The services we provide deliver comprehensive insight into the lifetime of customer interactions across on-line and off-line channels. We identify developing trends, analyze and test business hypotheses and optimize the performance of customer facing business systems without the need for significant investments in internal infrastructure.
Our customers can take advantage of the broad range of solutions we offer with flexible pricing and deployment options, including on-demand service and licensed software. Our WebSideStory line of products are typically delivered as an on-demand service over the Internet using secure, proprietary, and scalable applications and system architecture. On-demand delivery allows us to concurrently serve a large number of customers securely and to efficiently distribute the workload across our network of servers with provisions for redundant, fault-tolerant operations. These services are provided on a subscription basis to customers for a fee, which is either fixed or based on the actual number of web sites and total events (e.g., page views or rich internet application events) and
transactions monitored by our services. Contracts for subscription services typically range in duration from one to three years. The utility nature of our delivery model enables us to extend to our customers the services of over thirty business partners who exchange data through our system architecture.
Users of our Visual Sciences product line analyze information concerning their customers’ data and interactions as it streams in from their web sites, call centers, and messaging systems. We deliver our Visual Sciences product line either in-house by installation of licensed software on a customer’s hardware or on-demand over the Internet using secure, proprietary and scalable applications and system architectures. The pricing for the Visual Sciences product line is typically based on the number of licenses and modules sold. Post-contract support and professional services are often sold in addition to the licenses. The on-demand option is offered as a subscription service based upon the contract period, generally ranging from one month to three years. The licensed software delivery model enables us to respond to a broad range of application, performance, and security requirements found in the largest and most analytically competitive organizations. We provide our clients with a seamless transition between these two analytic product lines that preserves their data and their investment in our technology.
We derive our revenue from the sale of products and services that we classify into the following four categories: (1) subscription, hosting and support; (2) license; (3) professional services; and (4) advertising. We derive the majority of our revenue from HBX™ Analytics, the flagship product in the WebSideStory product line which is delivered as a hosted solution on a subscription basis. Web analytics refers to the collection, analysis and reporting of information about Internet user activity. HBX Analytics collects data from web browsers, processes that data and delivers analytic reports of online behavior to our customers on demand, allowing them to improve their websites and their online marketing campaigns.
As of December 31, 2006, we had over 1,500 customers purchasing services from our WebSideStory and Visual Sciences product lines. Our direct sales force sells our services to a broad range of organizations in many industries including sports and entertainment, news, retail, financial services, travel, technology, manufacturing, telecommunications and education.
The majority of our operations are conducted in the United States. In order to pursue the sale of our products and services in international markets, we established wholly owned subsidiaries in France (February 2000), the Netherlands (August 2000) and the United Kingdom (April 2003). See Note 2 to our consolidated financial statements for additional information regarding the geographic markets in which we operate.
Recent Acquisitions; $15 million Revolving Credit Facility
In May 2005, we acquired Avivo Corporation, which was doing business as Atomz, a provider of on-demand website search and web content management, in exchange for approximately $4.2 million in cash, 2,958,713 shares of common stock and 164,434 options to purchase our common stock. We believe the acquisition of Avivo advanced our strategy of using analytics data to drive the optimization of other, related marketing applications, which may expand our market opportunity. Over the course of 2006, Avivo’s website search and web content management applications, which we refer to as WebSideStory Search and WebSideStory Publish, respectively, were integrated with HBX Analytics to support this strategy.
In February 2006, we merged with Visual Sciences, LLC, a provider of streaming data analysis and visualization software and services, in exchange for $22.0 million in cash, 568,512 shares of common stock, warrants to purchase 1,082,923 shares of common stock with an exercise price of $18.47 per share, and $20.0 million in aggregate principal amount of senior notes. We also granted 189,507 shares of restricted common stock to certain employees of Visual Sciences and non-qualified stock options to purchase 350,000 shares of common stock to certain employees of Visual Sciences.
In February 2007, we entered into a two-year, $15 million senior secured revolving credit facility. We used $5.0 million of initial borrowings under this credit facility, together with cash-on-hand, to repay all of the senior notes we issued in connection with the Visual Sciences merger. For more information about the new credit facility, please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.”
The merger with Visual Sciences expanded and strengthened our strategic capabilities, enabling us to drive real-time customer intelligence applications into the full breadth of enterprise opportunities. The Visual Sciences brand extends our product suite in several dimensions: to real-time multichannel customer analytics for organizations that market and service through call centers, messaging systems, and retail points-of-sale; to licensed software deployments where security or privacy are dominant considerations as in healthcare or financial services; to intranets and extranets where hosted analytics is not practical; and to the largest and most complex web sites where parallel performance is required to manage terabytes of data.
Benefits of Our Services
We enable our clients to collect customer and business process information across multiple channels, such as the Web, retail points-of-sale, or call centers, and then apply such information to build a holistic picture of customer behavior, value, and business performance. Our clients use our products to monitor this stream of event and customer data for significant changes, to explore it visually and interactively, and to relate it to other corporate data assets. We help them apply the resulting insight by initiating or automating action through tailored web content, search results, or keyword bidding strategies. Our solutions enable our clients to make informed decisions about their customers and processes across a lifetime of interactions, transactions, and associated data resulting in significant revenue upside as well as business efficiencies.
We believe our services:
| • | Enable a More Complete View of the Customer Lifecycle: Our solutions deliver flexible deployment and data collection options which allow our customers to analyze any number of sources of data. Utilizing our Visual Sciences product line, the online behavioral data captured in our web analytics solutions can be analyzed separately or in conjunction with other data sources, enabling customer analysis across multiple channels. These potential data sources include, but are not limited to: integrated voice response (IVR); email traffic; product sales data across web, catalog, phone, and store channels; and custom data. | ||
| • | Provide Valuable Information to Improve Online and Offline Initiatives. Our analytic reports and drill down and visualization capabilities help our customers understand how users navigate and engage with their websites. Our reporting services allow businesses to compare the popularity and effectiveness of their content over time and across sections of their websites. These reports can reveal which paths in a website lead to the greatest number of sales and where bottlenecks occur and enable rapid testing of the effects that changes in content and design have on browsing, shopping and buying behavior. In addition, our services allow our customers to develop offline marketing strategies based on online analysis. We also correlate browsing and searching behavior with purchasing to reveal shopping patterns and trends. | ||
| • | Empower Customers to Implement Informed Marketing Decisions. While our web analytics service provides a basis for decisions affecting online marketing, our customers can use our analytics-driven applications to apply the insights gained. Our customers can use our website search application to influence how visitors navigate their website and search for content and products. Our web content management application allows our customers to publish and modify website content. Through integration with HBX Analytics, both site search and website content can be automatically optimized based on website visitor behavior. | ||
| • | Improve Marketing Return on Investment. Our web and internet channel analytics reports help businesses determine where their marketing budgets are best spent. We capture, analyze and report on on-line responses to both online and offline marketing campaigns. Using our services, our customers can run simultaneous campaigns, assess results in real time and then reallocate marketing resources to the most effective campaigns. Our customers can also identify which referral sources generate the most customer leads and can assess each campaign’s return on investment in terms of sales relative to costs. |
Our Strategy
We provide a broad range of solutions that address the diverse reporting and analysis needs found in the market today. We believe that success with analytical tools requires different levels of features, user interface, monitoring/reporting outputs, performance, and investment to capture every stage of the customer lifecycle and address the level of analytics maturity within an organization over time. An effective analytics solution also needs to provide the appropriate data to the relevant audience in the way that makes the most sense to that particular user or group of users.
To accomplish this, we offer a product line that ranges from our simplest and lowest-priced Web reporting product to our highest-priced and most capable multi-channel customer analytics products based on the Visual Sciences platform. Customers can invest anywhere along this product continuum with full confidence that their analytics needs will be met as their businesses change and mature, protecting their data and their investment for the life of our business relationship.
