10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2007

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT O F 1934

For the Transition Period from            to

Commission File Number 000-30093

Websense, Inc.

(Exact name of registrant as specified in its charter)

Delaware	51-0380839
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

10240 Sorrento Valley Road

San Diego, California 92121

858-320-8000

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

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

Large Accelerated Filer x Accelerated Filer o Non —Accelerated Filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):  Yes o No x

The number of shares outstanding of the registrant’s Common Stock, $.01 par value, as of October 31, 2007 was 45,376,906.

Websense, Inc.

Form 10-Q

For the Period Ended September 30, 2007

TABLE OF CONTENTS

			Page
Part I. Financial Information
	Item 1.	Consolidated Financial Statements (Unaudited)
		Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006	3
		Consolidated Statements of Income for the three and nine months ended September 30, 2007 and 2006	4
		Consolidated Statement of Stockholders’ Equity for the nine months ended September 30, 2007	5
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006	6
		Notes to Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	26
	Item 4.	Controls and Procedures	27
Part II. Other Information
	Item 1.	Legal Proceedings	28
	Item 1A.	Risk Factors	28
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	40
	Item 3.	Defaults upon Senior Securities	40
	Item 4.	Submission of Matters to a Vote of Security Holders	40
	Item 5.	Other Information	40
	Item 6.	Exhibits	41
Signatures			42

2

Part I — Financial Information

Item 1. Consolidated Financial Statements (Unaudited)

Websense, Inc.
Consolidated Balance Sheets
(Unaudited and in thousands)

	September 30,			December 31,
	2007			2006
				(See Note 1)
Assets
Current assets:
Cash and cash equivalents	$	45,645		$	83,523
Cash and cash equivalents-restricted	196,162			—
Marketable securities	15,035			243,382
Marketable securities-restricted	22,991			—
Accounts receivable, net	42,643			52,740
Prepaid income taxes	2,357			—
Current portion of deferred income taxes	18,052			18,179
Other current assets	5,167			3,943
Total current assets	348,052			401,767
Property and equipment, net	7,592			5,793
Intangible assets, net	13,138			1,067
Goodwill	73,625			—
Deferred income taxes, less current portion	21,608			13,806
Deposits and other assets	7,386			1,824
Total assets	$	471,401		$	424,257
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	1,425		$	2,712
Accrued payroll and related benefits	13,216			9,164
Other accrued expenses	12,414			7,084
Current portion of income taxes payable	1,105			4,229
Current portion of deferred revenue	145,742			148,539
Total current liabilities	173,902			171,728
Income taxes payable, less current portion	9,522			—
Deferred revenue, less current portion	73,528			71,804
Stockholders’ equity:
Common stock	514			509
Additional paid-in capital	258,958			237,302
Treasury stock, at cost	(139,786		)	(139,744		)
Retained earnings	94,763			82,748
Accumulated other comprehensive loss	—			(90		)
Total stockholders’ equity	214,449			180,725
Total liabilities and stockholders’ equity	$	471,401		$	424,257

See accompanying notes.

3

Websense, Inc.
Consolidated Statements of Income
(Unaudited) (in thousands, except per share amounts)

	Three Months Ended				Nine Months Ended
	September 30,		September 30,		September 30,		September 30,
	2007		2006		2007		2006
Revenue	$	50,429	$	45,742	$	150,625	$	131,489
Cost of revenues
Cost of revenues	4,466		3,873		13,299		10,955
Amortization of acquired technology	629		—		1,887		—
Total cost of revenues	5,095		3,873		15,186		10,955
Gross margin	45,334		41,869		135,439		120,534
Operating expenses:
Selling and marketing	25,249		21,309		75,289		58,245
Research and development	8,338		5,954		25,789		16,932
General and administrative	6,828		5,535		20,589		15,968
Write off of in-process research and development	—		—		1,270		—
Total operating expenses	40,415		32,798		122,937		91,145
Income from operations	4,919		9,071		12,502		29,389
Other income, net	3,928		2,784		7,843		8,240
Income before income taxes	8,847		11,855		20,345		37,629
Provision for income taxes	2,452		3,550		7,954		13,313
Net income	$	6,395	$	8,305	$	12,391	$	24,316
Net income per share:
Basic net income per share	$	0.14	$	0.18	$	0.28	$	0.52
Diluted net income per share	$	0.14	$	0.18	$	0.27	$	0.51
Weighted average shares – basic	45,194		45,796		45,028		47,102
Weighted average shares – diluted	45,607		46,401		45,517		47,926

See accompanying notes.

4

Websense, Inc.
Consolidated Statement of Stockholders’ Equity
(Unaudited and in thousands)

													Accumulated
													other			Total
	Common stock			Additional			Treasury			Retained			comprehensive			stockholders’
	Shares	Amount		paid-in capital			stock			earnings			income (loss)			equity
Balance at December 31, 2006	44,785	$	509	$	237,302		$	(139,744	)	$	82,748		$	(90	)	$	180,725
Cumulative impact of change in accounting for uncertainties in income taxes – upon adoption of FIN 48 (see note 8)	—	—		(858		)	—			(376		)	—			(1,234		)
Balance at January 1, 2007 upon adoption of FIN 48	44,785	509		236,444			(139,744		)	82,372			(90		)	179,491
Issuance of common stock upon exercise of options	320	4		3,042			—			—			—			3,046
Issuance of common stock for ESPP purchase	105	1		2,211			—			—			—			2,212
Issuance of common stock from restricted stock units, net	30	—		—			(42		)	—			—			(42		)
Share-based compensation expense	—	—		16,087			—			—			—			16,087
Excess tax benefit of share-based compensation	—	—		1,174			—			—			—			1,174
Net income	—	—		—			—			12,391			—			12,391
Net change in unrealized gain on marketable securities, net of tax	—	—		—			—			—			81			81
Net change in unrealized gain on fair market valuation of foreign currency contracts, net of tax	—	—		—			—			—			9			9
Comprehensive income																12,481
Balance at September 30, 2007	45,240	$	514	$	258,958		$	(139,786	)	$	94,763		$	—		214,449

See accompanying notes.

5

Websense, Inc.
Consolidated Statements of Cash Flows
(Unaudited and in thousands)

	Nine Months Ended
	September 30,			September 30,
	2007			2006
Operating activities:
Net income	$	12,391		$	24,316
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	3,309			2,432
Write-off of in-process research and development	1,270			—
Amortization of intangible assets	2,640			—
Share-based compensation	16,087			15,032
Deferred revenue	(1,402		)	13,554
Deferred income taxes	(5,997		)	(6,496		)
Unrealized gain on foreign exchange contracts	(49		)	76
Excess tax benefit of share-based compensation	(1,174		)	(2,889		)
Unrealized loss on option contracts on SurfControl acquisition.	645			—
Realized gain on option contracts on SurfControl acquisition.	(434		)	—
Changes in operating assets and liabilities, net of effects from purchase of PortAuthority:
Accounts receivable	10,802			9,897
Prepaid income taxes	(2,357		)	1,962
Other current assets	(349		)	(1,131		)
Deposits and other assets	(5,452		)	(23		)
Accounts payable	(1,453		)	67
Accrued payroll and related benefits	1,133			171
Other accrued expenses	4,253			2,106
Income taxes payable	3,762			2,486
Net cash provided by operating activities	37,625			61,560
Investing activities:
Purchase of intangible assets	—			(1,200		)
Cash paid to acquire PortAuthority, net of cash acquired	(81,988		)	—
Purchases of property and equipment	(4,362		)	(3,132		)
Change in restricted cash and cash equivalents.	(196,162		)	—
Purchases of marketable securities	(308,929		)	(472,950		)
Maturities of marketable securities	324,219			477,867
Purchases of marketable securities- restricted	(163,678		)	—
Maturities of marketable securities- restricted	353,825			—
Cash received from sale of the option contracts on SurfControl acquisition	5,104			—
Cash paid for option contracts on SurfControl acquisition	(5,750		)	—
Net cash (used in) provided by investing activities	(77,721		)	585
Financing activities:
Proceeds from exercise of stock options	3,046			8,786
Proceeds from issuance of common stock for stock purchase plan	2,212			1,988
Repayment of PortAuthority loan	(4,214		)	—
Excess tax benefit of share-based compensation	1,174			2,889
Purchases of treasury stock	—			(91,404		)
Net cash provided by (used in) financing activities	2,218			(77,741		)
Decrease in cash and cash equivalents	(37,878		)	(15,596		)
Cash and cash equivalents at beginning of period	83,523			61,629
Cash and cash equivalents at end of period	$	45,645		$	46,033
Supplemental cash flow information:
Income taxes paid	$	11,476		$	11,908
Unrealized gain on marketable securities	$	81		$	480
Amount transferred from marketable securities to marketable securities-restricted	$	213,138		$	—

See accompanying notes.

6

Websense, Inc.

Notes To Consolidated Financial Statements (Unaudited)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in conformity with United States generally accepted accounting principles for interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, certain information or footnote disclosures normally included in complete financial statements prepared in accordance with United States generally accepted accounting principles have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of management, the statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of our financial position and of the results for the interim periods presented.

These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2006, included in Websense, Inc.’s (“Websense” or the “Company”) Annual Report on Form 10-K filed with the Securities and Exchange Commission. Operating results for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2007. The balance sheet at December 31, 2006 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements.

These financial statements do not reflect the operating results or financial position of SurfControl plc, which Websense acquired on October 3, 2007 (see Note 5. Acquisitions).

2. Net Income Per Share

Websense computes net income per share as permitted by the Financial Accounting Standards Board (“FASB”) with Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings Per Share (“EPS”) (“SFAS No. 128”). Under the provisions of SFAS No. 128, basic net income per share is computed by dividing the net income for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares consist of dilutive stock options and restricted stock units. Dilutive securities include both dilutive stock options and dilutive restricted stock units and are calculated based on the average share price for each fiscal period using the treasury stock method.

During the three months ended September 30, 2007 and 2006, the difference between the weighted average shares used in determining basic EPS versus diluted EPS related to dilutive securities totaled 413,318 and 605,104 shares, respectively. Potentially dilutive securities totaling 7,111,932 and 5,604,382 shares for the three months ended September 30, 2007 and 2006, respectively, were excluded from the diluted earnings per share calculation because of their anti-dilutive effect.

During the nine months ended September 30, 2007 and 2006, the difference between the weighted average shares used in determining basic EPS versus diluted EPS related to dilutive securities totaled 488,634 and 824,096 shares, respectively. Potentially dilutive securities totaling 6,232,064 and 4,412,343 shares for the nine months ended September 30, 2007 and 2006, respectively, were excluded from the diluted earnings per share calculation because of their anti-dilutive effect.

7

The following is a reconciliation of the numerator and denominator used in calculating basic EPS to the numerator and denominator used in calculating diluted EPS for all periods presented:

	Net Income (Numerator)		Shares (Denominator)	Per Share Amount
	(In thousands, except per share amounts)
For the Three Months Ended:
September 30, 2007:
Basic EPS	$	6,395	45,194	$	0.14
Effect of dilutive securities	—		413	(0.00		)
Diluted EPS	$	6,395	45,607	$	0.14
September 30, 2006:
Basic EPS	$	8,305	45,796	$	0.18
Effect of dilutive securities	—		605	(0.00		)
Diluted EPS	$	8,305	46,401	$	0.18
For the Nine Months Ended:
September 30, 2007:
Basic EPS	$	12,391	45,028	$	0.28
Effect of dilutive securities	—		489	(0.01		)
Diluted EPS	$	12,391	45,517	$	0.27
September 30, 2006:
Basic EPS	$	24,316	47,102	$	0.52
Effect of dilutive securities	—		824	(0.01		)
Diluted EPS	$	24,316	47,926	$	0.51

3. Comprehensive Income

The components of comprehensive income, as required to be reported by SFAS No. 130, Reporting Comprehensive Income, were as follows (in thousands):

	Three Months Ended								Nine Months Ended
	September 30, 2007				September 30, 2006				September 30, 2007			September 30, 2006
Net income	$	6,395			$		8,305		$	12,391		$		24,316
Net change in unrealized gain on marketable securities, net of tax	67				278				81			480
Net change in unrealized gain on fair market valuation of foreign currency contracts, net of tax	(10			)	(40			)	9			76
Comprehensive income	$		6,452		$	8,543			$		12,481	$	24,872

8

4. Stockholders’ Equity

Share-Based Compensation

Employee Stock Purchase Plan

Shares available for issuance under the Company’s Employee Stock Purchase Plan are as follows:

	Number of  Shares
Shares reserved for issuance at December 31, 2006	1,483,241
Shares reserved for issuance during 2007 based on automatic increase in shares authorized	447,845
Shares issued during the nine months ended September 30, 2007	(105,321	)
Shares reserved for issuance at September 30, 2007	1,825,765

The Company used the following assumptions to estimate the fair value of the semi-annual employee stock purchase plan share grants during the nine months ended September 30, 2007 and 2006:

	Nine Months Ended
	September 30, 2007		September 30, 2006
Average expected life (years)	1.3		1.3
Average expected volatility factor	32.5	%	36.1	%
Average risk-free interest rate	4.8	%	4.9	%
Average expected dividend yield	—		—

Employee Stock Option Plans

The Amended and Restated 2000 Stock Incentive Plan (the “2000 Plan”) provides for the grant of stock options to the Company’s directors, employees and consultants. The 2000 Plan provides for the grant of incentive and non-statutory stock options, restricted stock units and rights to purchase stock to employees, directors or consultants of the Company. The 2000 Plan provides that incentive stock options will be granted only to employees and are subject to certain limitations as to fair value during a calendar year.  To date, only non-statutory stock options and restricted stock units have been granted under the 2000 Plan. Through September 30, 2007, the Company has granted 120,000 restricted stock units. The unvested restricted stock units have a weighted average grant date fair value of $29.48 and an aggregate intrinsic value (the amount by which the fair value exceeds the award price) of $1.8 million as of September 30, 2007.

