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Executives

Kate Patterson Vice President, Corporate Communications and Investor Relations

Douglas Wride Chief Operating Officer and Acting Chief Financial Officer

Gene Hodges Chief Executive Officer

Analysts

Samuel Wilson JMP Securities

Daniel Ives FBR Capital Markets

Philip Rueppel Wachovia Capital Markets

Eric Martinuzzi CraigHallum Capital

Philip Winslow Credit Suisse

Todd Raker Deutsche Bank Securities

Rob Owens Pacific Crest Securities

Walter Pritchard Cowen & Company

Craig Nankervis First Analysis

Websense, Inc. (WBSN) Q1 2009 Earnings Call April 28, 2009 5:00 PM ET

Operator

Good afternoon, ladies and gentlemen, and welcome to the Websense conference call. (Operator Instructions) I would now like to introduce your host, Kate Patterson, Websense's Vice President of Corporate Communications. Miss Patterson, please go ahead.

Kate Patterson

Thank you for joining me to discuss our first quarter results. Joining me today are Gene Hodges, Websense CEO; Doug Wride, our Acting Chief Financial Officer and Chief Operating Officer; John McCormack, our President; and Avelina Ibarra, Investor Relations Manager.

Before we begin a review of the financial results, let me outline our conference calendar for the second quarter. Management will be presenting at the following conferences: The JMP Securities Research Conference, May 18 in San Francisco; the 37th Annual JP Morgan Global Technology Media and Telecom Conference, May 20 in Boston; Cowen TMT Conference, May 28 in New York; and the Craig Hallum Conference, June 11 in Minneapolis. We hope to see you at one of these events.

Before turning the call over to Doug, let me remind you that during this conference call management may make forwardlooking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are known or subject to known and unknown risks, uncertainties, and other factors that may cause the company's actual results to be materially different from historical results or our forwardlooking guidance.

The potential risks and uncertainties which contribute to the uncertain nature of these statements include, among others, risks associated with integrating acquired businesses and launching new product offerings; customer acceptance of the company's services, products, fee structures in a changing market; the success of the Websense brand development effort; the volatile and competitive nature of the internet and security industries; changes in domestic and international market conditions; volatility in currency exchange rates; risks relating to the required use of cash for debt services; the risks of ongoing compliance through the covenants in the senior credit facility; risks related to changes in accounting interpretations; and other risks and uncertainties described in Websense's public filings with the Securities and Exchange Commission.

The information in this call related to financial results, projections, and other forwardlooking statements is based on current expectations; and we expressly disclaim any responsibility to update forwardlooking statements should circumstances change. Our discussion also includes financial measures that are numerical measures that can't be calculated in accordance with Generally Accepted Accounting Principles.

The company believes these nonGAAP financial measures enhance investors' ability to evaluate the company's operating results and compare current operating results with historical operating results. For more information, please consult the press release that was issued this afternoon and which is also posted on the investor relations portion of the company's website. I'll now turn the call over to Doug Wride.

Doug Wride

To frame our discussion today, let me make three points. It's clear that we're successfully balancing investment in our business with expense control. Our top line, excluding noise such as foreign exchange translation demonstrates the relevance of our strategy; and we are well positioned in a resilient market segment. I will focus on the first two, and Gene will speak to the final point.

Since these results represent the details of what we disclosed on April 7, I'm going to quickly review the Q1 highlights. Billings for the quarter were $67 million, reflecting normal seasonal patterns. Adjusted for Q1 2008 foreign exchange rates, billings for the quarter would have been approximately $72 million or up 7% yearoveryear. Billings in the U.S. grew for the third consecutive quarter on a yearoveryear basis.

The underlying business trends for product seats, contract duration, and average seat price remains strong and within historical ranges. Average contract duration shortened to 21.4 months from 22.5 in the fourth quarter of 2008, but increased slightly compared to 20.6 months a year ago.

Oneyear contracts accounted for 58% of billings; twoyear contracts, 6%; and threeyear contracts, 36%. This compares to 52, 8, and 40%, respectively, in Q4 2008 and 61, 7, and 32% respectively in Q1 2008. The average firstyear contract value declined a little this quarter reflecting higher discounts associated with the higher average duration. Recall that a year ago we did not offer threefortwo pricing promotions which have been fairly standard in many of our markets. Product seats increased 2 million from a year ago and 460,000 sequentially.