The key components of our strategy are to:
| • | Expand the Features and Functionality of Our Services. We plan to further enhance the features and functionality of our applications, as well as adapt our services to changing Internet environments and business practices. We also plan to continue to increase the number of languages supported by our services. | ||
| • | Pursue New Customers in Our Existing Markets, Cross-Sell Our Products and Expand into New Geographic Markets. Our applications currently serve diverse organizations, including Fortune 500 corporations, small and medium businesses, and educational and government institutions. We intend to continue marketing our services to a broad range of organizations, primarily through our direct sales force. We plan to increase the number of sales people that we employ and to develop other marketing or distribution channels for our services. Additionally, we plan to leverage our sales force to cross-sell our applications, extended services and packaged service offerings across our current and potential customer base. We also plan to increase our marketing efforts to customers outside of North America, and we may also expand outside North America. | ||
| • | Continue to Develop and Acquire Related Services and Technologies. We believe that our success in web analytics will help us sell both related customer analytics applications and analytics-driven applications such as call center analytics, point of sale analytics, website search applications, web content management, keyword bid management, marketing surveys, email marketing and affiliate marketing networks. In the past year, we have developed or acquired several of these customer intelligence applications, and we intend to develop or acquire additional applications. We believe our strengths in data analysis, scalability and delivery of on-demand application services will allow us to compete effectively with other companies that may attempt to offer comparable customer intelligence services. | ||
| • | Provide Superior Customer Service and Build Lasting Relationships with Our Customers. We believe that we can generate more revenue from our customers by promoting wider and more diverse deployments of our services. We seek to learn industry best practices based on feedback from our customers and to incorporate these practices into our technology and professional services. This strategy enhances the value our customers receive from our services. We intend to keep our customers satisfied by responding promptly to their feedback and requests and by building technology that helps them achieve their goals. | ||
| • | Encourage the Development of Third-Party Applications that Integrate with and are Complementary to Our Services. Our services are designed to allow third-party developers to create applications complementary to our core services offering. Our analytic reporting and data collection processes can be integrated with third-party applications through our published application programming interfaces, or APIs, and through standard-format data feeds. We actively encourage our customers to integrate our services with other systems and applications that they use to increase the value of our services. |
Our Services
Most typically our customers begin by leveraging our web and Internet channel analytics solutions and over time adopt our solutions across their other customer channels.
| Service | Description | |
HBX On-Demand Web Analytics
|
HBX is our on-demand web analytics service that collects, processes, stores and reports on Internet user behavior based on browser activity. Reports that we provide give our customers an extensive analysis of what visitors are doing on their web pages. For example, HBX can be used to inform our customers which marketing initiatives visitors responded to, what search engines they used, what keywords they entered, how much time they spent on web pages, what they bought online, when they abandoned shopping carts and what geographic area they live in. |
| Service | Description | |
Visual Site
|
Visual Site provides customers real-time visibility into Internet channel campaigns, sites, visitors and segments. Visual Site can integrate data from other visitor or transaction data sources to enable customers to gain a comprehensive view of their Internet visitors. | |
Visual Call
|
Visual Call provides customers real-time visibility into voice channel systems, customers and segments. | |
Visual Mail
|
Visual Mail provides customers real-time visibility into e-mail channel content, customers and segments. | |
WebSideStory Search
|
Search is our on-demand application that delivers relevant search results to visitors of our customers’ websites and guides them, step-by-step, to the products and information they want. Search also enables our customers to learn from their website visitors’ behavior and improve their business decisions based on what visitors are searching for and how often they find what they want. Customers can customize the search interface and results templates to match their website design. | |
WebSideStory Publish
|
Publish is our on-demand web content management application that helps businesses improve their website. Publish allows marketers and website owners to control website content, without sacrificing control over workflow, design and permissions required by web teams. For example, customers of Publish can navigate their own website to the content they want to modify, click a button and make the change. An additional click of a button will publish the changed content. Little to no training is required to utilize this application, and no technical expertise is needed. | |
WebSideStory Bid
|
Bid is our on-demand keyword bid management application that enables search engine marketers to actively manage pay-per-click bids from a single, easy-to-use interface. Bid is integrated with HBX to enable customers to analyze the effectiveness of their keyword bid strategies. |
Our other services include the following:
Professional Services. We also offer professional services to help our customers implement and use our applications. Our advice helps them interpret analytic reports, and we develop recommendations for improving our customers’ websites and marketing programs. We assist in implementing our own recommendations, analyze the results and develop new recommendations based on these results.
HBX DataFeed. HBX DataFeed allows companies to combine our on-demand web analytics with most in-house data applications. Customers that want the raw behavioral data that we collect can obtain it through data feeds that are easy to implement and compatible with standard database formats.
HitBox Professional. HitBox Professional is a web analytics application for small and medium-sized businesses that need web analytics services, but do not need all of the features and capabilities of HBX. HitBox Professional includes many, but not all of the features of HBX, and is offered at a lower base price.
Express Search. Express Search is a reduced-feature version of WebSideStory Search for small businesses and other website operators. We provide Express Search in exchange for the right to display text advertisements in the search results on our customers’ websites. We generate revenue from these online text advertisements.
Technology and Operations
Technology
WebSideStory Product Line:
The WebSideStory products are offered as on-demand solutions. These on-demand technologies are highly scalable, allowing us to serve large numbers of customers, including high-volume customers. Our on-demand proprietary software is designed to run on custom-built computer networks that we control and maintain. Unlike installed software, these solutions do not need to support different hardware, operating systems or databases, or develop software for customers’ unique computing environments. As a result, we can dedicate a greater proportion of our development resources to improve the features, functions, reliability and speed of our services.
Our technology is based on multi-tenant application architecture. We use commercially available hardware and proprietary software. To a lesser extent, we also use some commercially available software as components of our technology. We have custom-built core services such as visitor session measurement and a data management system that allow us to achieve both data manipulation and real-time reporting. We have built a distributed environment for both data collection and end-user report generation that routes both tasks efficiently to many servers, instead of to single, dedicated servers. Our customers can access our on-demand services through a web browser without installing any software. They can also receive reports and data from our systems through data feeds, a browser plug-in, a Microsoft Excel plug-in, our APIs and scheduled email delivery.
To handle large volumes of data efficiently at high speeds, we have built our own proprietary data management systems. These systems include proprietary data management software, data storage methods and compression algorithms. These data management systems allow us to make information and reports related to data collected over long periods of time available on demand.
Our services provide extensive reporting and analytics functionality accessible through hierarchical menus and interactive graphical reports available on demand. Users can customize reports and dashboards, schedule report delivery, model scenario analyses based on business criteria that they determine and monitor the results over time.
Other applications can address our services either through our APIs or through the use of data feeds from our network. Our systems allow customers and technology partners to insert and collect information from our services. We maintain security through the use of firewalls, intrusion detection, proprietary monitoring and network policies and procedures.
Visual Sciences Product Line:
Our proprietary Visual Sciences platform was designed to offer dramatic improvements in the collection, integration, analysis, visualization, and reporting of very large and disparate data sets for large enterprise customers. Our platform and applications allows us the flexibility to offer our clients an on premises or on-demand distribution model. As a result, we can meet the diverse needs and requirements of enterprise customers.
The platform technology is highly scalable due to our proprietary “clustering” capability which allows multiple servers to be managed and accessed together as if they are a single server. The platform runs on commodity and non-proprietary Intel and AMD server equipment keeping costs low both internally for systems we manage and for our customers who run our software in their internal environment. The distributed and parallel architecture of our platform allows the correct combination and capabilities to be delivered to each of our customers, regardless of size, security requirements, or complexity of their operating environments.
Our technology platform includes extremely flexible data collection and importing options. Our platform can extract, translate, and load data collected in real-time or batch from event tags, proprietary sensors on web and application servers, flat files or ODBC sources.
The Visual Sciences product line is available as an on-demand service or as an installed solution. Our customers access our on-demand services or on premises software through a thin client, Visual Workstation. Visual Workstation allows customers to access a rich language of metrics, dimensions and filters that can be defined in real-time and used in a wide array of visualizations. Customers can also receive reports and data from our systems through data feeds, output to Microsoft Excel, a web-based report portal and scheduled email delivery. Our system can also be configured to generate and publish reports and alerts based upon the occurrence of triggering events, thresholds, or calculated conditions.
The Visual Sciences Platform is composed of various product components including: Visual Workstation ® , Visual Dashboard™, Visual Report™, Visual Server ® , Visual Load ® , Visual Transform™, Visual Sensor ® , Visual Repeater™ and Visual Geography™. Together, these Platform software components provide an integrated system for collecting, processing, integrating, analyzing, and visualizing real-time information.
Our Visual Sciences Platform technology forms the core base upon which our market applications, such as Visual Site and Visual Call operate. The technology platform can also be easily configured to analyze various other data sources including: orders, payments, reservations, ATM transactions, kiosk transactions, document meta-data, electronic mail, network activity, and other types of event data.
Our technology development expenses, including related stock-based compensation expenses, were $12.8 million, $5.0 million and $3.8 million in the years ended December 31, 2006, 2005 and 2004, respectively.
Operations
All of our servers and our customers’ data are located at three, third-party co-location facilities: one in San Diego, California operated by Level 3 Communications, LLC, which we use primarily for our HBX web analytics services; one in San Jose, California operated by Equinix Operating Co., Inc., which we use for our site search and web content management services; and one in Ashburn, Virginia also operated by Equinix, which we use for our Visual Sciences product line. Our co-location agreements generally obligate the vendor to provide us with secure facilities, which generally includes biometric access screening and escort-controlled access, and on-site backup generators in the event of a power failure. The co-location agreements generally give us the right to keep our own network operators on-site around-the-clock. We regularly rotate tapes of customer data out of these facilities and store them in a separate location in the event of data loss at any of the facilities. In addition, we gain access to the Internet through several diverse Internet service providers, including Level 3. Our agreement with Level 3 expires in September 2007. Our agreement with Equinix for the San Jose facility expires in April 2007 but is subject to automatic one-year renewals unless either party provides notice of non-renewal to the other party at least 45 days prior to the end of the then-applicable term. Our agreement with Equinix for the Ashburn facility expires in November 2007 but is subject to automatic one-year renewals unless either party provides notice of non-renewal to the other party at least 90 days prior to the end of the then-applicable term.
