		$	44,463			$	30,653
Stockholders’ equity:
Preferred stock, $0.001 par value: 10,000,000 shares authorized, no shares issued or outstanding, actual or pro forma			—				—
Common stock, $0.001 par value: 123,000,000 shares authorized, 65,081,061 shares issued and outstanding, actual, 66,581,061 shares issued and outstanding, pro forma			65				67
Additional paid-in capital			106,230				133,849
Accumulated other comprehensive income			36				36
Accumulated deficit			(40,473	)			(40,539	)
Total stockholders’ equity			65,858				93,413
Total capitalization		$	110,321			$	124,066

The numbers of pro forma 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 September 30, 2009 and exclude:

 

•

12,072,658 shares of our common stock issuable upon exercise of options outstanding as of September 30, 2009 (including 219,501 shares of our common stock that we expect to be sold in this offering by a selling stockholder upon the exercise of a vested option with an exercise price of $2.69 per share at the closing of this offering), with a weighted average exercise price of $4.50 per share; and

 

•

5,046,287 shares of our common stock reserved for future issuance under our 2008 Stock Plan.

A $1.00 decrease or increase in the assumed offering price would result in an approximately $1.4 million decrease or increase in each of pro forma cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization.

 

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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. We have derived the following consolidated statement of income data for the nine months ended September 30, 2008 and 2009 and consolidated balance sheet data as of September 30, 2009 from our unaudited consolidated financial statements included elsewhere 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,																				Nine Months Ended September 30,
(in thousands, except per share data)		2004				2005				2006				2007				2008				2008				2009
																						(unaudited)
Revenue:
License		$	13,783			$	18,400			$	23,676			$	39,525			$	55,461			$	41,545			$	44,777
Maintenance and other			7,640				9,502				14,558				22,210				37,674				26,693				38,690
Total revenue			21,423				27,902				38,234				61,735				93,135				68,238				83,467
Cost of revenue (1)			186				257				490				2,253				3,588				2,606				3,585
Gross profit			21,237				27,645				37,744				59,482				89,547				65,632				79,882
Operating expenses:
Sales and marketing (1)			848				1,140				3,504				12,909				22,664				16,198				21,690
Research and development (1)			860				930				2,341				5,899				8,452				6,249				8,167
General and administrative (1)			566				973				6,477				9,763				16,464				12,486				13,127
Recapitalization expenses (2)			—				1,612				—				—				—				—				—
Total operating expenses			2,274				4,655				12,322				28,571				47,580				34,933				42,984
Operating income			18,963				22,990				25,422				30,911				41,967				30,699				36,898
Other income (expense):
Interest income			2				4				447				528				528				400				225
Interest expense			(4	)			(474	)			(10,682	)			(10,235	)			(8,539	)			(6,435	)			(3,659	)
Other expense			—				—				—				(73	)			(934	)			(43	)			(88	)
Total other expense			(2	)			(470	)			(10,235	)			(9,780	)			(8,945	)			(6,078	)			(3,522	)
Income before income taxes			18,961				22,520				15,187				21,131				33,022				24,621				33,376
Income tax expense (benefit)			—				(751	)			5,596				7,524				10,717				7,956				10,415
Net income			18,961				23,271				9,591				13,607				22,305				16,665				22,961
Amount allocated to participating preferred stockholders			—				(4,642	)			(4,791	)			(6,681	)			(10,922	)			(8,161	)			—
Net income available to common stockholders		$	18,961			$	18,629			$	4,800			$	6,926			$	11,383			$	8,504			$	22,961
Basic earnings per share available to common stockholders		$	6,320			$	13.95			$	0.18			$	0.25			$	0.40			$	0.30			$	0.50
Diluted earnings per share available to common stockholders		$	6,320			$	8.73			$	0.18			$	0.24			$	0.35			$	0.26			$	0.44
Shares used in computation of basic earnings per share available to common stockholders (3)			3				1,335				27,014				27,969				28,137				28,130				46,183
Shares used in computation of diluted earnings per share available to common stockholders (3)			3				2,667				54,055				56,030				32,652				32,410				51,801
Pro forma earnings per share (unaudited)
Basic																		$	0.40							$	0.38
Diluted																		$	0.37							$	0.35
Weighted average number of shares used in pro forma computation (unaudited)
Basic																			55,137								59,981
Diluted																			59,652								65,599
Other Data:
Adjusted EBITDA (4)		$	19,020			$	23,026			$	27,061			$	35,433			$	48,389			$	36,021			$	44,065

 

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Consolidated Balance Sheet Data:		December 31,																				September 30, 2009
(in thousands)		2004				2005				2006				2007				2008
																						(unaudited)
Cash and cash equivalents		$	137			$	828			$	9,342			$	19,303			$	40,566			$	125,805
Working capital (deficit)			(1,605	)			(631	)			1,676				6,130				16,393				83,745
Deferred revenue			4,416				7,531				8,353				17,092				27,162				36,750
Total assets			3,082				9,864				21,072				49,262				86,907				177,285
Long-term obligations and convertible preferred stock			—				110,027				102,909				101,987				95,379				46,149
Total stockholders’ equity (deficit)			(1,813	)			(108,822	)			(96,298	)			(78,534	)			(48,555	)			65,858

 

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

 

		Year Ended December 31,									Nine Months Ended September 30,
		2006			2007			2008			2008			2009
(in thousands)											(unaudited)
Cost of revenue		$	—		$	39		$	63		$	46		$	52
Sales and marketing			334			1,213			1,593			1,179			1,435
Research and development			190			467			755			563			818
General and administrative			991			2,091			3,509			2,515			3,323
		$	1,515		$	3,810		$	5,920		$	4,303		$	5,628

 

(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.

(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;

 

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•

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

 

•

we adopted the authoritative guidance for share-based payments 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, and $4.3 million and $5.6 million for the nine months ended September 30, 2008 and 2009, respectively. Prior to January 1, 2006, we accounted for stock-based compensation using the intrinsic value method under previously authorized guidance, 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 calculated as a 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 September 30, 2009 and must be at least 3.5 to 1.0 as of the last day of each fiscal quarter thereafter. The leverage ratio is calculated as a ratio of consolidated total debt to Adjusted EBITDA for the trailing four quarters. Our leverage ratio as of September 30, 2009 could not be more than 2.8 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 September 30, 2009. 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;

 

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•

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,									Nine Months Ended September 30,
Reconciliation of Adjusted EBITDA to Net Income		2006			2007			2008			2008			2009
(in thousands)											(unaudited)
Net income		$	9,591		$	13,607		$	22,305		$	16,665		$	22,961
Interest expense, net			10,235			9,707			8,011			6,035			3,434
Income tax expense			5,596			7,524			10,717			7,956			10,415
Depreciation			124			580			1,106			814			1,049
Amortization			—			205			330			248			578
Stock-based compensation expense			1,515			3,810			5,920			4,303			5,628
Adjusted EBITDA		$	27,061		$	35,433		$	48,389		$	36,021		$	44,065

 

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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, $44.1 million of which remained outstanding at September 30, 2009. 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.

Since 2007, we have 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, $93.1 million in 2008 and $83.5 million for the nine

 

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months ended September 30, 2009 and our operating income grew from $25.4 million in 2006 to $30.9 million in 2007, $42.0 million in 2008 and $36.9 million for the nine months ended September 30, 2009. Our average transaction size for new license sales in each of 2007, 2008 and the nine months ended September 30, 2009 was less than $7,000 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 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 made additional payments during 2008 of $0.8 million and $0.5 million upon achievement of the two development milestones related to the Neon acquisition. 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, opened a sales and support operation in Singapore in 2008 and established a research and development facility in the Czech Republic in 2008.

In May 2009, we completed our IPO, in which we issued and sold 9,000,000 shares of our common stock at a price of $12.50 per share. We raised a total of $112.5 million in gross proceeds from the offering, or approximately $100.5 million in net proceeds after deducting underwriting discounts and commissions of $7.9 million and other offering costs of $4.1 million.

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.

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

 

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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.

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 believe that the recent economic conditions have caused some customers, particularly small businesses, to be more cautious about their purchases of technology and other related items. However, we also believe that these conditions offer us an opportunity to market and sell our products to mid-size businesses and enterprise customers at compelling prices compared to the prices of many competing products. We expect to increase the percentage of our sales to larger customers and customers in the U.S. federal government, which tend to have larger transaction sizes. In the third quarter of 2009, we executed a larger number of sales transactions in amounts from $10,000 to $50,000 than in previous quarters.

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 international headquarters in Cork, Ireland in the third quarter of 2007, establishing a research and development facility in the Czech Republic in 2008, entering into a second outsourced development relationship in Eastern Europe 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, two of which were international. 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 typically include one year of maintenance as part of the initial purchase price of the

 

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product. License revenue reflects the revenue recognized from sales of new licenses and upgrades to our software. We have experienced 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. Because our maintenance base grew during 2007, 2008 and the first three quarters of 2009 due to new license sales and high customer retention, we expect maintenance revenue to continue to increase in the fourth quarter of 2009 and future periods.

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 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. Operating expenses as a percentage of revenue for 2008 and the nine months ended September 30, 2009 were approximately the same. We expect our operating expenses for the full year 2009 and in future periods to continue to increase in absolute dollars and to be consistent with operating expenses in 2008 and the nine months ended September 30, 2009 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 have continued to add resources to this facility. We also opened an international sales and support center in Singapore in June 2008 and have expanded operations since then at that center. We expect to continue to hire sales personnel in the United States and in both of our international offices in the fourth quarter of 2009 and in 2010.

 

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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. Since establishing our research and development center in the Czech Republic, we have significantly increased our research and development employee headcount and relied less on our Eastern European contract development vendors for research and development personnel.

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 have incurred additional costs in 2009 and expect to continue to incur higher costs 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 gains (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 and $101.1 million as of December 31, 2007 and 2008 and $44.1 million as of September 30, 2009. We expect interest expense to decrease in periods subsequent to the completion of this offering as we anticipate paying down a portion of our outstanding long-term debt balance with proceeds from this offering. Foreign exchange gains (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 by our United States and Irish entities. 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 continue 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.

 

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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 authoritative guidance for 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 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. In accordance with current guidance, we recognize revenue for software, maintenance and other services when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is probable.

 

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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.

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 stock options for common stock. On January 1, 2006, we adopted the authoritative guidance for share-based payments, which requires recognizing compensation costs for all

 

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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 the authoritative guidance for share-based payments 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, the authoritative guidance 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 previously issued guidance. 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 previously issued guidance, 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 basis over the respective vesting periods. Stock-based compensation decreased income before income taxes by $1.5 million, $3.8 million, $5.9 million and $5.6 million in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively.

For periods ended after January 1, 2006, pursuant to the authoritative guidance, 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 and the nine months ended September 30, 2009 were $83,000 and $2.2 million, respectively.

Pre-IPO Valuation of Common Stock

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

 

Grant Date		Options Granted		Exercise Price Per Share			SFAS 123(R) Fair Value
January 2007		362,250		$	4.06		$	982,270
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		261,850			8.68			1,337,588
April 2009		1,265,799			10.00			7,524,289

 

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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.

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 current guidance 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

 

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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 IPO 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 IPO, 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 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 IPO. Based on this study, we selected a discount of 10% due to our belief in the near-term prospects of an IPO. 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 current guidance, 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 an IPO. 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

 

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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 IPO. 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 IPO 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 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, we continued to use the $8.68 per share valuation based, in part, 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.

In April 2009, representatives of one of our managing underwriters provided us with an estimated valuation range for our IPO assuming an offering in the second quarter of 2009. Our board of directors also considered our operational metrics during the first quarter of 2009 relative to the challenging economic conditions. Our board of directors further noted increased optimism regarding the market for IPOs and determined that by consummating our IPO within the proposed valuation range, we would improve our cash and reduce our indebtedness and we would substantially eliminate any marketability discounts, resulting in an associated increase in the valuation of our company and our stock. After considering the estimated valuation range and these other factors, our board of directors concluded that the option exercise price for the April 2009 options grants should be $10.00 per share, within the estimated valuation range provided to us.

Post-IPO Valuation of Common Stock

In July 2009, after our IPO in May 2009, we granted options to purchase 40,243 shares of common stock at an exercise price of $19.99 per share and an aggregate fair value of $464,497. For purposes of determining the exercise price per share of the July 2009 grants, we used the closing sales price per share of our common stock as quoted on the NYSE on the date of the grant.

 

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Income Taxes

We use the liability method of accounting for income taxes as set forth in the authoritative guidance 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, guidance on accounting for uncertainty in income taxes clarified 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 this guidance 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 this guidance, 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 this guidance 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.

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.

 

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Consolidated Statement of Income Data		Year Ended December 31,												Nine Months Ended September 30,
(in thousands)		2006				2007				2008				2008				2009
														(unaudited)
Revenue:
License		$	23,676			$	39,525			$	55,461			$	41,545			$	44,777
Maintenance and other			14,558				22,210				37,674				26,693				38,690
Total revenue			38,234				61,735				93,135				68,238				83,467
Cost of revenue (1)			490				2,253				3,588				2,606				3,585
Gross profit			37,744				59,482				89,547				65,632				79,882
Operating expenses:
Sales and marketing (1)			3,504				12,909				22,664				16,198				21,690
Research and development (1)			2,341				5,899				8,452				6,249				8,167
General and administrative (1)			6,477				9,763				16,464				12,486				13,127
Total operating expenses			12,322				28,571				47,580				34,933				42,984
Operating income			25,422				30,911				41,967				30,699				36,898
Other income (expense):
Interest income			447				528				528				400				225
Interest expense			(10,682	)			(10,235	)			(8,539	)			(6,435	)			(3,659	)
Other expense			—				(73	)			(934	)			(43	)			(88	)
Total other expense			(10,235	)			(9,780	)			(8,945	)			(6,078	)			(3,522	)
Income before income taxes			15,187				21,131				33,022				24,621				33,376
Income tax expense			5,596				7,524				10,717				7,956				10,415
Net income		$	9,591			$	13,607			$	22,305			$	16,665			$	22,961
(1)    Includes stock-based compensation expense as follows:
Cost of revenue		$	—			$	39			$	63			$	46			$	52
Sales and marketing			334				1,213				1,593				1,179				1,435
Research and development			190				467				755				563				818
General and administrative			991				2,091				3,509				2,515				3,323
		$	1,515			$	3,810			$	5,920			$	4,303			$	5,628

Comparison of the Nine Months Ended September 30, 2008 and 2009

Revenue

 

		Nine Months Ended September 30,
		2008						2009
Revenue		Amount			Percentage of Revenue			Amount			Percentage of Revenue			Change
(dollars in thousands)
License		$	41,545		60.9	%		$	44,777		53.6	%		$	3,232
Maintenance and other			26,693		39.1				38,690		46.4				11,997
Total		$	68,238		100.0	%		$	83,467		100.0	%		$	15,229

Revenue was $83.5 million in the nine months ended September 30, 2009 compared to $68.2 million in the nine months ended September 30, 2008, an increase of $15.2 million, or 22.3%. This increase was comprised of a

 

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$12.0 million increase in maintenance and other revenue, which resulted from a growing maintenance base due to new license sales and high customer retention, and a $3.2 million increase in license revenue due to an increase in sales to both the U.S. federal government and commercial customers and an increase in our average transaction size. Our average transaction size for new license sales was approximately $5,900 and $6,800 for the nine months ended September 30, 2008 and 2009, respectively. While we had no single transaction over $0.5 million in the nine months ended September 30, 2008, we received six purchase orders from U.S. federal government customers that were each in excess of $0.5 million and resulted in the recognition of an aggregate of $3.9 million in license revenue for the nine months ended September 30, 2009.

Cost of Revenue and Gross Margin

 

		Nine Months Ended September 30,
Cost of Revenue and Gross Margin		2008				2009				Change
(dollars in thousands)
Total revenue		$	68,238			$	83,467			$	15,229
Total cost of revenue			2,606				3,585				979
Gross profit		$	65,632			$	79,882			$	14,250
Gross margin			96.2	%			95.7	%

Cost of revenue was $3.6 million in the nine months ended September 30, 2009 compared to $2.6 million in the nine months ended September 30, 2008, an increase of $1.0 million, or 37.6%. This increase was primarily due to a $0.9 million increase in cost of maintenance revenue related to increased headcount of our North American and European support organizations, and our addition of support personnel in the Asia-Pacific region, to support the new customers we added during 2008 and the nine months ended September 30, 2009. Cost of license revenue also increased by $0.3 million in the nine months ended September 30, 2009 compared to the same period in 2008 due to the amortization of acquired product technologies associated with the Trilenium acquisition in the fourth quarter of 2008. These increases were offset by a $0.2 million decrease in training, employment fees and travel expenses.

Operating Expenses

 

		Nine Months Ended September 30,
		2008						2009
Operating Expenses		Amount			Percentage of Revenue			Amount			Percentage of Revenue			Change
(dollars in thousands)
Sales and marketing		$	16,198		23.7	%		$	21,690		26.0	%		$	5,492
Research and development			6,249		9.2				8,167		9.8				1,918
General and administrative			12,486		18.3				13,127		15.7				641
Total		$	34,933		51.2	%		$	42,984		51.5	%		$	8,051

Sales and Marketing. Sales and marketing expenses were $21.7 million in the nine months ended September 30, 2009 compared to $16.2 million in the nine months ended September 30, 2008, an increase of $5.5 million, or 33.9%. Sales and marketing expenses increased in the nine month ended September 30, 2009 due to the expansion of our direct inside sales force in the United States, EMEA and the Asia Pacific region from September 2008 to September 2009, an increase in marketing operations in the United States and EMEA and an increase in business development costs. As a result of these efforts, our sales and marketing personnel costs increased by $4.9 million. Other costs such as credit card processing fees, contract services and software subscription costs increased by $0.6 million.

Research and Development. Research and development expenses were $8.2 million in the nine months ended September 30, 2009 compared to $6.2 million in the nine months ended September 30, 2008, an increase of $1.9 million, or 30.7%. In order to support our product development strategy, we increased the size of our

 

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research and development organization in 2009, including a significant increase to our personnel in our Czech Republic development center. Our personnel costs increased by $2.2 million offset by a decrease in fees we paid to our offshore contract research and development vendors of $0.4 million between the nine months ended September 30, 2009 and the nine months ended September 30, 2008.

General and Administrative. General and administrative expenses were $13.1 million in the nine months ended September 30, 2009 compared to $12.5 million in the nine months ended September 30, 2008, an increase of $0.6 million, or 5.1%. This increase was due primarily to a $1.5 million increase in personnel costs offset by a $0.8 million decrease in management fees.

Other Income (Expense)

 

		Nine Months Ended September 30,
Other Income (Expense)		2008				2009				Change
(dollars in thousands)
Interest income		$	400			$	225			$	(175	)
Interest expense			(6,435	)			(3,659	)			2,776
Other expense			(43	)			(88	)			(45	)
Total		$	(6,078	)		$	(3,522	)		$	2,556

Interest expense in the nine months ended September 30, 2009 decreased by $2.8 million from the nine months ended September 30, 2008 due to a lower amount of outstanding indebtedness because of our principal prepayments in 2009, a lower effective interest rate on our outstanding debt and a $0.3 million fee, paid to our lenders in March 2008 as consideration for an amendment to our credit agreements, that was treated as an additional interest expense. These decreases were offset by a $0.4 million write-off of debt issuance costs included in interest expense for 2009 and associated with the mandatory repayments of $7.2 million of principal in March 2009 and an additional $49.8 million of principal with the net proceeds of our IPO in May 2009, reducing our principal balance on our outstanding debt to $44.1 million as of September 30, 2009. Pursuant to the terms of our credit agreements, our interest rate is reset periodically. Our effective interest rate in the first three quarters of 2008 was 8.5%. Our effective interest rate in the nine months ended September 30, 2009, excluding the $0.4 million write-off of debt issuance costs, was 5.7%.

Income Tax Expense

Our income tax expense in the nine months ended September 30, 2009 increased by $2.5 million from the nine months ended September 30, 2008. This increase resulted from an increase in our income before income taxes of $8.8 million during the same periods. This increase was partially offset by a decrease in our expected effective tax rate from 32.3% in the nine months ended September 30, 2008 to 31.2% in the nine months ended September 30, 2009 as a result of an increase in the percentage of our revenue that is comprised of international revenue, which is taxed at a lower corporate tax rate.

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

 

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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.

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

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

 

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credit card processing fees, recruiting fees, and software licensing costs increased by $0.7 million. We expect sales and marketing expenses in 2009 to be consistent with those in 2008 as a percentage of revenue.

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. 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 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 IPO that were required to be expensed and legal fees, increased by $1.6 million. We expect general and administrative expenses in 2009 to be consistent with those in 2008 as a percentage of revenue.

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	)
Other expense			(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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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 hiring of European support personnel in connection with our establishment of our international headquarters 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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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
Other expense			—				(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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Quarterly Results of Operations

The following tables set forth unaudited quarterly consolidated statement of income data for 2007, 2008 and the first three quarters of 2009, 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				March 31, 2009				June 30, 2009				September 30, 2009
(in thousands, except per share data)		(unaudited)
Revenue		$	12,773			$	12,784			$	17,311			$	18,867			$	20,396			$	21,677			$	26,165			$	24,897			$	24,075			$	27,042			$	32,350
Cost of revenue			429				573				611				640				819				847				940				982				1,129				1,193				1,263
Gross profit			12,344				12,211				16,700				18,227				19,577				20,830				25,225				23,915				22,946				25,849				31,087
Operating expenses:
Sales and marketing			2,559				3,022				3,452				3,876				4,538				5,138				6,522				6,466				6,700				7,225				7,765
Research and development			1,229				1,529				1,522				1,619				1,920				1,990				2,339				2,203				2,426				2,755				2,986
General and administrative			1,889				2,268				2,566				3,040				4,172				3,787				4,527				3,978				3,865				4,112				5,150
Total operating expenses			5,677				6,819				7,540				8,535				10,630				10,915				13,388				12,647				12,991				14,092				15,901
Operating income			6,667				5,392				9,160				9,692				8,947				9,915				11,837				11,268				9,955				11,757				15,186
Other income (expense):
Interest income			140				109				106				173				150				110				140				128				79				53				93
Interest expense			(2,530	)			(2,560	)			(2,590	)			(2,555	)			(2,681	)			(1,858	)			(1,896	)			(2,104	)			(1,451	)			(1,540	)			(668	)
Other income (expense)			—				(26	)			9				(56	)			(133	)			6				84				(891	)			3				(9	)			(82	)
Total other expense			(2,390	)			(2,477	)			(2,475	)			(2,438	)			(2,664	)			(1,742	)			(1,672	)			(2,867	)			(1,369	)			(1,496	)			(657	)
Income before income taxes			4,277				2,915				6,685				7,254				6,283				8,173				10,165				8,401				8,586				10,261				14,529
Income tax expense			1,553				1,059				2,326				2,586				2,133				2,945				2,878				2,761				2,598				3,443				4,374
Net income			2,724				1,856				4,359				4,668				4,150				5,228				7,287				5,640				5,988				6,818				10,155
Amount allocated to participating preferred stockholders			(1,348	)			(910	)			(2,136	)			(2,287	)			(2,034	)			(2,560	)			(3,567	)			(2,761	)			(2,930	)			—				—
Net income available to common stockholders		$	1,376			$	946			$	2,223			$	2,381			$	2,116			$	2,668			$	3,720			$	2,879			$	3,058			$	6,818			$	10,155
Basic earnings per share available to common stockholders		$	0.05			$	0.03			$	0.08			$	0.08			$	0.08			$	0.09			$	0.13			$	0.10			$	0.11			$	0.15			$	0.16
Diluted earnings per share available to common stockholders		$	0.05			$	0.03			$	0.08			$	0.08			$	0.07			$	0.08			$	0.11			$	0.09			$	0.09			$	0.13			$	0.14
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				28,180				44,907				65,045
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				33,518				50,952				71,794
Other data:
Adjusted EBITDA		$	7,573			$	6,449			$	10,371			$	11,041			$	10,396			$	11,692			$	13,933			$	12,368			$	12,119			$	14,171			$	17,775

 

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		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			March 31, 2009			June 30, 2009			September 30, 2009
(in thousands, except per share data)		(unaudited)
Revenue		100.0	%		100.0	%		100.0	%		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			4.7			4.4			3.9
Gross margin		96.6			95.5			96.5			96.6			96.0			96.1			96.4			96.1			95.3			95.6			96.1
Operating expenses:
Sales and marketing		20.0			23.6			20.0			20.5			22.2			23.7			24.9			26.0			27.8			26.7			24.0
Research and development		9.6			12.0			8.8			8.6			9.4			9.2			8.9			8.8			10.1			10.2			9.2
General and administrative		14.8			17.7			14.8			16.1			20.5			17.5			17.3			16.0			16.1			15.2			15.9
Total operating expenses		44.4			53.3			43.6			45.2			52.1			50.4			51.2			50.8			54.0			52.1			49.2
Operating income		52.2			42.2			52.9			51.4			43.9			45.7			45.2			45.3			41.3			43.5			46.9
Other income (expense):
Interest income		1.1			0.9			0.6			0.9			0.7			0.5			0.5			0.5			0.3			0.2			0.3
Interest expense		(19.8	)		(20.0	)		(15.0	)		(13.5	)		(13.1	)		(8.6	)		(7.2	)		(8.5	)		(6.0	)		(5.7	)		(2.1	)
Other income (expense)		—			(0.2	)		0.1			(0.3	)		(0.7	)		0.1			0.3			(3.6	)		—			—			(0.3	)
Total other expense		(18.7	)		(19.4	)		(14.3	)		(12.9	)		(13.1	)		(8.0	)		(6.4	)		(11.5	)		(5.7	)		(5.5	)		(2.0	)
Income before income taxes		33.5			22.8			38.6			38.4			30.8			37.7			38.9			33.7			35.7			37.9			44.9
Income tax expense		12.2			8.3			13.4			13.7			10.5			13.6			11.0			11.1			10.8			12.7			13.5
Net income		21.3	%		14.5	%		25.2	%		24.7	%		20.3	%		24.1	%		27.9	%		22.7	%		24.9	%		25.2	%		31.4	%
Other data:
Adjusted EBITDA		59.3	%		50.4	%		59.9	%		58.5	%		51.0	%		53.9	%		53.3	%		49.7	%		50.3	%		52.4	%		54.9	%

Quarterly Revenue Trend

Our quarterly revenue increased 153.3% from the first quarter of 2007 to the third quarter of 2009 as a result of our increase in marketing and sales activity during 2007, 2008 and the nine months ended September 30, 2009. Our business model is based on a high volume of sales transactions at relatively low average transaction values. Our average license transaction in 2007, 2008 and the nine months ended September 30, 2009 was less than $7,000, 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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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.

Our quarterly revenue increased 58.6% from the first quarter of 2008 to the third quarter of 2009 as a result of our increase in marketing and sales activity during 2008 and the first three quarters of 2009. Our business model is based on a high volume of sales transactions at relatively low average transaction values. Our average license transaction in 2008 and the nine months ended September 30, 2009 was less than $7,000, but individual license transactions varied in size from under $1,000 to over $1.4 million.

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. 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.

In the first quarter of 2009, our revenue decreased by $0.8 million, or 3.3%, from the fourth quarter of 2008. Our average transaction size for new license sales was approximately $5,700 in the first quarter of 2009. The decrease in revenue was due to lower license revenue partially offset by an increase in maintenance and other revenue.

In the second quarter of 2009, our revenue increased by $3.0 million, or 12.3%, from the first quarter of 2009. Our average transaction size for new license sales was approximately $6,300 in the second quarter of 2009. The increase in revenue was due to growth in new license sales across all of our geographic regions and to the U.S. federal government.

In the third quarter of 2009, our revenue increased by $5.3 million, or 19.6%, from the second quarter of 2009. The increase in revenue was primarily due to continued growth in new license revenue associated with sales to the U.S. federal government and, to a lesser extent, increased sales to the commercial market and a continued increase in maintenance revenue due to an increasing maintenance customer base. We received four purchase orders from the U.S. federal government that were each in excess of $0.5 million and resulted in the recognition of an aggregate of $2.0 million in license revenue during the third quarter of 2009. Our average transaction size for new license sales was approximately $8,000 in this quarter. Prior to the third quarter of 2009, our maintenance contracts with multiple U.S. federal government customers had expired. In the third quarter of 2009, we received a maintenance renewal purchase order from a distributor on behalf of these customers that resulted in the recognition of $0.7 million in maintenance revenue during the third quarter of 2009 that would have been recognized in prior periods if these customers had renewed their maintenance contracts prior to their expiration.

 

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We expect to continue to make occasional larger sales transactions; however, we typically cannot predict or plan for these transactions in any particular quarter. In quarters in which we close individual transactions significantly greater than $0.5 million, it is likely that this will impact the quarterly linearity of our revenue and net income growth, as well as our average transaction size for new license sales.

Quarterly Cost of Revenue Trend

Cost of revenue increased sequentially each quarter of 2007, 2008 and the first three quarters of 2009 as we increased our technical support headcount in order to keep up with our sales growth. Our gross margin percentage fluctuated slightly over the periods presented. We expect our quarterly gross margin percentages in future quarters to approximate the gross margin during the three and nine months ended September 30, 2009 of 96.1% and 95.7%, respectively.

Quarterly Operating Expense Trend

Our operating expenses increased sequentially each quarter of 2007 and the first three quarters of 2008 due to growth in our sales and marketing, research and development and general and administrative headcount to support the growth in our business. 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 the IPO 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. Operating expenses increased in the first quarter of 2009 compared to the fourth quarter of 2008 due to higher personnel costs resulting from an increase in headcount in our sales and marketing teams as well as our development team in the Czech Republic. Other than the fourth quarter of 2008, we also had sequential quarterly increases in stock-based compensation during 2007, 2008 and the first three quarters of 2009 related to our increases in headcount across all operating categories. The sequential percent increases in operating expenses in the second and third quarters of 2009 are approximately the same as the percent increases in revenue over these periods. The increase in the three months and nine months ended September 30, 2009 included $0.7 million and $0.9 million, respectively, of outside legal expenses associated with our pending litigation with a former employee.

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. Our Adjusted EBITDA for the first, second and third quarters of 2009 was $12.1 million, $14.2 million and $17.8 million or 50.3%, 52.4% and 54.9% of total revenue, respectively.

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.

 

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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 the authoritative guidance for share-based payments on January 1, 2006 and recorded approximately $1.2 million, $1.4 million, $1.6 million, $1.7 million, $1.7 million $1.9 million and $2.1 million in stock-based compensation expense in the three months ended March 31, June 30, September 30 and December 31, 2008 and March 31, June 30 and September 30, 2009 respectively. Prior to January 1, 2006, we accounted for stock-based compensation using the intrinsic value method previously allowed, 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

 

•

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 calculated as a 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 September 30, 2009 and must be at least 3.5 to 1.0 as of the last day of each fiscal quarter thereafter. The leverage ratio is calculated as a ratio of consolidated total debt to Adjusted EBITDA for the trailing four quarters. Our leverage ratio as of September 30, 2009 could not be more than 2.8 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 September 30, 2009. 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;

 

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•

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 three-month periods indicated:

 

Reconciliation of Adjusted EBITDA to Net Income		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			March 31, 2009			June 30, 2009			September 30, 2009
(in thousands)		(unaudited)
Net income		$	2,724		$	1,856		$	4,359		$	4,668		$	4,150		$	5,228		$	7,287		$	5,640		$	5,988		$	6,818		$	10,155
Interest expense, net			2,390			2,451			2,484			2,382			2,531			1,748			1,756			1,976			1,372			1,487			575
Income tax expense			1,553			1,059			2,326			2,586			2,133			2,945			2,878			2,761			2,598			3,443			4,374
Depreciation			88			123			148			221			267			267			280			291			304			345			400
Amortization			4			45			78			79			81			82			85			83			189			193			196
Stock-based compensation expense			814			915			976			1,105			1,234			1,422			1,647			1,617			1,668			1,885			2,075
Adjusted EBITDA		$	7,573		$	6,449		$	10,371		$	11,041		$	10,396		$	11,692		$	13,933		$	12,368		$	12,119		$	14,171		$	17,775

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.

 

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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 19,611,615 shares of common stock and 19,611,615 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.

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 authoritative guidance for 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.

In May 2009, we completed our IPO, in which we issued and sold 9,000,000 shares of our common stock at a price of $12.50 per share. We raised a total of $112.5 million in gross proceeds from the offering, or approximately $100.5 million in net proceeds after deducting underwriting discounts and commissions of $7.9 million and other offering costs of $4.1 million.

Pursuant to the terms of our first lien credit agreement, we were required to repay a portion of the outstanding principal amount based on our leverage ratio for the 12 months immediately preceding the receipt of the net proceeds from our IPO. We did not elect to prepay any additional outstanding indebtedness under our December 2005 credit facilities with the net proceeds of our IPO. Therefore, we repaid $49.8 million of principal with the net proceeds from our IPO in May 2009, reducing the outstanding principal balance on our outstanding debt to $44.1 million as of September 30, 2009.

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, and $27.5 million and $36.0 million for the nine months ended September 30, 2008 and 2009, respectively. Net income was $9.6 million, $13.6 million and $22.3 million in 2006, 2007 and 2008, respectively, and $16.7 million and $23.0 million for the nine months ended September 30, 2008 and 2009, respectively. We incurred non-cash expenses totaling $3.1 million, $3.6 million and $7.4 million in 2006, 2007 and 2008, respectively, and $5.2 million and $5.9 million for the nine months ended September 30, 2008 and 2009, respectively. Non-cash expenses primarily consisted of stock-based compensation expense, excess tax benefit related to employee stock option exercises and the associated deferred tax asset reduction and depreciation and amortization expense.

The change in certain assets and liabilities resulted in a net source of cash of $4.5 million, $4.9 million and $5.5 million in 2006, 2007 and 2008, respectively, and $5.6 million and $7.2 million for the nine months ended September 30, 2008 and 2009, 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 payments of $8.1 million, $10.1 million and $8.6 million in 2006, 2007 and 2008, respectively, and $6.8 million and $4.4 million for the nine months ended September 30, 2008 and 2009, respectively. Net cash provided by operating activities was reduced by income tax payments of $5.4 million, $6.6 million and $12.9 million in 2006, 2007 and 2008, respectively, and $8.8 million and $5.9 million for the nine months ended September 30, 2008 and 2009, respectively.