And what seemed to be budgeteconomy driven, we did notice the customers were tending to hold on to their budget longer and wait until closer to the actual expiration date of their subscription to renew, resulting in a bit of compression of the time between expiration and subscription renewal.

NonGAAP revenue was $86.5 million and included $5.5 million of SurfControl add back revenue. While the total nonGAAP revenue number is essentially the same as it was in Q1 2008, a year ago we added back $19.6 million to GAAP revenue. We have now added back $82.6 million of the total $97.4 million written down at the time of the SurfControl acquisition. We expect to add back an additional $10.6 million or so through the remainder of 2009, leaving a total of a little more than $4 million to be added back to 2010 through 2012 revenue for nonGAAP comparative purposes.

NonGAAP operating expenses of $51.2 million declined $2.5 million sequentially and were up approximately $500,000 from a year ago as we continue to carefully manage discretionary expenses outside the investments we are making in sales and support capacity.

The operating margin for the first quarter was 31% and above our target range for the year. Due to the seasonality of billings, Q1 typically has the highest operating margin of the year as we pay lower commissions on seasonally lower billings.

Interest expense of $2.2 million was less than half of what it was a year ago, reflecting the dramatic reduction we've made in our longterm debt, paying down over $100 million in the last six quarters since the acquisition closed.

Cash flow of $36 million was the highest level in our history. This was due to the large account receivable balance at the beginning of the quarter, outstanding collections performance, and lower outflows associated with expenses. As outlined on our April 7 communication, we expect to generate more than $85 million in cash flow from operations for this year.

We ended the quarter with about $76 million in cash, slightly higher than our target of $60 million to $65 million. But we typically will maintain higher cash balances heading into Q2, as Q2 will be our lowest cash flow quarter of the year.

Also, we've adjusted our 10b51 plan accordingly to about $7.5 million per quarter. Under the plan in Q1, we repurchased approximately 649,500 shares. Our share repurchase plan is restricted by our credit facility based on a formula that accounts for net income performance; and based on our performance, we felt confident increasing the buyback.

Now, turning to the outlook for the rest of the year, we are reiterating our billings guidance of $365 million to $375 million and nonGAAP revenue guidance of $342 million to $350 million. The strength of our current business, combined with a robust product portfolio, success of retaining customers, and an increased level of renewal business in the remainder of the year, gives us the confidence to maintain our 2009 billings guidance.

Commenting on billings by quarter, we continue to expect low single digit yearoveryear growth in Q2, midsingle digit yearoveryear growth in Q3, and midteens yearoveryear growth in Q4. We are also assuming with this guidance that the major foreign exchange rates will remain in the current ranges.

The big jump in Q4 yearoveryear growth rate is based upon much less of an FX headwind from fluctuations since the majority of the strengthening of the U.S. dollar occurred near the end of Q3 and in early Q4 2008; full productivity by sales reps hired around the beginning of this year; and execution on the pipeline build we're seeing in the early parts of the year, especially for the web security gateway and our newly released appliance.

We continue to expect a sequential decline in revenue in Q2 of approximately $2 million turning to modest sequential increases in Q3 and then in Q4. Recall that revenue lags billings by about four quarters, and we expect the resulting yearoveryear revenue growth pattern will be similar to the yearoveryear billings growth pattern in 2008.

We are increasing our operating margin expectations for the full year to 26% to 29% due to the strong Q1 performance. We are also increasing our EPS guidance range to $1.25 to $1.35 for the same reason. Operating margin should improve again in 2010 as the revenue growth rate catches up with the billings growth rate.

Let me conclude by saying I am very pleased with our financial discipline and performance so far this year. Subscription lengths are shortening a little; but our customer retention remains stable and both existing and new customers are purchasing addon products, suggesting our strategy is working. We're doing all of this while weathering a challenging economy and the dramatic FX changes of the second half of 2008.

We have an achievable plan for 2009 and are executing well. Our pipeline continues to build, especially for our new web security gateway product, providing early evidence that our strategy is aligned with market requirements. The market for our products is one of the most resilient in the industry, and we are wellpositioned for success.