We regularly monitor the performance of our services. The monitoring features we have built or licensed include centralized performance consoles, automated load distribution and various self-diagnostic tools and programs. We have service-level agreements with our customers warranting certain levels of uptime reliability and permitting them to receive credits or terminate their agreements in the event that we fail to meet those levels.
Customers
As of December 31, 2006, we had over 1,500 customers purchasing our services across our product lines. None of our customers individually accounted for more than 10% of our revenues for the years ended December 31, 2006, 2005 or 2004.
Sales and Marketing
Direct Sales
We primarily sell our services through our direct sales force, consisting of inside sales and field sales personnel. Our inside sales representatives are responsible for sales primarily to small and medium business customers assigned by geographic region as well as following up on leads generated from our marketing campaigns. Our field sales
personnel are responsible for our enterprise business customers, and they generally sell our services in face-to-face client meetings rather than over the telephone. We organize our sales and marketing programs by geographic regions and by product lines. Our North American sales programs are managed out of our San Diego, California headquarters and our San Bruno, California office. All of our European sales programs are managed out of our Amsterdam facility. In addition, we have sales consultants in Australia, Singapore and Canada.
Marketing
Our marketing strategy is to build our brand name and raise awareness of the company as a leading provider of real-time customer intelligence applications. Our marketing campaigns include a variety of advertising, public relations activities and web-based seminars and roundtables, all of which are targeted at executives and other decision makers within business organizations.
Our principal marketing initiatives include:
| • | advertising on industry-related websites; | ||
| • | participation in, and sponsorship of, Internet user conferences, trade shows and industry events; | ||
| • | partnering with well-known organizations within the industry; | ||
| • | using our website to provide product and company information and industry-related downloads; and | ||
| • | issuing press releases about business and product developments as appropriate. |
Customer Service and Support
We believe that customer service and support begins with our sales personnel who are trained to understand our customers’ needs. Our sales people work with our technologists to ensure that our customers receive the services they need for their businesses. Continuing superior customer support beyond the signing of our service contract helps us retain and expand our customer base. Support and assistance is available to our customers by telephone or email, depending on the size of the customer and its preference. Our customer support group is equipped to answer general inquiries regarding our services and more technical questions relating to the use of our services. We offer training to our customers to help them use the services they purchase from us.
International Sales
In fiscal 2006, 2005 and 2004, we generated approximately 13%, 14% and 16% of our total revenue, respectively, from subsidiaries located outside the United States. Our international operations primarily consist of sales activities for customers based in Europe and Asia. Our United States operations provide technical, legal and network operating support services to support our European and Asian customers. Our international direct and indirect subsidiaries were established for the purpose of paying the salaries of our sales personnel based in Europe and other expenses related to the billing and collecting of revenue from our European customers. Our current international strategy is to grow and strengthen our presence in international markets by hiring additional sales personnel and designing our services to support additional languages.
Competition
The market for web analytics and other customer intelligence applications is rapidly evolving and highly competitive. We expect competition to increase from existing competitors as well as new market entrants. We compete primarily with other application service providers and software vendors on the basis of product functionality, price, performance and level of service. We also compete with companies that offer web analytics software bundled with other products or services. Our current principal competitors include:
| • | web analytics providers such as Coremetrics, Omniture and WebTrends; | ||
| • | website search providers such as Endeca, Google and Verity; |
| • | web content management providers such as Interwoven and Vignette; and | ||
| • | providers of keyword bid management solutions such as Did-It and Efficient Frontier. |
In addition, we face competition from companies that develop similar technologies for their own use. Many companies, including some of our largest potential customers, use internally-developed interactive marketing software rather than the commercial services or software offered by us or our competitors. These companies may seek to offer their internally-developed software commercially in the future, which would bring us into direct competition with their products.
We believe the principal competitive factors in our market include the following:
| • | product functionality and breadth of services offered; | ||
| • | price and cost of ownership; | ||
| • | brand name and reputation; | ||
| • | rates of user adoption among the decision makers; | ||
| • | performance, security, scalability, reliability and flexibility of the services; | ||
| • | ability to gather and process large amounts of data; | ||
| • | speed and ease of implementation and use; | ||
| • | ease of integration with existing applications; and | ||
| • | quality of customer support and services. |
We believe that we compete favorably on the basis of these factors. However, some competitors may have features in their services that we do not include, and that customers prefer. Many of our current competitors and potential competitors have longer operating histories, greater name recognition and substantially greater financial, technical and marketing resources than we have. As a result, our competitors may be able to devote a greater portion of their resources to the development, marketing and sale of their products than we can and may be able to respond more quickly to the rapid advancements in technology and to the constant changes in customer needs. We cannot assure you that our current or potential competitors will not offer or develop services that are considered superior to ours, or that services other than ours will not achieve greater market acceptance.
Intellectual Property
We rely on a combination of trademark, copyright and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and contractual provisions to protect our proprietary technology and our brands. We also enter into confidentiality and proprietary rights agreements with our employees, consultants and other third parties and control access to software, documentation and other proprietary information.
We pursue the registration of our trademarks and service marks in the United States and in other countries, although we have not secured registration of all of our marks. WebSideStory, Visual Sciences, Visual Site and HitBox, among others, are our United States registered service marks. WebSideStory, Visual Sciences, Visual Site, HBX and HitBox are also registered in the European Union. Certain of these marks as well as other marks are also registered in several other international jurisdictions. We have applied to register the HBX service mark in the United States.
As of December 31, 2006, we had three issued patents. Of these issued patents, two expire in 2019 and are generally directed to Internet website traffic analysis. The third issued patent expires in 2020 and is generally directed to the correction of indirect addresses in documents. We also have ten patent applications pending in the
United States, as well as one international patent application pending under the Patent Cooperation Treaty and one pending patent application in each of the following countries/regions: Australia, Canada and Europe. In addition, we have entered into a cross license agreement with NetIQ, pursuant to which we have a license to NetIQ’s U.S. Patent No. 6,112,238, which expires in 2017, and certain patents pending and NetIQ has a license to our patents and certain patents pending. We do not believe that this cross license is material to our ability to sell our current web analytics services. This cross license agreement will terminate on the date the last patent expires. We cannot assure you that our pending, or any future, patent applications will be granted, that any existing or future patents will not be challenged, invalidated or circumvented, or that the rights granted under any patent that may issue will provide competitive advantages to us. Many of our current and potential competitors dedicate substantially greater resources to the protection and enforcement of intellectual property rights, especially patents. If a patent has been or is issued to a third party that prevents us from using some or all of our non-patented technology, we would need either to obtain a license to, or to design around, that patent. We may not be able to obtain a license on acceptable terms, if at all, or design around the patent, which could harm our ability to provide our services.
The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. For example, we, along with several of our competitors with technology similar to ours, are currently involved in patent litigation with NetRatings, Inc. NetRatings filed a patent infringement lawsuit against us in New York federal court in February 2006, and we have filed a similar patent infringement lawsuit against NetRatings in federal court in San Diego. For more information about these lawsuits, please see “Item 3. Legal Proceedings” below.
While our patent applications, copyrights, trademarks and other intellectual property rights are important, we believe that our technical expertise and ability to introduce new products in a timely manner will also be important factors in maintaining our competitive position.
United States and Foreign Government Regulation
The Internet, and in particular, the regulation of commercial enterprises on the Internet, has become a focus of state, federal and foreign governments in recent years. Discussions among policymakers and proposed regulation regarding the Internet have focused on the protection of consumer privacy. Much of the proposed and enacted legislation regulates the collection and disclosure of personally identifiable information of computer users such as their names, addresses, credit card information and social security numbers.
It is possible that legislation intended to regulate tracking of consumer’s usage on the Internet could bring some or all of our services within a regulatory framework. Such regulation could prevent us from operating our business in its current fashion, and could require us to change our business practices or some of our services.
Additionally, in the European Union, there is a range of legislation addressing, or affecting, Internet-related businesses. In particular, the 1995 European Union Directive on Data Protection applies to the processing of personal data, defined to include collection, storage, consultation and disclosure of information about identified or identifiable individuals. In addition, the 2002 European Union Privacy and Electronic Communications Directive regarding the processing of personal data and privacy in electronic communications prohibits the use of cookies, spyware and other tracking devices unless the user is given clear and conspicuous notice and the right to opt out. Because our service does not generally collect personal data as defined under the European Union Directives, and because we do not associate the information we do collect with identified or identifiable individuals, we believe that the data we collect and provide to our customers does not constitute personal data regulated by this Directive. We also believe that in the instances where we collect personal data, we do so in compliance with the European Union Directives.