In addition, the 2000 Plan provides for automatic annual increases in the number of shares authorized and reserved for issuance thereunder equal to the lesser of (i) 4% of the Company’s outstanding shares on the last business day in December of the calendar year immediately preceding or (ii) 3,000,000 shares. At September 30, 2007, a total of 21,349,542 shares have been authorized for issuance under the 2000 Plan, of which 227,262 remain available for grant.

On January 8, 2007, the Compensation Committee of Websense’s Board of Directors adopted the Websense, Inc. 2007 Stock Incentive Assumption Plan (the “2007 Plan”).  In connection with the acquisition of PortAuthority Technologies, Inc. (“PortAuthority”), the Company agreed to substitute unvested stock options to purchase PortAuthority common stock that were granted under PortAuthority’s 2004 Global Share Option Plan (the “PortAuthority Option Plan”) and outstanding immediately prior to the effective time of the acquisition with options to purchase an aggregate of 74,891 shares of Websense common stock (the “Substitute Options”).  The Substitute Options have the same contractual lives and vesting periods as they did under the PortAuthority Option Plan.  The number of shares and exercise prices of the Substitute Options were determined based on the conversion ratio as defined by the merger agreement with PortAuthority.

9

The following table summarizes the Company’s stock option activity since December 31, 2006:

	Number of Shares		Weighted Average Exercise Price
Balance at December 31, 2006	7,038,259		$	22.61
Granted	2,861,134		21.96
Exercised	(320,808	)	9.49
Cancelled	(620,588	)	23.43
Balance at September 30, 2007	8,957,997		22.82

The results for the three and nine months ended September 30, 2007 include share-based compensation expense of $5.6 million (excluding tax effects) and $16.1 million (excluding tax effects), respectively, in the following expense categories of the consolidated statements of income (in thousands).

	Three Months Ended				Nine Months Ended
	September 30, 2007		September 30, 2006		September 30, 2007		September 30, 2006
Share-based compensation in:
Cost of revenues	$	380	$	392	$	1,097	$	1,088
Total share-based compensation in cost of revenues	380		392		1,097		1,088
Selling and marketing	2,231		2,204		6,436		6,208
Research and development	1,083		927		2,969		2,659
General and administrative	1,857		1,797		5,585		5,077
Total share-based compensation in  operating expenses	5,171		4,928		14,990		13,944
Total share-based compensation	$	5,551	$	5,320	$	16,087	$	15,032

The Company used the following assumptions to estimate the fair value of stock options granted under the 2000 plan for the three and nine months ended September 30, 2007 and 2006:

	Three Months Ended				Nine Months Ended
	September 30, 2007		September 30, 2006		September 30, 2007		September 30, 2006
Average expected life (years)	3.0		3.9		3.1		4.3
Average expected volatility factor	35.9	%	47.5	%	35.3	%	54.6	%
Average risk-free interest rate	4.3	%	5.0	%	4.6	%	4.8	%
Average expected dividend yield	—		—		—		—

The Company used the following assumptions to estimate the fair value of the options granted under the 2007 Plan for the nine months ended September 30, 2007: average expected life — 5.5 years; average expected volatility factor — 55.7%; average risk free interest rate — 4.7% and average expected dividend yield — zero.  No options were granted under the 2007 Plan during the third quarter of 2007.

10

Treasury Stock

As of September 30, 2007, the Company had repurchased 8,170,060 shares of its common stock since April 2003 under the Board of Directors’ authorized stock repurchase program, for an aggregate of $170.4 million at an average price of $20.86 per share.  The Company did not repurchase any shares of its common stock during the quarter ended September 30, 2007, and does not intend to repurchase additional shares for the remainder of 2007.  Under the terms of the Company’s new senior credit facility, the Company is restricted from repurchasing its common stock for an aggregate purchase price that exceeds the sum of $25 million plus 50% of aggregate amount of its consolidated net income during the period from the effective date of the facility through the most recent quarter end for which quarterly financial statements have been filed.  Remaining shares authorized for repurchase under the Company’s stock repurchase program as of September 30, 2007 were as follows:

	September 30, 2007
Shares authorized for stock repurchase	12,000,000
Shares repurchased to date	8,170,060
Remaining shares authorized for repurchase	3,829,940

5. Acquisitions

PortAuthority

On January 8, 2007, the Company acquired all of the outstanding stock of PortAuthority, a provider of information leak prevention technology.  The Company acquired PortAuthority to combine the two companies’ technologies to help customers prevent unauthorized use or disclosure of confidential data while simultaneously protecting users and data from external malicious threats.  The Company expects to benefit from the acquisition by expanding its current product offerings and increasing its revenues.  These are among the factors that contributed to a purchase price for the PortAuthority acquisition that resulted in the recognition of goodwill of $73.6 million. PortAuthority’s operations were assumed as of the date of the acquisition and are included in the Company’s results of operations beginning on January 9, 2007 and, as a result, are not reflected in the Company’s results of operations for the three and nine months ended September 30, 2006.

Pursuant to the terms of the agreement, the Company acquired all of PortAuthority’s outstanding capital stock for $88.2 million in cash, funded with existing cash resources. The purchase price includes $5.0 million which is held in an escrow account and will be available to satisfy any Company claims for indemnification from the former stockholders of PortAuthority until the escrow is scheduled to be released on January 8, 2008. The total purchase price, including transaction costs of approximately $1.9 million, has been allocated to tangible and intangible assets acquired based on estimated fair values, with the remainder classified as goodwill.

The total purchase price of the acquisition was as follows (in thousands):

Cash paid for PortAuthority business	$	88,334
Transaction costs	1,897
Total purchase price	$	90,231

The transaction costs incurred by the Company primarily consist of fees for attorneys, financial advisors, accountants, debt prepayment penalty and other advisors directly related to the transaction.

11

The total purchase price has been allocated as follows based on the assets and liabilities acquired as of January 8, 2007 (in thousands):

Fair value of net tangible assets acquired and liabilities assumed:
Cash and cash equivalents	$	8,078
Other assets	2,682
Other liabilities	(5,920		)
Long-term loan	(4,214		)
				626
Fair value of identifiable intangible assets acquired:
Technology	12,700
Non-compete agreements	800
Customer relationships	700
Trade name	510
				14,710
In-process research and development				1,270
Goodwill				73,625
Total purchase price				$	90,231

The $4.2 million of PortAuthority indebtedness assumed in the transaction was repaid in the first quarter of 2007.

The amount allocated to in-process technology represents the fair value of an acquired, to-be-completed research project. The estimated value of approximately $1.3 million of the research project was determined by estimating the costs to develop the acquired technology into a commercially viable product, estimating the future net cash flows from the project once commercially viable, and discounting the net cash flows to their present value. As of the acquisition date, this project was not expected to have reached technological feasibility and will have no alternative future use. Accordingly, the amount allocated to in-process technology was charged to Websense’s statement of income for the nine months ended September 30, 2007.

The accompanying consolidated statements of income reflect the operating results of the PortAuthority business since January 8, 2007.  Assuming the acquisition of PortAuthority had occurred on January 1, 2006, the pro forma unaudited results of operations would have been as follows (in thousands):

	Three Months Ended				Nine Months Ended
	September 30, 2007		September 30, 2006		September 30, 2007		September 30, 2006
Revenue	$	50,429	$	45,988	$	150,625	$	132,067
Net Income	6,395		5,503		12,285		16,586
Net income per share:
Basic	$	0.14	$	0.12	$	0.27	$	0.35
Diluted	$	0.14	$	0.12	$	0.27	$	0.35

The above pro forma unaudited results of operations do not include pro forma adjustments relating to costs of integration or post-integration cost reductions that may be incurred or realized by the Company in excess of actual amounts incurred or realized through September 30, 2007.

Surf Control

On October 3, 2007, the Company completed the acquisition of all of the issued and to-be-issued ordinary shares, excluding treasury shares, of SurfControl plc (“SurfControl”), a U.K. based provider of on-demand and software-based Web and e-mail security solutions.  The acquisition was effected by means of a Scheme of Arrangement under Section 425 of the UK Companies Act of 1985.  Pursuant to the acquisition, SurfControl became a wholly-owned subsidiary of Websense.  At the closing, each outstanding share of SurfControl was converted into the right to receive 700 pence in cash.  In connection with the acquisition, the holders of outstanding SurfControl capital stock, options, and long term incentive plan awards received total net cash of approximately £204 million (approximately $416 million based upon the exchange rate in effect on October 2, 2007, the date on which the acquisition was sanctioned by the U.K. courts).

12

Since the Company was obligated to pay the purchase price in British pounds, it entered into various option contracts to hedge against adverse foreign currency exchange rate movements (see Note 7. Foreign Currency Hedges).

As of September 30, 2007, the Company had incurred approximately $6.4 million of transaction costs in connection with this acquisition, which are reflected on the Company’s consolidated balance sheet in deposits and other assets, accounts payable and other accrued expenses.

On October 11, 2007, in order to finance a portion of the purchase price for SurfControl, Websense entered into an amended and restated senior credit agreement (the “Senior Credit Agreement”).  The $225 million senior credit facility consists of a five year $210 million term loan and a $15 million revolving credit facility. The term loan was fully funded on October 11, 2007, and the revolving line of credit remains unused. The senior credit facility is secured by substantially all of the assets of Websense, including pledges of stock of some of its subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by Websense’s domestic subsidiaries. The term loan amortizes at a rate of 2.5%, 10%, 12.5%, and 15%, respectively, during the first four years of the term and 60% during the fifth year. The initial interest rate is LIBOR plus 250 basis points (7.62% for the first month), and is subject to step downs in the spread over LIBOR based upon potential future improvements in Websense’s total leverage ratio. The Senior Credit Agreement contains financial covenants, including a consolidated leverage ratio and a consolidated interest coverage ratio, as well as affirmative and negative covenants. Websense did not borrow any amounts under the original interim credit facility which it entered into on April 26, 2007 and which was terminated by its terms when the Senior Credit Agreement was executed.

6. Goodwill and  Intangible Assets

As of September 30, 2007, the Company’s goodwill balance of $73.6 million solely related to the Company’s acquisition of PortAuthority on January 8, 2007.

The Company records goodwill when the purchase price of net tangible and intangible assets acquired exceeds their fair value. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company reviews goodwill that has an indefinite useful life for impairment at least annually in its fourth fiscal quarter, or more frequently if an event occurs indicating the potential for impairment. Intangible assets are carried at cost less accumulated amortization. The Company amortizes the cost of identified intangible assets on a straight-line basis over their expected economic lives. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the Company reviews intangible assets that have finite useful lives when an event occurs indicating the potential for earlier impairment.

The Company reviews for impairment using facts or circumstances, either internal or external, indicating that it may not recover the carrying value of the asset. The Company measures impairment losses related to long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values.  The Company measures fair value under SFAS No. 144, which is generally based on the present value of estimated future cash flows. The Company’s analysis is based on available information and on assumptions and projections it considers to be reasonable and supportable. The cash flow analysis considers the likelihood of possible outcomes and is based on the Company’s best estimate of projected future cash flows. If necessary, the Company performs subsequent calculations to measure the amount of the impairment loss based on the excess of the carrying value over the fair value of the impaired assets.