That said, if circumstances change dramatically, we have several levers we can pull; and our recurring revenue model gives us an early warning system. All in all, we believe we are justified in our sense of confidence in our ability to execute and rekindle growth. With that, let me turn the call over to Gene.

Gene Hodges

Reiterating Doug's main points, in Q1, Websense's strategy of balancing expense control and investment generated good results and we're on track to deliver for the rest of 2009. One of the metrics we follow most closely is incremental billings. These billings are to new customers plus the billings that come from upselling and crossselling to our large install base. This is where our growth will come from.

Incremental billings in Q1 were up 9% worldwide. The U.S. showed especially strong performance with incremental billings up 37% yearoveryear. About half of our 2009 incremental sales investments went into the U.S, and the hiring of those reps happened earlier than the hiring of our new international sales reps. Hence, we see this growth in U.S. incremental business as an early sign the sales investments we've made are paying off.

Our international regions are also showing signs of generating incremental billings improvements in local currencies, but this is still masked by the yearoveryear changes in foreign exchange rates.

As discussed at our analysts’ day, the investment sales hiring is completed for the year. In fact, the large majority of hiring was completed in January. All the sales investments were in direct sales manpower who will work with our channel partners, and over 90% was in reps focused of medium to larger enterprises. I have been on several calls with some of these new reps, both in the U.S. and internationally, and the quality of these people is uniformly strong.

Pipeline generation from the new reps was good in Q1, and the volume of incremental business we planned from the new reps looks like it will grow each quarter for the remainder of the year.

Demand for our recently shipped V10000 appliance seems to be strong, and we expect to return on the investment to build and distribute this appliance to be both cash and EPS accretive this year.

With the shipment of the V10K, we're also the only major vendor to offer customers a choice in the way they deploy web security in whatever manner minimizes their total cost of operation. Customers can choose an appliance on intheCloud solution or a traditional software solution from Websense. This breadth of deployment allows us to offer more options and be in more deals than we ever have before.

Another positive impact that we're seeing of our sales investments in Q1 was a substantial increase in the incremental business pipeline for our intheCloud offerings both for web and email security. Through Q1, we've not yet seen these product areas contributing to our growth but we seem poised to see more for the rest of the year.

Deal closure rates across our product lines for these incremental business opportunities were about the same in Q1 as in Q4. We're watching the close rates closely, of course, and believe the fact that they were stable in Q1 is positive. Even in the middle of the recession, many customers are still willing to invest to protect their essential information. Our Q1 and early Q2 billings patterns demonstrate, we believe, the success of our central information security strategy.

The single most important factor for our success in 2009 is demand for our new web security gateway. The web security gateway billings in Q1 were in line with our plan. WSG price points remain above our expectations, and the quarter saw a number of competitive wins against our larger competitors. WSG pipeline is strong for Q2 for software as well as for new appliances. The WSG pipeline grew especially quickly in Q1 in both Europe and Asia. Now, we are seeing strong demand for WSG globally.

DLP billings, that's data loss prevention billings, in Q1 were just under $2 million, up about 20% yearoveryear. This was somewhat lighter than we'd expected. DLP orders seem to be more heavily affected by the budget chaos, as customers scramble to understand their spending in the context of tightened budgets, especially in January and February. Many of these delayed orders have already come in in Q2. This seems to indicate that although the billing stream may be disrupted by economic chaos in Q1 and possibly late in the year, DLP comes through the belttightening analysis well.

We're also seeing increased interest in DLP in Asia and new interests in both the U.S. and European accounts, driven by their need to maintain confidentiality during downsizings and merger and acquisition activity.

In Q1, former SurfControl customers continued to be interested in upgrading to Websense products. 64% of the SurfControl customers who renewed, as measured by billings, upgraded. In fact, we're starting to see interest from the SurfControl base in upgrading beyond the equivalent baseline with filtering product, typically to our web security gateway. In fact, the first order we received for our V10000 appliance was a SurfControl upgrade driven through one of our top partners. Such upgrades yield considerably higher price points.

As Doug mentioned, the single biggest challenge that we face in Q1 to our top line continues to be foreign exchange. It's not renewal retention rates, contract shortening, or our ability to find incremental business. Overall, billings were down internationally on a dollar basis but up on a local currency basis.