State, federal and foreign governments are considering other laws that may regulate our activities or levy sales or other taxes relating to our activities. The laws governing the Internet, however, remain largely unsettled, even in areas where there has been some legislative action. It may take years to determine whether and how existing laws such as those governing intellectual property, privacy, libel and taxation apply to the Internet and e-commerce activities. In addition, the growth and development of the market for Internet commerce may prompt requests for more stringent consumer protection laws, both in the United States and abroad, that may impose additional burdens
on companies conducting business over the Internet. Our business and financial results could be materially harmed by the adoption or modification of laws or regulations relating to the Internet.
Employees
On December 31, 2006, we had 278 full-time employees. We have never had a work stoppage. None of our employees are represented under collective bargaining agreements. We consider our relationship with our employees to be good.
Available Information
All materials we file with or furnish to the Securities and Exchange Commission may be obtained electronically through use of the SEC internet site, http://www.sec.gov. Additionally, these materials may be obtained through the SEC’s Public Reference Room at 100 F Street N.E., Washington, D.C. 20549 or by calling the SEC at 1-800-SEC-0330.
We make available free of charge, on or through our Internet website, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Our Internet address is www.websidestory.com . Our internet address is not intended to function as a hyperlink. The information in our website is not and should not be considered part of this report and is not incorporated by reference in this document.
Item 1A. Risk Factors
The following information sets forth factors that could cause our actual results to differ materially from those contained in forward-looking statements we have made in this annual report and those we may make from time to time.
Risks Related to Our Business
Our web analytics services comprise a substantial majority of our revenue, and our business will be harmed if customer demand for these services declines.
Our web analytics services and related support represented 82%, 82% and 96% of our total revenue for the years ended December 31, 2006, 2005 and 2004, respectively. We anticipate that web analytics services and support will continue to represent a substantial majority of our total revenues. Our future success will depend, in part, on our ability to further enhance our web analytics services to meet client needs, to add functionality and to address technological advancements. Our future success will also be dependent upon our ability to attract new web analytics customers and to convince existing web analytics customers to renew their subscription agreements with us. In order to expand or to maintain our web analytics business, we may need to make significant investments in additional sales, marketing and other resources, which may not generate any additional revenues. We have experienced significant competition from other providers of web analytics services, and we cannot assure you that we will be able to continue to enhance our web analytics technology, expand our business or remain competitive in this market, any of which could have a material adverse effect on our business, financial condition and results of operations.
We have limited experience with customer intelligence applications other than web analytics and our efforts to expand our services beyond web analytics may not be successful.
We have historically focused on the web analytics market and our efforts to expand our business beyond web analytics may not be successful. In connection with our acquisition of Avivo in May 2005, we expanded our services to include website search and web content management. We also introduced our keyword bid management service in early 2006, and our strategy includes the further expansion of our service offerings to include additional customer intelligence applications in the future. The launch of new services can involve technological challenges, which may not be resolved on a timely basis or at all and may require significant development efforts and expenditures. We cannot assure you that our website search, web content management, keyword bid management or other new services will achieve broad market acceptance or generate significant revenues. In addition, the expansion
of our services beyond web analytics may result in a diversion of management’s attention and may require us to commit significant financial and other resources to an unproven business that may not generate a commensurate level of revenue or profits and could limit the resources we are able to devote to our existing business. If we are not successful in our expansion efforts, our brand image and existing business could be harmed and our stock price could decline.
Our indebtedness could adversely affect our financial health.
As of December 31, 2006, we had $20.0 million in aggregate principal amount of senior notes outstanding that were issued in connection with our merger with Visual Sciences in February 2006. In February 2007, we entered into a $15 million two-year, senior secured revolving credit facility. We used $5.0 million of initial borrowings under this credit facility, together with cash-on-hand, to repay all of the senior notes we issued in connection with the Visual Sciences merger. As a result, we have $5.0 million of indebtedness outstanding under our senior credit facility as of March 9, 2007.
Our indebtedness could have important consequences. For example, it could:
| • | increase our vulnerability to general adverse economic and industry conditions; | ||
| • | impair our ability to obtain additional financing in the future for working capital needs, capital expenditures, acquisitions and general corporate purposes; | ||
| • | require us to dedicate our cash flows from operations to the payment of principal and interest on our indebtedness, thereby eliminating or reducing the availability of our cash flows to fund working capital needs, capital expenditures, acquisitions and other general corporate purposes; | ||
| • | have a material adverse effect on our business and financial condition if we are unable to service our indebtedness or refinance such indebtedness; | ||
| • | limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate; and | ||
| • | place us at a disadvantage compared to our competitors that have less indebtedness. |
Covenants in our senior secured revolving credit facility may limit our ability to operate our business.
Under our senior secured credit agreement that we entered into in February 2007, we must comply with, among other things, certain specified financial ratios, including a minimum consolidated adjusted quick ratio and a minimum level of earnings before stock-based compensation, income taxes, depreciation and amortization expenses. If we default under the senior secured credit facility, because of a covenant breach or otherwise, the outstanding amounts thereunder could become immediately due and payable. In addition, the covenants contained in our senior secured credit facility limit our ability to incur additional debt, sell assets, make certain investments or acquisitions, grant liens, pay dividends and enter into certain merger and consolidation transactions, among other restrictions.
If we cannot successfully integrate our business with the businesses of Avivo and Visual Sciences, or if the benefits of these business combinations do not meet the expectations of investors or financial or industry analysts, the market price of our common stock may decline.
We completed our acquisition of Avivo and merger with Visual Sciences on May 4, 2005 and February 1, 2006, respectively. However, we cannot assure you that we will realize the anticipated benefits of these business combinations. The market price of our common stock may decline as a result of our business combinations with Avivo or Visual Sciences for a variety of reasons, including, among others, the following:
| • | we may not be able to integrate the business of Avivo or Visual Sciences with our business in a timely and efficient manner, or at all; | ||
| • | the combined company may not achieve the benefits of either business combination as rapidly as, or to the extent, anticipated by investors or financial or industry analysts; |
| • | we may not be able to expand the customer base of Avivo or Visual Sciences; or | ||
| • | the former stockholders of Avivo or Visual Sciences could dispose of a significant portion of our common stock that they received in connection with the business combinations. |
We operate in highly competitive markets, which could make it difficult for us to acquire and retain customers.
The market for customer intelligence applications is rapidly evolving and highly competitive. We expect competition to increase from existing competitors as well as new market entrants. We compete primarily with other application service providers and software vendors on the basis of product functionality, price, timeliness and level of service. Should our competitors consolidate, or if our smaller competitors are acquired by other, larger competitors, they may be able to provide services comparable to ours at a lower price due to their size. We also compete with companies that offer customer intelligence software bundled with other products or services, which may result in such companies effectively selling these services at prices below their market price. Our current principal competitors include:
| • | web analytics providers such as Coremetrics, Omniture and WebTrends; | ||
| • | website search providers such as Endeca, Google and Verity; | ||
| • | web content management providers such as Interwoven and Vignette; and | ||
| • | providers of keyword bid management solutions such as Did-It and Efficient Frontier. |
In addition, we face competition from companies that develop similar technologies for their own use. Many companies, including some of our largest potential customers, use internally-developed customer intelligence software rather than the commercial services or software offered by us or our competitors. These companies may seek to offer their internally-developed software commercially in the future, which would bring us into direct competition with their products. To date, no web analytics service has been adopted as the industry standard for measuring Internet user behavior and preferences. However, if one of our current or future competitors is successful in establishing its products and services as the industry standard, it will be difficult for us to retain current customers or attract additional customers for our services.
Furthermore, some businesses may require data or reports that are available only in competitors’ products, and potential customers may, therefore, select the products of our competitors. Many of our current and potential competitors have longer operating histories, greater name recognition, access to larger client bases, and substantially greater resources than us, including sales and marketing, financial, support and other resources. As a result, these competitors may be able to devote more resources to new customer acquisitions or may be able to respond to evolving market needs more quickly than us. If we are not able to compete successfully against our current and future competitors, it will be difficult to acquire and retain customers, and we may experience limited or no revenue growth, reduced operating margins, loss of market share and diminished value in our services.
Many of our services are sold pursuant to short-term subscription agreements, and if our customers elect not to renew these agreements, our revenue may decrease.
The majority of our services are sold pursuant to short-term subscription agreements, which are generally one to three years in length with no obligation to renew. Many of our customers are relatively new, which makes it difficult for us to predict if they will renew their agreements. Many of our subscription agreements will be subject to renewal in the next 12 months, and we cannot assure you that such agreements will be renewed. Our renewal rates may decline due to a variety of factors, including the services and prices offered by our competitors, the level of service we provide, consolidation in our customer base or cessation of operations by some of our customers. If our renewal rates are low or decline for any reason, or if customers renew on less favorable terms, our revenue may decrease, which could adversely affect our stock price.