 

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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, and $4.9 million and $2.2 million for the nine months ended September 30, 2008 and 2009, 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 increased our personnel. We relocated our corporate headquarters from Tulsa, Oklahoma to Austin, Texas in late 2006 and we opened our EMEA headquarters in Cork, Ireland in the third quarter of 2007. In 2008, we acquired certain assets and liabilities of Trilenium for an aggregate of $7.2 million in cash. We also 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. Cash used in investing activities for the nine months ended September 30, 2009 was primarily for purchase of software licenses and tools, computers and equipment, furniture and fixtures as we expanded our infrastructure and workforce.

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. Net cash used in financing activities was $1.4 million for the nine months ended September 30, 2008. Net cash provided by financing activities was $51.0 million for the nine months ended September 30, 2009. 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. 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. Net cash provided by financing activities in the nine months ended September 30, 2009 was due to the cash proceeds from our IPO of $104.6 million, after deducting underwriter discounts and commissions but before other offering costs, $2.7 million of proceeds from the exercise of employee stock options and the excess tax benefit related to employee stock option exercises of $2.2 million. These proceeds were offset by payments pursuant to our credit agreements, which required us to repay a portion of the outstanding principal amount in early 2009 equal to a specified percentage of our 2008 excess cash flow and in May 2009 equal to half of the net proceeds received by us in our IPO. These payments were $7.2 million and $49.8 million, respectively. In addition, we made payments in 2009 for offering costs of approximately $1.5 million.

Capital Resources

As of September 30, 2009, we had $125.8 million of cash and cash equivalents and $83.7 million of working capital. We raised approximately $100.5 million in net proceeds from our IPO in May 2009 after deducting underwriting discounts and commissions and other offering costs. The recapitalization in December 2005 resulted in our issuing $110.0 million of long-term debt. We repaid $7.5 million, $1.4 million, $7.2 million and $49.8 million of our outstanding long-term debt in December 2006, April 2008, March 2009 and May 2009, respectively, reducing our outstanding principal balance to $44.1 million as of September 30, 2009. The outstanding balance matures in December 2011. We intend to use a portion of our net proceeds from this offering to repay approximately $13.8 million of our outstanding long-term indebtedness of $44.1 million as of September 30, 2009 as required by our December 2005 credit facilities. Other than as required under our credit agreements, we do not currently intend to prepay any additional amounts of outstanding principal with the proceeds of this offering. We estimate our capital expenditures for 2009 to be approximately $3.5 million, comprised primarily of additional leasehold improvements, furniture and fixtures and computer equipment.

Pursuant to an agreement with our original stockholders, we expect to be required to pay an amount, up to a maximum of $20.0 million, after the expiration of the lock-up agreements entered into in connection with our IPO. This earnout payment is calculated in accordance with a formula provided in an agreement with certain of our original stockholders and will be either $0, $10.0 million or $20.0 million. If the closing price per share of

 

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our common stock on November 15, 2009, the expiration date of the lock-up agreements, is less than $8.05 per share, the earnout payment would be $0. If the closing price per share of our common stock on November 15, 2009 is equal to or greater than $8.06 per share but less than $10.75 per share, the earnout payment would be $10.0 million. If the closing price per share of our common stock on November 15, 2009 is equal to or greater than $10.75 per share, the earnout payment would be $20.0 million. Based on the price of our stock at October 23, 2009, we expect to make a $20.0 million payment in November 2009 pursuant to this agreement. This $20.0 million payment was treated as a dividend payable and was reflected in our consolidated statements of changes in convertible preferred stock and stockholders’ equity (deficit) as a reduction of additional paid in capital and a liability in our consolidated balance sheets.

We believe 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		$	—		$	—
Accrued interest payable (1)			2,011			2,011			—			—			—
Operating lease obligations (2)			13,452			2,466			4,570			3,222			3,194
Purchase obligations (3)			1,024			977			47			—			—
Capital lease obligations			35			25			10			—			—
Total contractual obligations (4)(5)		$	117,605		$	12,640		$	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% (4.1% at September 30, 2009) and the second lien note bears interest at the three-month LIBOR rate plus 5.25% to 6.25%, based on our leverage ratio under the second lien credit agreement (5.8% at September 30, 2009). Both notes are due and payable on December 13, 2011. The first lien credit agreement allows our lenders 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, $1.4 million,

 

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$7.2 million and $49.8 million in principal on the notes in December 2006, April 2008, March 2009 and May 2009, respectively. Thus, the total outstanding balance on the notes was $102.5 million at December 31, 2006 and 2007, $101.1 million at December 31, 2008 and $44.1 million at September 30, 2009. We repaid the $49.8 million of principal with a portion of the net proceeds from our IPO pursuant to the terms of the first lien agreement. Pursuant to the credit agreements, we will also be required to repay a portion of the outstanding principal amount based on our leverage ratio for the 12 months immediately preceding the receipt of the net proceeds from this offering. We currently expect to be required to repay an amount equal to approximately $13.8 million based on the net proceeds from this offering, which will be applied to repay indebtedness outstanding under our first lien credit agreement. 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 calculated as a 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 September 30, 2009 and must be at least 3.5 to 1.0 as of the last day of each fiscal quarter thereafter. The leverage ratio is calculated as a ratio of consolidated total debt to Adjusted EBITDA for the trailing four quarters. Our leverage ratio as of September 30, 2009 could not be more than 2.8 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 and financial covenants as of September 30, 2009. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quarterly 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 us and our subsidiaries and amended and permanently waived the default of certain covenants under the credit agreements. 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 was effective on July 1, 2009. The increase in our total operating lease obligations resulting from the lease amendment is shown in the table 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		$	1,607		$	1,940

 

(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 at December 31, 2008 related to uncertain tax positions from the amounts presented as the amounts that will be settled in cash are not known.

 

(5)

Based on the last reported sale price of our stock on the NYSE on October 23, 2009, we expect to make a $20.0 million payment in November 2009 pursuant an agreement with our original stockholders. The earnout payable is calculated in accordance with a formula provided in the agreement and will be either $0, $10.0 million or $20.0 million. We have accrued the earnout payable at the maximum $20.0 million payout in our consolidated financial statements for the nine months ended September 30, 2009.

Off-Balance Sheet Arrangements

During 2006, 2007 and 2008 and the nine months ended September 30, 2009, 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.

 

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Recently Adopted Accounting Principles

In June 2009, the Financial Accounting Standards Board, or FASB, issued The FASB Accounting Standards Codification, or the Codification, authorizing the Codification as the sole source for authoritative guidance in accordance with U.S. GAAP. The Codification is effective for financial statements issued for reporting periods that end after September 15, 2009. The position supersedes all accounting standards in U.S. GAAP, aside from those issued by the SEC.

In May 2009, the FASB issued a standard that sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This standard is effective for interim and annual periods ending after June 15, 2009. We adopted this standard in the quarter ended June 30, 2009 and it did not impact the consolidated financial results. Management has evaluated subsequent events up to October 26, 2009, the date of our issued financial statements.

In April 2009, the FASB and the Accounting Principles Board issued guidance about interim disclosures about value of financial instruments that requires an entity to provide disclosures about fair value of financial instruments in interim financial information. The new guidance is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. We adopted the new guidance in the quarter ended June 30, 2009. There was no impact on the condensed consolidated financial statements as it relates only to additional disclosures.

Recent Accounting Pronouncements

In September 2009, the FASB ratified two consensuses which will significantly affect the revenue recognition accounting policies for transactions that involve multiple deliverables and sales of software-enabled devices. The first consensus requires companies to allocate revenue in arrangements involving multiple deliverables based on the estimated selling price of each deliverable, even though those deliverables are not sold separately either by the company itself or other vendors. This consensus eliminates the requirement that all undelivered elements have objective and reliable evidence of fair value before a company can recognize the portion of the overall arrangement fee that is attributable to items that already have been delivered. In the absence of vendor-specific objective evidence and third-party evidence for one or more elements in a multiple-element arrangement, companies will estimate the selling prices of those elements. The overall arrangement fee will be allocated to each element, whether delivered or undelivered, based on their relative selling prices, regardless of whether those estimated selling prices are evidenced by vendor specific objective evidence, third-party evidence of fair value, or are based on the company’s judgment.

Under the second consensus, sales of tangible products that contain “essential” software will no longer be subject to the stringent revenue recognition requirements that used to apply to software licensing arrangements. The second consensus excludes tangible products from the scope of software revenue accounting requirements if they contain both software and non-software components that function together to deliver their essential functionality. For those tangible products, the new guidance from the first consensus will be applied and a greater proportion of the revenue from multiple-element arrangements involving tangible products that contain software will be recognized immediately in many circumstances.

Both consensuses will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. However, early adoption is permitted. If a company elects early adoption and the period of adoption is not the beginning of its fiscal year, the requirements must be applied retrospectively to the beginning of the fiscal year. Retrospective application to prior years is permitted, but not required. In the initial year of application, companies are required to make qualitative and quantitative disclosures about the impact of the changes. In many circumstances, the new guidance under these consensuses

 

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will require significant changes to a company’s revenue recognition policies and procedures, including system modifications. We are currently evaluating the potential impact of these consensuses on our financial position and results of operations, but do not expect it to have a material impact on our consolidated financial statements.

In August 2009, the FASB issued guidance on measuring liabilities at fair value, which provides clarification that in circumstances where a quoted market price in an active market for an identical liability is not available, a reporting entity must measure fair value of the liability using one of the following techniques: the quoted price of the identical liability when traded as an asset; quoted prices for similar liabilities or similar liabilities when traded as assets; or another valuation technique, such as a present value technique or the amount that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability that is consistent with the provisions of authoritative guidance. This statement becomes effective for the first reporting period, including interim periods, beginning after issuance. We will adopt this statement beginning in the fourth quarter of fiscal 2009.

Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity

We had cash and cash equivalents of $19.3 million at December 31, 2007, $40.6 million at December 31, 2008 and $125.8 million at September 30, 2009. 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, $101.1 million at December 31, 2008 and $44.1 million at September 30, 2009. 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 $0.4 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.

According to an April 2009 report published by IDC, in 2007 and 2008, we were one of the top ten network performance and operations management vendors based on market share (IDC, Worldwide Network Performance and Operations Management 2009-2013 Forecast and 2008 Vendor Shares, IDC #217780, April 2009). IDC estimates that worldwide revenue for network performance and operations management grew 10.7% from 2007 to 2008 while our revenue during the same period grew 50.9%, which was the highest revenue growth rate among the top ten vendors. We have increased the number of our customers from over 28,000 as of June 30, 2006 to over 88,000 as of September 30, 2009. Our customers include small and mid-size businesses, enterprises, including more than 425 of the Fortune 500 companies, and local, state and federal government entities that have 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 each of 2007, 2008 and the nine months ended September 30, 2009 was less than $7,000 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 and the nine months ended September 30, 2009, our revenue was $38.2 million, $61.7 million, $93.1 million and $83.5 million, respectively. In the same periods, we generated operating income of $25.4 million, $30.9 million, $42.0 million and $36.9 million and Adjusted EBITDA of $27.1 million, $35.4 million, $48.4 million and $44.1 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 lenders use 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,									Nine Months Ended September 30,
Reconciliation of Adjusted EBITDA to Net Income		2006			2007			2008			2008			2009
(in thousands)											(unaudited)
Net income		$	9,591		$	13,607		$	22,305		$	16,665		$	22,961
Interest expense, net			10,235			9,707			8,011			6,035			3,434
Income tax expense			5,596			7,524			10,717			7,956			10,415
Depreciation			124			580			1,106			814			1,049
Amortization			—			205			330			248			578
Stock-based compensation expense			1,515			3,810			5,920			4,303			5,628
Adjusted EBITDA		$	27,061		$	35,433		$	48,389		$	36,021		$	44,065

 

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

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:

 

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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.

 

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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.

 

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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.

 

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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.

 

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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:

 

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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.

 

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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.

 

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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 worldwide software revenue for managing networks and the availability and performance of networks and systems will grow from $4.33 billion in 2009 to $5.93 billion in 2013.⁽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 in February 2009, Compass Intelligence Research estimated that there were more than 35,000 enterprises and more than 1.6 million small and mid-size companies worldwide. In addition, they estimated that 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 $22,000 to $203,000.

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

 

(1)	Gartner, Inc. “Forecast: Enterprise Software Markets Worldwide, 2008-2013, 3Q09 Update” by Fabrizio Biscotti, Rene Millman et al., dated September 15, 2009. See “Special Note Regarding Forward-Looking Statements and Industry Data” for information regarding the industry data used in this prospectus.

 

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implementations of varying sizes and levels of complexity, ranging from a single device to over 100,000 installed devices.

Our software is:

 

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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.

 

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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.

 

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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.

 

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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.

 

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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, traffic analysis, application monitoring or IP address management, 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:

 

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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

 

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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.

 

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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, 2008 and the nine months ended September 30, 2009 was less than $7,000, 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.

 

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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.

 

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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.

 

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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.

 

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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:

 

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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.

 

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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.

 

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Cross-Sell and Up-Sell Existing Products into Our Growing Customer Base. We have more than 88,000 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.

 

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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 storage administrators, systems administrators, application managers, security administrators and web administrators.

 

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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, laptop 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.

Tools for Engineers

Our tools are desktop-based, laptop-based or server-based applications designed for individual network professionals who need specific solutions for routine, but complicated tasks. Our tools for engineers include individual

 

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tools and toolsets, which 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:

 

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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.

 

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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.

 

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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.

 

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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.

 

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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:

 

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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.

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,

 

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compliance and inventory. These products provide advanced network management functionality and are capable of scaling from a single device to over 100,000 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:

 

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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 substantial majority of our revenue.

 

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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, WAN performance monitoring and IP address management. Orion modules are purchased separately and are fully integrated with Orion NPM’s web console and database. Our current Orion modules are:

 

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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.

 

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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.

 

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Orion IP SLA Manager. IP SLA Manager monitors WAN performance from the perspective of multiple remote sites by tracking key edge-to-edge router performance statistics using Cisco IP SLA technology.

 

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Orion IP Address Manager. IP Address Manager tracks, manages and reports on the use of IP addresses through the Orion web interface.

 

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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.

 

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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 30,000 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 have expanded this facility rapidly. We acquired our New Zealand development facility in December 2008. 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, 56 product releases in 2008 and 63 product releases in the nine months ended September 30, 2009.

Our research and development expenses were $2.3 million, $5.9 million, $8.5 million, $6.2 million and $8.2 million in 2006, 2007, 2008 and the nine months ended September 30, 2008 and 2009, respectively.

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

 

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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 primarily 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 and customer references. 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.

Customers

As of September 30, 2009, we had over 88,000 customers in more than 170 countries, including small businesses, governments and more than 425 of the Fortune 500 companies. We define customers as individuals

 

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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. In the nine months ended September 30, 2009, this same distributor and one additional distributor with two customer identification numbers represented 13.9% and 15.3%, respectively, of our revenue from sales to various end-users. We do not believe, however, that our business is substantially dependent on either distributor or that the loss of either 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 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.

Employees

As of September 30, 2009, we had 303 employees, of which 204 were employed in the United States and 99 were employed outside of the United States. 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.

 

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Facilities

We currently lease approximately 85,665 square feet of space for our corporate headquarters in Austin, Texas under a lease agreement that expires on June 1, 2016. In March 2009, we entered into an amendment to the lease of our corporate headquarters in which we agreed to lease approximately 16,559 square feet of additional space effective January 1, 2010. We also lease space in Tulsa, Oklahoma. In addition, we lease space for our foreign subsidiaries in Cork, Ireland; Brno, Czech Republic; Napier, New Zealand and Singapore for their operations, including local sales, support and development personnel. We believe our current facilities and planned expansion 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 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 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. We have asserted counterclaims against the former employee. We have agreed to indemnify Mr. Yonce 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. Even if we prevail in the litigation, we have incurred litigation fees and expenses and could incur significant additional litigation fees and expenses. Because this lawsuit is at an early 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 September 30, 2009:

 

Name		Age		Position
Michael S. Bennett		57		Chief Executive Officer, Director and Chairman of the Board
Kevin B. Thompson		44		President, Chief Operating Officer, Chief Financial Officer and Treasurer
Douglas G. Hibberd		45		Senior Vice President, Engineering
J. Barton Kalsu		42		Chief Accountant and Vice President, Finance
David Owens		38		Vice President, Finance and Operations, EMEA
Rita J. Selvaggi		54		Senior Vice President, Marketing
Bryan A. Sims		41		Vice President, General Counsel and Secretary
Paul Strelzick		46		Senior Vice President, Worldwide Sales
Garry D. Strop		63		Vice President, Human Resources and Corporate Infrastructure
Kenny L. Van Zant		39		Senior Vice President and Chief Product Strategist
Steven M. Cakebread (1) (2)		57		Lead Independent Director
Jeffrey L. Horing (2)		45		Director
Bob L. Martin (1) (3)		60		Director
J. Benjamin Nye (2)		44		Director
Ellen F. Siminoff (1) (3)		42		Director
John D. Thornton (3)		44		Director
Donald C. Yonce		46		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

 

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business intelligence software company, from September 2004 until November 2005. From October 2000 until 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, Engineering 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 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.

Steven M. Cakebread has served on our board of directors since January 2008. Mr. Cakebread is currently a Senior Business Advisor to Xactly Corporation, a sales performance management software company. He previously served as Senior Vice President, Chief Accounting Officer and Chief Financial Officer of Xactly Corporation, 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 January 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. From March 2004 to March 2008, Ms. Siminoff served as President and Chief Executive Officer of Efficient Frontier, Inc., a pioneer of dynamic search engine marketing management services. 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.

 

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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, Metasolv, Mission Critical Software, Motive, TechRepublic, Tivoli and Vignette. 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. In accordance with our amended and restated certificate of incorporation, our board of directors is divided into three classes with staggered three-year terms. At each annual meeting of stockholders, the successors to directors whose terms then expire will be elected to serve from the time of election and qualification until the third annual meeting following election. Our directors are divided among the three classes as follows:

 

•

the Class I directors are Messrs. Horing, Nye and Yonce, and their terms expire at the first annual meeting of stockholders after our IPO;

 

•

the Class II directors are Messrs. Cakebread, Martin and Thornton, and their terms expire at the second annual meeting of stockholders after our IPO; and

 

•

the Class III directors are Mr. Bennett and Ms. Siminoff, and their terms expire at the third annual meeting of stockholders after our IPO.

Our amended and restated certificate of incorporation and our amended and restated bylaws 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 our IPO until the date of the first annual meeting of our stockholders following our IPO, 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

Our board of directors has an audit committee, a compensation committee and a nominating and governance committee, each of which has the composition and responsibilities described below.

 

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Audit Committee

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

 

•

evaluates our independent auditors’ qualifications, independence and performance;

 

•

determines the engagement of our independent auditors;

 

•

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

 

•

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

 

•

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

 

•

reviews and discusses 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 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 at www.solarwinds.com. 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.

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 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 at www.solarwinds.com. We believe that the compensation committee charter and the functioning of the compensation committee 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.

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 also:

 

•

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

 

•

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

 

•

reviews and administers our corporate governance principles.

 

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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 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 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 at www.solarwinds.com. We believe that the nominating and governance committee charter and the functioning of the nominating and governance committee 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.

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

Director Compensation

In 2008, our board of directors approved the following compensation policy 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.

 

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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			—			—				—

 

(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 July 30, 2009, we issued the 2009 annual equity grant pursuant to our director compensation policy of an option to purchase 6,861 shares of our common stock at an exercise price of $19.99 per share and 1,251 shares of restricted stock to each of Messrs. Cakebread and Martin and Ms. Siminoff.

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 is 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 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.

 

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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 the IPO.

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 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. Since our IPO, the compensation committee makes 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 is 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 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 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 our IPO 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 75^th 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 consists 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.

On June 1, 2009, Karen L. White, one of our NEOs, resigned and was no longer eligible to receive her base salary and certain other benefits. Ms. White agreed to provide consulting services to us until December 2009 and we agreed to provide certain payments and benefits pursuant to a consulting agreement further described below under “Executive Compensation—Employment and Consulting Agreements—Employment Agreement and Consulting Agreement with Karen L. White.”

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			2009 Base Salary			% 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		Former 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		SVP, Engineering			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 bonus 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.

We have adopted a 2009 Executive Bonus Plan based on a similar structure utilized in 2008. In 2009, we decided to use quarterly revenue targets instead of quarterly sales targets and conditioned the payout of the excess bonus on achievement of an annual revenue target.

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 set revenue and expense goals for 2009 based on our annual operating plan that we believe are challenging, but achievable for the executive group with excellent execution of our plan. We must meet these goals 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 initial annual target bonuses approved for our NEOs for 2009.

 

Officer		Target Bonus			Annual Target as % of 2009 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

Upon her resignation in June 2009, Ms. White is no longer eligible to receive a bonus payment after the payment related to the second quarter of 2009. In July 2009, our compensation committee approved an increase to the target bonuses of Messrs. Thompson, Van Zant and Hibberd to $300,000, $125,000 and $125,000, respectively. These increases are applicable to potential bonuses earned in the third and fourth quarter of 2009.

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 75^th 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 terminated in May 2009 for purposes of granting any future equity awards. We will grant equity awards in the future to our executive officers under our 2008 Stock Plan. The 2008 Stock 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. 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. 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

 

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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. Upon Ms. White’s resignation on June 1, 2009, the unvested portion of her option to purchase 375,000 shares was forfeited and the vested portion to purchase 125,000 shares became exercisable until June 1, 2010.

The compensation committee and our board of directors have approved the implementation of NEO equity grant guidelines 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 75^th percentile of the Peer Group. We did not approve 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.

We plan to make annual equity awards to our executive officers in the fourth quarter 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) Former Vice President, Corporate and Business Development		2008 2007			128,333 —				425,251 —			60,026 —			105,543 —	(7)			719,153 —
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, Engineering		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. Ms. White resigned on June 1, 2009 and has agreed to provide consulting services to us until December 2009.

(7)	Represents a $100,000 relocation payment earned and paid in 2008 and $5,543 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.

On April 23, 2009, our board of directors granted options to purchase 302,439, 318,517, 86,427 and 108,179 shares of common stock to Michael S. Bennett, Kevin B. Thompson, Kenny L. Van Zant and Douglas G. Hibberd, respectively, at an exercise price of $10.00 per share. These 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.

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	(2)		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.

(2)	On June 1, 2009, Ms. White resigned and forfeited the unvested portion of her option to purchase 375,000 shares. The vested portion to purchase 125,000 shares is exercisable until June 1, 2010.

*	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

 

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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.

Employment and Consulting 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 $300,000 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 and Consulting Agreement with Karen L. White

We entered into an employment agreement with Karen L. White, our former Vice President, Corporate and Business Development, on May 5, 2008. Under the employment agreement, Ms. White’s annual base salary was $220,000 with an annual target bonus of $100,000 that was paid quarterly. 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.

On April 14, 2009, Ms. White informed us that she was resigning effective as of June 1, 2009 and, upon tendering her resignation, ceased to be an executive officer. However, Ms. White has agreed to provide

 

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consulting services to us for a period six months following her resignation pursuant to a consulting agreement. Pursuant to the consulting agreement, we paid Ms. White $110,000 and all of her accrued vacation upon her resignation. The consulting agreement also contains a mutual release of claims between us and Ms. White. We also agreed to pay Ms. White up to $25,000 of any relocation costs and to maintain health and dental coverage for her and her dependents for a period of six months following her resignation. Under the consulting agreement, Ms. White was considered to be vested in options to purchase 125,000 shares of common stock, which are exercisable until June 1, 2010. The remaining shares subject to her stock option were forfeited on the date of her resignation.

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 year with a target bonus of $50,000 annually. Mr. Van Zant’s current base salary and target bonus are $250,000 and $125,000, 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, Engineering, 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 $125,000, 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. Mr. Kalsu’s current base salary and target bonus are $215,000 and $100,000, respectively. He received a one-time relocation payment of $100,000 upon his relocation to Austin, Texas in June 2009. 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.”

 

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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.”

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. Ms. Selvaggi’s current base salary and target bonus are $250,000 and $125,000, respectively. 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. Mr. Sims’ current base salary and target bonus are $200,000 and $100,000, respectively. 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. Mr. Strelzick’s current base salary and target bonus are $215,000 and $215,000, respectively. 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.”

 

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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. Mr. Strop’s current base salary and target bonus are $190,000 and $100,000, respectively. 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 an aggregate relocation payment of $100,000. 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 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,

 

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(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.

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

 

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(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.

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,

 

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(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 (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 Douglas Rogers, our former Vice President of Corporate Development, 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;

 

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(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 15 days of his receiving notice from us.

Pursuant to the employment agreement with Mr. Rogers, “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. Rogers’ prior written consent:

(i) assignment of duties to Mr. Rogers that materially and adversely alter the nature of his duties or responsibilities; or

(ii) requiring Mr. Rogers to relocate his primary work address outside of the greater Tulsa, Oklahoma area.

However, no act or event will constitute “good reason” if we fully cure the act or event within 30 days of receiving notice from Mr. Rogers.

Arrangements with Mr. Owens

The employment agreement with Mr. Owens states that, if his employment is terminated due to death, we must pay to his 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 he participates to the full extent of his rights under that plan, any accrued vacation pay and any appropriate business expenses incurred in connection with his duties. The employment agreement with Mr. Owens does not provide for separation or severance payments upon termination due to disability.

In addition, pursuant to the employment agreement with Mr. Owens, if he is terminated at any time within 12 months of his employment commencement date, we must pay him a lump sum cash severance amount equal to 6 months of his base salary.

If he is terminated within 12 months of a change of control, we must pay him an amount equal to any accrued but unpaid base salary and a lump sum cash severance amount equal to 3 months of his base salary as of the date of the termination. Additionally, the employment agreement with Mr. Owens provides that, if he is terminated or constructively dismissed within 12 months of a change of control, 50% of his original stock option grant will vest immediately as of the date of termination. He will have 90 days to exercise these vested options. The definition of “change of control” for purposes of the employment agreement with Mr. Owens is the same as in the employment agreements of our NEOs.

The stock option agreement with Mr. Owens provides that, if his employment is terminated due to death or disability, he is entitled to additional vesting with respect to his original stock option grant 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. If Mr. Owens is terminated or constructively terminated without “cause” during the 12-month period after the effective date of a change of control, the stock option agreement provides that an amount equal to 25% of his original stock option grant will fully vest as of the termination date. He will have 90 days from termination to exercise any vested stock options. The definition of “cause” for purposes of accelerated vesting under the stock option agreement with Mr. Owens is the same as in the employment agreements of Messrs. Kalsu, Sims and Strelzick.

 

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The following table provides the total dollar value of the compensation that would be paid to each of our NEOs in the event of his or her termination following a change in control, as well as other events resulting in termination of employment.

 

		Severance Other Than for Cause (1)					Change in Control (2)
Michael S. Bennett		Lump cash sum equal to 50% of current annual salary		$	187,500		Benefits equal to severance other than for cause (2)		$	245,089
		Bonus amounts earned in FY2008 but not paid as of December 31, 2008			51,563		Full vesting in all outstanding equity awards (4)			7,315,791
		12 months of health and dental premiums (3)			6,026		Cash severance			350,000
		Total		$	245,089				$	7,910,880
Kevin B. Thompson		Lump cash sum equal to 50% of current annual salary		$	137,500		Benefits equal to severance other than for cause (2)		$	185,112
		Bonus amounts earned in FY2008 but not paid as of December 31, 2008			37,500		Full vesting in all outstanding equity awards (4)			2,689,597
		12 months of health and dental premiums (3)			10,112		Cash severance			225,000
		Total		$	185,112		Total		$	3,099,709
Karen L. White		Lump cash sum equal to 6 months of current annual salary		$	110,000		Benefits equal to severance other than for cause (2)		$	133,806
		Bonus amounts earned in FY2008 but not paid as of December 31, 2008			18,750		Full vesting in all outstanding equity awards (4)			—
		6 months of health and dental premiums (3)			5,056		Cash severance			55,000
		Total		$	133,806		Total		$	188,806
Kenny L. Van Zant		Lump cash sum equal to 50% of current annual salary		$	112,500		Benefits equal to severance other than for cause (2)		$	141,362
		Bonus amounts earned in FY2008 but not paid as of December 31, 2008			18,750		Full vesting in all outstanding equity awards (4)			2,203,531
		12 months of health and dental premiums (3)			10,112		Cash severance			225,000
		Total		$	141,362		Total		$	2,569,893
Douglas G. Hibberd		Lump cash sum equal to 50% of current annual salary		$	107,500		Benefits equal to severance other than for cause (2)		$	136,362
		Bonus amounts earned in FY2008 but not paid as of December 31, 2008			18,750		Full vesting in all outstanding equity awards (4)			1,692,489
		12 months of health and dental premiums (3)			10,112		Cash severance			185,000
		Total		$	136,362		Total		$	2,013,851

 

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(1)

Severance other than for cause: In addition to a lump cash sum equal to 50% of current annual salary, the officer is entitled to any earned but unpaid bonus payment, reimbursement of health and dental insurance premiums incurred to effect continuation of health and dental coverage for 12 months, and any accrued but unused vacation pay payable within 21 days of termination. If termination is for cause, the officer is entitled to base salary earned but not paid through date of termination, any earned but unpaid bonus payments, and any accrued but unused vacation pay through the date of termination, but is not entitled to the lump sum cash payment equal to 50% of current annual salary.

(2)	Change in control: Upon a change in control, the officer has the same rights and benefits as in a severance other than for cause. In addition, the officer is entitled to full vesting in all outstanding equity awards and a one-time cash severance payment.

(3)	Health and Dental Premiums: Value is equal to the total amount we contributed to the officer’s health and dental insurance coverage during the 24 bi-monthly pay periods ended December 31, 2008.

(4)	Full vesting in all outstanding equity awards: Value represents the gain the executive would receive, calculated as the difference between the stock price on December 31, 2008 and the grant price of all unvested options. The stock price on December 31, 2008 was $8.68 per share.

Arrangements with Current and Former Executive Officers

In addition, in the employment agreements with all executive officers, we agreed to pay or reimburse the executive for reasonable business expenses incurred or paid during performance of his or her duties and responsibilities. In the employment agreements with Messrs. Bennett, Hibberd, Kalsu, Rogers and Thompson and Ms. Selvaggi, this included travel between Tulsa, Oklahoma and Austin, Texas. In addition, we agreed to pay temporary living expenses for Messrs. Bennett, Hibberd and Thompson and Ms. Selvaggi in Tulsa, Oklahoma, including the cost of a corporate apartment, a rental car and other reasonable expenses. In the employment agreements with Messrs. Kalsu and Sims, we agreed to pay or reimburse them for temporary living expenses in Austin, Texas. These amounts did not exceed $100,000 for any individual executive officer.

Our employment agreements with all executives include a non-competition provision effective during the executive’s employment and, in the case of Messrs. Kalsu and Strelzick, for six months thereafter. The agreements also provide that, during the executive’s employment and for 12 months thereafter in the case of the executive’s resignation or six months thereafter in the case of our termination of the executive, the executive may not solicit any of our employees or customers or seek to persuade any customer or prospect to conduct business elsewhere if that business could reasonably be expected to be conducted with us. Pursuant to the employment agreements with Messrs. Kalsu, Sims, Strop and Strelzick and Ms. White, the executive may not solicit any of our employees or customers as stated above, but the period lasts throughout employment and for 12 months thereafter in the case of the executive’s resignation or six months thereafter if we terminate the executive without cause.

The employment agreements with Messrs. Bennett, Hibberd, Rogers, Thompson and Van Zant and Ms. Selvaggi state that the executive will be provided indemnification to the maximum extent permitted by our certificate of incorporation and bylaws and by resolutions of our board of directors. The employment agreements with Ms. White and Mr. Strop state that we will enter into indemnification agreements with them.

In addition, the employment agreements with Messrs. Bennett, Hibberd, Thompson and Van Zant and Ms. Selvaggi provide that, during the executive’s employment and for six years thereafter, a directors’ and officers’ liability insurance policy will be kept in place providing the executive coverage, so long as we provide that coverage for any other current or former senior executive. The employment agreements with Mr. Strop and Ms. White provide that, during the executive’s employment and for a reasonable time thereafter, a directors’ and officers’ liability insurance policy will be kept in place providing the executive coverage.

 

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2008 Stock Plan

Our board of directors adopted and our stockholders approved our 2008 Equity Incentive Plan, or 2008 Stock Plan, in May 2008. Our 2008 Stock Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Code, to our employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance shares and performance units to our employees, directors and consultants and our parent and subsidiary corporations’ employees and consultants.

Share Reserve. As of September 30, 2009, options to purchase 40,043 shares of common stock were outstanding, 3,753 shares of restricted common stock subject to a repurchase right in favor of us were outstanding and 5,046,287 shares of common stock were reserved for future grants under the 2008 Stock Plan. The number of shares reserved for issuance under this plan will be increased up to a maximum of 11,265,818 shares to include:

 

•

any shares of our common stock issued under our 2005 Stock Plan that are forfeited or repurchased by us; and

 

•

any shares of our common stock issuable upon exercise of options or similar awards granted under our 2005 Stock Plan that expire or otherwise terminate without having been exercised in full at any time after the date of this prospectus.

In addition, our 2008 Stock Plan provides for annual increases in the number of shares available for issuance thereunder on the first day of each fiscal year, beginning with 2010, equal to the least of:

 

•

4.75% of the outstanding shares of our common stock on the last day of the preceding fiscal year;

 

•

6,000,000 shares; or

 

•

any lesser number of shares as may be determined by our board of directors.