Intangible assets, subject to amortization, were as follows as of September 30, 2007 (in thousands):

	Weighted Average Life (years)	Cost		Accumulated Amortization			Net
Technology	5.7	$	13,900	$	(2,021	)	$	11,879
Non-compete agreements	1	800		(600		)	200
Customer relationships	7	700		(75		)	625
Trade name	5	510		(76		)	434
Total		$	15,910	$	(2,772	)	$	13,138

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 Remaining amortization expense, as of September 30, 2007, is expected to be as follows (in thousands):

Years Ending December 31:
2007	$	880
2008	2,719
2009	2,585
2010	2,319
2011	2,319
Thereafter	2,316
Total expected amortization expense	$	13,138

7. Foreign Currency Hedges

The Company uses derivatives to manage foreign currency risk and not for speculative or trading purposes. The Company’s objective is to reduce the risk to earnings and cash flows associated with changes in foreign currency exchange rates. Gains and losses resulting from changes in the fair values of those derivative instruments will be recorded to earnings or other comprehensive income depending on the use of the derivative instrument and whether it qualifies for hedge accounting.

During the three and nine months ended September 30, 2007 and 2006, the Company utilized Euro foreign currency forward contracts to hedge anticipated Euro denominated accounts receivable. All such contracts entered into were designated as fair value hedges and were not required to be tested for effectiveness as hedge accounting was not elected. None of the contracts were terminated prior to settlement. Net realized losses related to the contracts designated as fair value hedges settled during 2007 and 2006 are included in other income, net, in the accompanying consolidated income statements and amounted to approximately $87,000 and $45,000 for the three months ended September 30, 2007 and 2006, respectively and $235,000 and $177,000 for the nine months ended September 30, 2007 and 2006, respectively.  There were no Euro contracts outstanding as of September 30, 2007.

During the three and nine months ended September 30, 2007 and 2006, the Company utilized British Pound zero-cost collar contracts to hedge anticipated operating expenses. All such contracts entered into were designated as cash flow hedges and were considered effective as defined by SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133), as amended. None of the contracts were terminated prior to settlement. Net realized gains related to the contracts designated as cash flow hedges settled during the nine months ended September 30, 2007 and 2006 are included in the respective operating categories the Company hedges its British Pound expenditu res against. These net realized gains amounted to approximately $33,000 and $57,000 for the three months ended September 30, 2007 and 2006, respectively and $19,000 and $106,000 for the nine months ended September 30, 2007 and 2006, respectively.  There were no British Pound contracts outstanding as of September 30, 2007.

Notional and fair values of the Company’s Euro and British Pound hedging positions at September 30, 2007 and 2006 are presented in the table below (in thousands):

	September 30, 2007						September 30, 2006
	Notional Value Local Currency		Notional Value USD		Fair Value USD		Notional Value Local Currency		Notional Value USD		Fair Value USD
Euro	€	—	$	—	$	—	€	2,200	$	2,818	$	2,841
British Pound	£	—	—		—		£	1,000	1,871		1,858
Total			$	—	$	—			$	4,689	$	4,699

During the three and nine months ended September 30, 2007, the Company utilized option and forward contracts to hedge against the £244.1 million funds certain purchase price for SurfControl under U.K. law.  These contracts did not qualify for hedge accounting as they related to a forecasted business combination.  During the three and nine months ended September 30, 2007, the Company has incurred a net realized gain of $0.4 million related to the sale of certain option contracts. During the three and nine months ended September 30, 2007, the Company has incurred a net unrealized gain/(loss) of $0.4 and ($0.6) million, respectively, on outstanding option and forward contracts.  These unrealized gains and

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losses are reflected in other income, net on the consolidated statement of income and within deposits and other assets on the consolidated balance sheet. The Company subsequently sold £200 million in option contracts and entered into GBP forward contracts expiring on October 11, 2007 (See Note 11. Subsequent Events).

8. Tax Matters

The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (FIN 48), at the beginning of fiscal year 2007. As a result of the implementation the Company recognized a $1.2 million increase to reserves for uncertain tax positions. This increase was accounted for as an adjustment to the January 1, 2007 balance of additional paid in capital and retained earnings on the consolidated balance sheet. Including the cumulative effect increase, at the beginning of 2007, the Company had approximately $9.2 million of total gross unrecognized tax benefits. Of this total, $5.8 million (net of federal, state and foreign tax benefits) represents the amount of unrecognized tax benefits that, if recognized, would decrease the effective income tax rate in future periods. In addition, consistent with the provisions of FIN 48, the Company determines the classification of uncertain tax liabilities as current or non-current based on anticipated payment date. Accordingly, the Company has reflected $9.5 million as non-current income taxes payable as of September 30, 2007.

Estimated interest and penalties related to the underpayment of income taxes are classified as a component of provision for income taxes in the consolidated statements of income and totaled $103,000 during the three months ended September 30, 2007 and $256,000 during the nine months ended September 30, 2007. Accrued interest and penalties were $434,000 as of January 1, 2007.

The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state and foreign jurisdictions. The Company has substantially concluded all U.S. federal and state income tax audits for years through 2002. Substantially all material foreign income tax audits have been concluded for years through 2002. California income tax returns for 2003 and 2004 and New York income tax returns for 2002 to 2005 are currently under examination. The IRS will begin an audit of the 2005 tax year in the fourth quarter. At September 30, 2007, the Company had deferred tax assets of $39.7 million.

The Company has requested a ruling regarding unrecognized state income tax benefits. It is reasonably possible within 12 months of September 30, 2007 that the uncertain tax position established for the 2006 tax year could be decided in the Company’s favor resulting in the reduction of the gross uncertain tax liability in an amount up to $1.7 million.  As a result of ongoing audits or the expiration of the statutes of limitations, it is reasonably possible that the liability associated with our unrecognized tax benefits will increase or decrease within the next twelve months; at this time an estimate of the range of the reasonably possible outcomes cannot be made.

9. Litigation

On September 29, 2006, Jason Tauber filed a putative class action against the Company and other unidentified individuals in California Superior Court for the County of San Diego, captioned Tauber v. Websense. The complaint alleges that the plaintiff and a putative class of certain software engineers and computer professionals who worked for the Company as exempt employees during the period from September 15, 2002 through the present should have been classified as non-exempt employees under California law and should have been paid for overtime. The complaint also alleges related wage and hour violations of the California Labor Code arising from the alleged misclassification and that the failure to pay overtime constitutes an unfair business practice under California Business and Professions Code §17200. The complaint seeks unspecified damages for unpaid overtime, prejudgment interest, attorneys’ fees and other costs, statutory penalties for alleged violations, and other proper relief. The parties to the action have been granted preliminary court approval to settle all claims made in the putative class action, and the claims administrator has delivered notices to the alleged class members.   During the second quarter of 2007, the Company charged the $3.2 million pending settlement amount between the operating expense categories and cost of revenue on the consolidated statement of income, apportioned based upon the Company’s estimate of amounts payable to eligible individuals in the settlement. As of September 30, 2007, $3.2 million remains as a reserve within other accrued expenses on the consolidated balance sheet relating to this settlement.

The Company is involved in various legal actions in the normal course of business. Based on current information, including consultation with the Company’s lawyers, the Company believes that it has adequately reserved, under generally accepted accounting principles, for any ultimate liability that may result from these actions such that any liability would not materially affect the Company’s consolidated financial positions, results of operation or cash flows. The Company’s

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evaluation of the likely impact of these actions could change in the future and unfavorable outcomes and/or defense costs, depending upon the amount and timing, could have a material adverse effect on the Company’s results of operations or cash flows in a future period.

10. Recently Issued Accounting Standards

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of FASB Statement No. 115 (“SFAS No. 159”). This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in SFAS No. 159 are elective; however, the amendment to SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities. The fair value option established by SFAS No. 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments. The accounting provisions of SFAS No. 159 will be effective for the Company beginning January 1, 2008. The Company is in the process of determining the effect the adoption of SFAS No. 159 will have on its financial statements.

11. Subsequent Events

On October 8, 2007, the Company sold the rights to a £200 million option contract that it had purchased for the SurfControl acquisition for $204,000, recording a realized loss of approximately $876,000.  The Company did not purchase any new option contracts on the British Pounds as it had secured £195 million through open market forward contracts, all expiring on October 11, 2007 at an all in rate of $2.039 per British Pound.

         See Note 5, SurfControl, above for a description of the Company’s acquisition of SurfControl on October 3, 2007 and the Company’s borrowing of a $210 million term loan on October 11, 2007.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the financial statements and related notes contained elsewhere in this report. See “Risk Factors” under Part II, Item 1A below regarding certain factors known to us that could cause reported financial information not to be necessarily indicative of future results.  Also note that because our acquisition of SurfControl plc was completed on October 3, 2007, there was no financial impact on our financial condition and results of operations for our quarter ended September 30, 2007.

Forward-Looking Statements

This report on Form 10-Q may contain “forward-looking statements” within the meaning of the federal securities laws made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements, which represent our expectations or beliefs concerning various future events, may contain words such as “may,” “will,” “expects,” “anticipates,” “intends,” “plans,” “believes,” “estimates,” or other words indicating future results. Such statements may include but are not limited to statements concerning the following:

•anticipated trends in revenue;

•growth opportunities in domestic and international markets;

•new and enhanced channels of distribution;

•customer acceptance and satisfaction with our products;

•expected trends in operating and other expenses;

•anticipated cash and intentions regarding usage of cash;

•changes in effective tax rates; and

•anticipated product enhancements or releases.

These forward-looking statements are subject to risks and uncertainties, including those risks and uncertainties described herein under Part II, Item 1A “Risk Factors,” that could cause actual results to differ materially from those anticipated as of the date of this report. We assume no obligation to update any forward-looking statements to reflect events or circumstances arising after the date of this report.

SurfControl Acquisition

The acquisition of SurfControl plc was completed on October 3, 2007.  Our third quarter ended on September 30, 2007.  Accordingly, all quarterly and historic financial statements in this Form 10-Q are on a pre-acquisition basis.  All statements made in this Form 10-Q regarding current status or as of dates after October 3, 2007 include Websense on a post-acquisition, consolidated basis, including the SurfControl operations.  In addition, all forward-looking statements, including but not limited to, trends, expectations or uncertainties, are made on a post-acquisition, consolidated basis.

Overview

Our products help organizations manage their networks and computing resources to provide a secure and productive computing environment. We provide Web filtering and Web security software products that enable organizations to protect employees and confidential information from external Web-based attacks such as spyware and phishing, as well as analyze, report and manage how employees use computing resources and the Internet. In January 2007, we acquired our technology development partner for information leak prevention (“ILP”) solutions, PortAuthority Technologies Inc. (“PortAuthority”). As a result, in addition to our Web filtering and Web security software products, we offer ILP software that helps prevent the loss of confidential information from internal threats, such as ineffective business process controls, employee error and malfeasance.  On October 3, 2007, we completed our acquisition of SurfControl plc (“SurfControl”), which significantly increased the size of our company and customer base, and accelerates our strategic initiatives in the small and  medium size business markets, on-demand delivery of web security products and threat research.

At the foundation of our Web filtering and Web security product offerings is the Websense Enterprise® software application, which serves as a central policy engine and management and reporting platform for our Web filtering and related add-on Web security products. Websense Enterprise gives organizations the ability to enhance network security, improve employee productivity, mitigate potential legal liability and conserve network bandwidth by allowing organizations to identify potential risk areas and implement and automate Web access and application usage policies that reduce these risks.

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When combined with our Web security products that utilize our ThreatSeeker™ technology including Security Filtering, Remote Filtering and Client Policy Manager™, Websense Enterprise allows organizations to enhance network and content security by blocking access to malicious Web sites and preventing the transmission of data to known spyware destination sites. To simplify the purchase process for our value-added resellers and customers, we have included Websense Enterprise and our most popular add-on security products and services, within Websense® Web Security Suite™. In July 2007, we launched Websense® Express to provide similar Web filtering and Web security functionality targeted for small and mid-sized organizations of fewer than 1,000 users (“SMB”). We currently derive a significant percentage of our revenue from subscriptions to our Web filtering and Web security solutions and expect this to continue in the future.

The Websense Content Protection Suite is an integrated ILP solution that protects organizations from information leaks and data loss by discovering the location of sensitive data inside the network, monitoring the data as it attempts to travel inside or outside the organization, and protecting the data, with policy-based controls that align to business processes.  The Content Protection Suite provides protection for data at rest, data in use, and data in motion, and is available with two modules: the Content Auditor™ and the Content Enforcer™.  Content Auditor is a proactive solution that finds sensitive data in the network and identifies who is using it and how it is being used.  Content Enforcer adds the ability to enforce user-defined data security policies.  Sales of our ILP products and other products under development will comprise only a very small portion of our overall sales in 2007 and 2008.

During the nine months ended September 30, 2007, we derived 40% of revenue from international sales, compared with 37% for the nine months ended September 30, 2006, with the United Kingdom comprising approximately 10% of our total revenue in both periods. We believe international markets continue to represent a significant growth opportunity and we are continuing to expand our international operations, particularly in selected countries in the European, Asia/Pacific and Latin American markets.