Because we recognize the majority of our revenue from subscriptions to our services over the term of the applicable agreement, the lack of subscription renewals or new subscription agreements may not be immediately reflected in our operating results.
We recognize a large portion of our revenue from our customers over the term of their agreements with us. As a result, the majority of our quarterly revenue usually represents deferred revenue from subscription agreements entered into during previous quarters. As such, a decline in new or renewed subscription agreements in any one quarter will not necessarily be fully reflected in the revenue for the corresponding quarter but will negatively affect our revenue in future quarters. In addition, the effect of significant downturns in sales and market acceptance of our services may not be fully reflected in our results of operations until future periods. Similarly, revenue recognition requirements also make it difficult for us to reflect any rapid expansion in our customer base or the addition of significant new subscription agreements.
We may have difficulty maintaining our profitability.
Although we had generated net income in 2005, we incurred net losses of $7.7 million for the year ended December 31, 2006 primarily due to the stock-based compensation expense associated with the adoption of SFAS No. 123R and the intangible asset amortization expense related to our merger with Visual Sciences. We may not be able to regain our profitability in the future. We expect that our expenses relating to the sales of our services, technology improvements and general and administrative functions, as well as the costs of operating and maintaining our networks, will increase in the future. Because a large portion of our costs are fixed, we may not be able to reduce or maintain our expenses in response to any decrease in our revenue, which could adversely affect our operating results and profitability.
If we fail to respond to rapidly changing technology or evolving industry standards, our services may become obsolete or less competitive.
The market for our services is characterized by rapid technological advances, changes in client requirements, changes in protocols and evolving industry standards. If we are unable to develop enhancements to and new features for our existing services or acceptable new services that keep pace with rapid technological developments, our services may become obsolete, less marketable and less competitive and our business would be harmed. The success of any enhancements, new features and services depends on several factors, including the timing of completion, functionality and market acceptance of the feature or enhancement. Failure to produce acceptable new features and enhancements may significantly impair our revenue growth and reputation.
We may be liable to our customers and may lose customers if we provide poor service, if our services do not comply with our agreements or if there is a loss of data.
The information in our databases may not be complete or may contain inaccuracies that our customers regard as significant. Our ability to collect and report data may be interrupted by a number of factors, including our inability to access the Internet or the failure of our network or software systems. In addition, computer viruses may harm our systems causing us to lose data, and the transmission of computer viruses could expose us to litigation. Our agreements generally give our customers the right to terminate their agreements for cause if we fail to meet certain reliability standards stated in the agreements or if we otherwise materially breach our obligations. Any failures in the services that we supply or the loss of any of our customers’ data may give our customers the right to terminate their agreements with us and could subject us to liability. We may also be required to spend substantial amounts to defend lawsuits and pay any resulting damage awards. We may be liable to our customers for loss of business, loss of future revenue, breach of contract or even for the loss of goodwill to their business. In addition to potential liability, if we supply inaccurate information or experience interruptions in our ability to supply information, our reputation could be harmed and we could lose customers.
Although we have errors and omissions insurance with coverage limits of up to $5 million, this coverage may be inadequate or may not be available in the future on acceptable terms, or at all. In addition, we cannot assure you that this policy will cover any claim against us for loss of data or other indirect or consequential damages and defending a suit, regardless of its merit, could be costly and divert management’s attention
We may expand through acquisitions of, or investments in, other companies or through business relationships, all of which may divert our management’s attention, result in additional dilution to our stockholders or consume resources that are necessary to sustain our business.
One of our business strategies is to acquire competing or complementary services, technologies or businesses. We also may enter into relationships with other businesses in order to expand our service offerings, which could involve preferred or exclusive licenses, additional channels of distribution or discount pricing or investments in other companies.
An acquisition, investment or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the acquired businesses, technologies, products, personnel or operations of the acquired companies, particularly if the key personnel of the acquired company choose not to work for us, and we may have difficulty retaining the customers of any acquired business due to changes in management and ownership. Acquisitions may also disrupt our ongoing business, divert our resources and require significant management attention that would otherwise be available for ongoing development of our business. Moreover, we cannot assure you that the anticipated benefits of any acquisition, investment or business relationship would be realized or that we would not be exposed to unknown liabilities. In connection with one or more of those transactions, we may:
| • | issue additional equity securities that would dilute our stockholders; | ||
| • | use cash that we may need in the future to operate our business; | ||
| • | incur debt on terms unfavorable to us or that we are unable to repay; | ||
| • | incur large charges or substantial liabilities; | ||
| • | encounter difficulties retaining key employees of the acquired company or integrating diverse business cultures; and | ||
| • | become subject to adverse tax consequences, or incur substantial depreciation or deferred compensation charges. |
We periodically engage in preliminary discussions relating to acquisitions, but we are not currently a party to any acquisition agreements relating to pending or proposed acquisitions.
Fluctuations in our operating results may make it difficult to predict our future performance and may result in volatility in the market price of our common stock.
Due to our limited experience in offering a suite of customer intelligence applications, our evolving business model and the unpredictability of our emerging industry, we may not be able to accurately forecast our rate of growth. In addition, we may experience significant fluctuations in our operating results for other reasons such as:
| • | our ability to retain and increase sales to existing customers, attract new customers and satisfy our customers’ requirements; | ||
| • | the timing and success of new product introductions or upgrades by us or our competitors; | ||
| • | changes in our pricing policies or payment terms or those of our competitors; | ||
| • | concerns relating to the security of our networks and systems; | ||
| • | the rate of success of our domestic and international expansion; | ||
| • | our ability to hire and retain key executives as well as technical and sales and marketing personnel; |
| • | our ability to expand our operations and the amount and timing of expenditures related to this expansion; | ||
| • | limitations in the scalability of our networks and systems; | ||
| • | costs related to the integration of Avivo and Visual Sciences with our business and the development or acquisition of other technologies, products or businesses; and | ||
| • | general economic, industry and market conditions. |
These factors tend to make the timing and amount of revenue unpredictable and may lead to greater period-to-period fluctuations in revenue than we have experienced historically.
As a result of the factors described above, we believe that our quarterly revenue and results of operations are likely to vary significantly in the future and that period-to-period comparisons of our operating results may not be meaningful. You should not rely on the results of one quarter as an indication of future performance. If our quarterly revenue or results of operations fall below the expectations of investors, the price of our common stock could decline substantially.
We rely on a small number of third parties to support our network, any disruption of which could affect our ability to provide our services and could harm our reputation.
Our networks are susceptible to outages due to fires, floods, power loss, telecommunications failures, systems failures, break-ins and similar events. We have experienced some outages due to power loss, systems failure and telecommunications failure. In addition, some of our network infrastructure is located in San Diego, California and in San Jose, California, areas susceptible to earthquakes and rolling electricity black-outs. We do not have multiple operating sites for our services in the event of any such occurrence. Our servers are vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems. Frequent or persistent disruptions of our services could cause us to suffer losses that are impossible to quantify at this time, such as claims by customers for indirect or consequential damages, loss of market share and damage to our reputation. Our business interruption insurance may not compensate us for every kind of loss resulting from disruptions of our services, and even if the type of loss is covered, the amount incurred may exceed the loss limitations in our insurance policies.
All of our servers and our customers’ data are located at three, third-party co-location facilities: one in San Diego, California, operated by Level 3 Communications, LLC, which we use primarily for our HBX web analytics services; one in San Jose, California, operated by Equinix Operating Co., Inc., which we use for our site search and web content management services; and one in Ashburn, Virginia also operated by Equinix, which we use for our Visual Sciences product line. Our agreement with Level 3 expires in September 2007 and Level 3 has the right to terminate the agreement if (i) we fail to pay any amounts past due within ten days after written notice or (ii) we fail to observe or perform any other material term of the agreement and such failure continues for 30 days after written notice to us by Level 3. In addition, Level 3 may terminate our rights to use the co-location space and receive co-location services under certain circumstances. Our agreement with Equinix for the San Jose facility expires in April 2007 but is subject to automatic one-year renewals unless either party provides notice of non-renewal to the other party at least 45 days prior to the end of the then-applicable term. Our agreement with Equinix for the Ashburn facility expires in November 2007 but is subject to automatic one-year renewals unless either party provides notice of non-renewal to the other party at least 90 days prior to the end of the then-applicable term. In addition, Equinix has the right to terminate an agreement with us if (i) we fail to pay any amounts past due within ten days after written notice, (ii) we liquidate, become insolvent or cease doing business or (iii) we breach any other material term of the applicable agreement and such failure continues for 30 days after written notice to us by Equinix.