Administration. The compensation committee is the plan administrator responsible for our 2008 Stock Plan. The plan administrator has the power to determine the terms of the awards, including the exercise price, the number of shares subject to the award, the exercisability schedule of the award and the form of consideration to pay the exercise price. The plan administrator also has the authority to institute an exchange program whereby the exercise prices of outstanding awards may be reduced, outstanding awards may be surrendered in exchange for awards with lower exercise prices, or outstanding awards may be transferred to a financial institution or other person or entity selected by the plan administrator.

Unless the plan administrator provides otherwise, our 2008 Stock Plan does not allow for the transfer of awards and only the recipient of an award may exercise an award during his or her lifetime.

Stock Options. The exercise price of an option must be at least equal to the fair market value of our common stock on the date of grant unless granted pursuant to a transaction described in, and in a manner consistent with, Section 424(a) of the Code. The term of an incentive stock option may not exceed ten years, except that, with respect to any participant who owns 10% or more of the voting power of all classes of our outstanding stock as of the grant date, the term must not exceed five years and the exercise price must equal at least 110% of the fair market value on the grant date unless granted pursuant to a transaction described in, and in a manner consistent with, Section 424(a) of the Code. The plan administrator determines the term of all other options.

After termination of an employee, director or consultant, he or she may exercise his or her option for the period of time stated in the option agreement. Generally, if termination is due to death or disability, the option will remain exercisable for 12 months. In all other cases, the option will generally remain exercisable for three months. However, an option may not be exercised later than the expiration of its term.

 

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Stock Appreciation Rights. We are authorized to grant stock appreciation rights under our 2008 Stock Plan. Stock appreciation rights allow the recipient to receive the appreciation in the fair market value of our common stock between the exercise date and the date of grant. The plan administrator determines the terms of stock appreciation rights, including when these rights become exercisable and whether to pay the increased appreciation in cash, with shares of our common stock, or with a combination thereof. The exercise price of a stock appreciation right must be at least equal to the fair market value of our common stock on the date of grant. Stock appreciation rights expire under the same rules that apply to stock options.

Restricted Stock Awards. We are authorized to grant restricted stock under our 2008 Stock Plan. Restricted stock awards are shares of our common stock that vest in accordance with terms and conditions established by the plan administrator. The plan administrator will determine the number of shares of restricted stock granted to any employee. Shares of restricted stock that do not vest are subject to our right of repurchase or forfeiture.

Restricted Stock Units. We are authorized to grant restricted stock units under our 2008 Stock Plan. Each restricted stock unit granted is a bookkeeping entry representing an amount equal to the fair market value of one share of our common stock. The plan administrator determines the terms and conditions of restricted stock units, including the vesting criteria and the form and timing of payment. The plan administrator may impose whatever conditions to vesting it determines to be appropriate. For example, the plan administrator may set restrictions based on the achievement of specific performance goals. Notwithstanding the foregoing, the plan administrator, in its sole discretion, may reduce or waive any vesting criteria that must be met to receive a payout.

Performance Shares and Performance Units. We are authorized to grant performance shares and performance units under our 2008 Stock Plan. Performance shares are awards that will result in a payment to a participant only if performance goals established by the plan administrator are achieved or the awards otherwise vest. The plan administrator will establish performance goals based on organizational or individual goals, or any other basis, in its discretion, which, depending on the extent to which they are met, will determine the number or the value of performance shares or performance units to be paid out to participants. Performance shares will have an initial value equal to the fair market value of our common stock on the grant date. Performance units will have an initial value that is established by the administrator on or before the date of grant. Payment for performance shares and performance units will be made in cash, shares of our common stock, or a combination of both, as determined by the plan administrator.

Formula Awards to Non-employee Directors. Each non-employee director first appointed to the board of directors, except for those directors who become non-employee directors by ceasing to be employee directors, will receive an automatic initial nonstatutory stock option to purchase 30,000 shares of common stock upon such appointment. In addition, non-employee directors who have been directors for at least the preceding six months will receive (i) a subsequent nonstatutory stock option to purchase a number of shares of common stock determined by dividing $75,000 by the value of an option to purchase one share of our common stock determined using the Black-Scholes valuation model or such other valuation method as the plan administrator determines in its discretion, and (ii) a number of shares of restricted stock determined by dividing $25,000 by the fair market value of a share of our common stock on the date of grant, immediately following each annual meeting of our stockholders.

All options granted under the automatic grant provisions will have a term of ten years and an exercise price equal to the fair market value of our common stock on the date of grant. Each initial option to purchase 30,000 shares will become exercisable as to one-third of the shares subject to the option on the first anniversary of its date of grant and 1/36 of the shares subject to the option monthly thereafter, provided the non-employee director remains a director on those dates. Each annual option will become exercisable as to 100% of the shares subject to the option on the earlier of (i) the date of the next year’s annual stockholder meeting or (ii) December 31 of the calendar year following the calendar year in which the grant occurs, provided the non-employee director remains a director on that date. The forfeiture provision of each annual restricted stock award will lapse on the earlier of (i) the date of the next year’s annual stockholder meeting or (ii) December 31 of the calendar year following the calendar year in which the award is granted, provided the non-employee director remains a director on that date.

 

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Change in Control Transactions. Our 2008 Stock Plan provides that, in the event of a merger or our “change in control,” our plan administrator will have authority to determine the treatment of outstanding options, including, without limitation, providing that outstanding options be assumed or an equivalent option or right substituted by the successor corporation or its affiliate. If the successor corporation does not assume or substitute outstanding awards, the options and stock appreciation rights will become fully vested and exercisable, all restrictions on restricted stock and restricted stock units will lapse, and, with respect to options with performance-based vesting, all performance goals or other vesting criteria will be deemed achieved at 100% of target levels and all other terms and conditions met. The plan administrator will not be required to treat all outstanding awards the same in the transaction.

In the event that awards granted to a non-employee director are assumed or substituted and the service of the non-employee director is terminated on or following a merger or change in control, other than pursuant to a voluntary resignation, his or her options and stock appreciation rights will become fully vested and immediately exercisable, all restrictions on restricted stock and restricted stock units will lapse, and, with respect to awards with performance-based vesting, all performance goals or other vesting requirements for performance shares and units will be deemed achieved at 100% of target levels, and all other terms and conditions will be deemed met.

Plan Amendments and Termination. Our board of directors has the authority to amend, suspend or terminate the 2008 Stock Plan provided that action does not impair the rights of any participant unless agreed to by the participant. The 2008 Stock Plan will terminate automatically in 2018, unless we terminate it sooner.

2005 Stock Plan

Our Amended and Restated Stock Incentive Plan, or 2005 Stock Plan, was adopted by our board of directors and approved by our stockholders on December 14, 2005. Our 2005 Stock Plan provided for the grant of incentive stock options, nonstatutory stock options and restricted stock to our employees, directors and consultants. Our 2005 Stock Plan was terminated in May 2009 for purposes of granting any future equity awards under the plan. As of September 30, 2009, options to purchase 12,032,615 shares of common stock were outstanding under this plan. Our 2005 Stock Plan will continue to govern the terms and conditions of these outstanding equity awards granted under the 2005 Stock Plan. Any shares of our common stock issued under our 2005 Stock Plan that are forfeited or repurchased by us and any shares of our common stock issuable upon exercise of options or similar awards granted under our 2005 Stock Plan that expire or otherwise terminate without having been exercised in full following the effective date of our 2008 Stock Plan will be added to the shares reserved under our 2008 Stock Plan.

The standard form of option agreement under the 2005 Stock Plan provides that options will 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. Under our 2005 Stock Plan, our board of directors, or its designated committee, had the authority to grant options with early exercise rights, subject to our repurchase right that lapses as the shares vest on the original vesting schedule, and to provide for accelerated vesting.

Our 2005 Stock Plan provides that our board of directors, or its designated committee, may equitably and proportionally adjust or substitute outstanding options upon certain events, including, without limitation, changes in our capitalization through stock splits, recapitalizations, mergers or consolidations. In lieu of an adjustment, our board of directors, or its designated committee, may terminate and cancel outstanding options in exchange for a cash payment or other consideration to the optionholder upon certain corporate events, including a change of control. The payment must equal the amount paid per share in connection with the event less the applicable exercise price per share for each cancelled option subject to exercise.

Our 2005 Stock Plan restricts the transfer of shares of our common stock issued pursuant to an award for 180 days following our IPO.

 

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401(k) Plan

We have established a tax-qualified employee savings and retirement plan for employees that satisfy certain eligibility requirements. In general, all of our U.S. employees are eligible to participate in our 401(k) plan. Under our 401(k) plan, employees may elect to defer their current compensation by up to 90% or the statutory limit, $16,500 in 2009, whichever is less, and have us contribute the amount of this reduction to the 401(k) plan. We intend for the 401(k) plan to qualify under Section 401 of the Code so that contributions by employees to the 401(k) plan, and income earned on plan contributions, are not taxable to employees until withdrawn from the 401(k) plan. We match up to a certain percentage of the contributions made by our employees to the 401(k) plan. All contributions are held in trust and are invested in accordance with the terms of the plan. Under the plan, each employee is fully vested in his or her deferred salary contributions and our matching contributions.

Limitation of Liability and Indemnification of Directors and Officers

Our amended and restated certificate of incorporation contains provisions that limit the liability of our directors for monetary damages to the fullest extent permitted by Delaware law. Consequently, no director will be personally liable to us or our stockholders for monetary damages for any breach of fiduciary duties as a director, except liability for:

 

•

any breach of the director’s duty of loyalty to us or our stockholders;

 

•

any act or omission not in good faith or that involves intentional misconduct or a knowing violation of law;

 

•

unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law; or

 

•

any transaction from which the director derived an improper personal benefit.

Our amended and restated certificate of incorporation and amended and restated bylaws provide that we are required to indemnify our directors and officers, in each case to the fullest extent permitted by Delaware law. Our amended and restated bylaws also provide that we are obligated to advance expenses incurred by a director or officer in advance of the final disposition of any action or proceeding, and permit us to secure insurance on behalf of any officer, director, employee or other agent for any liability arising out of his or her actions in that capacity regardless of whether we would otherwise be permitted to indemnify him or her under the provisions of Delaware law. We have entered into agreements to indemnify our current directors and executive officers and expect to continue to enter into agreements to indemnify any future directors and executive officers and such other employees as may be determined by our board of directors. With specified exceptions, these agreements provide for indemnification for related expenses including, among other things, attorneys’ fees, judgments, fines and settlement amounts incurred by any of these individuals in any action or proceeding. We believe that these bylaw provisions and indemnification agreements are necessary to attract and retain qualified persons as directors and officers. We also maintain directors’ and officers’ liability insurance.

The limitation of liability and indemnification provisions in our amended and restated certificate of incorporation and amended and restated bylaws may discourage stockholders from bringing a lawsuit against our directors and officers for breach of their fiduciary duties. They may also reduce the likelihood of derivative litigation against our directors and officers, even though an action, if successful, might benefit us and other stockholders. Further, a stockholder’s investment may be adversely affected to the extent that we pay the costs of settlement and damage awards against directors and officers as required by these indemnification provisions.

Rule 10b5-1 Sales Plans

In May 2009, all of our executive officers entered into stock selling plans in accordance with Rule 10b5-1 under the Exchange Act and our insider trading policy. Under these plans, an aggregate of 1,806,453 shares may be sold from December 2009 through December 2010, including an aggregate of 318,487 shares that may be sold prior to the expiration of the 90-day lock-up period commencing on the date of this prospectus.

 

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CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

The following is a description of transactions since January 1, 2006, in which we have been a participant, in which the amount involved exceeded or will exceed $120,000 and in which any of our directors, executive officers, beneficial holders of more than 5% of our capital stock, or entities affiliated with them, had or will have a direct or indirect material interest.

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. As a result of the recapitalization of our company that occurred in December 2005, we incurred $110.0 million of long-term debt, $44.1 million of which remained outstanding at September 30, 2009.

Registration Rights Agreement

In connection with the sale of stock by our original stockholders in December 2005, we entered into a registration rights agreement with the holders of our common stock and preferred stock that provides for certain rights relating to the registration of their shares of common stock, including those issued upon conversion of their preferred stock. The registration rights agreement was amended in December 2006 in connection with the sale of stock to Austin Ventures IX, L.P. and notice provisions and rights to sell certain amounts of shares of common stock were waived in October 2009 in connection with this offering. See “Description of Capital Stock—Registration Rights” below for additional information.

Stockholders Agreement

In connection with the sale of stock by our original stockholders in December 2005, we entered into a stockholders agreement with the holders of our common stock and preferred stock that provides for certain rights and obligations with respect to the voting of the securities subject to the agreement, certain rights of participation with respect to future issuances of our stock, certain “tag along” rights relating to the co-sale of these securities and certain obligations with respect to the sale of these securities in a transaction involving our change of control. Pursuant to this agreement, the parties agreed to vote any shares of our common stock and any of our other voting securities held by them in favor of the election to our board of directors of two directors designated by Bain Capital Ventures, one of which directors is currently J. Benjamin Nye and the other is currently vacant; two directors designated by Insight Venture Partners, which directors currently are Jeffrey L. Horing and Steven M. Cakebread; two directors designated by Donald C. Yonce, David A. Yonce and certain affiliated entities, which directors currently are Donald C. Yonce and John D. Thornton; our Chief Executive Officer, which director currently is Michael S. Bennett; and one director designated by a majority of the directors listed above in this sentence, which director currently is Bob L. Martin. All of the rights and obligations discussed above in this paragraph, including rights to designate directors, automatically terminated upon completion of our IPO, but members previously elected to our board of directors pursuant to the agreement have continued to serve as directors and will do so until their successors are duly elected by the holders of our common stock. We amended the stockholders agreement in March 2008 to eliminate certain transfer restrictions and other covenants upon the completion of our IPO. In addition, pursuant to this amendment we have agreed that, from the date of our IPO until the date of the first annual meeting of our stockholders after our IPO, we will nominate and use our best efforts to have one individual designated by any of Bain Capital Ventures, Insight Venture Partners and the Yonces and reasonably acceptable to us elected to our board of directors, 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,

 

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recapitalizations or other similar transactions. This agreement also requires us to purchase and maintain a directors’ and officers’ liability insurance policy. From January 1, 2007 through September 30, 2009, this policy cost us approximately $315,000.

Stock Purchase Agreement

In connection with the sale of stock by our original stockholders in December 2005, we entered into a stock purchase agreement, or the 2005 Stock Purchase Agreement, with our original stockholders and the purchasers of our common stock and preferred stock from our original stockholders in which we make certain representations, warranties and covenants (including indemnification of individuals serving as our officers and directors on or prior to the closing date of that transaction) to our original stockholders and the purchasers.

Redemption Agreement

In connection with the sale of stock by our original stockholders in December 2005, we entered into a Redemption Agreement dated as of December 14, 2005 with Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and Yonce Management, LLC, as amended by Amendment No. 1 to Redemption Agreement dated as of December 20, 2006, or, as so amended, the Redemption Agreement, which provides for the redemption by us of (i) 17,658,213 shares of our common stock and 17,658,213 shares of our preferred stock from Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC), or the SWM LLC Shares, and (ii) 1,953,402 shares of our common stock and 1,953,402 shares of our preferred stock from Yonce Management, LLC, or the Yonce LLC Shares. We redeemed the SWM LLC Shares for $94,509,443 in the aggregate and the Yonce LLC Shares for $10,490,550 in the aggregate. In addition, we agreed to make earn out payments to Donald C. Yonce, or the DCY Earn-Out Amount, and David A. Yonce, or the DAY Earn-Out Amount, upon the earlier to occur of a sale of our company or a qualified public offering. Our IPO constituted a qualified public offering for purposes of the Redemption Agreement, and thus Donald C. Yonce and David A. Yonce will be entitled to receive the DCY Earn-Out Amount and the DAY Earn-Out Amount, respectively, payable three business days following the expiration date of the lock-up agreements entered into in connection with our IPO by the holders of a majority of our outstanding common stock on an as-converted basis, or the Lock-Up Expiration Date. These earn out amounts are to be calculated in accordance with a formula provided in the Redemption Agreement, and will be either $0, $1,000,000 or $2,000,000, in the case of the DAY Earn-Out Amount, and either $0, $9,000,000 or $18,000,000, in the case of the DCY Earn-Out Amount. Factors used in determining the applicable earn out amounts include the number of our securities purchased by Bain Capital Venture Integral Investors, LLC and BCV Coinvest SW, L.P., or the Bain Entities, and Insight Venture Partners IV, L.P. and related funds, or the Insight Entities, pursuant to the 2005 Stock Purchase Agreement and sold by them and by certain transferees of securities of each of them, or the Charitably-Transferred Securities, in our IPO and the closing price of these securities on the Lock-Up Expiration Date; the number of our securities purchased by the Bain Entities and the Insight Entities pursuant to the 2005 Stock Purchase Agreement and held by them prior to the IPO, including all Charitably-Transferred Securities; and the purchase price per share paid by the Bain Entities and the Insight Entities for common stock and preferred stock pursuant to the 2005 Stock Purchase Agreement. Based on the last reported sale price per share of our common stock on October 23, 2009, it is anticipated that the maximum aggregate earnout amount of $20,000,000 will be paid to Donald C. Yonce and David A. Yonce pursuant to the Redemption Agreement. Donald C. Yonce is a current member of our board of directors and a former executive officer, and David A. Yonce is a former member of our board of directors and a former executive officer. In addition, Donald C. Yonce is the sole member of Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC), and David A. Yonce is the sole member of Yonce Management, LLC. As of September 30, 2009, Donald C. Yonce and David A. Yonce beneficially owned approximately 24.1% and 3.2%, respectively, of our outstanding common stock, or approximately 19.0% and 2.5%, respectively, following this offering if the underwriters exercise their option to purchase additional shares in full.

 

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Letter Agreements Regarding Management and Consulting Services

We entered into a letter agreement on December 13, 2005 pursuant to which we engaged Bain Capital Venture Partners, LLC, Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and Yonce Management, LLC to provide management and consulting services to us upon our request from time to time. In consideration for these services, we were obligated to pay these consultants fees annually in arrears, with the first payment due on December 31, 2006 and each payment thereafter due on the last day of each of our fiscal years. The fees were payable as follows: $333,333 to Bain Capital Venture Partners, LLC, $300,000 to Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and $33,333 to Yonce Management, LLC. In addition, in connection with the structuring of the senior financing for the transactions contemplated by the 2005 Stock Purchase Agreement described above, we paid fees in the aggregate amount of $666,667 to the same parties according to the same breakdown as the annual fee. This letter agreement terminated as to each consultant upon the closing of our IPO. Donald C. Yonce is the sole member of Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC), and David A. Yonce is the sole member of Yonce Management, LLC. As of September 30, 2009, Donald C. Yonce and David A. Yonce beneficially owned approximately 24.1% and 3.2%, respectively, of our outstanding common stock, or approximately 19.0% and 2.5%, respectively, following this offering if the underwriters exercise their option to purchase additional shares in full. As of September 30, 2009, Bain Capital Venture Integral Investors, LLC beneficially owned approximately 19.3% of our outstanding common stock, or approximately 15.3% following this offering if the underwriters exercise their option to purchase additional shares in full.

We also entered into a letter agreement on December 13, 2005 pursuant to which we engaged Insight Business Development to provide strategic and operational assistance to us on an as needed basis. The fees payable to Insight Business Development were $333,333 annually. This letter also terminated upon the closing of our IPO. As of September 30, 2009, affiliates of Insight Business Development beneficially owned approximately 23.9% of our outstanding common stock, or approximately 18.9% following this offering if the underwriters exercise their option to purchase additional shares in full.

2008 Stock Repurchase and Sale

In March 2008, we repurchased 725,556 shares of our common stock and 725,556 shares of our preferred stock from certain of our minority stockholders that were lenders or affiliated with lenders under our December 2005 credit facility, or the GoldenTree Entities, for $13.6 million, or $9.40 per share. The purchase price for the share repurchase was negotiated by one of our major stockholders, Insight Venture Partners, with the consent of our board of directors. After the purchase, we sold 725,556 shares of our common stock and 725,556 shares of our preferred stock to certain of our existing stockholders pro rata based on the relative percentages of shares of common stock and preferred stock held by those stockholders that elected to participate in the transaction at a price of $9.40 per share, which resulted in total proceeds to us of $13.6 million. Each of our existing stockholders was offered the opportunity to participate in this transaction. Each of the Bain Entities, the Insight Entities, the Martin Family Revocable Living Trust, Austin Ventures and Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC), elected to participate in the transaction and purchased its respective pro rata share of the common stock and preferred stock offered for sale. In addition to its own pro rata share, Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) also purchased the pro rata share offered to the Donald Yonce 2007 Trust, as its designee. For a discussion of our material relationships with the Bain Entities, the Insight Entities and Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC), over the past three years, see elsewhere in this section “Certain Relationships and Related Party Transactions.”

We participated in the transaction to assist the holders of a majority of our outstanding capital stock to acquire additional shares from the GoldenTree Entities while avoiding the adverse implications of the short swing trading rules, which effectively would have prevented most of our majority stockholders from being able to sell shares in our IPO if it occurred within six months of the transaction.

 

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Transactions with Our Original Stockholders and Entities Affiliated with Our Original Stockholders

Vendor Relationship

We have entered into an E-Commerce Automation System License Agreement dated as of December 14, 2005 with Yonce Properties, LLC, pursuant to which Yonce Properties, LLC has granted us a non-exclusive, perpetual, fully paid-up, royalty-free license to use, copy and modify the E-Commerce Automation System described therein solely for internal use in the operation of our business. No payments are due under this agreement, but our original stockholders were required to cause Yonce Properties, LLC to grant that license in connection with the 2005 Stock Purchase Agreement. Donald C. Yonce and David A. Yonce are the owners of Yonce Properties, LLC, holding 90% and 10% interests, respectively.

Lending and Lease Transactions

On March 13, 2007, we loaned David A. Yonce $1,737,569 to purchase shares of our common stock pursuant to a stock option agreement between us and Mr. Yonce. Pursuant to the promissory note, Mr. Yonce agreed that the loan amount would mature on the earliest of (i) January 25, 2012, (ii) the sale of all or substantially all of our assets, (iii) a merger or consolidation where, immediately prior to the merger or consolidation, we own less than a majority of interest in the surviving entity of the merger or consolidation, or (iv) our IPO; therefore, the loan would have matured upon our IPO. The promissory note provided that the unpaid principal amount of the loan bore interest at 4.88% per annum. In the event that Mr. Yonce did not repay the principal amount upon maturity, the note provided that the overdue amount would bear interest at an additional 5.0% per annum. This loan was repaid by Mr. Yonce and the note was cancelled in March 2008.

On March 12, 2007, we entered into a stock pledge agreement with David A. Yonce in which he assigned and pledged to us a security interest in the shares of our common stock purchased with the loan described above, including dividends, distributions or other proceeds with respect to these shares. Pursuant to the agreement, if we had foreclosed or exercised rights with respect to the pledged collateral and the proceeds had been insufficient to discharge Mr. Yonce’s debt to us, he would not have been liable for any deficiency. The corresponding loan was repaid by Mr. Yonce and the note was cancelled in March 2008.

We entered into a Lease Agreement with Yonce Properties, LLC, dated as of July 24, 2001, as amended by the Amendment to Lease dated as of December 14, 2005, pursuant to which we leased approximately 8,100 rentable square feet of office space in Tulsa, Oklahoma from Yonce Properties, LLC. We paid rent to Yonce Properties, LLC for this location totaling $150,000 for 2005, 2006 and 2007. Donald C. Yonce and David A. Yonce are the owners of Yonce Properties, LLC, holding 90% and 10% interests, respectively. This Lease Agreement was terminated as of March 31, 2006.

On April 1, 2006, we entered into a Term Lease Agreement with Yonce Ventures, LLC, pursuant to which we leased approximately 30,000 rentable square feet of office space in the Yorktown Place Office Building located in Tulsa, Oklahoma. We paid rent to Yonce Ventures, LLC under this lease totaling approximately $423,000 for 2006 and 2007. Donald C. Yonce and David A. Yonce are the owners of Yonce Ventures, LLC, holding 90% and 10% interests, respectively. This Term Lease Agreement was terminated on April 30, 2007.

Transactions with Our Directors and Executive Officers

On August 31, 2006, we entered into a license agreement with NetSuite Inc., or NetSuite. Under the terms of the agreement, we paid NetSuite approximately $148,000, $229,000, $471,000 and $582,000 in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively, for the use of NetSuite’s services. Kevin B. Thompson, our President, Chief Operating Officer, Chief Financial Officer and Treasurer, became a member of NetSuite’s board of directors in September 2006. The terms of these transactions were negotiated on an arm’s-length basis.

 

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We are a party to a master subscription agreement with salesforce.com, inc. Steven M. Cakebread, a member of our board of directors, was an executive officer of salesforce.com, inc during a portion of the term of this agreement. We paid $28,000, $98,000, $194,000 and $112,000 to salesforce.com, inc. in 2006, 2007, 2008 and the nine months ended September 30, 2009, respectively. The terms of these transactions were negotiated on an arm’s-length basis.

Employment and Consulting Agreements

We have entered into agreements containing compensation, termination and change of control provisions, among others, with each of our current executive officers and a consulting agreement with Karen L. White as described under the caption “Executive Compensation” above.

Employment Agreement with Douglas Rogers

We entered into an employment agreement with Douglas Rogers on December 14, 2005, upon commencement of his employment as our General Manager of Operations. On December 27, 2006, we entered into a new employment agreement with Mr. Rogers in which we employed him as our Vice President of Corporate Development and replaced the prior employment agreement in its entirety. Under this agreement, Mr. Rogers’ base salary was $150,000 per year with a target bonus of $50,000 annually. In addition, we acknowledged that Mr. Rogers held a fully vested option to purchase 1,350,000 shares of common stock at an exercise price of $2.69. Mr. Rogers is eligible to participate in all employee benefit plans and vacation programs. As a part of his employment agreement, Mr. Rogers is entitled to severance benefits upon termination of employment as described above under “Executive Compensation—Potential Payments upon Termination or Change of Control.”

Separation Agreements

Separation Agreement with John Timothy Spink

We entered into a separation agreement with John Timothy Spink, our former Vice President - Sales, on November 11, 2007. Pursuant to the separation agreement, we paid Mr. Spink $75,000.

Separation Agreement with David A. Yonce

We entered into a separation agreement and release of claims with David A. Yonce on January 25, 2007 in connection with the termination of his employment effective as of December 31, 2006. Pursuant to the separation agreement, we agreed to loan Mr. Yonce $1,737,569 at an interest rate of 4.88% per annum to enable him to purchase 647,091 shares of our common stock pursuant to a stock option agreement between us and him. This loan would have matured upon the occurrence of our IPO and was secured by the shares of our common stock purchased by Mr. Yonce with the proceeds of the loan. Mr. Yonce repaid the loan in March 2008.

Pursuant to the separation agreement, Mr. Yonce agreed that he had received all benefits and compensation due to him following his termination and was not entitled to any further compensation. The agreement provides that Mr. Yonce’s health insurance and any benefits and incidents of employment ceased on his effective date of termination. In addition, the separation agreement states that Mr. Yonce releases us from and agrees not to sue us concerning any claim, complaint, charge, duty, obligation or cause of action relating to any matters of any kind, whether known or unknown, that occurred prior to this separation agreement. The agreement also provides that this general release by Mr. Yonce does not limit (i) any of his rights under our organizational or governance documents or (ii) any continuing right he has to directors’ and officers’ insurance and indemnification. We released Mr. Yonce from any and all claims, liabilities, obligations or causes of action, whether known or unknown, of any kind and of every nature whatsoever that may have arisen out of or were related to Mr. Yonce’s employment with us; provided, however, that this release does not serve as a release in any way of any claims that we may have against Yonce Properties, LLC. Our release of Mr. Yonce also does not limit or release our

 

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rights (i) under the separation agreement, (ii) under any surviving provisions of our employment agreement with Mr. Yonce, (iii) under various documents related to the sale of shares by Mr. Yonce in December 2005, (iv) with respect to any claims we may have against Mr. Yonce related to our intellectual property or (v) under any of our organizational or governance documents.

The separation agreement provides that Mr. Yonce will continue to observe and maintain the confidentiality of all confidential and proprietary information. In addition, the separation agreement with Mr. Yonce states that he will adhere to his commitment of non-competition with us for 12 months from the effective date of the separation agreement.

Separation Agreement with Donald C. Yonce

We entered into a separation agreement and release of claims with Donald C. Yonce in June 2007 in connection with the termination of Mr. Yonce’s employment effective as of December 31, 2006. Pursuant to the separation agreement, we agreed to pay South Tulsa Baptist Church a lump sum severance payment of $300,000. However, we paid this amount to Mr. Yonce, who subsequently paid this amount to South Tulsa Baptist Church.

Pursuant to the separation agreement, Mr. Yonce agreed that he had received all benefits and compensation due to him following his termination and was not entitled to any further compensation. The agreement provides that Mr. Yonce’s health insurance and any benefits and incidents of employment ceased on his effective date of termination.

In addition, the separation agreement states that Mr. Yonce releases us from and agrees not to sue us concerning any claim, complaint, charge, duty, obligation or cause of action relating to any matters of any kind, whether known or unknown, related to his employment that occurred prior to this agreement. We released Mr. Yonce from and agreed not to sue concerning, or in any manner institute, prosecute or pursue, any claim, complaint, charge, duty, obligation or cause of action taken by Mr. Yonce in good faith as our employee.

The separation agreement also provides that this general release of us by Mr. Yonce and our general release of Mr. Yonce do not extend to obligations incurred under this agreement or various documents related to the sale of shares by Mr. Yonce in December 2005 that are specifically enumerated in the separation agreement.

The separation agreement provides that Mr. Yonce will continue to observe and maintain the confidentiality of all confidential and proprietary information. In addition, the separation agreement with Mr. Yonce states that he will adhere to his commitment of non-competition with us pursuant to the employment agreement.

The separation agreement also states that we will continue to pay Atlantis SolarWinds, LLC (formerly known as SolarWinds Management LLC) annual management fees in accordance with the management fee letter agreement dated December 13, 2005. However, we terminated this management fee letter immediately prior to the closing of our IPO.

Indemnification of Officers and Directors

Our amended and restated certificate of incorporation and bylaws provide that we indemnify each of our directors and officers to the fullest extent permitted by the Delaware General Corporation Law. Further, we have entered into indemnification agreements with each of our directors and officers. For further information, see “Executive Compensation—Limitation of Liability and Indemnification of Directors and Officers.”

In 2008 and 2009, we paid the legal expenses incurred by Donald C. Yonce pursuant to an agreement we made with Mr. Yonce relating to a pending legal proceeding further described in this prospectus under the caption “Business-Legal Proceedings.” We intend to reimburse Mr. Yonce for any future legal expenses incurred by Mr. Yonce in connection with this legal proceeding.

 

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Equity Awards

Certain grants of stock options to our directors and executive officers and related option grant policies are described in this prospectus under the captions “Management—Director Compensation,” “Compensation Discussion and Analysis—Components of Our 2009 Compensation Program,” “Executive Compensation— Grants of Plan-Based Awards in 2008,” “Executive Compensation—Outstanding Equity Awards at December 31, 2008” and “Executive Compensation—Employment Agreements.”

In addition to those option grants, on January 23, 2008, our board of directors granted options to purchase 24,000, 13,500 and 90,000 shares of common stock to J. Barton Kalsu, David Owens and Paul Strelzick, respectively, at an exercise price of $4.48 per share. These options vest and become exercisable at a rate of 25% on the first anniversary of the vesting commencement date, with the remainder vesting and becoming exercisable ratably over the next 36 months, subject to continued service through each applicable date.

On November 14, 2007, our board of directors granted an option to purchase 105,000 shares of common stock to Rita J. Selvaggi at an exercise price of $4.35 per share. This option also vests and becomes exercisable at a rate of 25% on the first anniversary of the vesting commencement date with the remainder vesting and becoming exercisable ratably over the next 36 months, subject to continued service through each applicable date.

On October 25, 2007, our board of directors granted an option to purchase 60,000 shares of common stock to Bryan A. Sims at an exercise price of $4.35 per share. This option also vests and becomes exercisable at a rate of 25% on the first anniversary of the vesting commencement date with the remainder vesting and becoming exercisable ratably over the next 36 months, subject to continued service through each applicable date.

On December 15, 2005, our board of directors granted Douglas Rogers an option to purchase 1,800,000 shares of common stock at an exercise price of $2.69 per share. This option was fully vested and exercisable on the date of grant. Mr. Rogers exercised the option with respect to 450,000 shares of common stock and sold them to Austin Ventures IX, L.P. in December 2006.

On April 23, 2009, our board of directors granted options to purchase 44,660, 77,728, 49,987 and 18,762 shares of common stock to Paul Strelzick, Rita J. Selvaggi, J. Barton Kalsu and Bryan A. Sims, respectively, at an exercise price of $10.00 per share. These options also vest and become exercisable at a rate of 25% on the first anniversary of the vesting commencement date with the remainder vesting and becoming exercisable ratably over the next 36 months, subject to continued service through each applicable date.

Policies and Procedures for Related Party Transactions

Our audit committee charter provides that our board of directors must review and approve in advance any related party transaction. All of our directors, officers and employees will be required to report to the audit committee any related party transaction prior to entering into the transaction.

All of the transactions set forth above were approved in advance by our board of directors. We believe that we have executed all of the transactions set forth above on terms no less favorable to us than we could have obtained from unaffiliated third parties. It is our intention to ensure that all future transactions between us and our officers, directors and principal stockholders and their affiliates are approved by the audit committee of our board of directors, and are on terms no less favorable to us than those that we could obtain from unaffiliated third parties.

 

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PRINCIPAL AND SELLING STOCKHOLDERS

The following table sets forth information regarding beneficial ownership of our common stock as of September 30, 2009, and as adjusted to reflect the shares of common stock to be issued and sold in this offering, by:

 

•

each person or group of affiliated persons known by us to be the beneficial owner of more than 5% of our common stock;

 

•

each of our named executive officers;

 

•

each of our directors;

 

•

all executive officers and directors as a group; and

 

•

each of our selling stockholders.