There were several bright growth spots, however, in addition to the U.S. India, the Middle East, central Europe, and the Beneluks, Italy and the Mediterranean and Canada all had good growth in dollar terms and, of course, were very strong when measured in their local currencies.

In Q1, we did see impact from the recession in our install base in the U.S. and the U.K. that we hadn't seen before. The biggest impact was from customers scrambling to figure out what was going on with their budgets. Many customers whose subscriptions expired late in Q1 did not renew on time. But many of those have already renewed early in Q2. We expect budget tightening to continue over the course of the year and, hence, we expect to see such budget chaos often through the course of 2009.

Also, in spite of the recession, we did see contract length extending slightly in Q1 2009 over Q1 2008. This was predominantly due to the fact that we stopped our key longterm promotions for a quarter last Q1, but have them in place this year. We plan for duration for the remainder of 2009 to stay approximately a month shorter than it was for corresponding quarters in 2008.

In summary, we believe Websense is well positioned in spite of the tough environment. We're at the start of a major new product cycle across all of our product line. These products are especially attractive in medium to largescale enterprises. Pipelines are growing well for these new products in multiple regions, including regions with large billings contributions like the U.S. and Europe.

The sales investments we've made are producing pipeline for both new customers as well as pipeline from cross and upselling our existing customers. We're fairly confident we'll see more contribution from these new hires this quarter and significant contribution in the second half of the year. Price points and conversion rates on SurfControl and WSG upgrades remain above our expectations. Even customers who were economically distressed and are shortening their contract length to conserve cash will eventually come back to us in 2010, rather than being lost to the competition or operating without the protection of our products.

At RSA, you saw our large competitors continuing to follow Websense strategy. Customers are starting to see the need to shift their spending towards protecting their critical information. Customer interest in protecting against Web 2.0 threats and blended web and email threats is growing rapidly. Customer interest in data loss prevention is being supported by concerns over confidential during layoffs and mergers. Customers are starting to see intheCloud web and email security services as a way to decrease their total cost of ownership in tight budgetary times.

Our competitors are not improving their win rates against us, even though they're much larger. Our new products, especially the new appliances, will make us more competitive in both defending our install base and in competing for our competitors' customers over the course of this year.

This economic situation is challenging for everyone, but the IT securities segment remains resilient. We do not expect a general recovery in our largest markets in 2009, although we might see some recovery in emerging markets in the latter half of the year. There could even be further economic deterioration which affects our renewal stream or our ability to close these new opportunities.

Barring such negative developments, however, we believe our new products, improved selling skills, and expanded sales team give us the opportunity to grow; and it sets the stage for an even stronger 2010. We remain focused on expense control to produce committed profits in cash flow as we've shown by our Q1 operating results.

The excellent visibility given by our subscription model will allow us to match spending with expected future revenues. This visibility, along with resilience and our renewal base, our continued ability to find new opportunities with our new products, makes us confident we can reach our financial and operational targets for 2009.

Now, we'll turn the call over to the operator so we can answer questions.

QuestionandAnswer Session

Operator

(Operator Instructions) We'll go first to Samuel Wilson JMP Securities.

Samuel Wilson JMP Securities

Just two small questions for you. Gene, I missed it, what were DLP bookings in the quarter?

Gene Hodges

Just below $2 million.

Samuel Wilson JMP Securities

Then on WSG, do you plan on breaking it out how it's doing for investors or are you going to speak qualitatively about it?

Gene Hodges

We'd like to continue to just speak qualitatively about it, unless we deviate from plan one way or the other.

Samuel Wilson JMP Securities

Lastly, how should we judge WSG sort of progress over the next [inaudible] quarters.

Gene Hodges

I think you will see how we do on the incremental billings; it is the largest growth component of the incremental billings. We're seeing even in our international business, which has had a baseline with filtering new customers starting to shift as well. If we get to our billings targets, it pretty much requires we hit and exceed the incremental billings number and that pretty much requires we get to the number on WSG.

Operator

Our next question comes from the line of Daniel Ives FBR Capital Markets.

Daniel Ives FBR Capital Markets

A question, when you look at expenses going forward, you being obviously prudent this quarter, can you talk going forward on specific items? On R&D, are you going to be focusing on maybe curtailing that a bit or on sales and marketing increases? Can you talk about expenses and specifically where you think that you will add and where you think you are going to need to contract.