We depend on access to the Internet through Internet service providers, or ISPs, to operate our business. If we lose the services of one or more of our ISPs for any reason, we could experience disruption in our service offerings. The loss of one of our ISPs as the result of consolidation in the ISP industry could delay us from retaining the services of a replacement ISP and increase the potential for disruption of our business. Any disruption in our access to the Internet could damage our reputation and result in a decrease in our revenue from the loss of current or potential customers.
A rapid expansion of our networks and systems could cause us to lose data or cause our networks or systems to fail.
In the future, we may need to expand our networks and systems at a more rapid pace than we have in the past. We may suddenly require additional bandwidth for which we have not adequately planned. We may secure an extremely large customer or a group of customers with extraordinary volumes of information to collect and process that would require significant system resources, and our systems may be unable to process the information. Our networks or systems may not be capable of meeting the demand for increased capacity, or we may incur additional unanticipated expenses to accommodate such capacity constraints. In addition, we may lose valuable data or our networks may temporarily shut down if we fail to expand our networks to meet future requirements. Any lapse in our ability to collect or transmit data will decrease the value of our data, prevent us from providing the complete data requested by our customers and affect some of our customers’ web pages. Any disruption in our network processing or loss of Internet user data may damage our reputation and result in the loss of customers.
If our security measures are breached and unauthorized access is obtained, our services may be perceived as not being secure, and customers may hold us liable or stop using our services.
Our services involve the storage and transmission of proprietary information, and security breaches could expose us to a risk of loss of this information, litigation and possible liability. While we have not experienced any material security breach in the past of which we are aware, if our security measures are breached as a result of third-party action, employee error or otherwise, and as a result, someone obtains unauthorized access to our data or our customers’ data, we could incur liability and our reputation would be damaged. For example, hackers or individuals who attempt to breach our network security could, if successful, misappropriate proprietary information or cause interruptions in our services. If we experience any breaches of our network security or sabotage, we might be required to devote significant capital and resources to protect against or to alleviate problems. We may not be able to remedy any problems caused by hackers or saboteurs in a timely manner, or at all. Because techniques used to obtain unauthorized access or to sabotage systems change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. If an actual or perceived breach of our security occurs, the perception of the effectiveness of our security measures could be harmed and we could lose current and potential customers.
Any failure to adequately expand our direct sales force will impede our growth.
We expect to be substantially dependent on our direct sales force to obtain new customers, particularly large enterprise customers, and to manage our customer relationships. We plan to expand our direct sales force and believe that there is significant competition for direct sales personnel with the advanced sales skills and technical knowledge we need. Our ability to achieve significant growth in revenue in the future will depend, in large part, on our success in recruiting, training and retaining sufficient direct sales personnel. New hires require significant training and may, in some cases, take twelve months or more before they achieve full productivity. Our recent hires and planned hires may not become as productive as we would like, and we may be unable to hire sufficient numbers of qualified individuals in the future in the markets where we do business. If we are unable to hire and develop sufficient numbers of productive sales personnel, sales of our services will suffer.
We may encounter difficulties managing our growth, which could adversely affect our results of operations.
We have experienced significant growth in recent periods. Our total annual revenue has grown from $14.3 million in 2000 to $64.5 million in 2006. We anticipate that we will need to continue to expand and effectively manage our organization, operations and facilities in order to manage our growth and regain our recent profitability. We increased the number of our full-time employees from 130 as of January 1, 2001 to 278 as of December 31, 2006, and we expect to continue to expand our team to meet our strategic objectives. If we continue to grow, it is possible that our management, systems and facilities currently in place may not be adequate. Our need to effectively manage our operations and growth requires that we continue to improve our operational, financial and management controls, reporting systems and procedures. We may not be able to successfully implement these tasks on a large scale and, accordingly, may not achieve our strategic objectives.
The success of our business depends in large part on our ability to protect and enforce our intellectual property rights.
We regard the protection of our inventions, patents, copyrights, service marks, trademarks and trade secrets as important to our future success. We rely on a combination of patent, copyright, service mark, trademark, and trade secret laws and contractual restrictions to establish and protect our proprietary rights, all of which only offer limited protection. We endeavor to enter into agreements with our employees and contractors and agreements with parties with whom we do business in order to limit access to and disclosure of our proprietary information. Despite our efforts, the steps we have taken to protect our intellectual property may not prevent the misappropriation of proprietary rights or the 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 such infringers being successful, but we cannot be sure such actions will be successful, even when our rights have been infringed.
Although we do have three issued U.S. patents, numerous registered U.S. and foreign service marks and pending patent and service mark applications, we cannot assure you that any future patents or service mark registrations will be issued with respect to pending or future applications or that any issued patents or registered service marks will be enforceable or provide adequate protection of our proprietary rights.
Because of the global nature of the Internet, our websites can be viewed worldwide, but we do not have intellectual property protection in every jurisdiction. Furthermore, effective patent, trademark, service mark, copyright and trade secret protection may not be available in every country in which our services are available over the Internet. In addition, the legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related industries are uncertain and still evolving.
If a third party asserts that we are infringing its intellectual property, whether successful or not, it could subject us to costly and time-consuming litigation or expensive licenses, and our business may be harmed.
The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. For example, we, along with several of our competitors with technology similar to ours, are currently involved in patent litigation with NetRatings. NetRatings filed a patent infringement lawsuit against us in February 2006 in New York federal court, and we have filed a similar patent infringement lawsuit against NetRatings in federal court in San Diego. For more information about these lawsuits, please see “Item 3. Legal Proceedings” below. We, and certain of our customers, have in the past received correspondence from third parties alleging that certain of our services or customers’ use of our services violates such third parties’ patent rights. For example, we are aware that four of our customers have received letters from third parties alleging, among other things, that such customers’ online activities, including the use of our services, infringe patent rights held by these third parties. Some of these customers have requested that we indemnify them against these allegations. Other customers may receive similar allegations of infringement and make similar requests for indemnification under our service agreements with them or these third parties may make claims directly against us. If a third party successfully asserts a claim that we or our customers are infringing their proprietary rights, royalty or licensing agreements might not be available on terms we find acceptable or at all. As currently pending patent applications are not publicly available, we cannot anticipate all such claims or know with certainty whether our technology infringes the intellectual property rights of third parties. We expect that the number of infringement claims in our market will increase as the number of services and competitors in our industry grows. These claims, whether or not successful, could:
| • | divert management’s attention; | ||
| • | result in costly and time-consuming litigation; | ||
| • | require us to enter into royalty or licensing agreements, which may not be available on acceptable terms, or at all; or | ||
| • | require us to redesign our software and services to avoid infringement. |
As a result, any third-party intellectual property claims against us could increase our expenses and adversely affect our business. In addition, many of our agreements require us to indemnify our customers for third-party intellectual property infringement claims, which would increase the cost to us resulting from an adverse ruling in any such claim. Even if we have not infringed any third parties’ intellectual property rights, we cannot be sure our legal defenses will be successful, and even if we are successful in defending against such claims, our legal defense could require significant financial resources and management’s time.
If we fail to develop our brands cost-effectively, our business may suffer.
We believe that developing and maintaining awareness of the brands maintained by WebSideStory and Visual Sciences in a cost-effective manner is critical to achieving widespread acceptance of our current and future services and is an important element in attracting new customers. Furthermore, we believe that brand recognition will become more important as competition in our market increases. Successful promotion of our brands will depend largely on the effectiveness of our marketing efforts and on our ability to provide reliable and useful services at competitive prices. Brand promotion activities may not yield increased revenue, and even if they do, any increased revenue may not offset the expenses we incur in building our brands. If we fail to successfully promote and maintain our brands, or incur substantial expenses in an unsuccessful attempt to promote and maintain our brands, we may fail to attract enough new customers or retain our existing customers to the extent necessary to realize a sufficient return on our brand-building efforts, and our business and results of operations could suffer.
We rely on our management team and will need to hire additional personnel to grow our business.
Our success and future growth depends to a significant degree on the skills and continued services of the members of our senior management team, including our chief executive officer and chief financial officer. We have employment agreements with many of our executive officers; however, under these agreements, our employment relationships with these executive officers are generally “at-will,” and they can terminate their employment relationships with us at any time. We do not maintain key person life insurance on any members of our management team. We anticipate that we will need to continue to hire key management personnel. We may not be able to successfully locate, hire, assimilate and retain other qualified key management personnel to grow our business.
Jeffrey W. Lunsford, who had served as our president and chief executive officer since April 2003, resigned in November 2006 to become chief executive officer of a privately-held company. James W. MacIntyre, IV, who previously served as the chief executive officer of our Visual Sciences subsidiary, was appointed as our president and chief executive officer effective as of November 20, 2006. Any disruptions that result from the transition of chief executive leadership from Mr. Lunsford to Mr. MacIntyre could adversely affect our business.