Beneficial ownership in this table is determined in accordance with the rules of the SEC and does not necessarily indicate beneficial ownership for any other purpose. Under these rules, the number of shares of common stock deemed outstanding includes shares issuable upon exercise of options held by the respective person or group that may be exercised within 60 days after September 30, 2009. For purposes of calculating each person’s or group’s percentage ownership, stock options exercisable within 60 days after September 30, 2009 are included for that person or group but not the stock options of any other person or group.

Percentage of beneficial ownership is based on 65,081,061 shares of common stock outstanding as of September 30, 2009 and 66,581,061 shares of common stock outstanding after completion of this offering.

Unless otherwise indicated and subject to applicable community property laws, to our knowledge, each stockholder named in the following table possesses sole voting and investment power over the shares listed, except for those jointly owned with that person’s spouse. Unless otherwise noted below, the address of each person listed on the table is c/o SolarWinds, Inc., 3711 South MoPac Expressway, Building Two, Austin, Texas 78746. Beneficial ownership representing less than 1% is denoted with an asterisk (*).

 

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Name and Address of Beneficial Owner		Shares Beneficially Owned Prior to the Offering					Number of Shares Offered		Shares Beneficially Owned After the Offering					Number of Shares to be Sold if Underwriters’ Option is Exercised in Full		Shares Beneficially Owned After the Offering if Underwriters’ Option is Exercised in Full
		Shares		Percentage					Shares		Percentage					Shares		Percentage
5% Stockholders:
Bain Capital Venture Integral Investors, LLC (1)		12,565,314		19.3	%		2,043,034		10,522,280		15.8	%		360,535		10,161,745		15.3	%
Entities affiliated with Insight Ventures (2)		15,567,630		23.9			2,531,189		13,036,441		19.6			446,680		12,589,761		18.9
Entities affiliated with Donald C. Yonce (3)		15,667,598		24.1			2,547,444		13,120,154		19.7			449,549		12,670,605		19.0
Named Executive Officers and Directors:
Michael S. Bennett (4)		2,929,341		4.3			—		2,929,341		4.3			—		2,929,341		4.2
Kevin B. Thompson (5)		733,245		1.1			—		733,245		1.1			—		733,245		1.1
Douglas G. Hibberd (6)		445,468		*			—		445,468		*			—		445,468		*
Kenny L. Van Zant (7)		544,013		*			—		544,013		*			—		544,013		*
Karen L. White (7)		125,000		*			—		125,000		*			—		125,000		*
Steven M. Cakebread (8)		22,361		*			—		22,361		*			—		22,361		*
Jeffrey L. Horing (2)		15,567,630		23.9			2,531,189		13,036,441		19.6			446,680		12,589,761		18.9
Bob L. Martin (9)		353,175		*			54,240		298,935		*			9,573		289,362		*
J. Benjamin Nye (10)		12,565,314		19.3			2,043,034		10,522,280		15.8			360,535		10,161,745		15.3
Ellen F. Siminoff (11)		15,417		*			0		15,417		*			—		15,417		*
John D. Thornton (12)		1,698,678		2.6			276,193		1,422,485		2.1			48,740		1,373,745		2.1
Donald C. Yonce (3)		15,667,598		24.1			2,547,444		13,120,154		19.7			449,549		12,670,605		19.0
All executive officers and directors as a group (17 people) (13)		51,458,086		72.8			7,452,100		44,005,986		60.9			1,315,077		42,690,909		59.1
Other Selling Stockholders:
Austin Ventures IX, L.P. (14)		1,698,678		2.6			276,193		1,422,485		2.1			48,740		1,373,745		2.1
BCV Coinvest SW, L.P. (15)		3,002,313		4.6			488,155		2,514,158		3.8			86,145		2,428,013		3.6
CBMR Enterprises, LLC (16)		1,350,000		2.0			219,501		1,130,499		1.7			38,735		1,091,764		1.6
David A. Yonce and affiliated entity (17)		2,092,609		3.2			340,244		1,752,365		2.6			60,043		1,692,322		2.5

 

(1)

J. Benjamin Nye is a Managing Director of Bain Capital Venture Investors, LLC, which is the administrative member of Bain Capital Venture Integral Investors, LLC, and may be deemed to share voting and dispositive power over the shares held by Bain Capital Venture Integral Investors, LLC. Michael A. Krupka is the sole managing member of Bain Capital Venture Investors, LLC and may also be deemed to share voting and dispositive power over shares held by Bain Capital Venture Integral Investors, LLC. Mr. Nye and Mr. Krupka disclaim beneficial ownership of shares held by Bain Capital Venture Integral Investors, LLC, except to the extent of their respective pecuniary interests therein. The address for each of Bain Capital Venture Integral Investors, LLC, Mr. Krupka and Mr. Nye is 111 Huntington Avenue, Boston, MA 02199. For a discussion of our material relationships with Bain Capital Venture Integral Investors, LLC, within the past three years, see “Certain Relationships and Related Party Transactions.” Does not include 3,002,313 shares owned by BCV Coinvest SW, L.P.

(2)

Represents 5,757,515 shares held by Insight Venture Partners V, L.P., 199,810 shares held by Insight Venture Partners (Cayman) IV, L.P., 1,743,291 shares held by Insight Venture Partners (Cayman) V, L.P., 5,837,829 shares held by Insight Venture Partners V Coinvestment Fund, L.P., 184,185 shares held by Insight Venture Partners IV (Co-Investors), L.P., 338,565 shares held by Insight Venture Partners V (Employee Co-Investors), L.P., 11,880 shares held by Insight Venture Partners IV (Fund B), L.P. and 1,494,555 shares held by Insight Venture Partners IV, L.P. In this offering, each of the Insight entities will sell the following number of shares of common stock: Insight Venture Partners V, L.P. (936,132); Insight Venture Partners (Cayman) IV, L.P. (32,488); Insight Venture Partners (Cayman) V, L.P. (283,447); Insight Venture Partners V Coinvestment Fund, L.P. (949,191); Insight Venture Partners IV (Co-Investors), L.P. (29,947); Insight Venture Partners V (Employee Co-Investors), L.P. (55,048); Insight Venture Partners IV (Fund B), L.P. (1,932); and Insight Venture Partners IV, L.P. (243,004). Assuming the underwriters exercise their overallotment option in full, each of the Insight entities

 

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will additionally sell up to the following number of shares of common stock: Insight Venture Partners V, L.P. (165,200); Insight Venture Partners (Cayman) IV, L.P. (5,733); Insight Venture Partners (Cayman) V, L.P. (50,020); Insight Venture Partners V Coinvestment Fund, L.P. (167,504); Insight Venture Partners IV (Co-Investors), L.P. (5,285); Insight Venture Partners V (Employee Co-Investors), L.P. (9,714); Insight Venture Partners IV (Fund B), L.P. (341); and Insight Venture Partners IV, L.P. (42,883). Insight Holdings Group, L.L.C. (“Insight Holdings”) is the managing member of Insight Venture Associates IV, L.L.C. (“Insight Associates IV”), which in turn is the general partner of (i) Insight Venture Partners IV, L.P., (ii) Insight Venture Partners IV (Fund B), L.P., (iii) Insight Venture Partners IV (Co-Investors), L.P. and (iv) Insight Venture Partners (Cayman) IV, L.P. (together with Insight Venture Partners IV, L.P., Insight Venture Partners IV (Co-Investors), L.P. and Insight Venture Partners IV (Fund B), L.P., the “Insight IV Funds”). Jeffrey L. Horing, Deven Parekh and Peter Sobiloff are the members of the board of managers of Insight Holdings. Because Messrs. Horing, Parekh and Sobiloff are the members of the board of managers of Insight Holdings, Insight Holdings is the managing member of Insight Associates IV and Insight Associates IV is the general partner of each of the Insight IV Funds, they have voting and dispositive power over these shares. The foregoing is not an admission by Insight Associates IV or Insight Holdings that it is the beneficial owner of the shares held by the Insight IV Funds. Each of Messrs. Horing, Parekh or Sobiloff disclaims beneficial ownership of the shares except to the extent of his pecuniary interests in these entities. Insight Holdings is the managing member of Insight Venture Associates V, L.L.C. (“Insight Associates V”), which in turn is the general partner of (i) Insight Venture Partners V, L.P., (ii) Insight Venture Partners V Coinvestment Fund, L.P., (iii) Insight Venture Partners V (Employee Co-Investors), L.P. and (iv) Insight Venture Partners (Cayman) V, L.P. (together with Insight Venture Partners V, L.P., Insight Venture Partners V Coinvestment Fund, L.P. and Insight Venture Partners V (Employee Co-Investors), L.P., the “Insight V Funds”). Jeffrey L. Horing, Deven Parekh and Peter Sobiloff are the members of the board of managers of Insight Holdings. Because Messrs. Horing, Parekh and Sobiloff are the members of the board of managers of Insight Holdings, Insight Holdings is the managing member of Insight Associates V and Insight Associates V is the general partner of each of the Insight V Funds, they have voting and dispositive power over these shares. The foregoing is not an admission by Insight Associates V or Insight Holdings that it is the beneficial owner of the shares held by the Insight V Funds. Each of Messrs. Horing, Parekh or Sobiloff disclaims beneficial ownership of the shares except to the extent of his pecuniary interests in these entities. The address of the Insight entities and Mr. Horing is 680 Fifth Avenue, 8th Floor, New York, NY 10019. For a discussion of our material relationships with entities associated with Insight within the past three years, see “Certain Relationships and Related Party Transactions.”

(3)

Represents 10,321,934 shares held by the Donald Yonce 2007 Trust and 5,345,664 shares held by Atlantis SolarWinds, LP. All shares sold in this offering, including those shares to be sold assuming the exercise of the over-allotment option, will be sold by the Donald Yonce 2007 Trust. Mr. Yonce is the trustee of the Donald Yonce 2007 Trust and has voting and dispositive power over the shares held by the Donald Yonce 2007 Trust. The Donald Yonce 2007 Trust is a grantor retained annuity trust. The annual annuity payment under the trust may be paid in partnership interests in Atlantis SolarWinds, LP. Atlantis SolarWinds, LLC is the general partner of Atlantis SolarWinds, LP. The Donald Yonce Family Trust is the sole member of Atlantis SolarWinds, LLC. Mr. Yonce is the trustee of the Donald Yonce Family Trust and, by virtue of this relationship, has sole voting and dispositive power over the shares held by Atlantis SolarWinds, LP.

(4)

Represents shares issuable upon the exercise of options exercisable within 60 days of September 30, 2009, of which 2,363,551 will be fully vested. MSB Asset Management, LP holds 1,139,022 of the vested options. MSB Asset Management GP, LLC is the general partner of the MSB Asset Management, LP. Mr. Bennett is the sole manager of MSB Asset Management GP, LLC, and, by virtue of this relationship, may be deemed to have voting and dispositive power over the shares issuable upon the exercise of options held by MSB Asset Management, L.P. Mr. Bennett disclaims beneficial ownership of the shares issuable upon the exercise of options held by MSB Asset Management, LP except to the extent of his pecuniary interest therein.

(5)	Represents shares issuable upon the exercise of options exercisable within 60 days of September 30, 2009, of which 658,057 will be fully vested.

(6)

Represents shares issuable upon the exercise of options exercisable within 60 days of September 30, 2009, of which 389,006 will be fully vested. Clontarf Investments, Ltd. holds 110,000 of the vested options. Clontarf Investments GP, LLC is the general partner of Clontarf Investments, Ltd. Mr. Hibberd and his wife are the sole members of Clontarf Investments GP, LLC, and, by virtue of this relationship, may be deemed to have voting and dispositive power over the shares issuable upon the exercise of the options held by Clontarf Investments, Ltd. Mr. Hibberd disclaims beneficial ownership of the shares issuable upon the exercise of options held by Clontarf except to the extent of his pecuniary interest therein.

 

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(7)	Represents shares issuable upon the exercise of options fully vested and exercisable within 60 days of September 30, 2009.

(8)

Includes 21,110 shares issuable upon the exercise of options fully vested and exercisable within 60 days of September 30, 2009 and 1,251 shares of restricted stock subject to a repurchase right held by us until the earlier to occur of our 2010 annual meeting of our stockholders or December 31, 2010, provided Mr. Cakebread remains a director on such date.

(9)

Represents 18,333 shares issuable upon the exercise of options fully vested and exercisable within 60 days of September 30, 2009, 1,251 shares of restricted stock held by Mr. Martin and subject to a repurchase right held by us until the earlier to occur of our 2010 annual meeting of our stockholders or December 31, 2010, provided Mr. Martin remains a director on such date, and 333,591 shares held by the 25PS1213 Trust u/a/d August 1, 2008. Mr. Martin is the trustee of the 25PS1213 Trust u/a/d August 1, 2008 and has voting and dispositive power over the shares held by the 25PS1213 Trust u/a/d August 1, 2008.

(10)

Represents 12,565,314 shares held by Bain Capital Venture Integral Investors, LLC. Mr. Nye is a Managing Director of Bain Capital Venture Investors, LLC, which is the administrative member of Bain Capital Venture Integral Investors, LLC, and may be deemed to share voting and dispositive power over the shares held by Bain Capital Venture Integral Investors, LLC. Mr. Nye disclaims beneficial ownership of shares held by Bain Capital Venture Integral Investors, LLC except to the extent of his pecuniary interest therein. Does not include 3,002,313 shares owned by BCV Co-Invest SW, LP.

(11)

Includes 14,166 shares issuable upon the exercise of options fully vested and exercisable within 60 days of September 30, 2009 and 1,251 shares of restricted stock subject to a repurchase right held by us until the earlier to occur of our 2010 annual meeting of our stockholders or December 31, 2010, provided that Ms. Siminoff remains a director on such date.

(12)

Represents shares held directly by Austin Ventures IX, L.P. (“AV IX”). AV Partners IX, L.P. (“AVP IX LP”), the general partner of AV IX, and AV Partners IX, L.L.C. (“AVP IX LLC”), the general partner AVP IX LP, may be deemed to have sole voting and dispositive powers over the shares held by AV IX. John D. Thornton is a limited partner of AVP IX LP and a member of AVP IX LLC and may be deemed to share voting and dispositive power over the shares held by AV IX. Mr. Thornton disclaims beneficial ownership of shares held by AV IX except to the extent of any pecuniary interest therein.

(13)

Includes 5,621,522 shares issuable upon exercise of options exercisable within 60 days of September 30, 2009, of which 4,867,620 will be fully vested, and 3,753 shares of restricted stock held by certain of our directors, which are subject to a repurchase right held by us until the 2010 annual meeting of our stockholders or December 31, 2010, provided such directors remain directors on such date.

(14)

Represents 1,689,678 shares held by AV IX. The sole general partner of AV IX is AVP IX LP and the sole general partner of AVP IX LP is AVP IX LLC. Joseph C. Aragona , Kenneth P. DeAngelis, John D. Thornton, Blaine F. Wesner, Christopher A. Pacitti and Venugopal R. Shamapant are members of AVP IX LLC and may be deemed to share voting and dispositive power over the shares held by AV IX. These persons and entities disclaim beneficial ownership of the shares held by AV IX except to the extent of any pecuniary interest therein. The address of Austin Ventures is 300 West 6th Street, Suite 2300, Austin, Texas 78701.

(15)

Auda Software LLC is the general partner of BCV Coinvest SW, L.P. Fritz Becker, Markus Stadlmann and Marcel Giacometti are the members of the board of directors of the general partner of the ultimate parent entity of Auda Software LLC and may be deemed to share voting and dispositive power over the shares held by BCV Coinvest SW, L.P. Fritz Becker, Markus Stadlmann and Marcel Giacometti disclaim beneficial ownership of shares held by BCV Coinvest SW, L.P. except to the extent of their respective pecuniary interests therein. The address for BCV Coinvest SW, L.P. is c/o Auda Software LLC, 745 Fifth Avenue, 29th Floor, New York, NY 10151. Does not include 12,565,314 shares held by Bain Capital Venture Integral Investors, LLC. BCV Coinvest SW, L.P. is an affiliate of a broker-dealer, purchased the securities in the ordinary course of business and, at the time of the purchase of the securities to be resold, had no agreements or understandings, directly or indirectly, with any person to distribute the securities.

(16)

Represents 1,350,000 shares issuable upon the exercise of options exercisable within 60 days of September 30, 2009, all of which are fully vested. Douglas Rogers, one of our employees, is the sole manager of CBMR Enterprises, LLC and thus has sole voting and dispositive power over the shares held by CBMR Enterprises, LLC.

(17)	Represents 1,513,943 shares held by Yonce Management, LLC and 578,666 shares held by David A. Yonce. Mr. Yonce is the sole member of Yonce Management, LLC and thus has sole voting and dispositive power over the shares held by Yonce Management, LLC.

 

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DESCRIPTION OF CAPITAL STOCK

The following descriptions of our capital stock and certain provisions of our amended and restated certificate of incorporation and amended and restated bylaws are summaries and are qualified by reference to the amended and restated certificate of incorporation and the amended and restated bylaws filed with the SEC as exhibits to our registration statement, of which this prospectus forms a part.

Our authorized capital stock consists of 123,000,000 shares of common stock, par value $0.001 per share, and 10,000,000 shares of preferred stock, par value $0.001 per share.

Common Stock

As of September 30, 2009, there were 65,081,061 shares of our common stock outstanding and held of record by 29 stockholders.

Holders of our common stock are entitled to one vote for each share of common stock held of record for the election of directors and on all matters submitted to a vote of stockholders. Holders of our common stock are entitled to receive ratably any dividends that are declared by our board of directors out of legally available funds, subject to any preferential dividend rights of any preferred stock then outstanding. Upon our dissolution, liquidation or winding up, holders of our common stock are entitled to share ratably in our net assets legally available after the payment of all our debts and other liabilities, subject to the preferential rights of any preferred stock then outstanding. Holders of our common stock have no preemptive, subscription, redemption or conversion rights. The rights, preferences and privileges of holders of common stock are subject to, and may be adversely affected by, the rights of the holders of shares of any series of preferred stock that we may designate and issue in the future.

Preferred Stock

Our board of directors is authorized, without further vote or action by the stockholders, to issue from time to time up to an aggregate of 10,000,000 shares of preferred stock in one or more series and to fix or alter the designations, rights, preferences and powers and any qualifications, limitations or restrictions of the shares of each such series of preferred stock, including the dividend rights, dividend rates, conversion rights, voting rights, terms of redemption including sinking fund provisions, redemption price or prices, liquidation preferences and the number of shares constituting any series or designations of that series, any or all of which may be greater than the rights of common stock. The issuance of preferred stock could adversely affect the voting power of holders of our common stock and the likelihood that holders of our common stock will receive dividend payments and payments upon liquidation and could have the effect of delaying, deferring or preventing a change in control. We have no present plans to issue any shares of preferred stock.

Registration Rights

We have entered into a registration rights agreement dated as of December 13, 2005, as amended, with certain stockholders. Subject to the terms of this agreement, holders of 48,895,464 shares having demand registration rights can demand that we file a registration statement. In addition, holders of 50,927,733 shares having piggyback registration rights can request that their shares be covered by a registration statement that we otherwise file. The following description of the terms of the registration rights agreement is intended as a summary only and is qualified in its entirety by reference to the registration rights agreement filed as an exhibit to the registration statement, of which this prospectus forms a part.

Demand Registration Rights

At any time, but subject to certain exceptions, one or more holders of then outstanding registrable securities may demand that we effect a registration under the Securities Act covering the public offering and sale of all or

 

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part of the registrable securities held by those stockholders, provided that the value of the registrable securities that those holders propose to sell in that offering is at least $50,000,000 or a lower amount as agreed by the holders of a majority of the registrable securities. Upon any such demand, we must use our best efforts to effect the registration of the registrable securities that we have been requested to register, together with all other registrable securities that we may have been requested to register by other stockholders pursuant to the piggyback registration rights described below, and if requested by certain of the largest participating holders, we must obtain acceleration of the effective date of the registration statement relating to such registration from the SEC.

Notwithstanding the foregoing, with certain exceptions, we are not obligated to effect a demand registration during the effectiveness of a lock-up agreement entered into in connection with a registration statement pertaining to an underwritten public offering of our securities for our own account. We are also not obligated to effect a demand registration on any form other than Form S-3 if the holders initiating that registration or certain related holders have previously demanded and received three or more registrations on any form other than Form S-3, so long as those registrations remained effective for at least 270 days in accordance with the provisions of the registration rights agreement and the holders initiating that registration together with all other holders of registrable securities joining in that registration were able to include at least 90% of the registrable securities they desired to include in that registration. In addition, we are not obligated to effect a demand registration if at the time of the request a registration statement with respect to another demand registration became effective within the preceding 90 days.

We have the ability to delay the filing of a registration statement, subject to certain restrictions, if we are in possession of material nonpublic information that it would be in our best interests not to disclose.

Piggyback Registration Rights

All parties to the registration rights agreement have piggyback registration rights. Under these provisions, if we register any securities for public sale, including pursuant to any stockholder-initiated demand registration, these stockholders have the right to include their shares in the registration statement, subject to certain exceptions relating to employee benefit plans, dividend reinvestment plans, and mergers and acquisitions. Piggyback registration rights will apply to this offering, unless the holders of a majority of the registrable securities determine otherwise. The underwriters of any underwritten offering will have the right to limit the number of shares having registration rights to be included in the registration statement.

Expenses of Registration

We will pay all registration expenses, other than underwriting discounts and commissions and any transfer taxes, related to any demand or piggyback registration. With respect to demand registrations, these expenses include all reasonable expenses that any stockholder incurs in connection with the registration of its securities, subject to certain limitations.

Indemnification

The registration rights agreement contains indemnification provisions pursuant to which we are obligated to indemnify the selling stockholders and any person who might be deemed to control us or any of our subsidiaries in the event of material misstatements or omissions in the registration statement or related violations of law attributable to us. We may, as a condition to including their securities in any registration statement filed pursuant to demand or piggyback registration rights, require the selling stockholders to agree to indemnify us for misstatements or omissions attributable to them.

Anti-Takeover Effects of Delaware Law and Our Certificate of Incorporation and Bylaws

Our amended and restated certificate of incorporation and our amended and restated bylaws contain certain provisions that could have the effect of delaying, deferring or discouraging another party from acquiring control

 

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of us. These provisions and certain provisions of Delaware law, which are summarized below, are expected to discourage coercive takeover practices and inadequate takeover bids. These provisions are also designed, in part, to encourage persons seeking to acquire control of us to negotiate first with our board of directors. We believe that the benefits of increased protection of our potential ability to negotiate more favorable terms with an unfriendly or unsolicited acquirer outweigh the disadvantages of discouraging a proposal to acquire us.

Undesignated Preferred Stock

As discussed above, our board of directors has the ability to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to change control of us. These and other provisions may have the effect of deterring hostile takeovers or delaying changes in control or management of our company.

Limits on Ability of Stockholders to Act by Written Consent

Our amended and restated certificate of incorporation provides that our stockholders may not act by written consent, which may lengthen the amount of time required to take stockholder actions. As a result, a holder controlling a majority of our capital stock would not be able to amend our bylaws or remove directors without holding a meeting of our stockholders called in accordance with our bylaws.

Requirements for Advance Notification of Stockholder Nominations and Proposals

Our amended and restated bylaws establishes advance notice procedures with respect to stockholder proposals and the nomination of candidates for election as directors, other than nominations made by or at the direction of our board of directors or a committee of our board of directors. These provisions may have the effect of precluding the conduct of certain business at a meeting if the proper procedures are not followed. These provisions may also discourage or deter a potential acquirer from conducting a solicitation of proxies to elect the acquirer’s own slate of directors or otherwise attempting to obtain control of our company.

Election and Removal of Directors; Classified Board

Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that establish specific procedures for appointing and removing members of our board of directors. Our directors are elected by a plurality vote. Vacancies and newly-created directorships on our board of directors may be filled only by a majority of the directors then serving on the board and our directors serve staggered three-year terms. The appointment and removal of directors are also subject to the provisions of our stockholders agreement, which is described in this prospectus under the caption “Certain Relationships and Related Party Transactions—Stockholders Agreement.”

No Cumulative Voting

Our amended and restated certificate of incorporation and amended and restated bylaws do not permit cumulative voting in the election of directors. Cumulative voting allows a stockholder to vote a portion or all of its shares for one or more candidates for seats on our board of directors. Without cumulative voting, a minority stockholder may not be able to gain as many seats on our board of directors as the stockholder would be able to gain if cumulative voting were permitted. The absence of cumulative voting makes it more difficult for a minority stockholder to gain a seat on our board of directors to influence our board’s decision regarding a takeover.

 

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Delaware Anti-Takeover Statute

In general, Section 203 prohibits a publicly held Delaware corporation from engaging, under certain circumstances, in a business combination with an interested stockholder for a period of three years following the date the person became an interested stockholder unless:

 

•

prior to the date of the transaction, our board of directors approved either the business combination or the transaction that resulted in the stockholder becoming an interested stockholder;

 

•

upon completion of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, calculated as provided under Section 203; or

 

•

at or subsequent to the date of the transaction, the business combination is approved by our board of directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least two-thirds of the outstanding voting stock that is not owned by the interested stockholder.

Generally, a business combination includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. An interested stockholder is a person who, together with affiliates and associates, owns or, within three years prior to the determination of interested stockholder status, did own 15% or more of a corporation’s outstanding voting stock.

Our amended and restated certificate of incorporation provides that Section 203 does not apply to us. The provisions of Delaware law and the provisions of our amended and restated certificate of incorporation and amended and restated bylaws could have the effect of discouraging others from attempting hostile takeovers and, as a consequence, they might also inhibit temporary fluctuations in the market price of our common stock that often result from actual or rumored hostile takeover attempts. These provisions might also have the effect of preventing changes in our management. It is possible that these provisions could make it more difficult to accomplish transactions that stockholders might otherwise deem to be in their best interests.

Transfer Agent and Registrar

The transfer agent and registrar for our common stock is American Stock Transfer & Trust Company. Its address is 6201 15th Avenue, Brooklyn, New York 11219, and its telephone number is (718) 921-8254.

Listing

Our common stock is listed on the NYSE under the symbol “SWI.”

 

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SHARES ELIGIBLE FOR FUTURE SALE

We make no prediction as to the effect, if any, that market sales of shares of common stock or the availability of shares of common stock for sale will have on the market price of our common stock prevailing from time to time. Nevertheless, sales of substantial amounts of common stock in the public market, or the perception that these sales could occur, could adversely affect the market price of common stock and could impair our future ability to raise capital through the sale of equity securities.

Upon the completion of this offering, we will have an aggregate of 66,800,562 shares of common stock outstanding, based on the 65,081,061 shares of our common stock outstanding as of September 30, 2009 and the 1,500,000 shares of common stock we will issue in this offering and assuming no exercise of options since September 30, 2009 other than the option to purchase 219,501 shares to be exercised at the closing of this offering. Of the outstanding shares, all of the shares sold in this offering, including any additional shares sold upon exercise of the underwriters’ option to purchase additional shares, and an aggregate of 14,024,920 shares sold in and since our IPO, will be freely tradable, except that any shares purchased by “affiliates” (as that term is defined in Rule 144 under the Securities Act) may only be sold in compliance with the limitations described below. The remaining 42,775,642 shares of common stock will be deemed “restricted securities” as defined in Rule 144. Restricted securities may be sold in the public market only if registered or if they qualify for an exemption from registration under Rule 144 or Rule 701, promulgated under the Securities Act, which rules are summarized below.

Lock-Up Agreements

In connection with our IPO, our directors, officers, and certain of our stockholders and optionees agreed, subject to limited exceptions, not to offer, pledge, sell, agree to sell, directly or indirectly, or otherwise dispose of any shares of common stock or any securities convertible into or exchangeable for shares of common stock prior to November 15, 2009 without the prior written consent of J.P. Morgan Securities Inc., Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated. These lock-ups expire on November 15, 2009 and, absent the lock-ups discussed in the next paragraph, substantially all of our shares of common stock would be freely tradeable subject to certain volume and other restrictions that apply to our affiliates under Rule 144. The shares to be sold by us and the selling stockholders in this offering are being released from these lock-ups with the consent of J.P. Morgan Securities Inc., Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated.

In connection with this offering, our directors, officers and the selling stockholders, who collectively beneficially own 57,903,008 shares of our common stock, have agreed, subject to limited exceptions, not to offer, pledge, sell, agree to sell, directly or indirectly, or otherwise dispose of any shares of common stock or any securities convertible into or exchangeable for shares of common stock for a period of 90 days after the date of this prospectus without the prior written consent of J.P. Morgan Securities Inc., Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated. Among other limited exceptions, the lock-up agreements entered into in connection with this offering permits our officers to sell shares pursuant to their existing stock selling plans entered into in accordance with Rule 10b5-1 of the Exchange Act.

As of September 30, 2009, an aggregate of 7,246,219 shares outstanding and available upon the exercise of vested options, other than the option to purchase 219,501 shares to be exercised at the closing of this offering, are subject to a lock-up agreement. Following this offering, 1,485,119 and 5,761,100 of these shares will become eligible for sale on November 15, 2009 and upon the expiration of the 90-day lock-up period agreed to in connection with this offering, respectively.

In May 2009, all of our executive officers entered into stock selling plans in accordance with Rule 10b5-1 under the Exchange Act and our insider trading policy. Under these plans, an aggregate of 1,806,453 shares may be sold from December 2009 through December 2010, including an aggregate of 318,487 shares that may be sold prior to the expiration of the 90-day lock-up period.

 

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We have agreed, subject to limited exceptions, that for a period of 90 days after the date of this prospectus, we will not, without the prior written consent of J.P. Morgan Securities, Inc., Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated, offer, pledge, sell or otherwise dispose of any shares of common stock, except for the shares of common stock offered in this offering and the shares of common stock issuable upon exercise or conversion of options, warrants or securities outstanding on the date of this prospectus and the shares of our common stock that are issued under our stock option plan.

The lock-up periods described above are subject to extension such that, in the event that either (1) during the last 17 days of the lock-up period, we issue an earnings release or material news or a material event relating to our company occurs or (2) prior to the expiration of the lock-up period, we announce that we will release earnings results during the 16-day period beginning on the last day of the lock-up period, the restrictions on offers, pledges, sales, agreements to sell or other dispositions of common stock or securities convertible into or exchangeable or exercisable for shares of our common stock described above will continue to apply until the expiration of the 18-day period beginning on the issuance of the earnings release.

Rule 144

In general, under Rule 144 as currently in effect, a person who is not deemed to have been one of our affiliates for purposes of the Securities Act at any time during the 90 days preceding a sale and who has beneficially owned the shares proposed to be sold for at least six months, including the holding period of any prior owner other than our affiliates, is entitled to sell those shares without complying with the manner of sale, volume limitation or notice provisions of Rule 144, subject to compliance with the public information requirements of Rule 144. If such a person has beneficially owned the shares proposed to be sold for at least one year, including the holding period of any prior owner other than our affiliates, then that person is entitled to sell those shares without complying with any of the requirements of Rule 144.

In general, under Rule 144, as currently in effect, our affiliates or persons selling shares on behalf of our affiliates are entitled to sell upon expiration of the lock-up agreements described above, within any three-month period, a number of shares that does not exceed the greater of:

 

•

1% of the number of shares of common stock then outstanding, which will equal approximately 665,811 shares immediately after this offering; or

 

•

the average weekly trading volume of the common stock during the four calendar weeks preceding the filing of a notice on Form 144 with respect to that sale.

Sales under Rule 144 by our affiliates or persons selling shares on behalf of our affiliates are also subject to certain manner of sale provisions and notice requirements and to the availability of current public information about us.

Rule 701

Rule 701 generally allows a stockholder who purchased shares of our common stock pursuant to a written compensatory plan or contract and who is not deemed to have been an affiliate of our company during the immediately preceding 90 days to sell these shares in reliance upon Rule 144, but without being required to comply with the public information, holding period, volume limitation or notice provisions of Rule 144. Rule 701 also permits affiliates of our company to sell their Rule 701 shares under Rule 144 without complying with the holding period requirements of Rule 144.

 

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Stock Options

We filed a registration statement on Form S-8 under the Securities Act covering all of the shares of our common stock subject to options outstanding or reserved for issuance under our stock plans. However, the shares registered on Form S-8 will be subject to volume limitations, manner of sale, notice and public information requirements of Rule 144 and will not be eligible for resale until expiration of the lock up agreements to which they are subject.

Registration Rights

We have granted demand registration rights, rights to participate in offerings that we initiate and Form S-3 registration rights to certain of our stockholders to sell our common stock. For a further description of these rights, see “Description of Capital Stock—Registration Rights.”

 

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MATERIAL UNITED STATES FEDERAL INCOME TAX CONSEQUENCES TO NON-U.S. HOLDERS

The following is a summary of the material U.S. federal income tax consequences of the ownership and disposition of our common stock to non-U.S. holders, but does not purport to be a complete analysis of all the potential tax considerations relating thereto. This summary is based upon the provisions of the Internal Revenue Code of 1986, as amended, or the Code, Treasury regulations promulgated thereunder, administrative rulings and judicial decisions, all as of the date hereof. These authorities may be changed, possibly retroactively, so as to result in U.S. federal income tax consequences different from those set forth below. We have not sought any ruling from the Internal Revenue Service, or the IRS, with respect to the statements made and the conclusions reached in the following summary, and there can be no assurance that the IRS will agree with such statements and conclusions.

This summary also does not address the tax considerations arising under the laws of any foreign, state or local jurisdiction. Except to the limited extent below, this summary does not address tax considerations arising under estate or gift tax laws. In addition, this discussion does not address tax considerations applicable to an investor’s particular circumstances or to investors that may be subject to special tax rules, including, without limitation:

 

•

banks, insurance companies or other financial institutions;

 

•

persons subject to the alternative minimum tax;

 

•

tax-exempt organizations;

 

•

dealers in securities or currencies;

 

•

traders in securities that elect to use a mark-to-market method of accounting for their securities holdings;

 

•

persons that own, or are deemed to own, more than five percent of our capital stock (except to the extent specifically set forth below);

 

•

certain former citizens or long-term residents of the United States;

 

•

persons who do not hold our capital stock as a capital asset within the meaning of Section 1221 of the Code (generally, property held for investments);

 

•

persons who hold our common stock as a position in a hedging transaction, “straddle,” “conversion transaction” or other risk reduction transaction; or

 

•

persons deemed to sell our common stock under the constructive sale provisions of the Code.