We sell our products through both indirect channels and directly. Sales through indirect channels currently account for more than 90% of our revenue, and we plan to increase the percentage of our revenue obtained through indirect channels. Our strategy is to increase new and renewal customer sales through independent software distributors and resellers and increase the focus of our internal sales and marketing force on supporting our channel strategy. In August 2006, we announced a new two-tier distribution strategy in North America and entered into a relationship with Ingram Micro to distribute, market and support our Web security and Web filtering software in North America. Through joint marketing programs with Websense, Ingram Micro will focus its efforts on recruiting new resellers, especially resellers focused on selling to SMBs, and on building awareness and demand within our existing North America channel partner base.  We also plan to increase sales to SMB customers through our new Websense Express™ software which is targeted for organizations with under 1,000 users.

We completed our acquisition of SurfControl on October 3, 2007.  SurfControl has historically participated in two markets within content security, the Web security market with its Web filtering and Web security solutions, and the Messaging security market with its e-mail filtering and anti-spam solutions.

SurfControl Web filtering solutions enable companies to monitor network use and abuse in an organization, across a spectrum of Web-based content, including instant messaging, peer-to-peer, streaming media, file downloads, and Web-based email.  We will support SurfControl Web Filter with a completely staffed maintenance and support team through at least December 31, 2011 and will enhance the solution by supplementing the SurfControl URL database with additional Web filtering and security coverage provided by Websense Security Labs™ and ThreatSeeker™ technology. Although Websense will renew existing subscriptions, we have decided to end of sale this product for new subscriptions on January 8, 2008.

SurfControl e-mail filter messaging protection software provides comprehensive content filtering for protection against inbound, outbound, and internal e-mail threats, such as spam, viruses, malware, phishing and harmful URLs.  SurfControl’s on-demand service offering, BlackSpider™, is a managed security service provider and operates MailControl™ and WebDefense™ on-demand services. MailControl services protect organizations from incoming e-mail and Web-based threats, such as spam, viruses, spyware, phishing/pharming attacks, and inappropriate content before reaching an organization’s in-house network. WebDefense services allow organizations to control outbound employee Web access and encrypt e-mail for secure extended enterprise communications.  These product lines are important to our long term growth strategy and we expect to integrate the technologies from these critical product lines more broadly across Websense’s offerings.

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Critical Accounting Policies

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition. When a purchase decision is made for our products, customers enter into a subscription agreement, which is generally 12, 24 or 36 months in duration and for a fixed number of users. Other services such as upgrades/enhancements and standard post-contract technical support services are sold together with our products and provided throughout the subscription term. We recognize revenue on a daily straight-line basis, commencing with the day the subscription begins, over the term of the subscription agreement, provided collectibility is reasonably assured. Upon entering into a subscription arrangement for a fixed or determinable fee, we electronically deliver access codes to users and then promptly invoice customers for the full amount of their subscriptions. Payment is due for the full term of the subscription, generally within 30 to 60 days of the invoice. Taxes invoiced, collected and remitted to governmental authorities are presented on a net basis in our consolidated statements of income. We record amounts billed to customers in excess of recognizable revenue as deferred revenue on our balance sheet. Upon expiration of the subscription, customers who wish to re-subscribe typically must do so at the then current rates to continue using our products. Our revenue is significantly influenced by new and renewal subscriptions.

We record channel marketing payments and channel rebates as an offset to revenue. We recognize channel marketing payments as an offset to revenue as the marketing service is provided. We recognize channel rebates as an offset to revenue on a straight-line basis over the term of the subscription agreement.

Goodwill and Intangible Assets. We record goodwill when the purchase price of net tangible and intangible assets we acquire exceeds their fair value. In accordance with SFAS No. 142, Goodwill and Other Intangible Assets, we review goodwill that has an indefinite useful life for impairment at least annually in our fourth fiscal quarter, or more frequently if an event occurs indicating the potential for impairment. Intangible assets are carried at cost, less accumulated amortization. We amortize the cost of identified intangible assets on a straight-line basis over their expected economic lives. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, we review intangible assets that have finite useful lives when an event occurs indicating the potential for impairment.

We review for impairment by facts or circumstances, either internal or external, indicating that we may not recover the carrying value of the asset.  We measure impairment losses related to long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values.  We measure fair value under SFAS No. 144, which is generally based on the present value of estimated future cash flows. Our analysis is based on available information and on assumptions and projections that we consider to be reasonable and supportable. The discounted cash flow analysis considers the likelihood of possible outcomes and is based on our best estimate of projected cash flows. If necessary, we perform subsequent calculations to measure the amount of the impairment loss based on the excess of the carrying value over the fair value of the impaired assets.

Share-Based Compensation. On January 1, 2006, we adopted the provisions of Statement No. 123R and SAB No. 107 requiring the measurement and recognition of all share-based compensation under the fair value method.  Share-based compensation expense related to stock options is recorded based on the fair value of the award on its grant date which we estimate using the Black-Scholes valuation model based on the provisions prescribed under Statement No. 123R and SAB No. 107.  Share-based compensation expense related to restricted stock unit awards is calculated based on the market price of our common stock on the grant date.

Deferred Tax Assets.   As required by SFAS No. 109, we recognize tax assets on the balance sheet if it is “more likely than not” that they will be realized on future tax returns. At September 30, 2007, we had deferred tax assets of $39.7 million. We believe that it is more likely than not that our deferred tax assets will be realized. Factors considered by us included: our earnings history, projected earnings based on current operations, and projected future taxable income. However, should we determine that we would not be able to realize all or part of our deferred tax assets in the future, an adjustment to the deferred tax assets would be charged against income in the period such determination was made.

Income Tax Provision and Uncertain Tax Positions.   Significant judgment is required in determining our consolidated income tax provision and evaluating our U.S. and foreign tax positions. In July 2006, the FASB issued Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), which became effective for us beginning in 2007. FIN 48 addressed the determination of how tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial

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statements.  Under FIN 48, we must recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon resolution. The impact of our reassessment of tax positions in accordance with FIN 48 did not have a material impact on the results of operations, financial condition or liquidity.

Results of Operations

Three months ended September 30, 2007 compared with the three months ended September 30, 2006

The following table summarizes our operating results as a percentage of total revenue for each of the periods shown.

	Three Months Ended
	September 30, 2007		September 30, 2006
	(Unaudited)
Revenue	100	%	100	%
Cost of revenues:
Cost of revenues	9		8
Amortization of acquired technology	1		—
Total cost of revenues	10		8
Gross margin	90		92
Operating expenses:
Selling and marketing	50		47
Research and development	17		13
General and administrative	13		12
Total operating expenses	80		72
Income from operations	10		20
Other income, net	8		6
Income before income taxes	18		26
Provision for income taxes	5		8
Net income	13	%	18	%

Revenue

Revenue increased to $50.4 million in the third quarter of 2007 from $45.7 million in the third quarter of 2006. The increase was a result of the addition of new, renewed and upgraded subscriptions from our customers that resulted in a 2.2 million increase in the number of seats under subscription from 24.9 million at September 30, 2006 to 27.1 million at September 30, 2007. As a percentage of subscription revenue, new business increased to 36% in the third quarter of 2007 from 33% in the third quarter of 2006. We expect revenue to increase due to the addition of our recently acquired SurfControl business, growth of our ILP business, our deferred revenue under existing subscriptions, our renewal business, expected growth in SMB business and expected growth in international sales, partially offset by increased channel marketing payments and channel rebates, which are recorded as reductions to revenue.  The expected growth of revenue will be impacted by potential sales dis-synergies as a result of the acquisition of SurfControl and by the expected significant write-down of SurfControl’s deferred revenue to fair value at acquisition as required by purchase accounting rules under generally accepted accounting principles.

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Cost of Revenues

Cost of revenues. Cost of revenues consists of the costs of content review, technical support and infrastructure costs associated with maintaining our databases. Cost of revenues increased to $4.5 million in the third quarter of 2007 from $3.9 million in the third quarter of 2006. The increase of $0.6 million was primarily due to additional personnel in our technical support group and allocated costs. We allocate the total costs for human resources, employee benefits, payroll taxes, information technology, facilities, fixed asset depreciation and legal costs to each of our functional areas based on salaries and headcount data. As a percentage of revenue, cost of revenues increased to 9% from 8% during the third quarters of 2007 and 2006.  Although we expect to derive substantial costs savings from the restructuring of SurfControl, we expect our future cost of revenues to increase in order to maintain the technical support needs of our growing customer base.  We expect that the increase in total cost of revenue will be proportional to the increase in revenue in future periods.

Amortization of acquired technology. Amortization of acquired technology primarily relates to the developed technology acquired from the PortAuthority acquisition in January 2007.  The acquired technology is being amortized on a straight-line basis over its estimated weighted average economic life of 5.7 years.  Our acquisition of SurfControl closed after the end of the third quarter, so it did not contribute to amortization of acquired technology.  We have not yet completed our purchase accounting analysis for the SurfControl acquisition, but the acquisition of SurfControl will have a material increase in amortization of acquired technology.

Gross Margin

Gross margin increased to $45.3 million in the third quarter of 2007 from $41.9 million in the third quarter of 2006. The increase was primarily due to increased revenue. As a percentage of revenue, gross margin decreased to 90% in the third quarter of 2007 from 92% in the third quarter of 2006 due to the increased costs described in the Costs of Revenues section above.

Operating Expenses

Selling and marketing. Selling and marketing expenses consist primarily of salaries, commissions and benefits related to personnel engaged in selling, marketing and customer support functions, including costs related to public relations, advertising, promotions and travel as well as allocated costs. Selling and marketing expenses do not include payments to channel partners for marketing services and rebates.  Selling and marketing expenses increased to $25.2 million, or 50% of revenue, in the third quarter of 2007, from $21.3 million, or 47% of revenue, in the third quarter of 2006. The increase in selling and marketing expenses of $3.9 million was primarily due to expenses associated with our new channel strategy, increased personnel costs and related travel, including new personnel added from the PortAuthority acquisition in January 2007, and allocated costs. We expect selling and marketing expenses to increase in absolute dollars in the future due to the addition of certain sales and marketing personnel of SurfControl, to support our expanding worldwide selling and marketing efforts, and due to increased sales resulting in higher overall sales commission expenses.  We expect to achieve cost savings from the historical SurfControl selling and marketing expense primarily as a result of a reduction in headcount.

Research and development. Research and development expenses consist primarily of salaries and benefits for software developers and allocated costs. Research and development expenses increased to $8.3 million, or 17% of revenue, in the third quarter of 2007 from $6.0 million, or 13% of revenue, in the third quarter of 2006. The increase of $2.3 million in research and development expenses was primarily due to increased personnel, including new personnel added from the PortAuthority acquisition in January 2007, needed to support our expanding list of technology partners, enhancements to Websense Enterprise, the development of Websense Express and enhancements to our new ILP products. We expect future research and development expenses to increase in absolute dollars as more personnel, including certain personnel from SurfControl, are added to support our continued enhancements of our existing products and new products.  In addition, we have established engineering centers in China and Israel, which we believe will enable us to slow the rate of growth in research and development expenses.

General and administrative. General and administrative expenses consist primarily of salaries, benefits and related expenses for our executive, finance, administrative personnel, third party professional service fees, and allocated costs. General and administrative expenses increased to $6.8 million, or 13% of revenue, in the third quarter of 2007 from $5.5 million, or 12% of revenue, in the third quarter of 2006. The $1.3 million increase in general and administrative expense was primarily due to additional personnel needed to support our growing operations, including the acquisitions of PortAuthority in January 2007 and SurfControl in October 2007, and allocated costs. We expect general and administrative expenses to increase in absolute dollars in the future periods due to our growth in operations and expansion of our international

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operations, including the addition of certain personnel of SurfControl.  We do not expect to continue the full historical SurfControl general and administrative expense due to the elimination of the positions of the executive officers of SurfControl and other headcount reductions, elimination of certain facilities and elimination of expenses relating to the maintenance of SurfControl as a public UK company listed on the London Stock Exchange.

Other Income, Net

Other income, net increased to $3.9 million in the third quarter of 2007 from $2.8 million in the third quarter of 2006. The increase was primarily due to a net gain of $0.8 million for the foreign exchange option and forward contracts purchased to hedge against the SurfControl acquisition purchase price in British Pounds. We expect other income, net to decrease in absolute dollars in the fourth quarter and subsequent periods as we used approximately $245 million of our restricted and non-restricted cash equivalents and marketable securities to fund a portion of the purchase price of SurfControl.  We also incurred $210 million in term debt under our senior secured credit facility, and the servicing of that debt will slow any potential future increase in our cash balances.