Our future success also depends on our ability to attract, retain and motivate highly skilled technical, managerial, sales, marketing and customer service personnel. We plan to hire additional personnel in all areas of our business, in particular for our sales, marketing and technology development areas, both domestically and internationally. Competition for these types of personnel is intense, particularly in the Internet industry. As a result, we may be unable to successfully attract or retain qualified personnel. Our inability to retain and attract the necessary personnel could adversely affect our business.
Our business strategy includes expanding our international operations; therefore, our business is susceptible to risks associated with international operations.
We currently maintain a sales office in the Netherlands and currently have sales personnel or independent sales consultants in Australia, Canada, France, Germany, Singapore, Sweden and the United Kingdom. We have limited experience operating in these foreign jurisdictions and no experience operating in other foreign markets into which we may expand in the future. Conducting international operations subjects us to new risks that we have not generally faced in the United States. These risks include but are not limited to:
| • | unexpected changes in foreign regulatory requirements; | ||
| • | localization of our service, including translation into foreign languages and associated expenses; |
| • | fluctuations in currency exchange rates; | ||
| • | political, social and economic instability abroad, including conflicts in the Middle East, terrorist attacks and security concerns in general; | ||
| • | longer accounts receivable payment cycles and difficulties in collecting accounts receivable; | ||
| • | difficulties in managing and staffing international operations; | ||
| • | potentially adverse tax consequences, including the complexities of foreign value added tax systems and restrictions on the repatriation of earnings; | ||
| • | maintaining and servicing computer hardware in distant locations; | ||
| • | the burdens of complying with a wide variety of foreign laws and different legal standards; and | ||
| • | reduced or varied protection for intellectual property rights in some countries. |
The occurrence of any one of these risks could negatively affect our international business and, consequently, our results of operations generally. In addition, the Internet may not be used as widely in international markets in which we expand our operations and, as a result, we may not be successful in offering our services internationally.
Some of our international fees are currently denominated in U.S. dollars and paid in local currency. As a result, fluctuations in the value of the U.S. dollar and foreign currencies may make our services more expensive for international customers, which could harm our business.
We previously identified material weaknesses in our internal control over financial reporting, and our business and stock price may be adversely affected if our internal controls are not effective.
Section 404 of the Sarbanes-Oxley Act of 2002 requires companies to perform a comprehensive evaluation of their internal control over financial reporting. To comply with this statute, we are required to document and test our internal control over financial reporting; our management is required to assess and issue a report concerning our internal control over financial reporting; and our independent registered public accounting firm is required to attest to and report on management’s assessment and the effectiveness of internal control over financial reporting. In connection with their evaluations of our disclosure controls and procedures, our Chief Executive Officer, or CEO, and Chief Financial Officer, or CFO, concluded that certain material weaknesses in our internal control over financial reporting existed during the periods ending December 31, 2005, March 31, 2006, June 30, 2006 and September 30, 2006. These material weaknesses included insufficient staffing in our accounting and financial reporting functions and weaknesses in our recognition of leasing transactions in accordance with related generally accepted accounting principles. Our independent registered public accounting firm attested and reported that our internal control over financial reporting was not effective as of December 31, 2005. We believe that each of these material weaknesses has now been adequately remediated. Although our management has concluded and our independent registered public accounting firm has attested and reported that our internal control over financial reporting was effective as of December 31, 2006, we cannot assure you that we will not discover other material weaknesses in the future. The existence of one or more material weaknesses could result in errors in our financial statements, and substantial costs and resources may be required to rectify these or other internal control deficiencies. If we cannot produce reliable financial reports, investors could lose confidence in our reported financial information, the market price of our common stock could decline significantly, we may be unable to obtain additional financing to operate and expand our business, and our business and financial condition could be harmed.
Changes in financial accounting standards or practices or existing taxation rules or practices may cause adverse, unexpected financial reporting fluctuations and affect our reported results of operations.
A change in accounting standards or practices or a change in existing taxation rules 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 taxation rules and varying interpretations of accounting pronouncements and taxation practice 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 we conduct our business. For example, in December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123R, Share-Based Payment , or SFAS No. 123R. This statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation , and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees , or APB No. 25. SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS No. 123R required that we change the way we account for share-based payments, including employee stock options. We previously accounted for stock-based awards to employees in accordance with APB No. 25. Under our previous accounting policy, we recorded stock-based compensation based on the difference between the exercise price of the stock option and the fair market value at the time of grant. To arrive at the fair value for each option grant, SFAS No. 123R requires the use of an option pricing model to evaluate our stock by factoring in additional variables such as expected life of the option, risk-free interest rate, expected volatility of the stock and expected dividend yield. Subsequently, in May 2005, the SEC approved a rule delaying the effective date of SFAS No. 123R to the annual period beginning after June 15, 2005. We adopted SFAS No. 123R effective as of January 1, 2006. The impact of the adoption of SFAS No. 123R on our results of operations is set forth in the consolidated financial statements contained in Item 8 of Part II of this report.
Our net operating loss carryforwards may expire unutilized, which could prevent us from offsetting future taxable income.
Changes in control have occurred that have triggered the limitations of Section 382 of the Internal Revenue Code on the net operating loss carryforwards of WebSideStory and Avivo. As a result of the Section 382 limitations, we can only utilize a portion of the net operating loss carryforwards generated prior to the ownership changes to offset future taxable income generated in U.S. federal and state jurisdictions.
At December 31, 2006, we had federal net operating loss carryforwards of approximately $30.6 million and state net operating loss carryforwards of approximately $22.3 million, which are available to offset future taxable income. The federal net operating loss carryforwards will begin to expire in 2020. The state net operating loss carryforwards will begin to expire in 2012.
In 2006, net deferred tax assets increased approximately $6.0 million primarily due to the recognition of approximately $4.3 million of net deferred tax assets in connection with compensation expense related to stock options. The realization of the tax benefits of this deferred tax asset is dependent upon the stock price of the Company exceeding the exercise price of the related stock options at the time of exercise, as well as the sufficiency of taxable income in future years. The combined deferred tax assets represent the amounts expected to be realized before expiration.
We periodically assess the likelihood that we will be able to recover our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible profits. As a result of this analysis of all available evidence, both positive and negative, we concluded that it is more-likely-than-not that our net deferred tax assets will ultimately be recovered and, accordingly, no valuation allowance on such assets was recorded as of December 31, 2006.
Risks Related to Our Industry
Widespread blocking or erasing of cookies or limitations on our ability to use cookies may impede our ability to collect information with our technology and reduce the value of that data.
Our technology currently uses cookies, which are small files of information placed on an Internet user’s computer, to collect information about the user’s visits to the websites of our customers. Third-party software and our own technology make it easy for users to block or delete our cookies. Several software programs, sometimes marketed as ad-ware or spyware detectors, block our cookies by default or prompt users to delete or block our cookies. If a large proportion of users delete or block our cookies, this could significantly undermine the value of the data that we collect for our customers and could negatively impact our ability to deliver accurate reports to our customers, which would harm our business.
Changes in web browsers may also encourage users to block our cookies. Microsoft, for example, frequently modifies its Internet Explorer web browser. Certain modifications by Microsoft could substantially impair our ability to use cookies for data collection purposes. If that happens and we are unable to adapt our technology and practices adequately in response to changes in Microsoft’s technology, then the value of our services would be substantially impaired. Additionally, other technologies could be developed that impede the operation of our services. These developments could prevent us from providing our services to our customers or reduce the value of our services.
In addition, laws regulating the use of cookies by us and our customers could also prevent us from providing our services to our customers or require us to employ alternative technology. A European Union Directive currently being implemented by member countries requires us to tell users about cookies placed on their computers, describe how we and our customers will use the information collected and offer users the right to refuse a cookie. Although no European country currently requires consent prior to delivery of a cookie, one or more European countries may do so in the future. If we were required to obtain consent before delivering a cookie or if the use or effectiveness of cookies is limited, we would be required to switch to alternative technologies to collect user profile information, which may not be done on a timely basis, at a reasonable cost, or at all.
Currently, the only alternative to using cookies to identify a browser and its browsing session is the use of an Internet protocol address, or IP address. The IP address is an identifier that each computer or other device connected to the Internet has. However, for purposes of web analytics, IP addresses are not as reliable as cookies, because they are often re-assigned by Internet service providers. We do not believe that a better alternative to using cookies currently exists for tracking online customer behavior. Creating replacement technology for cookies could require us to expend significant time and resources. We may be unable to complete this alternative technology development in time to avoid negative consequences to our business, and the replacement methods we develop may not be commercially feasible. The replacement of cookies might also reduce our existing customer base by requiring current customers to take specific action to accommodate new technology.
Privacy concerns and laws or other domestic or foreign regulations may subject us to litigation or limit our ability to collect and use Internet user information, resulting in a decrease in the value of our services and an adverse impact on the sales of our services.