In addition, if a partnership holds our common stock, the tax treatment of a partner generally will depend on the status of the partner and upon the activities of the partnership. Accordingly, partnerships that hold our common stock, and partners in such partnerships, should consult their tax advisors.

YOU ARE URGED TO CONSULT YOUR TAX ADVISOR WITH RESPECT TO THE APPLICATION OF THE UNITED STATES FEDERAL INCOME TAX LAWS TO YOUR PARTICULAR SITUATION, AS WELL AS ANY TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF OUR COMMON STOCK ARISING UNDER THE UNITED STATES FEDERAL ESTATE OR GIFT TAX RULES OR UNDER THE LAWS OF ANY STATE, LOCAL, FOREIGN OR OTHER TAXING JURISDICTION OR UNDER ANY APPLICABLE TAX TREATY.

Non-U.S. Holder Defined

For purposes of this discussion, you are a non-U.S. holder if you are a holder that, for U.S. federal income tax purposes, is not a U.S. person. For purposes of this discussion, you are a U.S. person if you are:

 

•

an individual citizen or resident of the United States;

 

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•

a corporation or other entity taxable as a corporation, or a partnership or entity taxable as a partnership, created or organized in the United States or under the laws of the United States or any political subdivision thereof;

 

•

an estate whose income is subject to U.S. federal income tax regardless of its source; or

 

•

a trust (x) whose administration is subject to the primary supervision of a U.S. court and which has one or more U.S. persons who have the authority to control all substantial decisions of the trust or (y) which has made an election to be treated as a U.S. person.

If you are an individual, you may, in many cases, be deemed to be a resident alien, as opposed to a nonresident alien, by virtue of being present in the United States for at least 31 days in the calendar year and for an aggregate of at least 183 days during a three-year period ending in the current calendar year. For these purposes, all the days present in the current year, one-third of the days present in the immediately preceding year, and one-sixth of the days present in the second preceding year are counted. Resident aliens are subject to United States federal income tax as if they were U.S. citizens. Such an individual is urged to consult his or her own tax advisor regarding U.S. federal income tax consequences of the sale, exchange of other disposition of common stock.

Distributions

We have not made any distributions on our common stock, and we do not plan to make any distributions for the foreseeable future. However, if we do make distributions on our common stock, those payments will constitute dividends for U.S. tax purposes to the extent paid from our current or accumulated earnings and profits, as determined under U.S. federal income tax principles. To the extent those distributions exceed both our current and our accumulated earnings and profits, they will constitute a return of capital and will first reduce your basis in our common stock, but not below zero, and then will be treated as gain from the sale of stock.

Any dividend paid to you generally will be subject to U.S. withholding tax either at a rate of 30% of the gross amount of the dividend or such lower rate as may be specified by an applicable income tax treaty. Generally, in order for us or our paying agent to withhold tax at a lower treaty rate, a non-U.S. holder must certify its entitlement to treaty benefits. A non-U.S. holder generally can meet this certification requirement by providing a Form W-8BEN (or any successor form) or appropriate substitute form to us or our paying agent. If the holder holds the stock through a financial institution or other agent acting on the holder’s behalf, the holder will be required to provide appropriate documentation to the agent. The holder’s agent will then be required to provide certification to us or our paying agent, either directly or through other intermediaries. For payments made to a foreign partnership or other pass-through entity, the certification requirements generally apply to the partners or other owners rather than to the partnership or other entity, and the partnership or other entity must provide the partners’ or other owners’ documentation to us or our paying agent.

Dividends received by you that are effectively connected with your conduct of a U.S. trade or business are exempt from such withholding tax. In order to obtain this exemption, you must provide us with an IRS Form W-8ECI properly certifying such exemption. Such effectively connected dividends, although not subject to withholding tax, are taxed at the same graduated rates applicable to U.S. persons, net of certain deductions and credits. In addition, if you are a corporate non-U.S. holder, that portion of your earnings and profits that is effectively connected with your conduct of a U.S. trade or business, subject to certain adjustments, may also be subject to a branch profits tax at a rate of 30% or such lower rate as may be specified by an applicable income tax treaty.

If you are eligible for a reduced rate of withholding tax pursuant to a tax treaty, you may obtain a refund of any excess amounts currently withheld if you file an appropriate claim for refund with the IRS.

 

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Gain on Disposition of Common Stock

You generally will not be subject to U.S. federal income tax on any gain realized upon the sale or other disposition of our common stock unless:

 

•

the gain is effectively connected with your conduct of a U.S. trade or business (and, if an income tax treaty applies, the gain is attributable to a permanent establishment maintained by you in the United States);

 

•

you are an individual who holds our common stock as a capital asset (generally, an asset held for investment purposes) and who is present in the United States for a period or periods aggregating 183 days or more during the calendar year in which the sale or disposition occurs and certain other conditions are met; or

 

•

our common stock constitutes a U.S. real property interest by reason of our status as a “United States real property holding corporation” for U.S. federal income tax purposes (a “USRPHC”) at any time within the shorter of the five-year period preceding the disposition or your holding period for our common stock.

We believe that we are not currently and will not become a USRPHC. However, because the determination of whether we are a USRPHC depends on the fair market value of our U.S. real property relative to the fair market value of our other business assets, there can be no assurance that we will not become a USRPHC in the future. Even if we become a USRPHC, however, as long as our common stock is regularly traded on an established securities market, such common stock will be treated as U.S. real property interests only if you actually or constructively hold more than five percent of such regularly traded common stock at any time during the applicable period that is specified in the Code.

If you are a non-U.S. holder described in the first bullet above, you will be required to pay tax on the net gain derived from the sale under regular graduated U.S. federal income tax rates, and corporate non-U.S. holders described in the first bullet above may be subject to the additional branch profits tax at a 30% rate or such lower rate as may be specified by an applicable income tax treaty. If you are an individual non-U.S. holder described in the second bullet above, you will be required to pay a flat 30% tax on the gain derived from the sale, which tax may be offset by U.S. source capital losses (even though you are not considered a resident of the United States). You should consult any applicable income tax or other treaties that may provide for different rules.

Federal Estate Tax

Our common stock that is held or treated as held by an individual non-U.S. holder at the time of death will be included in such holder’s gross estate for U.S. federal estate tax purposes, unless an applicable estate tax treaty provides otherwise.

Backup Withholding and Information Reporting

Generally, we must report annually to the IRS the amount of dividends paid to you, your name and address, and the amount of tax withheld, if any. A similar report is sent to you. Pursuant to applicable income tax treaties or other agreements, the IRS may make these reports available to tax authorities in your country of residence.

Payments of dividends or of proceeds on the disposition of stock made to you may be subject to information reporting and backup withholding (currently at a rate of 28%) unless you establish an exemption, for example by properly certifying your non-U.S. status on a Form W-8BEN or another appropriate version of IRS Form W-8. Notwithstanding the foregoing, backup withholding and information reporting may apply if either we or our paying agent has actual knowledge, or reason to know, that you are a U.S. person.

 

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Backup withholding is not an additional tax; rather, the U.S. income tax liability of persons subject to backup withholding will be reduced by the amount of tax withheld. If withholding results in an overpayment of taxes, a refund or credit may be obtained, provided that the required information is furnished to the IRS in a timely manner.

THE PRECEDING DISCUSSION OF UNITED STATES FEDERAL TAX CONSIDERATIONS IS FOR GENERAL INFORMATION ONLY. IT IS NOT TAX ADVICE. EACH PROSPECTIVE INVESTOR SHOULD CONSULT ITS OWN TAX ADVISOR REGARDING THE PARTICULAR UNITED STATES FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF PURCHASING, HOLDING AND DISPOSING OF OUR COMMON STOCK, INCLUDING THE CONSEQUENCES OF ANY PROPOSED CHANGE IN APPLICABLE LAWS.

 

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UNDERWRITING

We and the selling stockholders are offering the shares of common stock described in this prospectus through a number of underwriters. J.P. Morgan Securities Inc., Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated are acting as joint book-running managers of the offering and, along with Jefferies & Company, Inc., Thomas Weisel Partners LLC, FBR Capital Markets & Co. and Pacific Crest Securities, as representatives of the underwriters. We and the selling stockholders have entered into an underwriting agreement with the underwriters. Subject to the terms and conditions of the underwriting agreement, we and the selling stockholders have agreed to sell to the underwriters, and each underwriter has severally agreed to purchase, at the public offering price less the underwriting discounts and commissions set forth on the cover page of this prospectus, the number of shares of common stock listed next to its name in the following table:

 

Name		Number of Shares
J.P. Morgan Securities Inc.
Goldman, Sachs & Co.
Morgan Stanley & Co. Incorporated
Jefferies & Company, Inc.
Thomas Weisel Partners LLC
FBR Capital Markets & Co.
Pacific Crest Securities
Total		10,000,000

The underwriters are committed to purchase all the shares of common stock offered by us and the selling stockholders if they purchase any shares. The underwriting agreement also provides that if an underwriter defaults, the purchase commitments of non-defaulting underwriters may also be increased or the offering may be terminated.

The underwriters propose to offer the shares of common stock directly to the public at the public offering price set forth on the cover page of this prospectus and to certain dealers at that price less a concession not in excess of $                 per share. Any such dealers may resell shares to certain other brokers or dealers at a discount of up to $                 per share from the public offering price. After the initial public offering of the shares, the offering price and other selling terms may be changed by the underwriters. Sales of shares made outside of the United States may be made by affiliates of the underwriters.

The underwriters have an option to purchase up to 1,500,000 additional shares of common stock from the selling stockholders to cover sales of shares by the underwriters that exceed the number of shares specified in the table above. The underwriters have 30 days from the date of this prospectus to exercise this option to purchase additional shares. If any shares are purchased with this option, the underwriters will purchase shares in approximately the same proportion as shown in the table above. If any additional shares of common stock are purchased, the underwriters will offer the additional shares on the same terms as those on which the shares are being offered.

The underwriting discounts and commissions are equal to the public offering price per share of common stock less the amount paid by the underwriters to us and the selling stockholders per share of common stock. The underwriting discounts and commissions are $                 per share. The following table shows the per share and total underwriting discounts and commissions to be paid to the underwriters assuming both no exercise and full exercise of the underwriters’ option to purchase additional shares.

 

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Underwriting Discounts and Commissions

 

Paid by Us

Paid by Selling Stockholders

Total

No Exercise

Full Exercise

No Exercise

Full Exercise

No Exercise

Full Exercise

Per share

$

$

$

$

$

$

Total

$

$

$

$

$

$

We estimate that the total expenses of this offering, including registration, filing and listing fees, printing fees and legal and accounting expenses, but excluding the underwriting discounts and commissions, will be approximately $0.8 million.

A prospectus in electronic format may be made available on the websites maintained by one or more underwriters, or selling group members, if any, participating in the offering. The underwriters may agree to allocate a number of shares to underwriters and selling group members for sale to their online brokerage account holders. Internet distributions will be allocated by the representatives to underwriters and selling group members that may make Internet distributions on the same basis as other allocations.

We have agreed that we will not, subject to limited exceptions, (1) offer, sell, contract to sell, publicly announce the intention to sell, pledge, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase or otherwise transfer or dispose of, directly or indirectly, or file with the SEC a registration statement under the Securities Act relating to, any shares of our common stock or securities convertible into or exchangeable or exercisable for any shares of our common stock, or (2) enter into any swap or other arrangement that transfers all or a portion of the economic consequences associated with the ownership of any shares of common stock (regardless of whether any of these transactions are to be settled by the delivery of shares of common stock, or such other securities, in cash or otherwise), in each case without the prior written consent of J.P. Morgan Securities Inc., Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated for a period of 90 days after the date of this prospectus. Notwithstanding the foregoing, if (1) during the last 17 days of the 90-day restricted period, we issue an earnings release or material news or a material event relating to our company occurs; or (2) prior to the expiration of the 90-day restricted period, we announce that we will release earnings results during the 16-day period beginning on the last day of the 90-day period, the restrictions described above will continue to apply until the expiration of the 18-day period beginning on the issuance of the earnings release or the occurrence of the material news or material event.

Directors, executive officers, the selling stockholders and entities affiliated with any of them have entered into lock-up agreements with the underwriters prior to the commencement of this offering pursuant to which each of these persons or entities, with limited exceptions (including an exception with respect to shares sold by selling stockholders in this offering and shares sold pursuant to existing stock selling plans entered into in accordance with Rule 10b5-1 of the Exchange Act), for a period of 90 days after the date of this prospectus, may not, without the prior written consent of J.P. Morgan Securities Inc., Goldman, Sachs & Co. and Morgan Stanley & Co. Incorporated, (1) offer, pledge, publicly announce the intention to sell, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of our common stock or securities convertible into or exchangeable or exercisable for any shares of our common stock (including, without limitation, common stock which may be deemed to be beneficially owned by such directors, executive officers, managers and members in accordance with the rules and regulations of the SEC and securities which may be issued upon exercise of a stock option or warrant) or (2) enter into any swap or other agreement that transfers, in whole or in part, any of the economic consequences of ownership of the common stock, whether any such transaction described in clause (1) or (2) above is to be settled by delivery of common stock or such other securities, in cash or otherwise. Notwithstanding the foregoing, if (1) during the last 17 days of the 90-day restricted period, we issue an earnings release or material news or a material event relating to our company occurs; or (2) prior to the expiration of the 90-day restricted period, we announce that we will release earnings results during the 16-day

 

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period beginning on the last day of the 90-day period, the restrictions described above will continue to apply until the expiration of the 18-day period beginning on the issuance of the earnings release or the occurrence of the material news or material event.

We and the selling stockholders have agreed to indemnify the underwriters against certain liabilities, including liabilities under the Securities Act.

Our common stock is listed on the NYSE under the symbol “SWI.”

In connection with this offering, the underwriters may engage in stabilizing transactions, which involves making bids for, or purchasing and selling shares of, common stock in the open market for the purpose of preventing or retarding a decline in the market price of the common stock while this offering is in progress. These stabilizing transactions may include making short sales of the common stock, which involves the sale by the underwriters of a greater number of shares of common stock than they are required to purchase in this offering, and purchasing shares of common stock on the open market to cover positions created by short sales. Short sales may be “covered” shorts, which are short positions in an amount not greater than the underwriters’ option to purchase additional shares referred to above, or may be “naked” shorts, which are short positions in excess of that amount. The underwriters may close out any covered short position either by exercising their option to purchase additional shares, in whole or in part, or by purchasing shares in the open market. In making this determination, the underwriters will consider, among other things, the price of shares available for purchase in the open market compared to the price at which the underwriters may purchase shares through the option to purchase additional shares. A naked short position is more likely to be created if the underwriters are concerned that there may be downward pressure on the price of the common stock in the open market that could adversely affect investors who purchase in this offering. To the extent that the underwriters create a naked short position, they will purchase shares in the open market to cover the position.

The underwriters have advised us that, pursuant to Regulation M of the Securities Act, they may also engage in other activities that stabilize, maintain or otherwise affect the price of the common stock, including the imposition of penalty bids. This means that, if the representatives of the underwriters purchase common stock in the open market in stabilizing transactions or to cover short sales, the representatives can require the underwriters that sold those shares as part of this offering to repay the underwriting discount received by them.

These activities may have the effect of raising or maintaining the market price of the common stock or preventing or retarding a decline in the market price of the common stock, and, as a result, the price of the common stock may be higher than the price that otherwise might exist in the open market. If the underwriters commence these activities, they may discontinue them at any time. The underwriters may carry out these transactions on the NYSE, in the over-the-counter market or otherwise.

If you purchase shares of common stock offered in this prospectus, you may be required to pay stamp taxes and other charges under the laws and practices of the country of purchase, in addition to the offering price listed on the cover page of this prospectus.

Each underwriter has represented that (i) it has only communicated or caused to be communicated and will only communicate or cause to be communicated any invitation or inducement to engage in investment activity (within the meaning of Section 21 of the Financial Services Markets Act 2000 (as amended), or the FSMA) received by it in connection with the issue or sale of any common stock in circumstances in which Section 21(1) of the FSMA does not apply to us and (ii) it has complied and will comply with all applicable provisions of the FSMA with respect to anything done by it in relation to the shares in, from or otherwise involving the United Kingdom.

In relation to each Member State of the European Economic Area which has implemented the Prospectus Directive (each, a “Relevant Member State”), each underwriter has represented and agreed that with effect from

 

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and including the date on which the European Union Prospectus Directive (the “EU Prospectus Directive”) is implemented in that Relevant Member State (the “Relevant Implementation Date”) it has not made and will not make an offer of common stock to the public in that Relevant Member State prior to the publication of a prospectus in relation to the shares which has been approved by the competent authority in that Relevant Member State or, where appropriate, approved in another Relevant Member State and notified to the competent authority in that Relevant Member State, all in accordance with the EU Prospectus Directive, except that it may, with effect from and including the Relevant Implementation Date, make an offer of shares to the public in that Relevant Member State at any time:

 

•

to legal entities which are authorized or regulated to operate in the financial markets or, if not so authorized or regulated, whose corporate purpose is solely to invest in securities;

 

•

to any legal entity which has two or more of (1) an average of at least 250 employees during the last financial year; (2) a total balance sheet of more than €43,000,000 and (3) an annual net turnover of more than €50,000,000, as shown in its last annual or consolidated accounts;

 

•

to fewer than 100 natural or legal persons (other than qualified investors as defined in the EU Prospectus Directive) subject to obtaining the prior consent of the book-running managers for any such offer; or

 

•

in any other circumstances which do not require the publication by the Issuer of a prospectus pursuant to Article 3 of the Prospectus Directive.

For the purposes of this provision, the expression an “offer of shares to the public” in relation to any shares in any Relevant Member State means the communication in any form and by any means of sufficient information on the terms of the offer and the shares to be offered so as to enable an investor to decide to purchase or subscribe the shares, as the same may be varied in that Member State by any measure implementing the EU Prospectus Directive in that Member State and the expression EU Prospectus Directive means Directive 2003/71/EC and includes any relevant implementing measure in each Relevant Member State.

The shares may not be offered or sold by means of any document other than (i) in circumstances which do not constitute an offer to the public within the meaning of the Companies Ordinance (Cap.32, Laws of Hong Kong), or (ii) to “professional investors” within the meaning of the Securities and Futures Ordinance (Cap.571, Laws of Hong Kong) and any rules made thereunder, or (iii) in other circumstances which do not result in the document being a “prospectus” within the meaning of the Companies Ordinance (Cap.32, Laws of Hong Kong), and no advertisement, invitation or document relating to the shares may be issued or may be in the possession of any person for the purpose of issue (in each case whether in Hong Kong or elsewhere), which is directed at, or the contents of which are likely to be accessed or read by, the public in Hong Kong (except if permitted to do so under the laws of Hong Kong) other than with respect to shares which are or are intended to be disposed of only to persons outside Hong Kong or only to “professional investors” within the meaning of the Securities and Futures Ordinance (Cap.571, Laws of Hong Kong) and any rules made thereunder.

This prospectus has not been registered as a prospectus with the Monetary Authority of Singapore. Accordingly, this prospectus and any other document or material in connection with the offer or sale, or invitation for subscription or purchase, of the shares may not be circulated or distributed, nor may the shares be offered or sold, or be made the subject of an invitation for subscription or purchase, whether directly or indirectly, to persons in Singapore other than (i) to an institutional investor under Section 274 of the Securities and Futures Act, Chapter 289 of Singapore (the “SFA”), (ii) to a relevant person, or any person pursuant to Section 275(1A), and in accordance with the conditions, specified in Section 275 of the SFA or (iii) otherwise pursuant to, and in accordance with the conditions of, any other applicable provision of the SFA.

Where the shares are subscribed or purchased under Section 275 by a relevant person which is: (a) a corporation (which is not an accredited investor) the sole business of which is to hold investments and the entire share capital of which is owned by one or more individuals, each of whom is an accredited investor; or (b) a trust

 

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(where the trustee is not an accredited investor) whose sole purpose is to hold investments and each beneficiary is an accredited investor, shares, debentures and units of shares and debentures of that corporation or the beneficiaries’ rights and interest in that trust shall not be transferable for six months after that corporation or that trust has acquired the shares under Section 275 except: (1) to an institutional investor under Section 274 of the SFA or to a relevant person, or any person pursuant to Section 275(1A), and in accordance with the conditions, specified in Section 275 of the SFA; (2) where no consideration is given for the transfer; or (3) by operation of law.

The securities have not been and will not be registered under the Financial Instruments and Exchange Law of Japan (the Financial Instruments and Exchange Law) and each underwriter has agreed that it will not offer or sell any securities, directly or indirectly, in Japan or to, or for the benefit of, any resident of Japan (which term as used herein means any person resident in Japan, including any corporation or other entity organized under the laws of Japan), or to others for re-offering or resale, directly or indirectly, in Japan or to a resident of Japan, except pursuant to an exemption from the registration requirements of, and otherwise in compliance with, the Financial Instruments and Exchange Law and any other applicable laws, regulations and ministerial guidelines of Japan.

This prospectus is not a formal disclosure document and has not been lodged with the Australian Securities and Investments Commission, or ASIC. It does not purport to contain all information that an investor or their professional advisers would expect to find in a prospectus for the purposes of Chapter 6D.2 of the Australian Corporations Act 2001, or the Act, in relation to the securities or our company.

This prospectus is not an offer to retail investors in Australia generally. Any offer of securities in Australia is made on the condition that the recipient is a “sophisticated investor” within the meaning of section 708(8) of the Act or a “professional investor” within the meaning of section 708(11) of the Act, or on condition that the offer to that recipient can be brought within the exemption for ‘Small-Scale Offerings’ (within the meaning of section 708(1) of the Act). If any recipient does not satisfy the criteria for these exemptions, no applications for securities will be accepted from that recipient. Any offer to a recipient in Australia, and any agreement arising from acceptance of the offer, is personal and may only be accepted by the recipient.

If a recipient on-sells their securities within 12 months of their issue, that person will be required to lodge a disclosure document with ASIC unless either:

 

•

the sale is pursuant to an offer received outside Australia or is made to a “sophisticated investor” within the meaning of 708(8) of the Act or a “professional investor” within the meaning of section 708(11) of the Act; or

 

•

it can be established that our company issued, and the recipient subscribed for, the securities without the purpose of the recipient on-selling them or granting, issuing or transferring interests in, or options or warrants over them.

This prospectus has not been and will not be registered as a prospectus with the Registrar of Companies in India. This prospectus or any other material relating to these securities may not be circulated or distributed, directly or indirectly, to the public or any members of the public in India. Further, persons into whose possession this prospectus comes are required to inform themselves about and to observe any such restrictions. Each prospective investor is advised to consult its advisors about the particular consequences to it of an investment in these securities. Each prospective investor is also advised that any investment in these securities by it is subject to the regulations prescribed by the Reserve Bank of India and the Foreign Exchange Management Act and any regulations framed thereunder.

Our securities may not be offered, sold and delivered directly or indirectly, or offered or sold to any person for reoffering or resale, directly or indirectly, in Korea or to any resident of Korea except pursuant to the applicable laws and regulations of Korea, including the Securities and Exchange Act and the Foreign Exchange

 

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Transaction Law and the decrees and regulations thereunder. Our securities have not been registered with the Financial Supervisory Commission of Korea for public offering in Korea. Furthermore, our securities may not be resold to Korean residents unless the purchaser of our securities complies with all applicable regulatory requirements (including but not limited to government approval requirements under the Foreign Exchange Transaction Law and its subordinate decrees and regulations) in connection with the purchase of our securities.

Certain of the underwriters and their affiliates may provide from time to time in the future certain commercial banking, financial advisory, investment banking and other services for us and our affiliates in the ordinary course of their business, for which they may receive customary fees and commissions. In addition, from time to time, certain of the underwriters and their affiliates may effect transactions for their own account or the account of customers, and hold on behalf of themselves or their customers, long or short positions in our debt or equity securities or loans.

 

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LEGAL MATTERS

The validity of the shares of common stock offered hereby will be passed upon for us by Wilson Sonsini Goodrich & Rosati, Professional Corporation, Austin, Texas. Certain legal matters in connection with this offering will be passed upon for the underwriters by Fenwick & West LLP, Mountain View, California.

EXPERTS

The consolidated financial statements of SolarWinds, Inc. as of December 31, 2007 and 2008 and for each of the three years in the period ended December 31, 2008 included in this prospectus have been so included in reliance on the report of PricewaterhouseCoopers LLP, an independent registered public accounting firm, given on the authority of said firm as experts in auditing and accounting.

WHERE YOU CAN FIND MORE INFORMATION

We have filed with the SEC a registration statement on Form S-1 under the Securities Act with respect to the shares of common stock we are offering. The registration statement, including the attached exhibits and schedule, contains additional relevant information about us and our common stock. This prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedule thereto. The rules and regulations of the SEC allow us to omit from this prospectus certain information included in the registration statement. We also are subject to the reporting requirements of the Exchange Act and file reports and other information with the SEC.

For further information about us and our common stock, you may inspect a copy of the registration statement and the exhibits and schedule to the registration statement without charge at the offices of the SEC at 100 F Street, N.E., Washington, D.C. 20549. You may obtain copies of all or any part of the registration statement from the Public Reference Section of the SEC, 100 F Street, N.E., Washington, D.C. 20549 upon the payment of the prescribed fees. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements and other information regarding registrants like us that file electronically with the SEC. You can also inspect our registration statement on this website.

 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

		Page
SOLARWINDS, INC.
Report of Independent Registered Public Accounting Firm		F-2
Consolidated Balance Sheets		F-3
Consolidated Statements of Income		F-4
Consolidated Statements of Changes in Convertible Preferred Stock and Stockholders’ Equity (Deficit)		F-5
Consolidated Statements of Cash Flows		F-6
Notes to Consolidated Financial Statements		F-7
SOLARWINDS, INC. UNAUDITED PRO FORMA FINANCIAL STATEMENTS
Unaudited Condensed Pro Forma Financial Information		F-33
Unaudited Condensed Pro Forma Statements of Income		F-34

 

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of SolarWinds, Inc.:

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of changes in convertible preferred stock and stockholders’ deficit and of cash flows present fairly, in all material respects, the financial position of SolarWinds, Inc. and its subsidiaries at December 31, 2007 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP

Austin, Texas

March 6, 2009

 

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SolarWinds, Inc.

Consolidated Balance Sheets

(In thousands, except for share and per share information)

 

		December 31,								September 30, 2009
		2007				2008
										(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	19,303			$	40,566			$	125,805
Restricted cash			1,000				—				—
Accounts receivable, net of allowances of $230, $117 and $187 as of December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively.			10,851				13,722				20,964
Income tax receivable			—				728				104
Deferred taxes			—				40				49
Other current assets			785				1,420				2,101
Total current assets			31,939				56,476				149,023
Property and equipment, net			3,290				5,178				5,910
Debt issuance costs, net			1,473				1,101				450
Deferred taxes			1,294				1,847				2,019
Goodwill			9,134				15,745				15,791
Intangible assets and other, net			2,132				6,560				4,092
Total assets		$	49,262			$	86,907			$	177,285
Liabilities, convertible preferred stock and stockholders’ equity (deficit)
Current liabilities:
Accounts payable		$	1,532			$	1,471			$	2,202
Accrued liabilities			2,378				3,284				5,614
Accrued interest payable			2,463				2,011				574
Dividends payable			—				—				20,000
Income taxes payable			970				201				1,808
Deferred taxes			389				—				—
Current portion of deferred revenue			16,537				25,930				35,064
Current portion of capital lease obligations			123				25				16
Current portion of long-term debt			1,417				7,161				—
Total current liabilities			25,809				40,083				65,278
Long-term liabilities:
Deferred revenue, net of current portion			555				1,232				1,686
Capital lease obligations, net of current portion			322				10				—
Other long-term liabilities			—				188				366
Long-term debt, net of current portion			101,083				93,922				44,097
Total long-term liabilities			101,960				95,352				46,149
Total liabilities			127,769				135,435				111,427
Commitments and contingencies (Note 13)
Convertible preferred stock, $0.001 par value: 46,551,618 shares authorized and 27,000,003 shares issued and outstanding as of December 31, 2007 and 2008 and no shares authorized, issued or outstanding as of September 30, 2009 (unaudited)			27				27				—
Stockholders’ equity (deficit):
Common stock, $0.001 par value: 123,000,000 shares authorized and 28,097,094, 28,166,656 and 65,081,061 shares issued and outstanding as of December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively			28				28				65
Additional paid-in capital			8,921				15,166				106,230
Note receivable from stockholder			(1,738	)			—				—
Accumulated other comprehensive income (loss)			(6	)			(315	)			36
Accumulated deficit			(85,739	)			(63,434	)			(40,473	)
Total stockholders’ equity (deficit)			(78,534	)			(48,555	)			65,858
Total liabilities, convertible preferred stock and stockholders’ equity (deficit)		$	49,262			$	86,907			$	177,285

The accompanying notes are an integral part of these consolidated financial statements.

 

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SolarWinds, Inc.

Consolidated Statements of Income

(In thousands, except for per share information)

 

		Year Ended December 31,												Nine Months Ended September 30,
		2006				2007				2008				2008				2009
														(unaudited)
Revenue:
License		$	23,676			$	39,525			$	55,461			$	41,545			$	44,777
Maintenance and other			14,558				22,210				37,674				26,693				38,690
Total revenue			38,234				61,735				93,135				68,238				83,467
Cost of license revenue			95				219				272				191				458
Cost of maintenance and other revenue (1)			395				2,034				3,316				2,415				3,127
Gross profit			37,744				59,482				89,547				65,632				79,882
Operating expenses:
Sales and marketing (1)			3,504				12,909				22,664				16,198				21,690
Research and development (1)			2,341				5,899				8,452				6,249				8,167
General and administrative (1)			6,477				9,763				16,464				12,486				13,127
Total operating expenses			12,322				28,571				47,580				34,933				42,984
Operating income			25,422				30,911				41,967				30,699				36,898
Other income (expense):
Interest income			447				528				528				400				225
Interest expense			(10,682	)			(10,235	)			(8,539	)			(6,435	)			(3,659	)
Other expense			—				(73	)			(934	)			(43	)			(88	)
Total other expense			(10,235	)			(9,780	)			(8,945	)			(6,078	)			(3,522	)
Income before income taxes			15,187				21,131				33,022				24,621				33,376
Income tax expense			5,596				7,524				10,717				7,956				10,415
Net income			9,591				13,607				22,305				16,665				22,961
Amount allocated to participating preferred stockholders			(4,791	)			(6,681	)			(10,922	)			(8,161	)			—
Net income available to common stockholders		$	4,800			$	6,926			$	11,383			$	8,504			$	22,961
Basic earnings per share available to common stockholders		$	0.18			$	0.25			$	0.40			$	0.30			$	0.50
Diluted earnings per share available to common stockholders		$	0.18			$	0.24			$	0.35			$	0.26			$	0.44
Shares used in computation of basic earnings per share available to common stockholders			27,014				27,969				28,137				28,130				46,183
Shares used in computation of diluted earnings per share available to common stockholders			54,055				56,030				32,652				32,410				51,801
Pro forma earnings per share (unaudited)
Basic										$	0.40							$	0.38
Diluted										$	0.37							$	0.35
Weighted average number of shares used in pro forma computation (unaudited)
Basic											55,137								59,981
Diluted											59,652								65,599

 

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

 

		Year Ended December 31,										Nine Months Ended September 30,
		2006				2007			2008			2008			2009
(in thousands)												(unaudited)
Cost of maintenance revenue		$	—			$	39		$	63		$	46		$	52
Sales and marketing			334				1,213			1,593			1,179			1,435
Research and development			190				467			755			563			818
General and administrative			991				2,091			3,509			2,515			3,323

The accompanying notes are an integral part of these consolidated financial statements.

 

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SolarWinds, Inc.

Consolidated Statements of Changes in Convertible Preferred Stock and Stockholders’ Equity (Deficit)

(In thousands)

 

		Convertible Preferred Stock									Common Stock							Additional Paid-in Capital				Note Receivable from Stockholder				Accumulated Other Comprehensive Income (Loss)				Accumulated Deficit				Total Stockholders’ Equity (Deficit)
		Shares			Amount						Shares			Amount
Balances at December 31, 2005		27,000			$	27					27,000			$	27			$	60			$	—			$	—			$	(108,937	)		$	(108,850	)
Exercise of stock options		—				—					450				—				1,208				—				—				—				1,208
Stock-based compensation		—				—					—				—				1,515				—				—				—				1,515
Excess tax benefit from stock-based compensation		—				—					—				—				238				—				—				—				238
Net income		—				—					—				—				—				—				—				9,591				9,591
Balances at December 31, 2006		27,000				27					27,450				27				3,021				—				—				(99,346	)			(96,298	)
Comprehensive income:
Foreign currency translation adjustment		—				—					—				—				—				—				(6	)			—				(6	)
Net income		—				—					—				—				—				—				—				13,607				13,607
Comprehensive income																																			13,601
Exercise of stock option		—				—					647				1				1,737				(1,738	)			—				—				—
Interest on option exercised with note		—				—					—				—				30				—				—				—				30
Stock-based compensation		—				—					—				—				3,810				—				—				—				3,810
Excess tax benefit from stock-based compensation		—				—					—				—				323				—				—				—				323
Balances at December 31, 2007		27,000				27					28,097				28				8,921				(1,738	)			(6	)			(85,739	)			(78,534	)
Comprehensive income:
Foreign currency translation adjustment		—				—					—				—				—				—				(309	)			—				(309	)
Net income		—				—					—				—				—				—				—				22,305				22,305
Comprehensive income																																			21,996
Purchase of stock		(726	)			(1	)				(726	)			(1	)			(13,639	)			—				—				—				(13,640	)
Issuance of stock		726				1					726				1				13,639				—				—				—				13,640
Repayment of note receivable from stockholder		—				—					—				—				—				1,738				—				—				1,738
Exercise of stock options											70								227																227
Interest on option exercised with note		—				—					—				—				15				—				—				—				15
Stock-based compensation		—				—					—				—				5,920				—				—				—				5,920
Excess tax benefit from stock-based compensation		—				—					—				—				83				—				—				—				83
Balances at December 31, 2008		27,000				27					28,167				28				15,166				—				(315	)			(63,434	)			(48,555	)
Comprehensive income (unaudited):
Foreign currency translation adjustment (unaudited)		—				—					—				—				—				—				351				—				351
Net income (unaudited)		—				—					—				—				—				—				—				22,961				22,961
Comprehensive income (unaudited)																																			23,312
Common stock issued in public offering, net of issuance costs (Note 8) (unaudited)		—				—					9,000				9				100,540				—				—				—				100,549
Exercise of stock options (unaudited)		—				—					910				1				2,684				—				—				—				2,685
Issuance of restricted stock awards (unaudited)		—				—					4				—				—				—				—				—				—
Dividends payable to original stockholders (Note 13) (unaudited)		—				—					—				—				(20,000	)			—				—				—				(20,000	)
Conversion of preferred stock to common stock (unaudited)		(27,000	)			(27	)				27,000				27				—				—				—				—				27
Stock-based compensation (unaudited)		—				—					—				—				5,628				—				—				—				5,628
Excess tax benefit from stock-based compensation (unaudited)		—				—					—				—				2,212				—				—				—				2,212
Balances at September 30, 2009 (unaudited)		—			$	—					65,081			$	65			$	106,230			$	—			$	36			$	(40,473	)		$	65,858

The accompanying notes are an integral part of these consolidated financial statements.