Doug Wride

If you just look through the income statement as an example, you are going to see a little bit of an increase in cost of goods, not only as a increase in volume, but also with a little bit of impact from the appliance, which has a lower gross margin. When you look at sales and marketing expense, you will get the full quarter of the sales hires that we have talked about extensively.

R&D, we'll continue to build R&D at a much slower pace than we have in the past. But we need to continue to innovate on our expanded product offering. And of course on a technical support basis, you have more products in the marketplace to support. So, I think that pretty much covers it.

Daniel Ives FBR Capital Markets

Just a final question. When you are looking at April, you talked about early Q2, what have you seen in the month of April, some deals that closed, kind of billings in the month, just can you talk about coming off of March, how you've seen this quarter progress. You talked about it, so I can ask a question.

Gene Hodges

We don't want to call all of April, but the specific thing we saw that's different from what we've seen in prior quarters is, first, some of our renewal customers due in Q1 flopped over and, frankly, we expect we're going to start seeing that across the whole year. I think we're going to see people rebudgeting every quarter as they try to come to grips with the various changes that are rolling through the economy.

Second, as people were resetting their budgets in the first quarter, they had to think a little bit harder about DLP; and several of those orders came in in April. Normally, they wouldn't. DLP orders are almost all backended to the end of the quarter.

Operator

Our next question comes from the line of Philip Rueppel Wachovia Capital Markets.

Philip Rueppel Wachovia Capital Markets

You mentioned you expect to see an increase in renewals coming up throughout the upcoming year. Is that skewed towards SurfControl customers or traditional Websense customers?

Doug Wride

It's both. As you may recall, SurfControl was a June fiscal yearend. So they traditionally had a higher volume quarter in Q2 than we did, a larger emphasis. Then we both had pretty good emphasis on Q4. So just that ongoing seasonality will bring more people up for renewal in Q2 and Q4.

Philip Rueppel Wachovia Capital Markets

Could you give us, is there any color that you have on the roughly twothirds of Surf customers that are upgrading? Is there any commonality in their geography or customer size? Just trying to get a feel if you have sort of seen the lowhanging fruit or you are going to kind of continue to see that percentage of customers upgrading as we go forward?

Gene Hodges

It's pretty broadbased across geography. Our retention rates of Surf customers are higher on the high end and lower on the low end. We've addressed that in the first quarter by putting some automated systems in place to help us capture those lowend customers. There's some upside there. We haven't included that in guidance because it's still somewhat experimental. We'll see how that works out in Q2.

Doug Wride

I'd also add that, typically, it's your smaller customers that are willing to stick with what's already installed and not necessarily move to the latest and greatest. It isn't broken, it meets their needs, and they just don't want to change.

Philip Rueppel Wachovia Capital Markets

My final question. If the WSG and the appliance exceed your expectations, does that affect any of the metrics, skew them one way or another? Is there any change in contract duration or anything at all or are you seeing a sort of similar kinds of deals struck with that product set as you have in the past?

Gene Hodges

WSG is sold heavily, as I think John McCormack shared with you at analyst day, to larger customers. It's 85%, I believe, over 500 users and actually very heavily concentrated above several thousand users. And those users typically buy it longer duration.

Operator

Our next question comes from the line of Eric Martinuzzi CraigHallum Capital.

Eric Martinuzzi CraigHallum Capital

You made a comment about the strength of the retention; the ratings are higher on the high end and lower on the low end. I was wondering could you speak to that, as far as your distribution partners, the valueadded resellers that you're working with, how has their retention been? They may not have the same cash flow and balance sheet strength that you guys do. Could you talk to the VAR strength?

Gene Hodges

We haven't seen any serious weakness from VARS yet. Obviously it's something that we watch very closely. I think they are feeling the credit crunch, and distribution has been very helpful in helping them work that out. Our larger VARS, some of them I think who are looking at very rapid expansion of the business, are working with this to make sure that through distribution they have the credit they need, especially for WSG and DLP sales.

Eric Martinuzzi CraigHallum Capital

Is that you guys extending credit or is that your distribution partners extending credit? How is that working?

Gene Hodges

Through distribution.