We collect, use and distribute information derived from the activities of Internet users. Federal, state and foreign government bodies and agencies have adopted or are considering adopting laws regarding the collection, use and disclosure of personal information obtained from consumers. The costs of compliance with, and the other burdens imposed by, such laws may limit the adoption of our services. In addition, some companies have been the subject of class-action lawsuits and governmental investigations based on their collection, use and distribution of Internet user information without the consent of Internet users. For example, the Federal Trade Commission, or FTC, investigates companies’ compliance with their own stated privacy policies. While we are not aware of any FTC investigation regarding any practices we currently employ, the FTC may in the future investigate the practices we employ. Governmental entities and private persons or entities may assert that our methods of collecting, using and distributing Internet user information are illegal or improper. Any such legal action, even if unsuccessful, may distract our management’s attention, divert our resources, negatively affect our public image and harm our business.
Both existing and proposed laws regulate and restrict the collection and use of information over the Internet that personally identifies the Internet user. These laws continue to change and vary among domestic and foreign jurisdictions, but certain information such as names, addresses, telephone numbers, credit card numbers and email addresses are widely considered personally identifying. The scope of information collected over the Internet that is considered personally identifying may become more expansive, and it is possible that current and future legislation may apply to information that we currently collect without the explicit consent of Internet users. If information that we collect and use without consent is considered to be personally identifying, our ability to collect and use this information will be restricted and we would have to change our methods of operation.
Recently, the legislatures of several states including Utah, California, Arizona, Virginia, and Arkansas enacted legislation designed to protect Internet users’ privacy by prohibiting certain kinds of downloadable software defined as “spyware.” Similar legislation has been considered, or is being considered, in nearly all state legislatures and in the U.S. House of Representatives. Such legislation, if it includes a broad definition of “spyware,” could restrict our information collection methods. Any restriction or change to our information collection methods would cause us to spend substantial money and time to make such changes and could decrease the amount and utility of the information that we collect.
In addition, domestic and foreign governments are considering restricting the collection and use of Internet usage data. Some privacy advocates argue that even anonymous data, individually or when aggregated, may reveal too much information about Internet users. If governmental authorities were to follow privacy advocates’ recommendations and enact laws that limit our online data collection practices, we would likely have to obtain the express consent, or opt-in, of an Internet user before we could collect, share, or use any of that user’s information. It might not be possible to comply with all domestic and foreign governmental restrictions simultaneously. Any change to an opt-in system of data collection would damage our ability to aggregate and utilize the information we currently collect from Internet users and would reduce the amount and value of the information that we provide to customers. A reduction in the value of our information might cause some existing customers to discontinue their use of our services or discourage potential customers from subscribing to our services, which would reduce our revenue. We would also need to devote considerable effort and resources, both human and financial, to develop new information collection procedures to comply with an opt-in requirement. Even if we succeeded in developing new procedures, we might be unable to convince Internet users to agree to our collection and use of their information. This would negatively impact our revenue, growth and potential for expanding our business and could cause our stock price to decline.
The success of our business depends on the continued growth of the Internet as a business tool and the growth of the web analytics market.
Expansion in the sales of our services depends on the continued reliance on the Internet as a communications and commerce platform for enterprises. The use of the Internet as a business tool could be adversely impacted by the development or adoption of new standards and protocols to handle increased demands of Internet activity, security, reliability, cost, ease-of-use, accessibility and quality-of-service. The performance of the Internet and its acceptance as a business tool has been harmed by viruses, worms, and similar malicious programs, and the Internet has experienced a variety of outages and other delays as a result of damage to portions of its infrastructure. If, for any reason, the Internet does not remain a widespread communications medium and commercial platform and business processes do not continue to move online, the demand for our service would be significantly reduced, which would harm our business.
In addition, the market for Internet user measurement and analysis services is new and rapidly evolving. In particular, the market for outsourced, on-demand information services such as ours is relatively new and evolving. We will not be able to sell our services or grow our business if the market for Internet user measurement and analysis services does not grow or is not outsourced, or if on-demand services are not widely adopted.
Risks Related to the Securities Market and the Ownership of Our Common Stock
Our stock price may be volatile and you may not be able to sell your shares at an attractive price.
Our common stock had not been publicly traded prior to our initial public offering, which was completed in October 2004, and an active trading market may be difficult to sustain. We have not paid cash dividends since our inception and do not intend to pay cash dividends in the foreseeable future. Therefore, investors will have to rely on appreciation in our stock price and a liquid trading market in order to achieve a gain on their investment. The market prices for our common stock and for securities of technology companies in general have been highly volatile and may continue to be highly volatile in the future. The trading price of our common stock may fluctuate substantially as a result of one or more of the following factors:
| • | variations in our operating results; | ||
| • | announcements of technological innovations, new services or service enhancements or significant agreements by us or by our competitors; |
| • | recruitment or departure of key personnel; | ||
| • | changes in the estimates of our operating results or changes in recommendations by any securities analysts that elect to follow our common stock; | ||
| • | sales of our common stock, including sales by officers, directors and funds affiliated with them; | ||
| • | fluctuations in stock market prices and trading volumes of similar companies or of the securities markets generally; | ||
| • | market conditions in our industry, the industries of our customers and the economy as a whole; or | ||
| • | economic and political factors, including wars, terrorism and political unrest. |
We might require additional capital to support business growth and this capital might not be available on acceptable terms, or at all.
We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new services or enhance our existing services, enhance our operating infrastructure and acquire competing or complementary businesses and technologies. Accordingly, we may need to engage in equity or debt financings to secure additional funds. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock. The senior secured credit agreement we entered into in February 2007 includes restrictive covenants which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. In addition, we may not be able to obtain additional financing on terms favorable to us, or at all. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, our ability to continue to support our business growth and to respond to business challenges could be significantly limited. If we need to raise additional funds and are unable to do so, we may be required to modify our operations, which would have an adverse effect on our financial position, results of operations and cash flows.
Future sales of our common stock by our stockholders may depress our stock price.
Our existing stockholders hold a substantial number of shares of our common stock that they generally are currently able to sell in the public market. In particular, the former Avivo shareholders who received shares of our common stock pursuant to the merger agreement with Avivo are generally able to sell in the public market. We have also registered the shares of our common stock that are subject to outstanding stock options or reserved for issuance under our stock option plans, which shares can also be freely sold in the public market upon issuance. In addition, certain stockholders have rights, subject to some conditions, to require us to file registration statements covering their shares or to include their shares in registration statements that we may file for ourselves or for other stockholders. Sales by our existing stockholders of a substantial number of shares, or the expectation that such sales may occur, could significantly reduce the market price of our common stock.
In addition, in connection with our merger with Visual Sciences, 568,512 shares of our common stock were placed in escrow for the benefit of the former members and certain optionholders of Visual Sciences. These shares are subject to release from escrow on April 1, 2007, unless we assert indemnification claims against them under our merger agreement, and generally may be sold in the public market pursuant to Rule 144 or pursuant to a shelf registration statement that we are required to file with respect to such shares. Moreover, we issued to the former members and certain optionholders of Visual Sciences warrants to purchase 1,082,923 shares of our common stock at an exercise price of $18.47 per share. Any shares issued upon exercise of the warrants may also be sold pursuant to such shelf registration statement, once it becomes effective. Sales by the former members and optionholders of Visual Sciences of a substantial number of shares, or the expectation that such sales may occur, could significantly reduce the market price of our common stock.
Moreover, certain of our stockholders have established trading plans under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, or the Exchange Act, for the purpose of effecting sales of common stock, and other employees and affiliates, including our directors and executive officers, may choose to establish similar plans in the future. Sales of a substantial number of shares of our common stock in the public market by our affiliates could cause the market price of our common stock to decline and could impair our ability to raise additional capital through equity financings.
Provisions in our amended and restated certificate of incorporation and bylaws or under Delaware law might discourage, delay or prevent a change of control of our company or changes in our management and, therefore, depress the trading price of our common stock.
Our amended and restated certificate of incorporation and bylaws contain provisions that could depress the trading price of our common stock by acting to discourage, delay or prevent a change of control of our company or changes in our management that the stockholders of our company may deem advantageous. These provisions:
| • | establish a classified board of directors so that not all members of our board are elected at one time; | ||
| • | provide that directors may only be removed “for cause” and only with the approval of the holders of 66 2/3% of our outstanding voting stock; | ||
| • | require super-majority voting to amend some provisions in our amended and restated certificate of incorporation and bylaws; | ||
| • | authorize the issuance of “blank check” preferred stock that our board of directors could issue to increase the number of outstanding shares to discourage a takeover attempt; | ||
| • | prohibit stockholder action by written consent, requiring all stockholder actions to be taken at a meeting of our stockholders; | ||
| • | provide that the board of directors is expressly authorized to make, alter or repeal our bylaws; and | ||
| • | establish advance notice requirements for nominations for elections to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings. |
Additionally, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder and which may discourage, delay or prevent a change of control of our company.
Item 1B. Unresolved Staff Comments.
None