Provision for Income Taxes

In the third quarter of 2007, United States and foreign income tax expense was $2.5 million, compared to $3.6 million for the third quarter of 2006.  The effective income tax rate decreased to 28% in the third quarter of 2007 from 30% in the third quarter of 2006.  The decrease in the tax rate is primarily related to the expiration of the statute of limitations for the assessment of certain taxes in various jurisdictions and the tax treatment of the foreign currency option contracts purchased for the SurfControl acquisition, partially offset by less tax exempt interest income and an increase in FAS 123R expense in jurisdictions where a tax deduction is not available. Included in income tax expense are the tax benefit of  $0.9 million and $0.2 million  for the third quarter of 2007 and 2006, respectively, related to the expiration of the statute of limitations for the assessment of taxes in various jurisdictions.   Our effective tax rate may change in future periods due to the composition of taxable income between domestic and international operations along with potential changes or interpretations in tax rules and legislation, or corresponding accounting rules.

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Nine months ended September 30, 2007 compared with the nine months ended September 30, 2006

The following table summarizes our operating results as a percentage of total revenue for each of the periods shown.

	Nine Months Ended
	September 30, 2007		September 30, 2006
	(Unaudited)
Revenue	100	%	100	%
Cost of Revenues:
Cost of revenue	9		8
Amortization of acquired technology	1		—
Total cost of revenues	10		8
Gross margin	90		92
Operating expenses:
Selling and marketing	50		44
Research and development	17		13
General and administrative	14		12
Write off of in-process research and development	1		—
Total operating expenses	82		69
Income from operations	8		22
Other income, net	5		6
Income before income taxes	13		28
Provision for income taxes	5		10
Net income	8	%	18	%

Revenue

Revenue increased to $150.6 million in the first nine months of 2007 from $131.5 million in the first nine months of 2006. The increase was due to the addition of new, renewed and upgraded subscriptions from our customers that resulted in a 2.2 million increase in the number of seats under subscription from 24.5 million at September 30, 2006 to 26.7 million at September 30, 2007. As a percentage of subscription revenue, new business increased to 37% in the first nine months of 2007 from 35% in the first nine months of 2006.

Cost of Revenue

Cost of revenues. Cost of revenues consists of the costs of content review, technical support and infrastructure costs associated with maintaining our databases. Cost of revenue increased to $13.3 million in the first nine months of 2007 from $11.0 million in the first nine months of 2006. The increase of $2.3 million was primarily due to additional personnel in our technical support group and allocated costs. We allocate the total costs for human resources, employee benefits, payroll taxes,

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information technology, facilities, fixed asset depreciation and legal costs to each of our functional areas based on salaries and headcount data. As a percentage of revenue, costs of revenue increased to 9% during the first nine months of 2007 from 8% in 2006.

Amortization of acquired technology. Amortization of acquired technology primarily relates to the developed technology acquired from the PortAuthority acquisition in January 2007.  The acquired technology is being amortized on a straight-line basis over its estimated weighted average economic life of 5.7 years.

Gross Margin

Gross margin increased to $135.4 million in the first nine months of 2007 from $120.5 million in the first nine months of 2006. The increase was primarily due to increased revenue. As a percentage of revenue, gross margin decreased to 90% in the first nine months of 2007 from 92% in the first nine months of 2006 primarily due to the increased costs as described in the Costs of Revenue section above.

Operating Expenses

       Selling and marketing. Selling and marketing expenses consist primarily of salaries, commissions and benefits related to personnel engaged in selling, marketing and customer support functions, including costs related to public relations, advertising, promotions and travel as well as allocated costs. Selling and marketing expenses do not include payments to channel partners for marketing services and rebates.  Selling and marketing expenses increased to $75.3 million in the first nine months of 2007 from $58.2 million in the first nine months of 2006. The increase in selling and marketing expenses of $17.1 million was primarily due to expenses associated with our new channel strategy, increased personnel costs and related travel, including new personnel added from the PortAuthority acquisition in January 2007, and allocated costs.

         Research and development. Research and development expenses consist primarily of salaries and benefits for software developers and allocated costs. Research and development expenses increased to $25.8 million in the first nine months of 2007 from $16.9 million in the first nine months of 2006. The increase of $8.9 million in research and development expenses was primarily due to the litigation settlement expense for the putative class action entitled Tauber vs. Websense, increased personnel, including new personnel added from the PortAuthority acquisition in January 2007, needed to support our expanding list of technology partners, the enhancements of Websense Enterprise, the development of Websense Express and enhancements to our new ILP products and allocated costs.

         General and administrative. General and administrative expenses consist primarily of salaries, benefits and related expenses for our executive, finance, administrative personnel, third party professional service fees, and allocated costs. General and administrative expenses increased to $20.6 million in the first nine months of 2007 from $16.0 million in the first nine months of 2006. The $4.6 million increase in general and administrative expense was primarily due to additional personnel needed to support our growing operations, including the acquisition of PortAuthority in January 2007, and allocated costs.

Write off of in-process research and development. Write off of in-process research and development represents the fair value of an acquired, to be completed research project obtained from the PortAuthority acquisition that had not reached technological feasibility at the acquisition date and is not expected to have an alternative future use.  Accordingly, the $1.3 million of in-process research and development was charged to our statement of income during the first nine months of 2007.

Other Income, Net

Other income, net decreased to $7.8 million in the first nine months of 2007 from $8.2 million in the first nine months of 2006. The decrease was primarily due to a net loss of $0.2 million for the foreign exchange option and forward contracts purchased to hedge against the SurfControl acquisition purchase price in British Pounds and lower cash, cash equivalents and marketable securities balances during the first nine months of 2007 compared to the first nine months of 2006, principally related to the acquisition of PortAuthority for approximately $90 million in January 2007, partially offset by higher interest rates during the first nine months of 2007 compared to the first nine months of 2006.

Provision for Income Taxes

In the first nine months of 2007, United States and foreign income tax expense decreased to $8.0 million compared to $13.3 million in 2006. The effective income tax rate increased to 39% in the first nine months of 2007 from 35% in the first

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nine months of 2006. The increase in the tax rate was primarily driven by a reduction in tax exempt interest income, an increase in FAS 123R expense in jurisdictions where a tax deduction is not available, and the write-off of non-deductible in- process research and development acquired in the PortAuthority acquisition, partially offset by income tax benefits of $0.9 million and $0.2 million for the nine months ended 2007 and 2006, respectively, related to the expiration of the statute of limitations for the assessment of taxes in various jurisdictions.

Liquidity and Capital Resources

As of September 30, 2007, we had restricted and non-restricted cash and cash equivalents of $241.8 million, restricted and non-restricted investments in marketable securities of $38.0 million and retained earnings of $94.8 million. We used approximately $245 million of our restricted and non-restricted cash equivalents and marketable securities to fund the acquisition of SurfControl on October 3, 2007.  After the funding of the purchase price for SurfControl, none of our current cash, cash equivalents and marketable securities remain restricted.

Net cash provided by operating activities was $37.6 million in the first nine months of 2007 compared with $61.6 million in the first nine months of 2006. The $24.0 million decrease in cash provided by operating activities was primarily due to decreased net income of $11.9 million and decreased growth in deferred revenue as a result of higher growth in recognized revenue than growth in subscription amounts compared to the first nine months of 2006.  Our operating cash flow is significantly influenced by subscription renewals and accounts receivable collections, and deferred revenue.  A future decrease in subscription renewals or accounts receivable collections, or a lower deferred revenue balance, would negatively impact our operating cash flow.

Net cash used in investing activities was $77.7 million in the first nine months of 2007 compared with net cash provided by investing activities of $0.6 million in the first nine months of 2006. The $78.3 million increase of net cash used in investing activities was primarily due to cash used of $82.0 million to purchase PortAuthority in January 2007.

Net cash provided by financing activities was $2.2 million in the first nine months of 2007 compared with net cash used in financing activities of $77.7 million in the first nine months of 2006. The $79.9 million increase of net cash provided by financing activities was primarily due to no share repurchases in the first nine months of 2007 compared with 4,300,000 shares repurchased for $91.4 million in the first nine months of 2006, partially offset by the repayment of the PortAuthority loan and reduced proceeds from the exercise of stock options compared with the first nine months of 2006.

We had operating lease and software license commitments of approximately $17.8 million as of September 30, 2007 (which does not include SurfControl commitments for operating leases and software licenses). A majority of our operating lease commitments are related to our corporate headquarters lease, which extends through December 2013. Our corporate headquarters lease includes escalating rent payments from 2007 to 2013. The rent expense related to our worldwide office space leases are recorded monthly on a straight-line basis in accordance with generally accepted accounting principles. Future minimum annual payments under non-cancelable operating leases and software license agreements at September 30, 2007 are as follows (in thousands):

Years Ending December 31:	Operating Leases		Software License		Total
2007	$	1,353	$	—	$	1,353
2008	2,897		307		3,204
2009	2,717		307		3,024
2010	2,675		—		2,675
2011	2,597		—		2,597
2012	2,450		—		2,450
2013	2,539		—		2,539
	$	17,228	$	614	$	17,842

As of September 30, 2007 and 2006, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

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In April 2003, we announced that our Board of Directors authorized a stock repurchase program of up to 4 million shares of our common stock.  In August 2005, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 8 million shares. In July 2006, we announced that our Board of Directors increased the size of the stock repurchase program by an additional 4 million shares, for a total program size of up to 12 million shares. Repurchases may be made from time to time on the open market at prevailing market prices or in privately negotiated transactions. Depending on market conditions and other factors, purchases under this program may be commenced or suspended at any time, or from time to time, without prior notice. As of September 30, 2007, we had repurchased 8,170,060 shares of our common stock under this program, for an aggregate of $170.4 million at an average price of $20.86 per share. Under the terms of our new senior credit facility, we are restricted from repurchasing our common stock for an aggregate purchase price that exceeds the sum of $25 million plus 50% of aggregate amount of our consolidated net income during the period from the effective date of the facility through the most recent quarter end for which we have filed quarterly financial statements.  We do not intend to repurchase shares for the remainder of 2007.

On April 26, 2007, we entered into a Senior Credit Agreement for a $300 million senior credit facility and an interim credit facility in connection with the funds certain requirements for the acquisition of SurfControl that was announced on April 26, 2007. We completed the acquisition of SurfControl on October 3, 2007. In order to finance a portion of the purchase price, on October 11, 2007, we amended and restated the Senior Credit Agreement. The $225 million senior credit facility described in our amended and restated Senior Credit Agreement consists of a five year $210 million term loan and a $15 million revolving credit facility. The term loan was fully funded on October 11, 2007, and the revolving line of credit remains unused. The senior credit facility is secured by substantially all of our assets, including pledges of stock of some of our subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by our domestic subsidiaries. The term loan amortizes at a rate of 2.5%, 10%, 12.5%, and 15%, respectively, during the first four years of the term and 60% during the fifth year. The initial interest rate is LIBOR plus 250 basis points (7.62% for the first month), and is subject to step downs in the spread over LIBOR based upon  potential future improvements in our total leverage ratio.  We are required to use 50% of excess cash flow for fiscal year 2007 and then 25% after fiscal year 2007, as defined in the senior credit agreement, to make mandatory prepayments of principal, which are not subject to any prepayment penalties.  The amended and restated Senior Credit Agreement contains financial covenants, including a consolidated leverage ratio and a consolidated interest coverage ratio. The amended and restated Senior Credit Agreement also contains affirmative and negative covenants. We did not borrow any amounts under the original interim credit facility, which was terminated by its terms when the Senior Credit Agreement was amended and restated.

We believe that our unrestricted cash and cash equivalents balances, investments in marketable securities and our ongoing cash flow from operations will be sufficient to satisfy our cash requirements, including our one-time restructuring costs and capital expenditures, for at least the next 12 months.  Our cash requirements may increase for reasons we do not currently foresee or we may make acquisitions as part of our growth strategy that increase our cash requirements.  We may elect to raise funds for these purposes through capital markets transactions or debt or private equity transactions as appropriate, including drawdowns on our revolving line of credit, subject to the restrictions on incurring additional debt in our senior credit facility and our obligation to use all of the proceeds of any equity offering to make mandatory prepayments of principal under our se nior credit facility.  We intend to continue to invest our cash in excess of current operating requirements in interest-bearing, investment-grade securities.

Off-Balance Sheet Arrangements

As of September 30, 2007, we did not have any material off-balance sheet arrangements as defined in Regulation S-K Item 303 (a)(4).

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our market risk exposures are related to our cash, cash equivalents and investments in marketable securities. We invest our excess cash in highly liquid short-term investments, municipal securities, commercial paper and corporate bonds. These investments are not held for trading or other speculative purposes. Changes in interest rates affect the investment income we earn on our investments and therefore impact our cash flows and results of operations.