 

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SolarWinds, Inc.

Consolidated Statements of Cash Flows

(In thousands)

 

		Year Ended December 31,												Nine Months Ended September 30,
		2006				2007				2008				2008				2009
														(unaudited)
Cash flows from operating activities
Net income		$	9,591			$	13,607			$	22,305			$	16,665			$	22,961
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			124				785				1,436				1,062				1,627
Provision for doubtful accounts			112				118				505				315				132
Stock-based compensation expense			1,515				3,810				5,920				4,303				5,628
Deferred taxes			833				(1,242	)			(1,005	)			(878	)			(181	)
Excess tax benefit from stock-based compensation			(238	)			(323	)			(83	)			(85	)			(2,212	)
Loss on asset disposal			331				—				—				—				—
Other non-cash expenses			388				453				663				509				896
Changes in operating assets and liabilities, net of assets acquired and liabilities assumed in business combinations:
Accounts receivable			(239	)			(5,362	)			(3,553	)			(4,050	)			(7,224	)
Income taxes receivable			—				—				(693	)			—				619
Prepaid income taxes			(869	)			869				—				—				—
Prepaid and other current assets			(125	)			(383	)			(846	)			(497	)			(643	)
Accounts payable			572				828				(32	)			279				700
Accrued liabilities			2,246				(93	)			956				2,124				1,872
Accrued interest payable			2,192				(208	)			(452	)			(660	)			(1,437	)
Income taxes payable			—				1,293				(397	)			49				3,991
Deferred revenue and other liabilities			698				7,955				10,493				8,354				9,292
Net cash provided by operating activities			17,131				22,107				35,217				27,490				36,021
Cash flows from investing activities
Purchases of property and equipment			(1,465	)			(2,092	)			(3,395	)			(3,024	)			(1,806	)
Purchases of intangible assets			(98	)			(353	)			(349	)			(291	)			(305	)
(Increase) decrease in restricted cash			(1,000	)			—				1,000				—				—
Acquisition of businesses, net of cash acquired			—				(9,768	)			(8,281	)			(1,574	)			(46	)
Net cash used in investing activities			(2,563	)			(12,213	)			(11,025	)			(4,889	)			(2,157	)
Cash flows from financing activities
Repayment of long-term debt			(7,500	)			—				(1,417	)			(1,417	)			(56,986	)
Exercise of stock options			1,208				—				227				170				2,685
Net cash proceeds from initial public offering			—				—				—				—				104,625
Interest on options exercised with note			—				30				15				15				—
Excess tax benefit from stock-based compensation			238				323				83				85				2,212
Repayments of capital lease obligations			—				(115	)			(27	)			(20	)			(19	)
Payments for offering costs			—				(84	)			(2,092	)			(1,932	)			(1,496	)
Proceeds from note receivable from stockholder			—				—				1,738				1,738				—
Proceeds from issuance of stock			—				—				13,640				13,640				—
Purchase of stock			—				—				(13,640	)			(13,640	)			—
Net cash (used in) provided by financing activities			(6,054	)			154				(1,473	)			(1,361	)			51,021
Effect of exchange rate changes on cash and cash equivalents			—				(87	)			(1,456	)			(736	)			354
Net increase in cash and cash equivalents			8,514				9,961				21,263				20,504				85,239
Cash and cash equivalents
Beginning of period			828				9,342				19,303				19,303				40,566
End of period		$	9,342			$	19,303			$	40,566			$	39,807			$	125,805
Supplemental disclosure of cash flow information
Cash paid for interest		$	8,100			$	10,069			$	8,619			$	6,815			$	4,402
Cash paid for income taxes		$	5,395			$	6,640			$	12,879			$	8,789			$	5,903
Noncash investing and financing transactions
Fixed assets acquired under capital leases		$	480			$	80			$	—			$	—			$	—
Exercise of stock option with note receivable from stockholder		$	—			$	1,738			$	—			$	—			$	—
Capital lease termination and related asset write-off		$	—			$	—			$	412			$	412			$	—
Debt issuance costs write-off		$	—			$	—			$	—			$	—			$	428
Dividends payable		$	—			$	—			$	—			$	—			$	20,000

The accompanying notes are an integral part of these consolidated financial statements.

 

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SolarWinds, Inc.

Notes to Consolidated Financial Statements

1. Organization and Nature of Operations

SolarWinds, Inc., a Delaware corporation, and its subsidiaries, or we or us, are a provider of enterprise-class network management software designed by network professionals for network professionals. Our customer base spans small businesses to Fortune 500™ companies, government agencies, including the military, and educational institutions.

2. Summary of Significant Accounting Policies

Basis of Consolidation

The accompanying consolidated financial statements include our accounts and the accounts of our wholly owned subsidiaries. We have eliminated all intercompany balances and transactions.

Unaudited Interim Financial Information

The accompanying unaudited interim consolidated balance sheet as of September 30, 2009, the consolidated statements of income and cash flows for the nine months ended September 30, 2008 and 2009, and the consolidated statement of changes in convertible preferred stock and stockholders’ equity (deficit) for the nine months ended September 30, 2009 are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States. In the opinion of our management, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and include all adjustments necessary for the fair presentation of our financial position, as of September 30, 2009, the results of operations and cash flows for the nine months ended September 30, 2008 and 2009 and stockholders’ equity (deficit) for the nine months ended September 30, 2009. The results of operations for the nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the year ending December 31, 2009 or for any other period.

Unaudited Pro Forma Presentation

Upon the completion of our initial public offering, or IPO, in May 2009, all of the outstanding shares of our convertible preferred stock automatically converted into shares of our common stock. The unaudited pro forma earnings per share for the year ended December 31, 2008 and the nine months ended September 30, 2009 were computed using the weighted average number of common shares outstanding and have been prepared assuming the conversion of the convertible preferred stock outstanding into 27,000,003 shares of common stock.

Recently Adopted Accounting Principles

In June 2009, the Financial Standards Accounting Board, or FASB, issued The FASB Accounting Standards Codification, or the Codification, authorizing the Codification as the sole source for authoritative guidance in accordance with United States generally accepted accounting principles, or GAAP. The Codification is effective for financial statements issued for reporting periods that end after September 15, 2009. The position supersedes all GAAP accounting standards aside from those issued by the United States Securities and Exchange Commission, or SEC.

In May 2009, the FASB issued a standard that sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements; the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. This standard is effective for

 

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interim and annual periods ending after June 15, 2009. We adopted this standard in the quarter ended June 30, 2009. This standard did not impact the consolidated financial results. Management has evaluated subsequent events up to October 26, 2009, the date of our issued financial statements.

In April 2009, the FASB and the Accounting Principles Board issued a clarification of previous guidance for interim disclosures about fair value of financial instruments, that requires an entity to provide disclosures about fair value of financial instruments in interim financial information. The new guidance is to be applied prospectively and is effective for interim and annual periods ending after June 15, 2009 with early adoption permitted for periods ending after March 15, 2009. We adopted the new guidance in the quarter ended June 30, 2009. There was no impact on our consolidated financial statements as it relates only to additional disclosures.

Recent Accounting Pronouncements

In September 2009, the FASB ratified two consensuses that will significantly affect the revenue recognition accounting policies for transactions that involve multiple deliverables and sales of software-enabled devices. The first consensus requires companies to allocate revenue in arrangements involving multiple deliverables based on the estimated selling price of each deliverable, even though those deliverables are not sold separately either by the company itself or other vendors. This consensus eliminates the requirement that all undelivered elements have objective and reliable evidence of fair value before a company can recognize the portion of the overall arrangement fee that is attributable to items that already have been delivered. In the absence of vendor-specific objective evidence and third-party evidence for one or more elements in a multiple-element arrangement, companies will estimate the selling prices of those elements. The overall arrangement fee will be allocated to each element, whether delivered or undelivered, based on their relative selling prices, regardless of whether those estimated selling prices are evidenced by vendor-specific object evidence, third-party evidence of fair value, or are based on the company’s judgment.

Under the second consensus, sales of tangible products that contain “essential” software will no longer be subject to the stringent revenue recognition requirements that used to apply to software licensing arrangements. The second consensus excludes tangible products from the scope of software revenue accounting requirements if they contain both software and non-software components that function together to deliver their essential functionality. For those tangible products, the new guidance from the first consensus will be applied, and a greater proportion of the revenue from multiple-element arrangements involving tangible products that contain software will be recognized immediately in many circumstances.

Both consensuses will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. However, early adoption is permitted. If a company elects early adoption and the period of adoption is not the beginning of its fiscal year, the requirements must be applied retrospectively to the beginning of the fiscal year. Retrospective application to prior years is permitted, but not required. In the initial year of application, companies are required to make qualitative and quantitative disclosures about the impact of the changes. In many circumstances, the new guidance under these consensuses will require significant changes to a company’s revenue recognition policies and procedures, including system modifications. We are currently evaluating the potential impact of these consensuses on our financial position and results of operations, but do not expect it to have a material impact on our consolidated financial statements.

In August 2009, the FASB issued guidance on measuring liabilities at fair value, which provides clarification that in circumstances, where a quoted market price in an active market for an identical liability is not available, a reporting entity must measure fair value of the liability using one of the following techniques: the quoted price of the identical liability when traded as an asset; quoted prices for similar liabilities or similar liabilities when traded as assets; or another valuation technique, such as a present value technique or the amount that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability that is consistent with the provisions of authoritative guidance. This statement becomes effective for the first reporting period, including interim periods, beginning after issuance. We will adopt this statement beginning in the fourth quarter of fiscal 2009.

 

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Use of Estimates

The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Significant items subject to those estimates and assumptions include the carrying amounts of property and equipment, intangible assets and goodwill, the allowance for doubtful accounts, the valuation of stock options, the fair value of common stock and deferred income taxes. Actual results could differ from those estimates.

Foreign Currency Translation

The functional currency of our foreign subsidiaries is determined in accordance with authoritative guidance issued by the FASB. We translate assets and liabilities for these subsidiaries at exchange rates in effect at the balance sheet date. We translate income and expense accounts for these subsidiaries at the average monthly exchange rates for the periods. We record resulting translation adjustments as a component of accumulated other comprehensive income (loss) within stockholders’ equity (deficit). Foreign currency translation losses were $6,000 and $0.3 million for the years ended December 31, 2007 and 2008, respectively. Foreign currency translation gains were $0.4 million for the nine months ended September 30, 2009 (unaudited). We record gains and losses from currency transactions denominated in currencies other than the functional currency as other income or expense in our consolidated statements of income. There were no equity transactions denominated in foreign currencies for the years ended December 31, 2007 and 2008 and the nine months ended September 30, 2009 (unaudited).

Local currency transactions of international subsidiaries that have the U.S. dollar as the functional currency are remeasured into U.S. dollars using current rates of exchange for monetary assets and liabilities and historical rates of exchange for non-monetary assets and liabilities. Gains and losses from remeasurement of monetary assets and liabilities, as reflected within the consolidated statements of income, were not material for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2009 (unaudited).

Fair Value of Financial Instruments

The carrying amounts of our financial instruments, including cash equivalents, accounts receivable, accounts payable and accrued liabilities, approximate their respective fair values, due to the short-term nature of these instruments.

On January 1, 2008, we adopted the authoritative guidance on fair value measurements for financial assets and liabilities. The guidance became effective for financial assets and liabilities on January 1, 2008. On January 1, 2009, we began applying the provisions of the guidance for non-recurring fair value measurements of non-financial assets and liabilities, such as goodwill, indefinite-lived intangible assets, and property, plant and equipment. The guidance defines fair value, thereby eliminating inconsistencies in guidance found in various prior accounting pronouncements, and increases disclosures surrounding fair value calculations.

The guidance establishes a three-tiered fair value hierarchy that prioritizes inputs to valuation techniques used in fair value calculations. The three levels of inputs are defined as follows:

Level 1: Unadjusted quoted prices for identical assets or liabilities in active markets accessible by us.

Level 2: Inputs that are observable in the marketplace other than those inputs classified as Level 1.

Level 3: Inputs that are unobservable in the marketplace and significant to the valuation.

The following section describes the valuation methodologies we use to measure different financial assets and financial liabilities at fair value.

 

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Money Market Funds and Short-Term Investments

In order to determine fair value of our money market funds and short-term investments, we use quoted prices in active markets for identical assets. Therefore, our money market funds and short-term investments are considered a Level 1 item. We currently have no financial instruments that qualify as Level 2 or 3 items.

The following table summarizes the basis used to measure certain financial assets and liabilities at fair value on a recurring basis in our consolidated balance sheets:

 

		Basis of Fair Value Measurements
		Balance at December 31, 2008			Quoted Prices In Active Markets for Identical Items (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
		(in thousands)
Cash equivalents — money market funds		$	25,000		$	25,000		$	—		$	—
		Basis of Fair Value Measurements
		Balance at September 30, 2009			Quoted Prices In Active Markets for Identical Items (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
		(in thousands-unaudited)
Cash equivalents — money market funds		$	101,000		$	101,000		$	—		$	—

Long-Term Debt

On December 13, 2005, we entered into credit agreements with an investment management firm pursuant to which we borrowed $85.0 million on a first lien note, or First Lien Note, and $25.0 million on a second lien note, or Second Lien Note, and collectively the Notes. The First Lien Note had an outstanding principal balance of $76.1 million and $19.1 million at December 31, 2008 and September 30, 2009 (unaudited), respectively. The Second Lien Note had an outstanding principal balance of $25.0 million as of December 31, 2008 and September 30, 2009. In March and May 2009, respectively, we repaid $7.2 million of principal based on our excess cash flow and $49.8 million with proceeds from the IPO of our common stock, reducing the total outstanding principal balance on the Notes to $44.1 million as of September 30, 2009 (unaudited).

The estimated fair value of our total amounts outstanding under the credit agreements at December 31, 2008 and September 30, 2009 (unaudited) was $97.0 million and $42.8 million, respectively, and was determined in accordance with fair value disclosure requirements. We estimated the fair value of the credit agreements by discounting future cash flows using interest rate spreads currently available for a credit agreement with similar terms and maturity to our existing outstanding borrowings. The total outstanding borrowings at December 31, 2008 and September 30, 2009 (unaudited) were recorded in our financial statements at their carrying values of $101.1 million and $44.1 million, respectively.

Cash and Cash Equivalents and Restricted Cash

We consider all highly liquid investments with original maturities of three months or less to be cash equivalents. At December 31, 2007, we had $1.0 million pledged as collateral for a letter of credit, which we had recorded as restricted cash on our consolidated balance sheets. During 2008, this letter of credit was released and our restricted cash balance at December 31, 2008 and September 30, 2009 (unaudited) was zero.

Accounts Receivable

Accounts receivable represent trade receivables from customers when we have provided software licenses and/or annual software maintenance agreements and we have not yet received payment. We present accounts

 

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receivable net of an allowance for doubtful accounts. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of customers to make required payments. In doing so, we consider the current financial condition of the customer, the specific details of the customer account, the age of the outstanding balance and the current economic environment. Any change in the assumptions used in analyzing a specific account receivable might result in an additional allowance for doubtful accounts being recognized in the period in which the change occurs. In 2008, we wrote-off $0.6 million primarily related to collection issues with two resellers. We have historically had insignificant write-offs related to bad debts. The allowance for doubtful accounts was $0.2 million, $0.1 million and $0.2 million at December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively.

Concentrations of Risks

Financial instruments that potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and accounts receivable. As of December 31, 2008, our $40.6 million in cash and cash equivalents consisted of $15.6 million of cash deposited with banks in demand deposit accounts and $25.0 million of cash equivalents invested in money market funds. As of September 30, 2009 (unaudited), our $125.8 million in cash and cash equivalents consisted of $24.8 million of cash deposited with banks in demand deposit accounts and $101.0 million of cash equivalents in money market funds. Our cash deposited with banks in demand deposit accounts may exceed the amount of insurance provided on these deposits. Our cash equivalents invested in money market funds are not insured and we are therefore at risk of losing our full investment. Generally, we may redeem our cash deposits and withdraw our invested cash equivalents upon demand. We strive to maintain our cash deposits and invest our money market funds with financial institutions of reputable credit and therefore bear minimal credit risk.

We provide credit to distributors, resellers and direct customers in the normal course of business. We generally extend credit to new customers based upon industry reputation and existing customers based upon prior payment history. We did not have any customer that represented 10% or more of our revenue for the years ended December 31, 2006 and 2007. In 2008, we had one distributor that represented 14.9% of our revenue. During the nine months ended September 30, 2009 (unaudited), that same distributor and one additional distributor with two customer identification numbers represented 13.9% and 15.3%, respectively, of our revenue.

Property and Equipment

We record property and equipment at cost and depreciate them using the straight-line method over their estimated useful lives. We depreciate equipment over five years, furniture and fixtures over five to seven years, and purchased software over three to five years. We amortize leasehold improvements using the straight-line method over the shorter of the lease term or the estimated useful lives of the related assets. Upon retirement or sale of property and equipment, we remove the cost of assets disposed of and any related accumulated depreciation from our accounts and credit or charge any resulting gain or loss to income. We expense repairs and maintenance as they are incurred.

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

 

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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 (Note 3). 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 authoritative guidance for 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 events and circumstances that we consider include the business climate, legal factors, operating performance indicators and competition. We evaluate impairment of goodwill and other intangible assets with indefinite lives using a two-step process. The first step involves a comparison of the fair value of a reporting unit with its carrying amount. If the carrying amount of the reporting unit exceeds its fair value, the second step of the process involves a comparison of the fair value and carrying amount of the goodwill and other intangible assets with indefinite lives of that reporting unit. If the carrying amount of the goodwill and other intangible assets with indefinite lives of a reporting unit exceeds the fair value of that goodwill and other intangible assets with indefinite lives, we would recognize an impairment loss in an amount equal to the excess of carrying value over fair value. 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.

Intangible Assets

Intangible assets consist of acquired developed product technologies, acquired customer relationships, patents and licenses to use intellectual property. As discussed in Note 3, we made two acquisitions in 2007 and one acquisition in 2008 that resulted in the recognition of intangible assets. We record intangible assets at fair value and amortize those with finite lives over the shorter of the contractual life or the estimated useful life, which is generally three years for customer relationships, five years for acquired developed product technologies and ten years for intellectual property. We estimate the useful lives of acquired developed product technologies and customer relationships based on factors that include the planned use of each developed product technology and the expected pattern of future cash flows to be derived from each developed product technology and existing customer relationships. We include amortization of acquired developed product technologies in cost of license revenue and amortization of customer relationships in general and administrative expenses in our consolidated statements of income.

Deferred Offering Costs

Deferred offering costs, consisting of legal, accounting and filing fees relating to our IPO in May 2009, were capitalized. Deferred offering costs, which were included in other intangible assets, were $84,000, $2.2 million and $0 at December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively. Upon the effectiveness of our IPO in May 2009, $4.1 million of deferred offering costs were offset against our public offering proceeds.

Leases

We lease facilities worldwide and certain equipment under non-cancelable lease agreements. The terms of some of our lease agreements provide for rental payments on a graduated basis. We recognize rent expense on a straight-line basis over the lease period and accrue rent expense incurred but not paid.

Debt Issuance Costs

We amortize debt issuance costs over the term of the associated debt. The gross carrying amount of debt issuance costs was $2.2 million at December 31, 2007 and 2008 and $1.2 million at September 30, 2009

 

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(unaudited) and accumulated amortization was $0.7 million, $1.1 million and $0.8 million at December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively. In May 2009, we paid down $49.8 million of long-term debt with proceeds from our IPO and wrote-off $0.4 million of debt issuance costs related to the portion of debt paid down. Interest expense includes the amortization and write-off of debt issuance costs, which was $0.4 million for each of the years ended December 31, 2006, 2007 and 2008 and $0.3 million and $0.7 million for the nine months ended September 30, 2008 and 2009 (unaudited), respectively.

Comprehensive Income

Comprehensive income consists of net income and other comprehensive income (loss), which includes certain changes in equity that are excluded from net income. Cumulative foreign currency translation adjustments, net of tax, are included in accumulated other comprehensive income (loss). We have reflected accumulated other comprehensive income (loss) in stockholders’ equity (deficit). Net income and comprehensive income were approximately the same in 2006 and 2007. In 2008, net income and comprehensive income were $22.3 million and $22.0 million, respectively. For the nine months ended September 30, 2009 (unaudited), net income and comprehensive income were $23.0 million and $23.3 million, respectively.

Research and Development Costs

We expense costs incurred in the research and development of our products as they are incurred. We expense costs associated with the development of computer software to be marketed prior to the establishment of technological feasibility and capitalize them from the point technological feasibility is reached until the product is ready for general release. We did not capitalize any software development costs for the years ended December 31, 2006, 2007 and 2008 and for the nine months ended September 30, 2008 and 2009 (unaudited), as costs incurred subsequent to the establishment of technological feasibility, but prior to general release, were insignificant.

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. In accordance with current guidance, we recognize revenue for software, maintenance and other services 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, for periods prior to January 1, 2007, for implied post contract support services. We recognize maintenance revenue ratably on a daily basis over the contract period, and 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.

Deferred Revenue

Deferred revenue consists of billings or payments received in advance of revenue recognition from maintenance fees and training services and, for periods prior to October 1, 2006, also from implied post contract support services. We generally bill maintenance agreements annually in advance for services to be performed over a 12-month period. On occasion, customers will purchase maintenance renewals for periods longer than 12 months. We initially record the amounts to be paid under maintenance agreements as deferred revenue and recognize these amounts ratably on a daily basis over the term of the maintenance agreement. We record deferred revenue that will be recognized during the succeeding 12-month period as current deferred revenue and the remaining portion is recorded as long-term deferred revenue.

We recognize training revenue upon delivery of the training course to the end-user. We establish VSOE of fair value for training through the standard rates we charge for training when sold separately.

Contingencies

We account for claims and contingencies in accordance with authoritative guidance that requires we record an estimated loss from a claim or loss contingency when information available prior to issuance of our financial statements indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. If we determine that it is reasonably possible but not probable that an asset has been impaired or a liability has been incurred or if the amount of a probable loss cannot be reasonably estimated, then we are permitted to disclose the amount or range of estimated loss if the amount or range of estimated loss is material. Accounting for claims and contingencies

 

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requires us to use our judgment. We consult with legal counsel on those issues related to litigation and seek input from other experts and advisors with respect to matters in the ordinary course of business.

Cost of Revenue

Cost of License Revenue. Cost of license revenue consists of amortization of acquired developed product technologies, the costs of media kits and shipping-related costs. We are amortizing the acquired developed product technologies on a straight-line basis over their estimated useful lives of five years. Amortization of acquired developed product technologies was $0.1 million, $0.2 million, $0.2 million and $0.5 million for the years ended December 31, 2007 and 2008 and the nine months ended September 30, 2008 and 2009 (unaudited), respectively.

Cost of Maintenance and Other Revenue. Cost of maintenance and other revenue consists of compensation and benefits related to personnel providing customer support and an allocation of facilities and other overhead costs.

Advertising

We expense advertising costs as incurred. Our advertising expense was $0.1 million, $0.5 million and $1.5 million for the years ended December 31, 2006, 2007 and 2008, respectively, and $1.0 million and $0.8 million for the nine months ended September 30, 2008 and 2009 (unaudited), respectively. Advertising expense is included in operating expenses in the consolidated statements of income.

Stock-Based Compensation

We have granted our employees stock options for common stock. On January 1, 2006, we adopted the authoritative guidance on share-based payments that 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 this guidance using the modified prospective transition method, which does not result in the revision of prior periods. Under the modified prospective transition method, this guidance 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 the previous guidance. 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 the previous guidance 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 basis over the respective vesting periods. Stock-based compensation decreased income before income taxes by $1.5 million, $3.8 million, $5.9 million, $4.3 million and $5.6 million for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2008 and 2009 (unaudited), respectively.

We have recorded compensation expense for stock options pursuant to the authoritative guidance. Because these amounts are not deductible for tax purposes until the stock option is exercised, a deferred tax asset is recorded for the deductible temporary difference related to nonstatutory stock options. The effect of compensation expense for qualified stock options is treated as a permanent difference. The exercise of nonstatutory stock options in May and July 2009 resulted in a tax deduction and utilization of deferred tax assets for stock-based compensation.

 

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An excess tax benefit arises when the tax deduction related to stock options is greater than the amount previously recognized for those stock options as deferred tax assets pursuant to the authoritative guidance. For financial reporting purposes, the deductible tax benefit is first recognized through the utilization of the deferred tax asset related to the stock options being exercised. The excess of the deductible tax benefit over the related deferred tax assets previously recognized is not recorded as a tax benefit in our consolidated income statement but is instead treated as additional paid-in capital in our consolidated balance sheet.

Pursuant to the authoritative guidance, 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 the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2008 and 2009 (unaudited), we reflected excess tax benefits from stock-based compensation awards of $0.2 million, $0.3 million, $83,000, $85,000 and $2.2 million, respectively, as a cash outflow from operating activities and a cash inflow from financing activities in our consolidated statements of cash flows, resulting in no net impact on cash.

Income Taxes

We use the liability method of accounting for income taxes as set forth in the authoritative guidance for 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 FASB issued guidance on accounting for uncertainty in income taxes, which 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 this guidance 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.

We accrue interest and penalties related to unrecognized tax benefits as a component of income tax expense. As of the adoption date of this guidance, there were no accrued interest and penalties.

Earnings Per Share

We computed basic earnings per share available to common stockholders by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the reporting period. We computed diluted earnings per share similarly to basic earnings per share except that it reflects the potential dilution that could occur if dilutive securities or other obligations to issue common stock were exercised or converted into common stock.

Reclassifications

Certain reclassifications have been made to the consolidated balance sheet as of December 31, 2007 to conform with the December 31, 2008 presentation. These reclassifications had no effect on total assets, total liabilities, total stockholders’ equity (deficit) or cash flows.

3. Business Combinations

On April 19, 2007, we acquired substantially all of the assets and liabilities of IPMonitor Corporation, or IPMonitor, for $5.9 million in cash. The only assets and liabilities that we did not acquire were the deferred tax and investment tax credits. We also incurred direct acquisition costs of approximately $0.3 million. IPMonitor provided us an immediate product offering, also called ipMonitor, that was missing from our product offerings

 

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and eliminated the normal time to market required to develop a new software product. ipMonitor is an all-in-one availability monitoring application for network devices, servers and applications. We included the operating results of IPMonitor in our consolidated financial statements from the effective date of the acquisition.

On May 14, 2007, we completed the acquisition of all of the issued and outstanding shares of Neon Software, Inc., or Neon, for $3.75 million in cash. We also incurred direct acquisition costs of approximately $0.3 million. Under the purchase agreement, we paid an additional $0.8 million and $0.5 million in May 2008 and September 2008, respectively, upon the achievement of the two development milestones. The payments made under the purchase agreement increased the amount of goodwill recorded. The Neon acquisition provided us an immediate desktop application for automated network discovery and topology mapping and eliminated the normal time to market required to develop a new software product. We included the operating results of Neon in our consolidated financial statements from the effective date of the acquisition.

We made both of these acquisitions because of the immediate availability of product offerings that complemented our existing products. We accounted for the IPMonitor and Neon acquisitions using the purchase method of accounting. We paid the purchase price for each of the acquisitions during 2007. There were no significant adjustments to the purchase prices of the acquisitions during 2007 or 2008.

We allocated the purchase prices for IPMonitor and Neon as follows:

 

(in thousands)		IPMonitor				Neon
Intangible assets:
Developed product technologies		$	702			$	456
Customer relationships			91				61
Trademarks			298				195
Goodwill			5,353				3,781
Deferred revenue			(472	)			(314	)
Net other assets (liabilities)			38				(421	)
Total purchase price, net of cash acquired		$	6,010			$	3,758

The following table presents our unaudited pro forma results of operations for 2006 and 2007 as if the acquisitions had occurred at the beginning of each period presented. We prepared the pro forma financial information for the combined entities for comparative purposes only, and it is not indicative of what actual results would have been if the acquisitions had taken place at the beginning of each period presented, or of future results.

 

		For the Years Ended December 31,
		2006			2007
		Pro Forma			Pro Forma
(in thousands)
Revenue		$	41,147		$	62,607
Net income			9,379			13,434
Net income available to common stockholders			4,694			6,851
Net income per share:
Basic		$	0.17		$	0.24
Diluted		$	0.17		$	0.24

On December 23, 2008, we acquired substantially all of the assets and liabilities of Trilenium Investments Limited for $7.2 million in cash. We also incurred direct acquisition costs of approximately $91,000. This acquisition provided us immediate product offerings titled Kiwi Syslog Server and Kiwi CatTools. By acquiring these products, we eliminated the normal time to market required to develop a new software product. We made the payment of the purchase price for the acquisition during 2008. There were no significant adjustments to the

 

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purchase price of the acquisition during 2008 or the nine months ended September 30, 2009 (unaudited). We included the operating results of this acquisition in our consolidated results from the effective date of the acquisition. This business is not considered material to our consolidated results of operations, financial position or cash flows.

We allocated the purchase price to the assets acquired, including cash and intangible assets, based on estimated fair value at the date of acquisition. We estimated the values of assets based on purchase price and future intended use. We derived the value of intangible assets from the present value of estimated future benefits from the various intangible assets acquired. Goodwill represents the excess of the purchase price over the aggregate fair value of the net identifiable assets acquired. The allocation of the purchase price to the assets acquired, including goodwill, has not been completed due to the pending completion of the valuation of intangible assets.

We allocated the purchase price as follows:

 

(in thousands)
Intangible assets:
Developed product technologies		$	1,750
Customer relationships			280
Trademarks			110
Goodwill			4,962
Total purchase price, net of cash acquired		$	7,102

The acquisitions in 2007 and 2008 were financed with cash flows from operations.

We considered trademarks to have an indefinite life and, accordingly, we do not amortize them. They will be subject to periodic impairment testing in future periods in accordance with the authoritative guidance on goodwill and other intangible assets. We are amortizing the acquired developed product technologies and customer relationships on a straight-line basis over their estimated useful lives of five years and three years, respectively. See Note 4 for discussion of the goodwill recognized in connection with the acquisitions in 2007 and 2008.

4. Goodwill and Other Intangible Assets

At December 31, 2007, we had goodwill in the amount of $9.1 million associated with the two acquisitions completed during 2007 as discussed in Note 3. At December 31, 2008 and September 30, 2009 (unaudited), we had goodwill in the amounts of $15.7 million and $15.8 million, respectively. The increase from 2007 consisted of $5.0 million associated with the acquisition completed during 2008 as discussed in Note 3, additional payments during 2008 of $0.8 million and $0.5 million upon achievement of the two development milestones related to the Neon acquisition and additional payments of $0.3 million related to direct acquisition costs. In accordance with SFAS No. 142, we assess the impairment of goodwill annually in the fourth quarter, or more frequently if other indicators of potential impairment arise. No impairment was noted at December 31, 2007, December 31, 2008 or September 30, 2009 (unaudited).

We record intangible assets in accordance with the authoritative guidance for business combinations. The developed product technologies that we acquired were as follows: (i) IPMonitor, the all-in-one availability monitoring application for network devices, servers and applications (and the intellectual property contained therein), to which we sell a perpetual license; (ii) Neon’s desktop application for automated network discovery and topology mapping (and the intellectual property contained therein); (iii) Kiwi Syslog Server, which receives, logs, displays and forwards syslog messages from network devices; and (iv) Kiwi CatTools, which manages and backs up network configurations. The product technologies above were feasible at the date of acquisition as they were being actively marketed and sold by the acquired companies at the respective acquisition dates. We

 

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recognize the developed product technologies as intangible assets separate from goodwill as they were capable of being separated or divided from the acquired entities and sold or licensed. We based the estimated useful lives of these assets primarily on future cash flows of the existing technologies considering future development cycles. In addition to the developed product technologies, we also recorded intangible assets for the acquired companies’ customer relationships and trademarks.