Eric Martinuzzi CraigHallum Capital

Then on the vertical commentary, if you could, could you speak to strength, weakness, financials, government, health care, whatever insight you can give would be helpful. And then if you expect those trends to persist.

Gene Hodges

We don't see any vertical trends in Q1 that were outside the general demographic trends. Automotive and transportation was pretty tough. That's where we saw a lot of distressed accounts. Financial services is fairly tough in the U.S. and the U.K. but in pretty good shape in the rest of the world from what we can see. Health care is kind of a bright spot as is government spending around the world.

Operator

Our next question comes from the line of Philip Winslow Credit Suisse.

Philip Winslow Credit Suisse

Just wondering if you could comment on just the pricing environment. You mentioned some relative stability. Is that true when you look across whether it's a large enterprise and small and midsize businesses? I guess when you look over the course of the year, just what are your expectations there?

Gene Hodges

Pricing was fairly stable in Q1. There was a broader scattergram, if you will, than we've normally had. We did have significantly appreciated price points in WSG sales, where you may remember we charge an uplift of about 30%; but we're doing better at list price. But we're doing better than that at street. And the biggest price pressure that we saw were from highly distressed accounts who were simply trying to conserve cash any way they could. Typically, what we do with those accounts is push back on price and agree to shorten their contracts as they need.

Operator

Our next question comes from the line of Todd Raker Deutsche Bank Securities.

Todd Raker Deutsche Bank Securities

I was wondering if you could just comment in terms of the linearity that you guys are seeing in terms of the billings over the course of Q1 and what we should be thinking about here for Q2?

Doug Wride

I think linearity is continuing to push deeper in the month, deeper in the quarter, deeper in the subscription period as Gene said. And I also commented to there's this compression in the window between the renewal date and the actual subscription renewal itself, the expiration date in the subscription renewal. Everybody is hanging on to their money longer, and you would just sort of suspect that to happen.

Todd Raker Deutsche Bank Securities

As you guys look at Q1 over the course of the quarter, were there any signs in your mind that things have stabilized or are getting better towards the end of the quarter or was it pretty consistent throughout the quarter?

Gene Hodges

I think there were two trends, the general trend of how much impact we see both in Q1 and we would speculate over the course of the year is we expect continued decay. We don't think we're at the bottom yet. Unemployment will keep going up. We will see more bankruptcies. What happened we think in Q1 is probably an unprecedented level of what's happening with my budget. That really made things extremely chaotic, it drove the backend loading.

We would expect that budget impulses, if there are some more disruptive events of the bankruptcies in the automotives or another big dislocation in finance, those industries will go back and replan budgets and people will scramble around for a couple of months.

I think there's been some discussion that there may have been a lightening in March and April. We don't see it as a lightening; we just see it as a stabilization once people got a handle around where they were going to cut and it wasn't in our parts of IT security.

Doug Wride

All that said, I would just add that it's good to be in the security software business, because that's an industry segment that seems to be much more stable than others. It's not something where you're going to go naked and unprotected.

Operator

Our next question comes from the line of Rob Owens Pacific Crest Securities.

Rob Owens Pacific Crest Securities

I was surprised to see your sequential seat growth count. Maybe you can shed some light on that, especially in light of Gene's comments about seeing some major slippage with U.S. and European renewals. You grew it sequentially. What would you expect for the rest of the year there?

Doug Wride

The growth is in product seats, so as we continue to have success in crossselling the products, that number should continue to grow, even in a rougher employment environment. When we go back years, even two years ago, we didn't have multiple products. We had web security. Today, you have web security, DLP, and email security. Those are all three different product seats.

Rob Owens Pacific Crest Securities

Along those lines, is WSG considered a single product customer or a dual product customer because it has the filtering underneath?

Doug Wride

It's single product, so if you are a web security customer or web filtering customer and you upgrade to WSG for the same number of seats, that's an upsell or upgrade.

Rob Owens Pacific Crest Securities

So we're primarily seeing that as a function of a better attach rate of multiple products per customer?

Doug Wride

Correct.

Gene Hodges

And fairly strong continue to buy of base web filtering outside of the U.S.

Rob Owens Pacific Crest Securities

And then back on the pricing front. I think your annualized average price was down for the first time since you've done the acquisition.  What's going on with that dynamic and would you expect that to continue, I guess, as we move throughout this year?