Our interest income is exposed to changes in interest rates primarily from our short-term available-for-sale investments. A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would not materially affect the fair value of our interest sensitive financial instruments at September 30, 2007. Changes in interest rates over time will, however, affect our interest income. As of September 30, 2007, we did not use interest rate derivative instruments to

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manage exposure to interest rate changes.

After our acquisition of SurfControl, which closed on October 3, 2007, our interest expense will be subject to changes in interest rates for our borrowings under our variable rate senior credit facility.  Our senior credit agreement provides that we must maintain hedge agreements so that at least 50% of the aggregate principal amount of the term loan is subject to either a fixed interest rate or interest rate protection for a period of not less than 2.5 years.

We utilize foreign currency forward contracts, zero-cost collar contracts and option contracts to hedge foreign currency market exposures of underlying assets and liabilities.  In addition, working funds necessary to facilitate the short-term operations of our subsidiaries are kept in the local currencies in which they do business. Our objective is to reduce the risk to earnings and cash flows associated with changes in foreign currency exchange rates. We do not use foreign currency contracts for speculative or trading purposes.

Notional and fair values of our Euro and British Pound hedging positions at September 30, 2007 and 2006 are presented in the table below (in thousands):

	September 30, 2007						September 30, 2006
	Notional Value Local Currency		Notional Value USD		Fair Value USD		Notional Value Local Currency		Notional Value USD		Fair Value USD
Euro	€	—	$	—	$	—	€	2,200	$	2,818	$	2,841
British Pound	£	—	—		—		£	1,000	1,871		1,858
Total			$	—	$	—			$	4,689	$	4,699

The $2.8 million notional decrease in our Euro hedged position at September 30, 2007 compared to September 30, 2006 is primarily due to the need for funds required for the SurfControl acquisition. There were no Euro contacts outstanding as of September 30, 2007.  For both the three and nine months ended September 30, 2007, less than 15% of our total billings were denominated in the Euro. We do not expect Euro billings to represent more than 15% of our total billings during 2007.

The $1.9 million notional decrease in our British Pound hedged position at September 30, 2007 compared to September 30, 2006 is primarily due to the natural hedge against our British Pound expenditures by billings in the British Pound which began in May 2007. As of September 30, 2007 no British Pound contracts were outstanding.  We do not expect to hedge the British Pound as we continue billing in the British Pound which creates a natural hedge against our British Pound expenditures.

At September 30, 2007, we utilized a £200 million option contract, with a strike price of $2.10 or $420.0 million, and a £25 million ($51.2 million) forward, expiring on October 11, 2007 at a rate of $2.048 per British Pound, to hedge the purchase price for SurfControl. There were no such contracts related to the SurfControl acquisition outstanding as of September 30, 2006.  We subsequently sold the £200 million option and entered into GBP forward contracts expiring on October 11, 2007. After the funding for the SurfControl acquisition was fully disbursed, we do not expect to enter into any additional foreign currency hedges related to the acquisition of SurfControl.

Item 4. Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rules 13a — 15(e) and 15d — 15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) designed to ensure that we are able to collect the information we are required to disclose in the reports we file under the Exchange Act, and to record, process, summarize and report this information within the time periods specified in the rules of the Securities and Exchange Commission. Our Chief Executive Officer and Chief Financial Officer evaluated our disclosure controls and procedures as of the end of the period covered by this report. Based on their evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures are effective as of the end of the period covered by this Quarterly Report.

Changes In Internal Control Over Financial Reporting

There have been no significant changes in our internal control over financial reporting or in other factors that could significantly affect our internal control over financial reporting, including any corrective actions with regard to significant deficiencies and material weaknesses, during the period covered by this Quarterly Report.

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Part II - Other Information

Item 1. Legal Proceedings

On September 29, 2006, Jason Tauber filed a putative class action against us and other unidentified individuals in California Superior Court for the County of San Diego, captioned Tauber v. Websense. The complaint alleges that the plaintiff and a putative class of certain software engineers and computer professionals who worked for us as exempt employees during the period from September 15, 2002 through the present should have been classified as non-exempt employees under California law and should have been paid for overtime. The complaint also alleges related wage and hour violations of the California Labor Code arising from the alleged misclassification and that the failure to pay overtime constitutes an unfair business practice under California Business and Professions Code §17200. The complaint seeks unspecified damages for unpaid overtime, prejudgment interest, attorneys’ fees and other costs, statutory penalties for alleged violations, and other proper relief. The parties to the action have been granted preliminary court approval to settle all claims made in the putative class action, and the claims administrator has delivered notices to the alleged class members.  During the second quarter of 2007, the Company charged the $3.2 million of the pending settlement amount between the operating expense categories and cost of revenue on the consolidated statement of income, apportioned based upon the Company’s estimate of amounts payable to eligible individuals in the settlement. As of September 30, 2007, $3.2 million remains as a reserve within other accrued expenses on the consolidated balance sheet relating to this settlement.

We are involved in various legal actions in the normal course of business. Based on current information, including consultation with our lawyers, we believe we have adequately reserved for any ultimate liability that may result from these actions such that any liability would not materially affect our consolidated financial positions, results of operations or cash flows. Our evaluation of the likely impact of these actions could change in the future and unfavorable outcomes and/or defense costs, depending upon the amount and timing, could have a material adverse effect on our results of operations or cash flows in a future period.

Item 1A. Risk Factors

You should carefully consider the following information in addition to other information in this report in evaluating our business and our prospects.  The risks and uncertainties described below are those that we currently deem to be material and that we believe are specific to our company and our industry.  In addition to these risks, our business may be subject to risks currently unknown to us.  If any of these or other risks actually occur, our business may be adversely affected, the trading price of our common stock could decline, and you may lose all or part of your investment in Websense.

We have marked with an asterisk (*) those risk factors that reflect material changes from the risk factors included in our Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on August 8, 2007.

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We have experienced declining growth rates, particularly for Web filtering sales to large enterprises in North America and Western Europe, and therefore need to increase our sales to small and medium sized business customers.*

Our growth plans for new sales in North America and Western Europe are largely dependent on our ability to increase sales in the SMB segment and maintain our subscription base in the large enterprise market through subscription renewals. We released our first product targeted at the SMB segment, Websense Express, in July 2007, and we cannot assure that we will have success in increasing sales to the SMB segment. We will also need to increase sales through our two-tier distribution channel in North America and our two-tier distribution arrangements in Western Europe that target SMB customers. Numerous competitors target the SMB segment for Web filtering and security sales, many of whom are different competitors from our primary competitors in the large enterprise space. If Websense Express does not meet our customers’ expectations in the SMB segment or if we fail to compete effectively for volume business through our two-tier distribution model, our financial results will be negatively affected.

We have moved toward a two-tier distribution channel in North America which is intended to increase the quantity of our indirect sales.*

As we continue to move toward a two-tier indirect sales model in North America, our revenue will be derived almost entirely from sales through indirect channels, including value-added resellers, distributors that sell our products to end-users, providers of managed Internet services and other resellers. Ingram Micro and All Tech are our only broad-line distributors in North America, so the success of our North American sales efforts is reliant on their success in selling our products to their reseller network. Our indirect sales model involves a number of additional risks, including:

•our resellers and distributors, including Ingram Micro and All Tech, are not subject to minimum sales requirements or any obligation to market our products to their customers;

•we cannot control the level of effort our resellers and distributors expend or the extent to which any of them will be successful in marketing and selling our products;

•we cannot assure that our channel partners will market and sell our new product offerings such as our security-oriented offerings and our new ILP offerings;

•our reseller and distributor agreements are generally nonexclusive and may be terminated at any time without cause; and

•our resellers and distributors frequently market and distribute competing products and may, from time to time, place greater emphasis on the sale of these products due to pricing, promotions, and other terms offered by our competitors.

Our ability to meaningfully increase the amount of our products sold through our sales channels also depends on our ability to adequately and efficiently support these channel partners with, among other things, appropriate financial incentives to encourage pre-sales investment and sales tools, such as sales training, technical training and product collateral needed to support their customers and prospects. Additionally, we are continually evaluating the changes to our internal ordering and partner management systems in order to effectively execute our two-tier distribution strategy. Any failure to properly and efficiently support our sales channels will result in lost sales opportunities.

Acquired companies or technologies can be difficult to integrate, disrupt our business, dilute stockholder value and adversely affect our operating results.*

In January 2007, we acquired PortAuthority Technologies Inc., and on October 3, 2007 we acquired SurfControl.  We may acquire additional companies, services and technologies in the future as part of our efforts to expand and diversify our business. Although we review the records of companies or businesses we are interested in acquiring, even an in-depth review may not reveal existing or potential problems or permit us to become familiar enough with a business to assess fully its capabilities and deficiencies. Integration of acquired companies may disrupt or slow the momentum of the activities of our business.

In the case of the SurfControl acquisition, we expect to achieve cost synergies from restructuring of the combined businesses following the closing.  As previously disclosed, we expect that the combination with SurfControl will be dilutive to our earnings during the fourth quarter of 2007.  We expect to incur restructuring and other related expenses that will negatively affect our results of operations under generally accepted accounting principles.  The size and scope of the acquisition of SurfControl increase both the scope and consequence of ongoing integration risks. We may not successfully address the integration challenges in a timely manner, or at all, and we may not fully realize all of the anticipated benefits or

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synergies of the SurfControl acquisition (which are principally associated with restructurings, including workforce reductions and other operational efficiencies).  The timing of the achievement of synergies may also deviate from our estimates depending upon the success of the integration process.

Acquisitions involve numerous risks, including:

•difficulties in integrating operations, technologies, services and personnel of the acquired company;

•potential loss of customers and original equipment manufacturing relationships of the acquired company;

•diversion of financial and management resources from existing operations;

•risk of entering new markets;

•potential loss of key employees of the acquired company;

•integrating personnel with diverse business and cultural backgrounds;

•preserving the development, distribution, marketing and other important relationships of the companies;

•assumption of liabilities of the acquired company, including debt and litigation; and

•inability to generate sufficient revenue and cost savings to offset acquisition costs.

Acquisitions may also cause us to:

•issue equity securities that would dilute our current stockholders’ percentage ownership;

•assume certain liabilities;

•incur additional debt, such as the debt we incurred to partially fund the acquisition of SurfControl;

•make large and immediate one-time write-offs and restructuring and other related expenses;

•become subject to intellectual property or other litigation; and

•create goodwill or other intangible assets that could result in significant impairment charges and/or amortization expense.

As a result, if we fail to properly evaluate, execute and integrate acquisitions such as PortAuthority and SurfControl, our business and prospects may be seriously harmed.

The covenants in our new senior credit facility restrict our financial and operational flexibility, including our ability to complete additional acquisitions and invest in new business opportunities.*

In connection with our acquisition of SurfControl, on October 11, 2007 we entered into an amended and restated senior credit facility to provide financing for a substantial portion of the acquisition purchase price.  Our senior credit facility contains covenants that restrict, among other things, our ability to borrow money, make particular types of investments, including investments in our subsidiaries, make other restricted payments, pay down subordinated debt, swap or sell assets, merge or consolidate or make acquisitions.  An event of default under our senior credit facility could allow the lenders to declare all amounts outstanding with respect to the senior credit facility to be immediately due and payable.  As collateral for the loan, we pledged substantially all of our consolidated assets and the stock of some of our subsidiaries (subject to limitations with respect to foreign subsidiaries) to secure the debt under our senior credit facility.  If the amounts outstanding under the senior credit facility were accelerated, the lenders could proceed against those consolidated assets and the stock of our subsidiaries.  Any event of default, therefore, could have a material adverse effect on our business.  Our senior credit

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facility also requires us to maintain specified financial ratios.  Our ability to meet these financial ratios can be affected by events beyond our control, and we cannot assure that we will meet those ratios.

The amount of our debt outstanding may prevent us from taking actions we would otherwise consider in our best interest.*

On October 11, 2007, we borrowed $210 million under the senior credit agreement.  As a result, we are incurring interest expense for the amounts we borrowed under the senior credit facility, and we expect our income from our cash, cash equivalents and marketable securities to decline as we used a significant portion of our cash to fund a portion of the acquisition cost.   This debt and the limitations our senior credit facility impose on us could have important consequences, including:

•it may be difficult for us to satisfy our obligations under the senior credit facility;

•we will have to use much of our cash flow for scheduled debt service rather than for potential investments;

•we may be less able to obtain other debt financing in the future;

•we could be less able to take advantage of significant business opportunities, including acquisitions or divestitures, as a result of debt covenants;

•our vulnerability to general adverse economic and industry conditions could be increased; and

•we could be at a competitive disadvantage to competitors with less debt.