Intangible assets consisted of the following at December 31, 2008 and September 30, 2009:

 

		December 31, 2008										September 30, 2009
		Gross Carrying Amount			Accumulated Amortization				Net			Gross Carrying Amount			Accumulated Amortization				Net
(in thousands)												(unaudited)
Finite-lived intangible assets:
Developed product technologies		$	2,908		$	(378	)		$	2,530		$	2,908		$	(808	)		$	2,100
Customer relationships			432			(83	)			349			432			(190	)			242
Intellectual property			526			(74	)			452			614			(117	)			497
Total finite-lived intangibles			3,866			(535	)			3,331			3,954			(1,115	)			2,839
Indefinite-lived intangible assets:
Trademarks			806			—				806			1,024			—				1,024
Total intangible assets		$	4,672		$	(535	)		$	4,137		$	4,978		$	(1,115	)		$	3,863

Intangible asset amortization expense was $0.2 million, $0.3 million, $0.2 million and $0.6 million for the years ended December 31, 2007 and 2008 and for the nine months ended September 30, 2008 and 2009 (unaudited), respectively. We estimate aggregate intangible asset amortization expense to be $0.8 million for the full year 2009, $0.8 million in 2010, $0.7 million in 2011, $0.5 million in 2012 and $0.4 million in 2013. We amortize finite-lived intangible assets on a straight-line basis over their respective estimated useful lives. We use a useful life of five years for acquired developed product technologies, ten years for intellectual property and three years for customer relationships.

Deferred offering costs, which are included in other intangible assets, were $84,000, $2.2 million and $0 at December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively. See Note 2 for a discussion of deferred offering costs. Deposits of $4,000, $0.2 million and $0.2 million were also included in other intangible assets at December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively.

5. Property and Equipment

Property and equipment, including software, consisted of the following at December 31, 2007 and 2008 and September 30, 2009:

 

		December 31,								September 30, 2009
		2007				2008
(in thousands)										(unaudited)
Equipment		$	1,502			$	2,942			$	3,692
Furniture and fixtures			1,120				1,562				1,751
Software			924				980				1,356
Leasehold improvements			458				1,124				1,586
Construction in progress			—				—				8
			4,004				6,608				8,393
Less: Accumulated depreciation and amortization			(714	)			(1,430	)			(2,483	)
Property and equipment, net		$	3,290			$	5,178			$	5,910

 

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Depreciation and amortization expense on property and equipment was $0.1 million, $0.6 million, $1.1 million, $0.8 million and $1.2 million for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2008 and 2009 (unaudited), respectively. We had furniture and fixtures and equipment under capital leases at December 31, 2007 and 2008 and September 30, 2009 (unaudited). Accumulated depreciation related to capital leases was $78,000, $25,000 and $37,000 at December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively.

In accordance with the authoritative guidance on accounting for the impairment or disposal of long-lived assets, we evaluate long-lived assets held and used by us for impairment whenever events or changes in circumstances indicate that their net book value may not be recoverable. No circumstances or events indicated impairment to long-lived assets at December 31, 2007 or 2008 or at September 30, 2009 (unaudited).

6. Accrued Liabilities

Accrued liabilities at December 31, 2007 and 2008 and September 30, 2009 were as follows:

 

		December 31,						September 30, 2009
		2007			2008
(in thousands)								(unaudited)
Payroll-related accruals		$	1,297		$	1,831		$	3,006
Accrued management fees			334			276			—
Other accrued expenses			747			1,177			2,608
		$	2,378		$	3,284		$	5,614

7. Long-Term Debt

On December 13, 2005, we entered into credit agreements with an investment management firm pursuant to which we borrowed $85.0 million on a first lien note, or First Lien Note, and $25.0 million on a second lien note, or Second Lien Note, and collectively the Notes. The First Lien Note bears interest at the three-month LIBOR rate plus 3.5% (7.4% at December 31, 2008 and 4.1% at September 30, 2009), 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 and guaranty agreement, or Second Lien Credit Agreement (9.0% at December 31, 2008 and 5.8% at September 30, 2009). The Notes are payable on December 13, 2011. The total outstanding principal balance on the Notes was $101.1 million at December 31, 2008.

The first lien credit and guaranty agreement, or First Lien Credit Agreement, allows our lenders 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 First Lien Credit Agreement. The First Lien Credit 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. In early 2009, we made such an offer and prepaid $7.2 million of principal in March 2009. This $7.2 million prepayment is reflected as current portion of long-term debt in our December 31, 2008 consolidated balance sheet.

Pursuant to the terms of the First Lien Credit Agreement, we were required to repay a portion of the outstanding principal amount based on our leverage ratio for the 12 months immediately preceding the receipt of the net proceeds from our IPO. We did not elect to prepay any additional outstanding indebtedness under our December 2005 credit facilities with the net proceeds of our IPO. Therefore, we repaid an additional $49.8 million of principal with the net proceeds from our May 2009 IPO, reducing our outstanding principal balance on the Notes to $44.1 million as of September 30, 2009.

We have pledged substantially all of our North American assets as collateral on the Notes. The Notes include covenants that limit our incurrence of new borrowings, our ability to make acquisitions, capital

 

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expenditures and payments of cash dividends and that require us to maintain certain financial performance ratios. In March and August 2008, we amended our credit agreements. These amendments clarified certain provisions of the credit agreements related to the structure of the lender’s security interest and amended and permanently waived the default of certain covenants under the credit agreements. We paid a fee of $0.3 million in March 2008 related to these amendments. We were in compliance with each of these key operational and financial covenants as of September 30, 2009.

8. Stockholders’ Equity and Stock-Based Compensation

Common Stock and Preferred Stock

We declared a 3-for-1 stock split of our common stock and preferred stock in January 2008. We have presented all share and per share information giving effect to the stock split.

On March 14, 2008, we repurchased 725,556 shares of our common stock and 725,556 shares of our preferred stock from our lender and certain of its affiliated entities for an aggregate purchase price of $13.6 million, or $9.40 per share. We then sold 725,556 shares of our common stock and 725,556 shares of our preferred stock to the rest of our stockholders based on their pro rata ownership of our common and preferred stock for $9.40 per share, which resulted in total proceeds to us of $13.6 million.

Following the consummation of our IPO in May 2009, we amended our certificate of incorporation to, among other things, set the authorized capital stock of the company at 133,000,000 shares, par value of $0.001 per share, comprised of 123,000,000 shares of common stock and 10,000,000 shares of preferred stock. Each share of common stock entitles the holder thereof to one vote on each matter submitted to a vote at any meeting of stockholders.

Upon the closing of our IPO in May 2009, all 27,000,003 shares of preferred stock that were outstanding immediately prior to the closing of the offering converted into 27,000,003 shares of common stock in accordance with the terms of our certificate of incorporation.

Initial Public Offering

In May 2009, we completed our IPO, in which we issued and sold 9,000,000 shares of our common stock at a price of $12.50 per share. We raised a total of $112.5 million in gross proceeds from the offering, or approximately $100.5 million in net proceeds after deducting underwriting discounts and commissions of $7.9 million and other offering costs of $4.1 million.

2005 Stock Plan

Our Amended and Restated Stock Incentive Plan, or 2005 Stock Plan, was adopted by our board of directors and approved by our stockholders on December 14, 2005. Our 2005 Stock Plan provides for the grant of incentive stock options, nonstatutory stock options and restricted stock to our employees, directors and consultants. Our ability to grant any future equity awards under the 2005 Stock Plan was terminated in May 2009. As of September 30, 2009, options to purchase 12,032,615 shares of common stock were outstanding under the 2005 Stock Plan. Our 2005 Stock Plan will continue to govern the terms and conditions of the outstanding equity awards granted under the 2005 Stock Plan.

The standard form of option agreement under the 2005 Stock Plan provides that options will 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. Under our 2005 Stock Plan, our board of directors, or its designated committee, has the authority to grant options with early exercise rights, subject to our repurchase right that lapses as the shares vest on the original vesting schedule, and to provide for accelerated vesting.

 

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Our 2005 Stock Plan provides that our board of directors, or its designated committee, may equitably and proportionally adjust or substitute outstanding options upon certain events, including, without limitation, changes in our capitalization through stock splits, recapitalizations, mergers or consolidations. In lieu of an adjustment, our board of directors, or its designated committee, may terminate and cancel outstanding options in exchange for a cash payment or other consideration to the optionholder upon certain corporate events, including a change of control. The payment must equal the amount paid per share in connection with the event less the applicable exercise price per share for each cancelled option subject to exercise.

Our 2005 Stock Plan restricts the transfer of shares of our common stock issued pursuant to an award for 180 days following our IPO.

2008 Stock Plan

Our board of directors adopted and our stockholders approved our 2008 Equity Incentive Plan, or 2008 Stock Plan, in May 2008. Our 2008 Stock Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended, or the Code, to our employees and any parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance shares and performance units to our employees, directors and consultants and our parent and subsidiary corporations’ employees and consultants. All equity awards that have been granted following our IPO were granted under our 2008 Stock Plan. As of September 30, 2009, options to purchase 40,043 shares of common stock were outstanding and 5,046,287 shares of common stock were reserved for future grants under the 2008 Stock Plan.

 

The exercise price of an option granted under our 2008 Stock Plan must be at least equal to the fair market value of our common stock on the date of grant unless granted pursuant to a transaction described in, and in a manner consistent with, Section 424(a) of the Code. The term of an incentive stock option granted under our 2008 Stock Plan may not exceed ten years, except that, with respect to any participant who owns 10% or more of the voting power of all classes of our outstanding stock as of the grant date, the term must not exceed five years and the exercise price must equal at least 110% of the fair market value on the grant date unless granted pursuant to a transaction described in, and in a manner consistent with, Section 424(a) of the Code.

Each non-employee director first appointed to the board of directors will receive an automatic initial nonstatutory stock option to purchase 30,000 shares of common stock upon such appointment. Each initial option to purchase 30,000 shares will become exercisable as to one-third of the shares subject to the option on the first anniversary of its date of grant and 1/36 of the total number of shares subject to the option monthly thereafter, provided the non-employee director remains a director on those dates.

Immediately following each annual meeting of our stockholders, non-employee directors who have been directors for at least the preceding six months will receive (i) a subsequent nonstatutory stock option to purchase a number of shares of common stock determined by dividing $75,000 by the value of an option to purchase one share of our common stock determined using the Black-Scholes valuation model or such other valuation method as the plan administrator determines in its discretion, and (ii) a number of shares of restricted stock determined by dividing $25,000 by the fair market value of a share of our common stock on the date of grant. All options granted under the foregoing automatic grant provisions will have a term of ten years and an exercise price equal to the fair market value of our common stock on the date of grant. Each annual option will become exercisable as to 100% of the shares subject to the option and the forfeiture provision of each annual restricted stock award will lapse on the earlier of (i) the date of the next year’s annual stockholder meeting or (ii) December 31 of the calendar year following the calendar year in which the award is granted, provided the non-employee director remains a director on that date.

 

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Option grant activity under the 2005 and 2008 Stock Plan was as follows:

 

		Number of Shares Outstanding			Weighted- Average Exercise Price
Balances at December 31, 2005		3,000,000			$	2.69
Options granted		6,229,800				2.69
Options exercised		(450,000	)			2.69
Options forfeited		(139,697	)			2.69
Balances at December 31, 2006		8,640,103				2.69
Options granted		2,899,425				4.23
Options exercised		(647,091	)			2.69
Options forfeited		(376,295	)			3.00
Balances at December 31, 2007		10,516,142				3.10
Options granted		1,957,414				7.67
Options exercised		(69,562	)			3.27
Options forfeited		(399,993	)			3.94
Balances at December 31, 2008		12,004,001				3.82
Options granted (unaudited)		1,567,892				10.04
Options exercised (unaudited)		(910,649	)			2.95
Options forfeited (unaudited)		(588,586	)			7.74
Balances at September 30, 2009 (unaudited)		12,072,658			$	4.50

Additional information regarding options outstanding and exercisable at December 31, 2008 is as follows:

 

		Options Outstanding							Options Exercisable
Range of Exercise Prices		Number of Shares		Average Remaining Contractual Life (Years)		Weighted-Average Exercise Price			Number of Shares		Average Remaining Contractual Life (Years)		Weighted-Average Exercise Price
$2.69-9.40		12,004,001		8.00		$	3.82		7,792,499		7.61		$	2.92

Additional information regarding options outstanding at September 30, 2009 (unaudited) is as follows:

 

		Options Outstanding							Options Exercisable
Range of Exercise Prices		Number of Shares		Average Remaining Contractual Life (Years)		Weighted-Average Exercise Price			Number of Shares		Average Remaining Contractual Life (Years)		Weighted-Average Exercise Price
$2.69 -19.99		12,072,658		7.52		$	4.50		8,329,136		7.02		$	3.30

The aggregate intrinsic value of options exercised, vested and expected to vest in 2006 was $0. The aggregate intrinsic value of stock options exercised in 2007 was $0.9 million, resulting in income tax benefits of $0.3 million. The aggregate intrinsic value of stock options exercised in 2008 was $0.4 million, resulting in income tax benefits of $83,000. The aggregate intrinsic value of stock options exercised in the nine months ended September 30, 2009 (unaudited) was $8.5 million, resulting in income tax benefits of $2.2 million. The aggregate intrinsic value of outstanding stock options was $59.3 million and $211.7 million as of December 31, 2008 and September 30, 2009 (unaudited), respectively. The aggregate intrinsic value of stock options exercisable at December 31, 2008 and September 30, 2009 (unaudited) was $47.6 million and $156.0 million, respectively. As of December 31, 2008 and September 30, 2009, 11,818,041 and 11,900,951 shares, respectively, were vested and expected to vest with weighted average exercise prices of $3.78 and $4.45 per share, respectively, and had

 

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aggregate intrinsic values of $58.7 million and $209.2 million, respectively. These shares have weighted average remaining contractual terms of 7.98 and 7.50 years, respectively.

The total unrecognized stock-based compensation expense related to unvested stock options and subject to recognition in future periods was approximately $14.8 million and $15.6 million as of December 31, 2008 and September 30, 2009 (unaudited), respectively. The $14.8 million of unrecognized share-based compensation expense related to unvested stock options and subject to recognition in future periods at December 31, 2008 relates to 5,863,264 shares with a per share weighted-average fair value of $2.88. The $15.6 million of unrecognized stock-based compensation expense related to unvested stock options and subject to recognition in future periods at September 30, 2009 (unaudited) relates to 4,606,938 shares with a per share weighted-average fair value of $3.83. We expected to recognize this expense over weighted-average periods of approximately 2.36 and 2.25 years at December 31, 2008 and September 30, 2009 (unaudited), respectively.

We estimated fair value for these options at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

 

		Year Ended December 31, 2006		Year Ended December 31, 2007		Year Ended December 31, 2008		Nine Months Ended September 30, 2009
								(unaudited)
Expected dividend yield		0.0%		0.0%		0.0%		0.0%
Volatility		69.0%		65.7%		57.6%		63.4%
Risk-free rate of return		4.6 - 5.0%		4.0 - 4.7%		2.6 - 3.7%		2.2 - 3.7%
Expected life		6.25 years		6.03 years		6.05 years		6.06 years

We have not paid and do not anticipate paying cash dividends on our common stock; therefore, we assumed the expected dividend yield to be zero. The dividend payable reflected in our consolidated balance sheet at September 30, 2009 is related to an earnout payment to our original stockholders. Since we were a private entity prior to our IPO in May 2009 with no historical data regarding the volatility of our own common stock price, we based the expected volatility on the historical and implied volatility of comparable companies from a representative industry peer group. We determined expected volatility of options granted using an average of the historical volatility measures of this peer group of companies. We based the risk-free rate of return on the U.S. treasury yield curve for seven-year terms for the years ended December 31, 2007 and 2008 and the nine months ended September 30, 2009 (unaudited). As allowed under current guidance, we have elected to apply the “simplified method” in developing our estimate of expected life for “plain vanilla” stock options by using the midpoint between the vesting date and contractual termination date since we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term due to the limited period of time our common stock has been publicly traded.

The weighted average grant date fair values of options granted during the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2009 (unaudited) were $1.79, $2.67, $4.35 and $5.95 per share, respectively.

 

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In 2007, 2008 and during the nine months ended September 30, 2009 (unaudited), we granted options to purchase shares of common stock with exercise prices as follows:

 

Grant Date		Options Granted		Exercise Price Per Share
January 2007		362,250		$	4.06
April 2007		650,325			4.06
July 2007		213,450			4.06
October 2007		773,400			4.35
November 2007		900,000			4.35
January 2008		679,989			4.48
March 2008		122,300			9.40
April 2008		187,450			9.40
May 2008		515,800			9.40
June 2008		275,850			9.40
July 2008		88,900			9.40
August 2008		42,350			9.40
November 2008		44,775			8.68
March 2009		261,850			8.68
April 2009		1,265,799			10.00
July 2009		40,243			19.99

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 March 2007, one of our original stockholders exercised an option to purchase 647,091 shares of our common stock at an exercise price of $2.69 per share and paid the exercise price with a non-recourse promissory note in the amount of $1.7 million. The note was secured by the shares of common stock. The promissory note, which bears interest at a rate of 4.88%, was due on the earliest of (i) January 25, 2012, (ii) the sale of all or substantially all of our assets, (iii) a merger or consolidation where our equity securities owned prior to merger or consolidation are less than a majority of the outstanding equity securities of the surviving entity and (iv) our IPO. On March 5, 2008, that stockholder repaid the note receivable.

 

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Restricted Stock Awards

The following table summarizes restricted stock activity under the 2008 Stock Plan:

 

		Number of Awards Outstanding		Weighted- Average Grant Date Fair Value (Per Share)
Balances at December 31, 2008		—		$	—
Awards granted (unaudited)		3,753			19.99
Awards exercised (unaudited)		—			—
Awards forfeited (unaudited)		—			—
Balances at September 30, 2009 (unaudited)		3,753		$	19.99

To date, no restricted stock has vested. As of September 30, 2009, restricted stock awards for 3,753 shares of our common stock were outstanding, with an aggregate intrinsic value of $83,000 based on the share price as of September 30, 2009 (unaudited). These awards are expected to vest as of the 2010 annual meeting of our stockholders.

9. Earnings Per Share

We computed basic earnings per share available to common stockholders using the weighted average number of our common shares outstanding during the reporting period. We adjusted diluted earnings per share for the after-tax impact of incremental shares that would be available for issuance upon the assumed exercise of stock options and for the shares that would be issued upon the conversion of the convertible preferred stock.

A reconciliation of the number of the numerator and denominator used in the calculation of basic and diluted earnings per share follows:

 

		Year Ended December 31,									Nine Months Ended September 30,
		2006			2007			2008			2008			2009
											(unaudited)
Basic earnings per share
(in thousands)
Numerator:
Net income available to common stockholders		$	4,800		$	6,926		$	11,383		$	8,504		$	22,961
Denominator:
Weighted average common shares outstanding			27,014			27,969			28,137			28,130			46,183
Weighted average shares used in computing basic earnings per share available to common stockholders			27,014			27,969			28,137			28,130			46,183
Diluted earnings per share
Numerator:
Net income available to common stockholders		$	4,800		$	6,926		$	11,383		$	8,504		$	22,961
Add amount allocated to participating preferred stockholders			4,791			6,681			—			—			—
Net income		$	9,591		$	13,607		$	11,383		$	8,504		$	22,961
Denominator:
Weighted average shares used in computing basic earnings per share			27,014			27,969			28,137			28,130			46,183
Add options to purchase common stock			41			1,061			4,515			4,280			5,618
Add conversion of preferred stock			27,000			27,000			—			—			—
Weighted average shares used in computing diluted earnings per share available to common stockholders			54,055			56,030			32,652			32,410			51,801

 

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Net income has been allocated to the common and preferred stock based on their respective rights to share in dividends. The conversion of the convertible preferred stock outstanding into 27,000,003 shares of common stock was not included in diluted earnings per share for the year ended December 31, 2008 or for the nine months ended September 30, 2008 under the if-converted method because the results would have been antidilutive.

Dilution from assumed exercises of stock options is dependent upon several factors, including the market price of our common stock. During the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2008 and 2009 (unaudited), options to purchase approximately 6,643,000, 6,721,000, 1,959,000, 2,139,000 and 44,000 shares of common stock, respectively, were outstanding but were not included in the computation of diluted earnings per share because the average market price of the underlying stock did not exceed the sum of the option exercise price, unrecognized compensation expense and the excess tax benefit. The calculation of diluted earnings per share requires us to make certain assumptions related to the use of proceeds that would be received upon the assumed exercise of stock options. These assumed proceeds include the excess tax benefit that we receive upon assumed exercises.

10. Employee Benefit Plan

In October 2008, we established a 401(k) matching program for all eligible employees. We match an amount equal to 100% of the employee’s contributions for the first 3%, and 50% for the next 2% of the employee’s total eligible compensation. The total contributions per participant per year were limited to $15,500 for 2008 and are limited to $16,500 for 2009. We, as sponsor of the plan, use an independent third party to provide administrative services to the plan. We have the right to terminate the plan at any time. Employees are fully vested in all contributions to the plan. Our expense totaled approximately $86,000 for the year ended December 31, 2008 and $0.4 million for the nine months ended September 30, 2009 (unaudited).

11. Related Party Transactions

Historically, we leased our office space in two locations from companies owned by our original stockholders. These lease agreements were terminated prior to May 2007. Effective May 2007, we no longer rented office space from our original stockholders. Rent expense on these locations was $0.3 million and $0.1 million for the years ended December 31, 2006 and 2007, respectively.

We purchased transportation services of $5,000 in 2006 from companies owned by our original stockholders.

We employed our original stockholders as officers and paid them combined salaries of $0.5 million in 2006.

We have previously been required to pay management fees to certain stockholders pursuant to contractual agreements. We expensed $1.0 million for each of the years ended December 31, 2006, 2007 and 2008 for these management fees. We also paid management fees and legal expenses incurred by our founder and a current member of our board of directors of $0.7 million and $1.2 million in 2008 and the nine months ended September 30, 2009 (unaudited), respectively. The management fees are no longer required to be paid due to the completion of our IPO in May 2009.

On August 31, 2006, we entered into a license agreement with NetSuite Inc. Under the terms of the agreement, we paid approximately $148,000, $229,000, $471,000, $340,000 and $582,000 for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2008 and 2009 (unaudited), respectively, for the use of their services. Our President, Chief Operating Officer, Chief Financial Officer and Treasurer became a member of NetSuite’s Board of Directors in September 2006.

 

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We entered into a 24-month contract with salesforce.com, inc. on September 1, 2006 for use of their license and support. We paid $28,000, $98,000, $194,000, $81,000 and $112,000 to salesforce.com for the years ended December 31, 2006, 2007 and 2008 and the nine months ended September 30, 2008 and 2009 (unaudited), respectively. The then President and Chief Strategy Officer for salesforce.com became a member of our board of directors in January 2008.

12. Income Taxes

U.S. and International components of income before income taxes were as follows:

 

		Year Ended December 31,
(in thousands)		2006			2007			2008
U.S.		$	15,187		$	20,090		$	28,985
International			—			1,041			4,037
Income before income taxes		$	15,187		$	21,131		$	33,022

Income tax expense (benefit) was composed of the following:

 

		Year Ended December 31,
(in thousands)		2006				2007				2008
Current:
Federal		$	4,341			$	7,900			$	11,068
State			422				540				200
International			—				326				431
			4,763				8,766				11,699
Deferred:
Federal			759				(1,031	)			(941	)
State			74				(32	)			13
International			—				(179	)			(54	)
			833				(1,242	)			(982	)
		$	5,596			$	7,524			$	10,717

The difference between the income tax expense (benefit) derived by applying the Federal statutory income tax rate to our income before income taxes and the amount recognized in our consolidated financial statements is as follows:

 

		Year Ended December 31,
(in thousands)		2006				2007				2008
Expense derived by applying the Federal statutory income tax rate to income before income taxes		$	5,315			$	7,398			$	11,558
State taxes, net of federal benefit			509				270				225
Permanent items			(223	)			(356	)			(808	)
Research and development tax credits			(123	)			(138	)			(437	)
Stock-based compensation			118				585				1,030
Effect of foreign operations			—				(235	)			(851	)
		$	5,596			$	7,524			$	10,717

 

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The components of the net deferred tax amounts recognized in the accompanying consolidated balance sheets were:

 

		December 31,
(in thousands)		2007			2008
Deferred tax assets:
Allowance for doubtful accounts		$	119		$	21
Accrued expenses			133			317
Stock-based compensation			1,190			2,155
Foreign royalty			181			216
Total deferred tax assets			1,623			2,709
Deferred tax liabilities:
Property and equipment			66			398
Prepaid expenses			221			296
Change in accounting method			420			—
Amortization			11			128
Total deferred taxes liabilities			718			822
Net deferred tax asset		$	905		$	1,887

We establish valuation allowances when necessary to reduce deferred tax assets to amounts expected to be realized. As of December 31, 2007 and 2008, we have not recorded a valuation allowance as it is more likely than not that the deferred tax assets will be realized.

We do not record federal income taxes on the undistributed earnings of our foreign subsidiaries that we consider to be permanently reinvested in foreign operations. The cumulative amount of these undistributed earnings was approximately $4.9 million at December 31, 2008 and $1.3 million at December 31, 2007. The estimated amount of the deferred tax liability associated with these undistributed earnings is approximately $1.3 million and $0.3 million respectively, which includes a benefit related to foreign tax credits generated by the repatriation of foreign earnings.

On January 1, 2007, we adopted the guidance on accounting for uncertainty in income taxes. As a result of applying the provisions of this guidance, there were no liabilities for material unrecognized tax benefits and no reduction in accumulated deficit as of January 1, 2007, and therefore no accrued interest and penalties recognized as of January 1, 2007. 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. Our policy is to include interest and penalties related to unrecognized tax benefits in income tax expense, and as of December 31, 2007 and December 31, 2008, there were no accrued interest and penalties.

The aggregate changes in the balance of unrecognized tax benefits as of December 31, 2008 were as follows:

 

(in thousands)
Balance, beginning of year		$	—
Increases for tax positions related to the current year			188
Increases for tax positions related to prior years			—
Decreases for tax positions related to prior years			—
Reductions due to lapsed statute of limitations			—
Balance, end of year		$	188

As of December 31, 2008, there were no unrecognized tax benefits that we expect would change significantly over the next 12 months.

 

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We file U.S., state and foreign income tax returns in jurisdictions with varying statutes of limitations. The 2006 through 2008 tax years generally remain subject to examination by federal and state tax authorities. In significant foreign jurisdictions, the 2007 and 2008 tax years generally remain subject to examination by their respective tax authorities. The statute of limitations for the 2005 tax year expired during the quarter ended September 30, 2009. The Internal Revenue Service, or the IRS, has concluded its examination of the tax year ended December 31, 2006, which resulted in no changes. We are not currently under audit in any major taxing jurisdictions.

13. Commitments and Contingencies

Leases

At December 31, 2008, future minimum lease payments under noncancellable operating leases were as follows:

 

(in thousands)
2009		$	2,466
2010			2,335
2011			2,235
2012			1,857
2013			1,365
Thereafter			3,194
Total minimum lease payments		$	13,452

In conjunction with the corporate building lease agreement, we entered into a letter of credit agreement totaling $1.5 million. As of December 31, 2008, the letter of credit was unused.

The future minimum lease payments under the capital lease as of December 31, 2008 were $25,000 for 2009 and $10,000 for 2010.

After December 31, 2008, we amended our lease agreement whereby we will expand our current corporate headquarters in Austin, Texas. Our future minimum operating lease obligations, including the amended lease agreement, are presented below:

 

(in thousands)
2009		$	2,868
2010			3,138
2011			3,038
2012			2,661
2013			2,168
Thereafter			5,134
Total minimum lease payments		$	19,007

In conjunction with the amended lease agreement, the letter of credit agreement totaling $1.5 million will be increased by $0.5 million.

Outstanding Obligations

At December 31, 2007, 2008 and September 30, 2009 (unaudited), we had outstanding purchase orders aggregating $0.7 million, $1.0 million and $1.2 million, respectively, that represented purchases of software license and support fees, marketing activities and computer hardware and software.

 

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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 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 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 co-author and co-owner, as well as punitive damages and unspecified other legal and equitable relief. We have asserted counterclaims against the former employee. We have agreed to indemnify Mr. Yonce 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. Even if we prevail in the litigation, we have incurred litigation fees and expenses and could incur significant additional litigation fees and expenses. Because this lawsuit is at an early 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.

In the ordinary course of business, we may be subject to litigation related to matters arising out of our business operations. We do not believe that any of these outstanding matters will have a material adverse effect on our consolidated financial position, result of operations or liquidity.

Registration Rights

We entered into an agreement in 2005 providing our stockholders with rights to have their shares of our common stock registered under the Securities Act of 1933, if requested by a majority of the holders of the shares.

Other

We entered into an agreement in 2005 to pay specified amounts, up to a maximum of $20.0 million, to our original stockholders, upon the completion of an exit event meeting specified parameters. An exit event is defined as either a sale of or a public offering by our company. Our IPO in May 2009 met the parameters for an exit event and this payout is due to our original stockholders after the expiration of the IPO lock-up agreements on November 15, 2009 based on the closing price per share of our common stock on November 15, 2009. Based on our stock price at September 30, 2009, we expect that we will make the maximum earnout payment of $20.0 million to our original stockholders. Therefore, the amount of this earnout payment is reflected as a dividend payable in our consolidated statement of changes in convertible preferred stock and stockholders’ equity (deficit) and as a reduction of additional paid-in capital and a current liability in our September 30, 2009 consolidated balance sheet.

The dividend payable of $20.0 million as of September 30, 2009 (unaudited) is calculated in accordance with a formula provided in an agreement with certain of our original stockholders and will either be $0, $10.0 million or $20.0 million. If the closing price per share of our common stock on November 15, 2009 is less than $8.05 per share, the earnout paid would be $0. If the closing price per share on November 15, 2009 is equal to or greater than $8.06 per share but less than $10.75 per share, the earnout paid would be $10.0 million. If the closing price per share on November 15, 2009 is equal to or greater than $10.75 per share, the earnout paid would be $20.0 million.

 

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14. Operating Segment and Geographic Information

We operate as a single segment. Our chief operating decision-maker is considered to be our Chief Operating Officer. The chief operating decision-maker allocates resources and assesses performance of the business at the consolidated level.

The authoritative guidance for disclosures about segments of an enterprise establishes standards for reporting information about operating segments. It defines operating segments as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision-maker in deciding how to allocate resources and in assessing performance. Our Chief Operating Officer reviews financial information including profit and loss information on a consolidated basis, accompanied by revenue information by product and by geography, for purposes of allocating resources and evaluating financial performance. We have one business activity, and there are no segment managers who are held accountable for operations, operating results or components below the consolidated unit level. Accordingly, we considered ourselves to be in a single operating and reporting segment structure.

We based revenue by geography for the period from July 1, 2007 to September 30, 2009 on the billing address of each customer because we established our international operations effective July 1, 2007. For periods prior to July 1, 2007, all revenue was reflected as North American revenue because all sales were made directly from our North American operations to our international customers. The following table sets forth revenue by geographic area:

 

		Year Ended December 31,									Nine Months Ended September 30,
		2006			2007			2008			2008			2009
(in thousands)											(unaudited)
North America		$	38,234		$	57,762		$	75,806		$	56,106		$	67,577
International			—			3,973			17,329			12,132			15,890
Total		$	38,234		$	61,735			93,135		$	68,238		$	83,467

Net long-lived assets were $2.9 million, $3.9 million and $4.3 million in North America and $0.4 million, $1.3 million and $1.6 million in our international subsidiaries at December 31, 2007 and 2008 and September 30, 2009 (unaudited), respectively.

 

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UNAUDITED CONDENSED PRO FORMA FINANCIAL INFORMATION

We have derived the following unaudited condensed pro forma financial information by applying pro forma adjustments to the historical consolidated statements of income for the year ended December 31, 2008 and the nine months ended September 30, 2009 included elsewhere in this prospectus. The unaudited condensed pro forma statement of income gives pro forma effect to the closing of this offering, including the application of the proceeds therefrom, as if the closing had occurred on January 1, 2008. We refer to the adjustments related to the closing of this offering as the “Offering Adjustments.” We have described the adjustments, which are based upon available information and upon assumptions that management believes to be reasonable, in the accompanying notes. The unaudited condensed pro forma financial information is for informational purposes only, should not be considered indicative of actual results that would have been achieved had this offering actually been consummated on the dates indicated and does not purport to be indicative of results of operations or for any future period.

You should read our unaudited condensed pro forma financial information and the related notes in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our historical consolidated financial statements and related notes, all included elsewhere in this prospectus.

 

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UNAUDITED CONDENSED PRO FORMA STATEMENT OF INCOME

For the Year Ended December 31, 2008

 

						Pro Forma
		Actual(1)				Offering Adjustments				As Adjusted
(in thousands, except per share data)
Revenue		$	93,135			$	—			$	93,135
Cost of revenue			3,588				—				3,588
Sales and marketing			22,664				—				22,664
Research and development			8,452				—				8,452
General and administrative			16,464				—				16,464
Other income (expense)			(8,945	)			4,739	(2)			(4,206	)
Income before income taxes			33,022				4,739				37,761
Income tax expense			10,717				1,824	(3)			12,541
Net income		$	22,305			$	2,915			$	25,220
Net income available to common stockholders		$	11,383			$	13,837	(4)		$	25,220
Earnings per share available to common stockholders:
Basic		$	0.40							$	0.41
Diluted		$	0.35							$	0.38
Shares used in computation of per share amounts
Basic			28,137				33,935	(5)			62,072
Diluted			32,652				33,935	(5)			66,587
Additional earnings per share data:
Net income available to common stockholders		$	11,383			$	13,837	(4)		$	25,220
Earnings per share available to common stockholders:
Basic		$	0.40							$	0.38
Diluted		$	0.35							$	0.36
Shares used in computation of per share amounts
Basic			28,137				37,500	(6)			65,637
Diluted			32,652				37,500	(6)			70,152

 

(1)	Derived from the audited consolidated statement of income for SolarWinds for the year ended December 31, 2008.

(2)

Represents the reduction in interest expense associated with the repayment of $49.8 million of the outstanding principal amount of our long-term debt with the net proceeds from our IPO in May 2009 and with the repayment of approximately $13.8 million of the outstanding principal amount of our long-term debt, each as required under the terms of our credit facilities and described under “Use of Proceeds.” In addition, the amortization of our debt issuance costs was decreased as a result of the lower outstanding principal balance due to the repayment of our long-term debt.

(3)	Represents the tax effect of the interest expense adjustment discussed in footnote (2) above, assuming a statutory tax rate of 38.5%.