Gene Hodges

That's the threefortwo phenomenon of last Q1 against this Q1.

Rob Owens Pacific Crest Securities

That was just Q1 of last year? You brought that program back in June, correct?

Gene Hodges

Yes.

Rob Owens Pacific Crest Securities

So we shouldn't expect the same type of negative compare yearoveryear at this point?

Gene Hodges

We don't think so, no.

Rob Owens Pacific Crest Securities

Last one, if I can. Any material impact on your OEM business and how did that trend either sequentially or yearoveryear?

Gene Hodges

Q1 in OEM is the big quarter because our OEM business lags a quarter from billings. So basically, we get the Q4 sales from the OEMs in Q1. The OEM business has greater staying power in most of these guys that we've turned off than we expected. That surprised us a little bit. There's a winddown period of those contracts. That was positive in Q1.

Operator

Our next question comes from the line of Walter Pritchard Cowen & Company.

Walter Pritchard Cowen & Company

I am wondering if I look at billings and look at percentage of billings in Q1 over what your expectation for the year is, I get about 18%. If I look at that last year, it's about 20%. I am wondering, I know you have some new products ramping this year and just trying to get a sense of why that the year would progress differently than last year did?

Doug Wride

That's a good question. There are a number of factors. The largest factor is the apples to apples of foreign currency rates. When you look at the fourth quarter of this year with the stable FX environment through 2009, we'll be at the same kind of comparative rates. That's part of how we get to the midteen growth in the fourth quarter versus mild growth throughout the rest of the year.

Additionally to that, you have the products continuing to ramp  the appliance just released, the WSG growing in momentum, and then you have the productivity factor. You have the sales people that we have added in the first part of this year. As they build their pipeline, transactions start to come out of that pipeline late this quarter and certainly in the second half. So there's sort of a threelayer impact that's driving that.

Walter Pritchard Cowen & Company

I know it's a little early, but any update or progress report on the CFO search and sort of what type of person you're looking for there?

Doug Wride

I would say that the CFO search is going well. We find that, in this economy, Websense is a bit of a bright light. It's a very stable business with good results and a good team. We have attracted a number of candidates. That said, it's a very critical hire for us; and we continue to move through in a very diligent manner. I'd say it's on track. It's going well. It's just going to take a little time to get the right person on board.

Operator

Our next question comes from the line of Craig Nankervis First Analysis.

Craig Nankervis First Analysis

I wonder if you could just clarify the source of the Q1 billings being just a little light from the guidance, how much it was from contract duration versus sequential FX changes, please.

Doug Wride

First of all, to be clear, we didn't give guidance for billings in Q1. I would say if we look at the negative impact or negative pressures on Q1 billings, on a yearoveryear basis, you were certainly going to have the foreign exchange rates; and we spoke to that being about $5 million on a Q1 to Q1 rate basis.

I also think that you have some impact on the compression of when people renewed or when they purchased. Both Gene and I spoke to that. You have got some business that rolled over into Q2. All of those were sort of headwinds we worked against. On the other side of that, we had good reception on our WSG product. We had good customer retention and pretty much held our own, I think, in the quarter, which was across the board a pretty tough quarter.

Gene Hodges

Just to keep everything clear, the compression and the budget chaos in Q1, we do not expect to be something that benefits Q2 differentially. We expect to see that same type of compression and chaos pushing a couple of million dollars each quarter into the next quarter until the economy actually starts to solidify, which by and large will not be this year.

Craig Nankervis First Analysis

Secondly, when you talked about the WSG pipeline being good, it sounded like it's started in Europe and Asia and I was trying to understand or if you could explain why. I thought that was particularly for mature markets maybe it would have started in the U.S. and why it might have been reversed at least versus my ...

Gene Hodges

The WSG pipe built very quickly in the U.S. in the fourth quarter and continued to build in Q1. The pipeline build in Europe started at the beginning of December and is still going gangbusters. Asia really started to turn on about midQ1, so we saw a lag, less lag than we normally see between those regions from the introduction of a new technology; and it's gratifying to see the pipeline coming online now around the world.

Operator

We have no further questions at this time.

Kate Patterson

Thank you very much. If you have further questions, we will all be in our offices.

Operator

This concludes today's conference. We thank you for your participation.

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