Our future success depends on our ability to sell new, renewal and upgraded Web filtering and Web security subscriptions.*

Substantially all of our revenue in the first nine months of 2007 was derived from new and renewal subscriptions to our Web filtering and Web security products, and we expect that a significant majority of our sales for the fourth quarter of 2007 will continue to be derived from our Web filtering and security products as well as from sales of SurfControl’s products. We expect sales of our ILP products and other products under development to comprise only a very small portion of our overall sales in the fourth quarter of 2007. If our Web filtering and security products fail to meet the needs of our existing and target customers, or if they do not compare favorably in price, features and performance to competing products, our operating results and our business will be significantly impaired.  If we cannot sufficiently increase our customer base with the addition of new customers, particularly in the SMB segment, increase seats under subscriptions from existing customers or renew a sufficient number of SurfControl’s Web filtering customers or migrate them to our Web filtering product, we will not be able to grow our business to meet expectations.

Subscriptions for our Web filtering and security products typically have durations of 12, 24 or 36 months. Our customers have no obligation to renew their subscriptions upon expiration. Our revenue also depends upon maintaining a high rate of sales of renewal subscriptions and in selling further subscriptions to existing customers in order to add additional seats or product offerings within their respective organizations. This may require increasingly costly sales efforts targeting senior management and other management personnel associated with our customers’ Internet and security infrastructure. We may not be able to maintain or continue to generate increasing revenue from existing customers.

Failure of our security products, including our ILP products and on-demand security solutions to achieve more widespread market acceptance will seriously harm our business.*

Our future financial performance depends on our ability to diversify our offerings by successfully developing, introducing and gaining customer acceptance of our new products and services, particularly our security offerings. On January 8, 2007, we acquired PortAuthority Technologies, Inc., and as a result of that acquisition, we now sell Websense Content Protection Suite, our ILP offering for the content security market.   In addition, on October 3, 2007, we acquired SurfControl, and as a result of that acquisition, we now sell on-demand security solutions based upon SurfContol’s BlackSpider technology.  We may not be successful in achieving market acceptance of these or any new products that we develop.   Moreover, our recent increased emphasis on the development, marketing and sale of our security offerings and ILP products as well as the integration of SurfControl could distract us from sales of our core Web filtering and Web security offerings, negatively impacting our overall sales. Any failure or delay in diversifying our existing offerings, or diversification at the detriment to our core Web filtering and Web security offerings, could harm our business, results of operations and financial condition.

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We face increasing competition from much larger software and hardware companies, which places pressure on our pricing and which could prevent us from increasing revenue or maintaining profitability. In addition, as we increase our emphasis on our security-oriented products, we face competition from better-established security companies that have significantly greater resources.*

The market for our products is intensely competitive and is likely to become even more so in the future.  Our current principal Web filtering competitors frequently offer their products at a significantly lower price than our products, which has resulted in pricing pressures on sales of our product and potentially could result in the commoditization of products in our space. We also face current and potential competition from vendors of Internet servers, operating systems and networking hardware, many of which now, or may in the future, develop and/or bundle Web filtering or other competitive products with their products. Increased competition may cause price reductions or a loss of market share, either of which could have a material adverse effect on our business, results of operations and financial condition. If we are unable to maintain the current pricing on sales of our products or increase our pricing in the future, our profitability could be negatively impacted. Even if our products provide greater functionality and are more effective than certain other competitive products, potential customers might accept this limited functionality in lieu of purchasing our products. In addition, our own indirect sales channels may decide to develop or sell competing products instead of our products. Pricing pressures and increased competition generally could result in reduced sales, reduced margins or the failure of our products to achieve or maintain more widespread market acceptance, any of which could have a material adverse effect on our business, results of operations and financial condition.

Our current principal competitors include:

•companies offering Web filtering and Web security solutions, such as Microsoft, Symantec, McAfee, Cisco Systems, Juniper Networks, Message Labs, Trend Micro, Google, ScanSafe, Blue Coat Systems, Secure Computing, Alladin, Finjan, FaceTime, Mi5 Networks, St. Bernard Software, 8e6 Technologies, Marshal, Clearswift, Sophos, Barracuda, Digital Arts and Computer Associates;

•companies integrating Web filtering into specialized security appliances, such as 8e6 Technologies, Blue Coat Systems, Cisco Systems, McAfee, WatchGuard and SonicWALL;

•companies offering information leak prevention solutions, such as Vontu (recently announced to be acquired by Symantec), Verdasys, Vericept, Tablus, Symantec, Secure Computing, IBM, Reconnex, Provilla, Proofpoint, Palisade Systems, Orchestria, Oakley Networks, McAfee, Intrusion, Fidelis, Checkpoint and Code Green Networks;

•companies offering messaging security, such as McAfee, Symantec, Google, Barracuda, Secure Computing, Sonicwall, Tumbleweed, Messagelabs, MXlogic, Microsoft, Proofpoint and Borderware

•companies offering on-demand e-mail and web security services, such as Google, Messagelabs, McAfee, Symantec, MXLogic, and Scansafe;

•companies offering desktop security solutions such as Check Point Software, Cisco Systems, McAfee, Microsoft, Symantec, Computer Associates, Internet Security Systems (IBM) and Trend Micro; and

•companies offering proxy based solutions such as Microsoft, BlueCoat Systems, Cisco Systems and Juniper.

As we develop and market our products with an increasing security-oriented emphasis, we also face increasing competition from security solutions providers. Many of our competitors within the Web security market, such as Symantec, McAfee, Trend Micro, Cisco Systems and Microsoft enjoy substantial competitive advantages, including:

•greater name recognition and larger marketing budgets and resources;

•established marketing relationships and access to larger customer bases; and

•substantially greater financial, technical and other resources.

As a result, we may be unable to gain sufficient traction as a provider of Web security solutions, and our competitors may be able to respond more quickly and effectively than we can to new or emerging technologies and changes in customer requirements, or devote greater resources to the development, marketing, promotion and sale of their products than we can.

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Current and potential competitors have established or may establish cooperative relationships among themselves or with third parties to increase the functionality and market acceptance of their products. In addition, our competitors may be able to replicate our products, make more attractive offers to existing and potential employees and strategic partners, develop new products or enhance existing products and services more quickly. Accordingly, new competitors or alliances among competitors may emerge and rapidly acquire significant market share. In addition, we also expect that competition will increase as a result of industry consolidation. For all of the foregoing reasons, we may not be able to compete successfully against our current and future competitors.

Our international operations involve risks that could increase our expenses, adversely affect our operating results, and require increased time and attention of our management.*

We have significant operations outside of the United States, including research and development, sales and customer support. We have established engineering operations in Beijing, China, and acquired PortAuthority Technologies, Inc., whose engineering efforts are based in Israel. We intend to maintain our principal engineering efforts for our ILP products in Israel.  SurfControl also has substantial engineering operations outside the United States, including in the United Kingdom, Australia and China.

We plan to continue to expand our international operations, but such expansion is contingent upon the financial performance of our existing international operations as well as our identification of growth opportunities.  Our international operations are subject to risks in addition to those faced by our domestic operations, including:

•difficulties associated with managing a distributed organization located on multiple continents in greatly varying time zones;

•potential loss of proprietary information due to misappropriation or laws that may be less protective of our intellectual property rights;

•requirements of foreign laws and other governmental controls, including trade and labor restrictions and related laws that reduce the flexibility of our business operations;

•political unrest, war or terrorism, particularly in areas in which we have facilities;

•difficulties in staffing, managing, and operating our international operations, including difficulties related to administering our stock plans in some foreign countries;

•difficulties in coordinating the activities of our geographically dispersed and culturally diverse operations;

•seasonal reductions in business activity in the summer months in Europe and in other periods in other countries;

•restrictions on our ability to repatriate cash from our international subsidiaries or to exchange cash in international subsidiaries into cash available for use in the United States; and

•costs and delays associated with developing software in multiple languages.

All of our foreign subsidiaries’ operating expenses are incurred in foreign currencies. As a result, should the dollar weaken, our foreign operating expenses would increase. Should foreign currency exchange rates fluctuate, our earnings and net cash flows from international operations may be adversely affected, especially if the trend continues of international sales growing as a percentage of our total sales.

Sales to customers outside the United States have accounted for a significant portion of our revenue, which exposes us to risks inherent in international sales.*

We market and sell our products outside the United States through value-added resellers, distributors and other resellers. International sales represented 41% of our total revenue generated during the quarter ended September 30, 2007 compared with 37% of our total revenue during the quarter ended September 30, 2006. As a key component of our business strategy to generate new business sales, we intend to expand our international sales, but success cannot be assured. In addition to the risks associated with our domestic sales, our international sales are subject to the following risks:

•our ability to adapt to sales and marketing practices and customer requirements in different cultures;

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•our ability to successfully localize software products for a significant number of international markets;

•the significant presence of some of our competitors in some international markets;

•laws and business practices favoring local competitors;

•dependence on foreign distributors and their sales channels;

•longer payment cycles for sales in foreign countries and difficulties in collecting accounts receivable;

•compliance with multiple, conflicting and changing governmental laws and regulations, including tax laws and regulations and consumer protection and privacy laws; and

•regional economic and political conditions.

These factors could have a material adverse effect on our international sales. Any reduction in international sales, or our failure to further develop our international distribution channels, could have a material adverse effect on our business, results of operations and financial condition.

Our international revenue is currently primarily denominated in U.S. dollars. As a result, fluctuations in the value of the U.S. dollar and foreign currencies may make our products more expensive for international customers, which could harm our business. We currently bill certain international customers in Euros and British Pounds. SurfControl has historically billed certain international customers in Euros, British Pounds, Australian Dollars, China Yuan Renminbi, Singapore Dollars, Japanese Yen and Israel New Shekels. This may increase our risks associated with fluctuations in foreign currency exchange rates since we cannot be assured of receiving the same U.S. dollar equivalent as when we bill exclusively in U.S. dollars. We engage in currency hedging activities with the intent of limiting the risk of exchange rate fluctuation. Our hedging activities also involve inherent risks that could result in an unforeseen loss. If we fail to properly forecast rate fluctuations these activities could have a negative impact.

We may not be able to develop acceptable new products or enhancements to our existing products at a rate required by our rapidly changing market.

Our future success depends on our ability to develop new products or enhancements to our existing products that keep pace with rapid technological developments and that address the changing needs of our customers. Although our products are designed to operate with a variety of network hardware and software platforms, we will need to continuously modify and enhance our products to keep pace with changes in Internet-related hardware, software, communication, browser and database technologies. We may not be successful in either developing such products or introducing them to the market in a timely fashion. In addition, uncertainties about the timing and nature of new network platforms or technologies, or modifications to existing platforms or technology could increase our research and development expenses. The failure of our products to operate effectively with the existing and future network platforms and technologies will limit or reduce the market for our products, result in customer dissatisfaction and seriously harm our business, results of operations and financial condition.

We may spend significant time and money on research and development to design and develop our ILP products. If these products fail to achieve broad market acceptance in our target markets, we may be unable to generate significant revenue from our research and development efforts. Moreover, even if we are able to develop information leak prevention products, they may not be accepted in our target markets. As a result, our business, results of operations and financial condition would be adversely impacted.

Our products may fail to keep pace with the rapid growth and technological change of the Internet in accordance with our customers’ expectations.

The ongoing evolution of the Internet and computing environments will require us to continually improve the functionality, features and reliability of our databases. Because our products primarily manage access to URLs and software applications included in our databases, if our databases do not contain a meaningful portion of relevant content, the effectiveness of our Web filtering products will be significantly diminished. Any failure of our databases to keep pace with the rapid growth and technological change of the Internet, such as the increasing amount of multimedia content on the Internet that is not easily classified, will impair the market acceptance of our products.

We rely upon a combination of automated filtering technology and human review to categorize URLs and software applications in our proprietary databases. Our customers may not agree with our determinations that particular URLs and software applications should be included or not included in specific categories of our databases. In addition, it is possible that

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our filtering processes may place objectionable or security risk material in categories that are generally unrestricted by our users’ Internet and computer access policies, which could result in such material not being blocked from the network. Any miscategorization could result in customer dissatisfaction and harm our reputation. Any failure to effectively categorize and filter URLs and software applications according to our customers’ expectations will impair the growth of our business. Our databases and database technologies may not be able to keep pace with the growth in the number of URLs and software applications, especially the growing amount of content utilizing foreign languages and the increasing sophistication of malicious code and the delivery mechanisms associated with spyware, phishing and other hazards associated with the Internet.

Failure of our products to work properly or misuse of our products could impact sales, increase costs, and create risks of potential negative publicity and legal liability.