(4)	Represents the amount allocated to participating preferred stockholders due to the conversion of all outstanding shares of our convertible preferred stock into 27,000,003 shares of our common stock.

(5)

Represents the conversion of all outstanding shares of our convertible preferred stock into 27,000,003 shares of our common stock, 1,791,000 shares issued related to the $20.0 million earnout and 4,500,000 shares issued related to the repayment of $49.8 million of the outstanding principal amount of our long-term debt from the IPO completed in May 2009. In addition, the adjustment represents 750,000 shares issued related to the repayment of $13.8 million of the outstanding principal amount of our long-term debt from this offering.

(6)

Represents the conversion of all outstanding shares of our convertible preferred stock into 27,000,003 shares of our common stock and the sale of 9,000,000 shares of common stock sold by us upon the closing of our IPO. In addition, the adjustment represents the sale of 1,500,000 shares of common stock sold by us in this offering.

 

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UNAUDITED CONDENSED PRO FORMA STATEMENT OF INCOME

For the Nine Months Ended September 30, 2009

 

						Pro Forma
		Actual(1)				Offering Adjustments				As Adjusted
(in thousands, except per share data)
Revenue		$	83,467			$	—			$	83,467
Cost of revenue			3,585				—				3,585
Sales and marketing			21,690				—				21,690
Research and development			8,167				—				8,167
General and administrative			13,127				—				13,127
Other income (expense)			(3,522	)			2,471	(2)			(1,051	)
Income before income taxes			33,376				2,471				35,847
Income tax expense			10,415				890	(3)			11,305
Net income		$	22,961			$	1,581			$	24,542
Earnings per share available to common stockholders:
Basic		$	0.50							$	0.37
Diluted		$	0.44							$	0.34
Shares used in computation of per share amounts
Basic			46,183				20,733	(4)			66,916
Diluted			51,801				20,733	(4)			72,534
Additional earnings per share data:
Earnings per share available to common stockholders:
Basic		$	0.50							$	0.37
Diluted		$	0.44							$	0.34
Shares used in computation of per share amounts
Basic			46,183				19,897	(5)			66,080
Diluted			51,801				19,897	(5)			71,698

 

(1)	Derived from the unaudited consolidated statement of income for SolarWinds for the nine months ended September 30, 2009.

(2)

Represents the reduction in interest expense associated with the repayment of $49.8 million of the outstanding principal amount of our long-term debt with the net proceeds from our IPO in May 2009 and with the repayment of approximately $13.8 million of the outstanding principal amount of our long-term debt, each as required under the terms of our credit facilities and described in the “Use of Proceeds.” In addition, the amortization of our debt issuance costs was decreased as a result of the lower principal balance due to the repayment of our long-term debt.

(3)	Represents the tax effect of the interest expense adjustment discussed in footnote (2) above, assuming a statutory tax rate of 36.0%.

(4)

Represents the conversion of all outstanding shares of our convertible preferred stock into 27,000,003 shares of our common stock, 1,791,000 shares issued related to the $20.0 million earnout and 4,500,000 shares issued related to the repayment of $49.8 million of the outstanding principal amount of our long-term debt from the IPO completed in May 2009. In addition, the adjustment represents 750,000 shares issued related to the repayment of $13.8 million of the outstanding principal amount of our long-term debt from this offering.

(5)

Represents the conversion of all outstanding shares of our convertible preferred stock into 27,000,003 shares of our common stock and the sale of 9,000,000 shares of common stock sold by us upon the closing of our IPO. In addition, the adjustment represents the sale of 1,500,000 shares of common stock sold by us in this offering.

 

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10,000,000 Shares

Common Stock

Prospectus

Joint Book-Running Managers

 

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

 

 

 

Jefferies & Company		Thomas Weisel Partners LLC

 

FBR Capital Markets				Pacific Crest Securities

                    , 2009

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PART II

INFORMATION NOT REQUIRED IN THE PROSPECTUS

 

Item 13.

Other Expenses of Issuance and Distribution.

Estimated expenses, other than underwriting discounts and commissions, payable by the Registrant in connection with the sale of the common stock being registered under this registration statement are as follows:

 

SEC registration fee		$	12,709
FINRA filing fee			25,500
Printing and engraving expenses			125,000
Legal fees and expenses			200,000
Accounting fees and expenses			200,000
Blue Sky fees and expenses (including legal fees)			25,000
Transfer agent and registrar fees and expenses			30,000
Miscellaneous			181,791
Total		$	800,000

 

Item 14.

Indemnification of Directors and Officers.

The Registrant’s amended and restated certificate of incorporation contains provisions that eliminate, to the maximum extent permitted by the General Corporation Law of the State of Delaware, the personal liability of the Registrant’s directors and executive officers for monetary damages for breach of their fiduciary duties as directors or officers. The Registrant’s amended and restated certificate of incorporation and bylaws provide that the Registrant must indemnify its directors and executive officers and may indemnify its employees and other agents to the fullest extent permitted by the General Corporation Law of the State of Delaware.

Sections 145 and 102(b)(7) of the General Corporation Law of the State of Delaware provide that a corporation may indemnify any person made a party to an action by reason of the fact that he or she was a director, executive officer, employee or agent of the corporation or is or was serving at the request of a corporation against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by him or her in connection with such action if he or she acted in good faith and in a manner he or she reasonably believed to be in, or not opposed to, the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful, except that, in the case of an action by or in right of the corporation, no indemnification may generally be made in respect of any claim as to which such person is adjudged to be liable to the corporation.

The Registrant has entered into indemnification agreements with its current directors and executive officers, in addition to the indemnification provided for in its amended and restated certificate of incorporation and bylaws, and intends to enter into indemnification agreements with any new directors and executive officers in the future.

The Registrant has purchased and intends to maintain insurance on behalf of each any person who is or was a director or officer of the Registrant against any loss arising from any claim asserted against him or her and incurred by him or her in any such capacity, subject to certain exclusions.

The Underwriting Agreement (see Exhibit 1.1 hereto) provides for indemnification by the underwriters of the Registrant, certain of its stockholders and its executive officers and directors, and by the Registrant of the underwriters, for certain liabilities, including liabilities arising under the Securities Act.

See also the undertakings set out in response to Item 17 herein.

 

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Item 15.

Recent Sales of Unregistered Securities.

(1) On December 19, 2006, the Registrant issued and sold an aggregate of 450,000 shares of the Registrant’s common stock pursuant to an option exercise by an executive officer at the purchase price of $2.69 per share for an aggregate consideration of $1,208,340.00. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering. The recipient of the securities in this transaction represented his intention to acquire the securities for investment only and not with a view to, or for resale in connection with, any distribution thereof, and appropriate legends were affixed to the share certificate issued in such transaction. The recipient received adequate information about the Registrant or had adequate access, through his relationship with the Registrant, to information about the Registrant.

(2) On January 16, 2007, the Registrant granted to certain of its employees options to purchase an aggregate of 302,250 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.06 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(3) On January 16, 2007, the Registrant granted to one of its employees options to purchase an aggregate of 60,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.06 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering.

(4) On March 13, 2007, the Registrant issued and sold an aggregate of 647,091 shares of common stock pursuant to an option exercise by a director at the purchase price of $2.69 per share for an aggregate consideration of $1,737,568.76. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering. The recipient of the securities in this transaction represented his intention to acquire the securities for investment only and not with a view to, or for resale in connection with, any distribution thereof, and appropriate legends were affixed to the share certificate issued in such transaction. The recipient received adequate information about the Registrant or had adequate access, through his relationship with the Registrant, to information about the Registrant.

(5) On April 26, 2007, the Registrant granted to certain of its employees options to purchase an aggregate of 410,325 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.06 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(6) On April 26, 2007, the Registrant granted to one of its executive officers an option to purchase an aggregate of 240,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.06 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

(7) On July 26, 2007, the Registrant granted to certain of its employees options to purchase an aggregate of 138,450 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.06 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

 

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(8) On July 26, 2007, the Registrant granted to one of its executive officers an option to purchase an aggregate of 75,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.06 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

(9) On October 25, 2007, the Registrant granted to certain of its employees and a consultant options to purchase an aggregate of 197,400 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.35 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(10) On October 25, 2007, the Registrant granted to certain of its executive officers options to purchase an aggregate of 576,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.35 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

(11) On November 14, 2007, the Registrant granted to certain of its employees options to purchase an aggregate of 30,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.35 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(12) On November 14, 2007, the Registrant granted to certain of its executive officers options to purchase an aggregate of 870,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.35 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

(13) On January 23, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 529,989 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.48 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(14) On January 23, 2008, the Registrant granted to certain of its executive officers and certain of its directors options to purchase an aggregate of 150,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $4.48 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

(15) On March 3, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 72,300 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(16) On March 3, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 45,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering.

 

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(17) On March 9, 2008, the Registrant granted one of its directors an option to purchase 5,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

(18) On March 14, 2008, the Registrant issued and sold an aggregate of 725,556 shares of its common stock for an aggregate purchase price of $6,820,226.40 and 725,556 shares of its preferred stock for an aggregate purchase price of $6,820,226.40. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering. Each of the purchasers of the securities in this transaction represented its intention to acquire the securities for investment only and not with a view to, or for resale in connection with, any distribution thereof, and appropriate legends were affixed to the share certificates issued in that transaction. Each of the purchasers received adequate information about the Registrant or had adequate access, through its relationships with the Registrant, to information about the Registrant.

(19) On April 16, 2008, the Registrant issued and sold an aggregate of 40,000 shares of the Registrant’s common stock pursuant to an option exercise by an executive officer at the purchase price of $2.69 per share for an aggregate consideration of $107,468.00. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering. The recipient of the securities in this transaction represented his intention to acquire the securities for investment only and not with a view to, or for resale in connection with, any distribution thereof, and appropriate legends were affixed to the share certificate issued in such transaction. The recipient received adequate information about the Registrant or had adequate access, through his relationship with the Registrant, to information about the Registrant.

(20) On April 24, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 87,450 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(21) On April 24, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 100,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering.

(22) On April 30, 2008, the Registrant issued and sold an aggregate of 15,500 shares of the Registrant’s common stock pursuant to an option exercise by a former employee at the purchase price of $4.06 per share for an aggregate consideration of $62,930.00. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering. The recipient of the securities in this transaction represented his intention to acquire the securities for investment only and not with a view to, or for resale in connection with, any distribution thereof, and appropriate legends were affixed to the share certificate issued in such transaction. The recipient received adequate information about the Registrant or had adequate access, through his relationship with the Registrant, to information about the Registrant.

(23) On May 14, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 15,800 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

 

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(24) On May 14, 2008, the Registrant granted to one of its executive officers options to purchase an aggregate of 500,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

(25) On June 20, 2008, the Registrant granted to certain of its directors and executive officers options to purchase an aggregate of 255,000 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as transactions by an issuer not involving a public offering.

(26) On June 20, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 20,850 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(27) On July 22, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 88,900 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(28) On August 22, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 42,350 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $9.40 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(29) On November 14, 2008, the Registrant granted to certain of its employees options to purchase an aggregate of 44,775 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $8.68 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(30) On December 2, 2008, the Registrant issued and sold an aggregate of 14,062 shares of the Registrant’s common stock pursuant to an option exercise by a former employee at the purchase price of $4.06 per share for an aggregate consideration of $57,091.72. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(31) On January 28, 2009, the Registrant issued and sold an aggregate of 19,689 shares of the Registrant’s common stock pursuant to an option exercise by a former employee at the purchase price of $4.06 per share for an aggregate consideration of $79,937.34. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(32) On March 3, 2009, the Registrant granted to certain of its employees options to purchase an aggregate of 261,850 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $8.68 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

 

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(33) On April 16, 2009, the Registrant issued and sold an aggregate of 2,719 shares of the Registrant’s common stock pursuant to an option exercise by a former employee at the purchase price of $2.69 per share for an aggregate consideration of $7,305.14. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(34) On April 23, 2009, the Registrant granted to certain of its employees options to purchase an aggregate of 259,100 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $10.00 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(35) On April 23, 2009, the Registrant granted to certain of its executive officers options to purchase an aggregate of 1,006,699 shares of the Registrant’s common stock under the Amended and Restated Stock Incentive Plan at an exercise price of $10.00 per share. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Section 4(2) of the Securities Act as a transaction by an issuer not involving a public offering.

(36) On April 24, 2009, the Registrant issued and sold an aggregate of 27,000 shares of the Registrant’s common stock pursuant to an option exercise by a former employee at the purchase price of $4.06 per share for an aggregate consideration of $109,620.00. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

(37) On May 1, 2009, the Registrant issued and sold an aggregate of 38,750 shares of the Registrant’s common stock pursuant to an option exercise by a former employee at the purchase price of $2.69 per share for an aggregate consideration of $104,109.63. The issuance and sale of these securities were deemed to be exempt from registration pursuant to Rule 701 promulgated under the Securities Act as transactions pursuant to a compensatory benefit plan approved by the Registrant’s board of directors.

There were no underwriters employed in connection with any of the transactions set forth in Item 15.

 

Item 16.

Exhibits and Financial Statement Schedules.

(a) Exhibits:

 

Exhibit Number		Exhibit Title
1.1*		Form of Underwriting Agreement
2.1(1)		Stock Purchase Agreement by and among SolarWinds Worldwide, LLC (as successor in interest to the Registrant), Neon Software, Inc., each of the shareholders of Neon Software, Inc. and U.S. Bank, National Association, dated May 14, 2007

 

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Exhibit Number		Exhibit Title
2.2(1)		Asset Purchase Agreement by and among SolarWinds Worldwide, LLC (as successor in interest to the Registrant), IPMonitor Corporation, each of the shareholders of IPMonitor Corporation and Gowling Lafleur Henderson LLP, dated April 19, 2007
3.1(2)		Amended and Restated Certificate of Incorporation of the Registrant
3.2(3)		Amended and Restated Bylaws of the Registrant
4.1(4)		Specimen Common Stock Certificate of the Registrant
4.2(1)		Stock Purchase Agreement by and among the Registrant, certain preferred and common stock holders and certain purchasers of common and preferred stock, dated December 14, 2005
4.3(1)		Stockholders Agreement by and among the Registrant and certain preferred and common stock holders, dated December 13, 2005, with Amendment No. 1 to Stockholders Agreement, dated March 13, 2008
4.4(1)		Registration Rights Agreement by and among the Registrant and certain preferred and common stock holders, dated December 13, 2005, with Amendment No. 1 to the Registration Rights Agreement by and among the Registrant and certain preferred and common stock holders, dated December 20, 2006
4.4A		Waiver under Registration Rights Agreement by and among the Registrant and certain preferred and common stock holders, dated October 25, 2009
4.5(1)		Redemption Agreement by and among the Registrant, Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and Yonce Management, LLC, dated December 14, 2005, as amended by Amendment No. 1 to Redemption Agreement by and among the Registrant, Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and Yonce Management, LLC, dated December 20, 2006
4.6(1)		Stock Purchase Agreement by and among the Registrant, Austin Ventures IX, L.P. and certain preferred and common stock holders, dated December 20, 2006
4.7(1)		1999 Management Incentive Stock Option Agreement by and between the Registrant and Dave Yonce, dated January 28, 1999
4.8(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners IV, L.P. regarding management rights, dated December 14, 2005
4.9(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners V, L.P. regarding management rights, dated December 14, 2005
4.10(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners (Cayman) IV, L.P. regarding management rights, dated December 14, 2005
4.11(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners (Cayman) V, L.P. regarding management rights, dated December 14, 2005
4.12(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners V (Coinvestment), L.P. regarding management rights, dated December 14, 2005
4.13(1)		Letter Agreement between the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), Bain Capital Venture Partners, LLC, Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and Yonce Management, LLC regarding management and monitoring services, dated December 13, 2005
4.14(1)		Letter Agreement between the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC) and Insight Venture Management, LLC regarding strategic and operational assistance to be provided by Insight Business Development, dated December 13, 2005

 

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Exhibit Number		Exhibit Title
4.15(1)		Stock Purchase Agreement by and among the Registrant and certain common and preferred stockholders, dated March 14, 2008
5.1		Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation
10.1(5)		Form of Indemnification Agreement for directors and officers
10.1A(5)		Indemnification Agreement by and between the Registrant and Donald C. Yonce, dated July 22, 2008
10.2(1)		Amended and Restated Stock Incentive Plan
10.3A(1)		Form of Stock Option Agreement under Amended and Restated Stock Incentive Plan (Standard Form)
10.3B(1)		Form of Stock Option Agreement under Amended and Restated Stock Incentive Plan (Early Exercise Form)
10.4(6)		2008 Equity Incentive Plan
10.5(6)		Form of Stock Option Agreement under 2008 Equity Incentive Plan
10.6(6)		Form of Restricted Stock Purchase Agreement under 2008 Equity Incentive Plan
10.6A(6)		Form of Restricted Stock Unit Agreement under 2008 Equity Incentive Plan
10.7(1)		Employment Agreement between the Registrant and Michael S. Bennett, dated May 11, 2006
10.8(1)		Employment Agreement between the Registrant and Kevin B. Thompson, dated June 28, 2006
10.9(1)		Employment Agreement between the Registrant and Kenny L. Van Zant, dated September 25, 2006
10.10(1)		Employment Agreement between the Registrant and Douglas G. Hibberd, dated August 7, 2006
10.11(1)		Employment Agreement between the Registrant and Rita J. Selvaggi, dated July 2006
10.12(1)		Employment Agreement between the Registrant and J. Barton Kalsu, dated August 1, 2007
10.13(1)		Employment Agreement between the Registrant and Douglas Rogers, dated December 27, 2006
10.14(1)		Employment Agreement between the Registrant and Bryan A. Sims, dated April 1, 2007
10.15(1)		Employment Agreement between the Registrant and Paul Strelzick, dated July 24, 2007
10.16(7)		Employment Agreement between SolarWinds Software Europe Limited and David Owens, dated March 23, 2007
10.16A(6)		Employment Agreement between the Registrant and Karen L. White, dated May 5, 2008
10.16B(6)		Employment Agreement between the Registrant and Garry D. Strop dated June 2, 2008
10.16C(8)		Consulting Agreement and Release between the Registrant and Karen L. White, dated April 14, 2009
10.17(1)		Separation Agreement and Release of Claims between the Registrant and David A. Yonce, dated January 25, 2007
10.18(4)		Separation Agreement and Release of Claims between the Registrant and Donald C. Yonce, dated May 31, 2007
10.19(1)		Sublease Agreement between the Registrant and Vignette Corporation, dated October 20, 2006, as amended by First Amendment to Sublease Agreement between the Registrant and Vignette Corporation, dated November 20, 2006
10.20(1)		Lease between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Brandywine Acquisition Partners, LP, dated as of February 6, 2008
10.20A(9)		Second Amendment to Lease between SolarWinds Worldwide, LLC and Brandywine Acquisition Partners, LP, dated as of March 3, 2009

 

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Exhibit Number		Exhibit Title
10.21(1)		Credit and Guaranty Agreement by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various lenders, GoldenTree Asset Management, LP and The Bank of New York regarding the Registrant’s first lien senior secured credit facility, dated December 13, 2005
10.22(1)		Notes (first lien secured credit facility)
10.23(1)		Amendment and Waiver No. 1 to First Lien Credit Agreement by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various guarantors and The Bank of New York, dated March 14, 2008
10.23A(10)		Amendment Number Two to Credit Agreement by and among Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various lenders, GoldenTree Asset Management, LP and Wells Fargo Foothill, LLC, dated September 5, 2008
10.24(1)		Credit and Guaranty Agreement by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various lenders, GoldenTree Asset Management, LP and The Bank of New York regarding the Registrant’s second lien senior secured credit facility, dated December 13, 2005
10.25(1)		Notes (second lien secured credit facility)
10.26(1)		Amendment and Waiver No. 1 to Second Lien Credit Agreement by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various guarantors and The Bank of New York, dated March 14, 2008
10.26A(10)		Amendment Number Two to Credit Agreement (Second Lien) by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various lenders, GoldenTree Asset Management, LP and Wells Fargo Foothill, LLC, dated September 5, 2008
10.27(1)		License Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and NetSuite Inc., dated August 31, 2006
10.28(1)		Master Subscription Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant), salesforce.com, inc. and salesforce.com Sàrl
10.29(1)		Master Services Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and SoftServe, Inc., dated October 12, 2006
10.30(1)		Term Lease Agreement between the Registrant and Yonce Ventures, LLC, dated April 1, 2006
10.31(1)		E-Commerce Automation System License Agreement between the Registrant and Yonce Properties, LLC, dated December 14, 2005
10.32(1)		Promissory Note made by David A. Yonce in favor of the Registrant, dated March 13, 2007
10.33(1)		Stock Pledge Agreement between the Registrant and David A. Yonce, dated March 12, 2007
21.1(9)		List of subsidiaries of the Registrant
23.1		Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm
23.2*		Consent of Wilson Sonsini Goodrich & Rosati, Professional Corporation (included in Exhibit 5.1)
24.1		Power of Attorney (see page II-13 to this Registration Statement on Form S-1)
99.1		Consent of Compass Intelligence Southwest, dated October 20, 2009

 

*	To be filed by amendment.

(1)	Incorporated by reference to the same numbered exhibit to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-149581) filed on March 21, 2008.

(2)	Incorporated by reference to Exhibit 3.2 to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on June 10, 2008.

 

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(3)	Incorporated by reference to Exhibit 3.4 to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on June 10, 2008.

(4)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 3 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on July 18, 2008.

(5)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 4 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on August 22, 2008.

(6)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on June 10, 2008.

(7)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 1 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on May 7, 2008.

(8)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 7 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on April 17, 2009.

(9)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 6 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on March 6, 2009.

(10)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 5 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on October 30, 2008.

(b) Financial Statement Schedules.

The following schedule is filed as part of this registration statement:

Schedule II—Valuation and Qualifying Accounts

All other schedules have been omitted because the information required to be presented in them is not applicable or is shown in the consolidated financials statements or related notes.

SCHEDULE II

SOLARWINDS, INC. VALUATION AND QUALIFYING ACCOUNTS

 

		Beginning Balance			Additions (Recoveries Charged to Operations)			Write-offs			Ending Balance
Allowance for doubtful accounts, customers and other:
Year ended December 31, 2006		$	—		$	112		$	—		$	112
Year ended December 31, 2007			112			168			50			230
Year ended December 31, 2008			230			511			624			117

 

(c)	Report of Independent Registered Public Accounting Firm on Financial Statement Schedule

Report of Independent Registered Public Accounting Firm

on Financial Statement Schedule

To the Board of Directors and Stockholders of SolarWinds, Inc.:

Our audits of the consolidated financial statements referred to in our report dated March 6, 2009 appearing in this Registration Statement on Form S-1 for SolarWinds, Inc. also included an audit of the financial statement schedule listed in Item 16(b) of this Registration Statement. In our opinion, this financial statement schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements.

/s/ PricewaterhouseCoopers LLP

Austin, Texas

March 6, 2009

 

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Item 17.

Undertakings.

The undersigned Registrant hereby undertakes to provide to the underwriters at the closing specified in the underwriting agreement certificates in such denominations and registered in such names as required by the underwriters to permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the Registrant pursuant to the provisions described in Item 14 above, or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer or controlling person of the Registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.

The undersigned Registrant hereby undertakes that:

 

(1)

For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this registration statement as of the time it was declared effective.

 

(2)

For purposes of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

 

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SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Austin, State of Texas, on October 26, 2009.

 

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Michael S. Bennett and Kevin B. Thompson, jointly and severally, as his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign the Registration Statement on Form S-1 of SolarWinds, Inc. and any or all amendments (including post-effective amendments) thereto and any new registration statement with respect to the offering contemplated thereby filed pursuant to Rule 462(b) of the Securities Act, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite or necessary to be done in and about the premises hereby ratifying and confirming all that said attorneys-in-fact and agents, or his or her or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Act of 1933, this Registration Statement has been signed on October 26, 2009 by the following persons in the capacities indicated:

 

Signature		Title
/s/    MICHAEL S. BENNETT         Michael S. Bennett		Chairman of the Board and Chief Executive Officer
/s/    KEVIN B. THOMPSON         Kevin B. Thompson		President, Chief Operating Officer and Chief Financial Officer
/s/    J. BARTON KALSU         J. Barton Kalsu		Chief Accountant and Vice President, Finance
/s/    STEVEN M. CAKEBREAD         Steven M. Cakebread		Director
/s/    JEFFREY L. HORING         Jeffrey L. Horing		Director
/s/    BOB L. MARTIN         Bob L. Martin		Director
/s/    J. BENJAMIN NYE         J. Benjamin Nye		Director
/s/    ELLEN F. SIMINOFF         Ellen F. Siminoff		Director
/s/    JOHN D. THORNTON         John D. Thornton		Director
/s/    DONALD C. YONCE         Donald C. Yonce		Director

 

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EXHIBIT INDEX

 

Exhibit Number		Exhibit Title
1.1*		Form of Underwriting Agreement
2.1(1)		Stock Purchase Agreement by and among SolarWinds Worldwide, LLC (as successor in interest to the Registrant), Neon Software, Inc., each of the shareholders of Neon Software, Inc. and U.S. Bank, National Association, dated May 14, 2007
2.2(1)		Asset Purchase Agreement by and among SolarWinds Worldwide, LLC (as successor in interest to the Registrant), IPMonitor Corporation, each of the shareholders of IPMonitor Corporation and Gowling Lafleur Henderson LLP, dated April 19, 2007
3.1(2)		Amended and Restated Certificate of Incorporation of the Registrant
3.2(3)		Amended and Restated Bylaws of the Registrant
4.1(4)		Specimen Common Stock Certificate of the Registrant
4.2(1)		Stock Purchase Agreement by and among the Registrant, certain preferred and common stock holders and certain purchasers of common and preferred stock, dated December 14, 2005
4.3(1)		Stockholders Agreement by and among the Registrant and certain preferred and common stock holders, dated December 13, 2005, with Amendment No. 1 to Stockholders Agreement, dated March 13, 2008
4.4(1)		Registration Rights Agreement by and among the Registrant and certain preferred and common stock holders, dated December 13, 2005, with Amendment No. 1 to the Registration Rights Agreement by and among the Registrant and certain preferred and common stock holders, dated December 20, 2006
4.4A		Waiver under Registration Rights Agreement by and among the Registrant and certain preferred and common stock holders, dated October 25, 2009
4.5(1)		Redemption Agreement by and among the Registrant, Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and Yonce Management, LLC, dated December 14, 2005, as amended by Amendment No. 1 to Redemption Agreement by and among the Registrant, Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and Yonce Management, LLC, dated December 20, 2006
4.6(1)		Stock Purchase Agreement by and among the Registrant, Austin Ventures IX, L.P. and certain preferred and common stock holders, dated December 20, 2006
4.7(1)		1999 Management Incentive Stock Option Agreement by and between the Registrant and Dave Yonce, dated January 28, 1999
4.8(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners IV, L.P. regarding management rights, dated December 14, 2005
4.9(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners V, L.P. regarding management rights, dated December 14, 2005
4.10(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners (Cayman) IV, L.P. regarding management rights, dated December 14, 2005
4.11(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners (Cayman) V, L.P. regarding management rights, dated December 14, 2005
4.12(1)		Letter Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Insight Venture Partners V (Coinvestment), L.P. regarding management rights, dated December 14, 2005
4.13(1)		Letter Agreement between the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), Bain Capital Venture Partners, LLC, Atlantis SolarWinds, LLC (formerly known as SolarWinds Management, LLC) and Yonce Management, LLC regarding management and monitoring services, dated December 13, 2005

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Exhibit Number		Exhibit Title
4.14(1)		Letter Agreement between the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC) and Insight Venture Management, LLC regarding strategic and operational assistance to be provided by Insight Business Development, dated December 13, 2005
4.15(1)		Stock Purchase Agreement by and among the Registrant and certain common and preferred stockholders, dated March 14, 2008
5.1		Opinion of Wilson Sonsini Goodrich & Rosati, Professional Corporation
10.1(5)		Form of Indemnification Agreement for directors and officers
10.1A(5)		Indemnification Agreement by and between the Registrant and Donald C. Yonce, dated July 22, 2008
10.2(1)		Amended and Restated Stock Incentive Plan
10.3A(1)		Form of Stock Option Agreement under Amended and Restated Stock Incentive Plan (Standard Form)
10.3B(1)		Form of Stock Option Agreement under Amended and Restated Stock Incentive Plan (Early Exercise Form)
10.4(6)		2008 Equity Incentive Plan
10.5(6)		Form of Stock Option Agreement under 2008 Equity Incentive Plan
10.6(6)		Form of Restricted Stock Purchase Agreement under 2008 Equity Incentive Plan
10.6A(6)		Form of Restricted Stock Unit Agreement under 2008 Equity Incentive Plan
10.7(1)		Employment Agreement between the Registrant and Michael S. Bennett, dated May 11, 2006
10.8(1)		Employment Agreement between the Registrant and Kevin B. Thompson, dated June 28, 2006
10.9(1)		Employment Agreement between the Registrant and Kenny L. Van Zant, dated September 25, 2006
10.10(1)		Employment Agreement between the Registrant and Douglas G. Hibberd, dated August 7, 2006
10.11(1)		Employment Agreement between the Registrant and Rita J. Selvaggi, dated July 2006
10.12(1)		Employment Agreement between the Registrant and J. Barton Kalsu, dated August 1, 2007
10.13(1)		Employment Agreement between the Registrant and Douglas Rogers, dated December 27, 2006
10.14(1)		Employment Agreement between the Registrant and Bryan A. Sims, dated April 1, 2007
10.15(1)		Employment Agreement between the Registrant and Paul Strelzick, dated July 24, 2007
10.16(7)		Employment Agreement between SolarWinds Software Europe Limited and David Owens, dated March 23, 2007
10.16A(6)		Employment Agreement between the Registrant and Karen L. White, dated May 5, 2008
10.16B(6)		Employment Agreement between the Registrant and Garry D. Strop dated June 2, 2008
10.16C(8)		Consulting Agreement and Release between the Registrant and Karen L. White, dated April 14, 2009
10.17(1)		Separation Agreement and Release of Claims between the Registrant and David A. Yonce, dated January 25, 2007
10.18(4)		Separation Agreement and Release of Claims between the Registrant and Donald C. Yonce, dated May 31, 2007
10.19(1)		Sublease Agreement between the Registrant and Vignette Corporation, dated October 20, 2006, as amended by First Amendment to Sublease Agreement between the Registrant and Vignette Corporation, dated November 20, 2006

 

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Exhibit Number		Exhibit Title
10.20(1)		Lease between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and Brandywine Acquisition Partners, LP, dated as of February 6, 2008
10.20A(9)		Second Amendment to Lease between SolarWinds Worldwide, LLC and Brandywine Acquisition Partners, LP, dated as of March 3, 2009
10.21(1)		Credit and Guaranty Agreement by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various lenders, GoldenTree Asset Management, LP and The Bank of New York regarding the Registrant’s first lien senior secured credit facility, dated December 13, 2005
10.22(1)		Notes (first lien secured credit facility)
10.23(1)		Amendment and Waiver No. 1 to First Lien Credit Agreement by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various guarantors and The Bank of New York, dated March 14, 2008
10.23A(10)		Amendment Number Two to Credit Agreement by and among Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various lenders, GoldenTree Asset Management, LP and Wells Fargo Foothill, LLC, dated September 5, 2008
10.24(1)		Credit and Guaranty Agreement by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various lenders, GoldenTree Asset Management, LP and The Bank of New York regarding the Registrant’s second lien senior secured credit facility, dated December 13, 2005
10.25(1)		Notes (second lien secured credit facility)
10.26(1)		Amendment and Waiver No. 1 to Second Lien Credit Agreement by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various guarantors and The Bank of New York, dated March 14, 2008
10.26A(10)		Amendment Number Two to Credit Agreement (Second Lien) by and among the Registrant, SolarWinds Worldwide, LLC (formerly known as SolarWinds.Net, LLC), various lenders, GoldenTree Asset Management, LP and Wells Fargo Foothill, LLC, dated September 5, 2008
10.27(1)		License Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and NetSuite Inc., dated August 31, 2006
10.28(1)		Master Subscription Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant), salesforce.com, inc. and salesforce.com Sàrl
10.29(1)		Master Services Agreement between SolarWinds Worldwide, LLC (as successor in interest to the Registrant) and SoftServe, Inc., dated October 12, 2006
10.30(1)		Term Lease Agreement between the Registrant and Yonce Ventures, LLC, dated April 1, 2006
10.31(1)		E-Commerce Automation System License Agreement between the Registrant and Yonce Properties, LLC, dated December 14, 2005
10.32(1)		Promissory Note made by David A. Yonce in favor of the Registrant, dated March 13, 2007
10.33(1)		Stock Pledge Agreement between the Registrant and David A. Yonce, dated March 12, 2007
21.1(9)		List of subsidiaries of the Registrant
23.1		Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm
23.2*		Consent of Wilson Sonsini Goodrich & Rosati, Professional Corporation (included in Exhibit 5.1)
24.1		Power of Attorney (see page II-13 to this Registration Statement on Form S-1)
99.1		Consent of Compass Intelligence Southwest, dated October 20, 2009

 

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Table of Contents

 

*	To be filed by amendment.

(1)	Incorporated by reference to the same numbered exhibit to the Registrant’s Registration Statement on Form S-1 (SEC File No. 333-149581) filed on March 21, 2008.

(2)	Incorporated by reference to Exhibit 3.2 to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on June 10, 2008.

(3)	Incorporated by reference to Exhibit 3.4 to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on June 10, 2008.

(4)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 3 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on July 18, 2008.

(5)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 4 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on August 22, 2008.

(6)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 2 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on June 10, 2008.

(7)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 1 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on May 7, 2008.

(8)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 7 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on April 17, 2009.

(9)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 6 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on March 6, 2009.

(10)	Incorporated by reference to the same numbered exhibit to the Registrant’s Amendment No. 5 to Registration Statement on Form S-1 (SEC File No. 333-149581) filed on October 30, 2008.

 

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