Our products are complex and are deployed in a wide variety of complex network environments. Our products may have errors or defects that users identify after deployment, which could harm our reputation and our business. In addition, products as complex as ours frequently contain undetected errors when first introduced or when new versions or enhancements are released. We have from time to time found errors in versions of our products, and we expect to find such errors in the future. Because customers rely on our products to manage employee behavior to protect against security risks and prevent the loss of sensitive data, any significant defects or errors in our products may result in negative publicity or legal claims. For example, an actual or perceived breach of network or computer security at one of our customers, regardless of whether the breach is attributable to our products, could adversely affect the market’s perception of our security products. Moreover, parties whose Web sites or software applications are placed in security-risk categories or other categories with negative connotations may seek redress against us for falsely labeling them or for interfering with their business. The occurrence of errors could adversely affect sales of our products, divert the attention of engineering personnel from our product development efforts and cause significant customer relations or legal problems.

Our products may also be misused or abused by customers or non-customer third parties who obtain access and use of our products. These situations may arise where an organization uses our products in a manner that impacts their end users’ or employees’ privacy or where our products are misappropriated to censor private access to the Internet. Any of these situations could result in negative press coverage and negatively affect our reputation.

We face risks related to customer outsourcing to system integrators.

Some of our customers have outsourced the management of their information technology departments to large system integrators. If this trend continues, our established customer relationships could be disrupted and our products could be displaced by alternative system and network protection solutions offered by system integrators. Significant product displacements could impact our revenue and have a material adverse effect on our business.

Other vendors may include products similar to ours in their hardware or software and render our products obsolete.

In the future, vendors of hardware and of operating system software or other software may continue to enhance their products or bundle separate products to include functions that are currently provided primarily by network security software. If network security functions become standard features of computer hardware or of operating system software or other software, our products may become obsolete and unmarketable, particularly if the quality of these network security features is comparable to that of our products. Furthermore, even if the network security and/or management functions provided as standard features by hardware providers or operating systems or other software is more limited than that of our products, our customers might accept this limited functionality in lieu of purchasing additional software. Sales of our products would suffer materially if we were then unable to develop new Web filtering, security and ILP products to further enhance operating systems or other software and to replace any obsolete products.

Our worldwide income tax provisions and other tax accruals may be insufficient if any taxing authorities assume taxing positions that are contrary to our positions.

Significant judgment is required in determining our worldwide provision for income taxes and for our accruals for other state, federal and international taxes such as sales and VAT taxes. In the ordinary course of a global business, there are many transactions for which the ultimate tax outcome is uncertain. Some of these uncertainties arise as a consequence of intercompany arrangements to share revenue and costs. In such arrangements there are uncertainties about the amount and manner of such sharing, which could ultimately result in changes once the arrangements are reviewed by taxing authorities.

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Although we believe that our approach to determining the amount of such arrangements is reasonable, no assurance can be given that the final tax authority review of these matters will not be materially different than that which is reflected in our historical income tax provisions and other tax accruals. Such differences could have a material effect on our income tax provisions or benefits, or other tax accruals, in the period in which such determination is made, and consequently, on our results of operations for such period.

From time to time, we are also audited by various state, federal and international authorities relating to tax matters. We fully cooperate with all audits. Our audits are in various stages of completion; however, no outcome for a particular audit can be determined with certainty prior to the conclusion of the audit and appeals process. As each audit is concluded, adjustments, if any, are appropriately recorded in our financial statements in the period determined. To provide for potential tax exposures, we maintain allowances for tax contingencies based on reasonable estimates of our potential exposure with respect to the tax liabilities that may result from such audits. However, if the reserves are insufficient upon completion of any audits, there could be an adverse impact on our financial position and results of operations.

Any failure to protect our proprietary technology would negatively impact our business.*

Intellectual property is critical to our success, and we rely upon 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 Websense and SurfControl brands. We rely on trade secrets to protect technology where we believe patent protection is not appropriate or obtainable. However, trade secrets are difficult to protect. While we require employees, collaborators and consultants to enter into confidentiality agreements, we cannot assure that these agreements will not be breached or that we will have adequate remedies for any breach. We may not be able to adequately protect our trade secrets or other proprietary information in the event of any unauthorized use or disclosure or the lawful development by others of such information.

We have registered our Websense and Websense Enterprise trademarks in several countries and have registrations for the Websense trademark pending in several other countries. Effective trademark protection may not be available in every country where our products are available. Furthermore, any of our trademarks may be challenged by others or invalidated through administrative process or litigation.

We currently have only nine issued patents in the United States and six patents issued internationally, and we may be unable to obtain further patent protection in the future. We have other pending patent applications in the United States and in other countries. We cannot ensure that:

•we were the first to make the inventions covered by each of our pending patent applications;

•we were the first to file patent applications for these inventions;

•any of our pending patent applications are not obvious or anticipated such that they will not result in issued patents;

•others will not independently develop similar or alternative technologies or duplicate any of our technologies;

•any patents issued to us will provide us with any competitive advantages or will not be challenged by third parties;

•we will develop additional proprietary technologies that are patentable; or

•the patents of others will not have a negative effect on our ability to do business.

Furthermore, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain. Effective patent, trademark, copyright and trade secret protection may not be available to us in every country in which our products are available. The laws of some foreign countries may not be as protective of intellectual property rights as U.S. laws, and mechanisms for enforcement of intellectual property rights may be inadequate. As a result our means of protecting our proprietary technology and brands may not be adequate. Furthermore, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property, including the misappropriation or misuse of the content of our proprietary databases of universal resource locators (“URLs”) and software applications. Any such infringement or misappropriation could have a material adverse effect on our business, results of operations and financial condition.

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Third parties claiming that we infringe their proprietary rights could cause us to incur significant legal expenses and prevent us from selling our products.

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 patent infringement or other violations of intellectual property rights. As we expand our product offerings in the data leakage and security area where larger companies with large patent portfolios compete, the possibility of an intellectual property claim against us grows. We could receive claims that we have infringed the intellectual property rights of others, including claims regarding patents, copyrights, and trademarks. Any such claim, with or without merit, could result in costly litigation and distract management from day-to-day operations. If we are not successful in defending such claims, we could be required to stop selling our products, pay monetary amounts as damages, enter into royalty or licensing arrangements, or satisfy indemnification obligations that we have with some of our customers.

Because we recognize revenue from subscriptions for our products ratably over the term of the subscription, downturns in sales may not be immediately reflected in our revenue.

We expect that nearly all of our revenue for the foreseeable future will come from subscriptions to Websense Enterprise and our add-on products. Upon execution of a subscription agreement, we invoice our customers for the full term of the subscription agreement. We then recognize revenue from customers daily over the terms of their subscription agreements, which typically have durations of 12, 24 or 36 months. As a result, a majority of the revenue we report in each quarter is derived from deferred revenue from subscription agreements entered into and paid for during previous quarters. Because of this financial model, the revenue we report in any quarter or series of quarters may mask significant downturns in sales and the market acceptance of our products, before these downturns result in declining revenues.

Our quarterly operating results may fluctuate significantly, and these fluctuations may cause our stock price to fall.

Our quarterly operating results have varied significantly in the past, and will likely vary in the future primarily as the result of fluctuations in our billings, revenues, operating expenses and tax provisions. Although a significant portion of our revenue in any quarter comes from previously deferred revenue, a meaningful portion of our revenue in any quarter depends on the number, size and length of subscriptions to our products that are sold in that quarter. The risk of quarterly fluctuations is increased by the fact that a significant portion of our quarterly sales have historically been generated during the last month of each fiscal quarter, with many of the largest enterprise customers purchasing subscriptions to our products nearer to the end of the last month of each quarter. Due to the unpredictability of these end-of-period buying patterns, forecasts may not be achieved.

We expect that our operating expenses will increase substantially in the future as we expand our selling and marketing activities, increase our research and development efforts and hire additional personnel which could impact our gross margins. In addition, our operating expenses historically have fluctuated, and may continue to fluctuate in the future, as the result of the factors described below and elsewhere in this quarterly report:

•timing of marketing expenses for activities such as trade shows and advertising campaigns;

•quarterly variations in general and administrative expenses, such as recruiting expenses and professional services fees;

•increased research and development costs prior to new or enhanced product launches; and

•timing of expenses associated with commissions paid on sales of subscriptions to our products.

Consequently, our results of operations may not meet the expectations of current or potential investors. If this occurs, the price of our common stock may decline.

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The market price of our common stock is likely to be highly volatile and subject to wide fluctuations.

The market price of our common stock has been and likely will continue to be highly volatile and could be subject to wide fluctuations in response to a number of factors that are beyond our control, including:

•announcements of technological innovations or new products or services by our competitors;

•demand for our products, including fluctuations in subscription renewals;

•changes in the pricing policies of our competitors; and

•changes in government regulations.

In addition, the market price of our common stock could be subject to wide fluctuations in response to:

•announcements of technological innovations or new products or services by us;

•changes in our pricing policies; and

•quarterly variations in our revenues and operating expenses.

Further, the stock market has experienced significant price and volume fluctuations that have particularly affected the market price of the stock of many Internet-related companies, and that often have been unrelated or disproportionate to the operating performance of these companies. A number of publicly traded Internet-related companies have current market prices below their initial public offering prices. Market fluctuations such as these may seriously harm the market price of our common stock. In the past, securities class action suits have been filed following periods of market volatility in the price of a company’s securities. If such an action were instituted, we would incur substantial costs and a diversion of management attention and resources, which would seriously harm our business, results of operations and financial condition.

We are dependent on our management team, and the loss of any key member of this team may prevent us from implementing our business plan in a timely manner.*

Our success depends largely upon the continued services of our executive officers and other key management personnel and our ability to recruit new personnel to executive and key management positions.  We are also substantially dependent on the continued service of our existing engineering personnel because of the complexity of our products and technologies. We do not have employment agreements with a majority of our executive officers, key management or development personnel and, therefore, they could terminate their employment with us at any time without penalty. We do not maintain key person life insurance policies on any of our employees. The loss of one or more of our key employees could seriously harm our business, results of operations and financial condition. In such an event we may be unable to recruit personnel to replace these individuals in a timely manner, or at all, on acceptable terms.

Because competition for our target employees is intense, we may not be able to attract and retain the highly skilled employees we need to support our planned growth.

To execute our growth plan, we must attract and retain highly qualified personnel. We need to hire additional personnel in virtually all operational areas, including selling and marketing, research and development, operations and technical support, customer service and administration. Competition for these personnel is intense, especially for engineers with high levels of experience in designing and developing software and Internet-related products. We may not be successful in attracting and retaining qualified personnel. We have from time to time in the past experienced, and we expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. In order to attract and retain personnel in a competitive marketplace, we believe that we must provide a competitive compensation package, including cash and equity based compensation. The volatility of our stock price may from time to time adversely affect our ability to recruit or retain employees. Many of the companies with which we compete for experienced personnel have greater resources than we have. If we fail to attract new personnel or retain and motivate our current personnel, our business and future growth prospects could be severely harmed.

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Compliance with changing regulation of corporate governance, accounting principles and public disclosure may result in additional expenses.

Changing laws, regulations and standards relating to corporate governance, accounting principles and public disclosure, including the Sarbanes-Oxley Act of 2002, new SEC regulations and NASDAQ Global Select Market rules, are creating uncertainty for companies such as ours. These new or changed laws, regulations and standards are subject to varying interpretations in many cases due to their lack of specificity and, as a result, their application in practice may evolve over time. Further guidance by regulatory and governing bodies can result in continuing uncertainty regarding compliance matters and higher costs related to the ongoing revisions to accounting, disclosure and governance practices. Our efforts to comply with evolving laws, regulations and standards have resulted in, and are likely to continue to result in, increased general and administrative expenses and a diversion of management time and attention from revenue-generating activities to compliance activities. In particular, our efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our required assessment of our internal controls over financial reporting and our external auditors’ audit of that assessment has required the commitment of significant financial and managerial resources. If our efforts to comply with new or changed laws, regulations and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to practice, our reputation may be harmed.

If we cannot effectively manage our internal growth and the integration of acquired businesses, our business revenues, profit margins and prospects may suffer.*

If we fail to manage our internal growth and the integration of acquired businesses in a manner that minimizes strains on our resources, we could experience disruptions in our operations that could negatively affect our revenue, billings or profitability.  We are pursuing a strategy of organic growth through implementation of two-tier distribution, international expansion, introduction of new products and expansion of our product sales to the small and medium sized businesses. We also completed two strategic acquisitions, and are continuing the process of integrating PortAuthority and SurfControl.  Finally, we have opened or acquired engineering centers in China, Israel, the United Kingdom and Australia.  Each of these initiatives requires an investment of our financial and employee resources and involves risks that may result in a lower return on our investments than we expect. These initiatives also may limit the opportunities we pursue or investments we would otherwise make, which may in turn impact our prospects.

It may be difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.

Some provisions of our certificate of incorporation and bylaws, as well as some provisions of Delaware law, may discourage, delay or prevent third parties from acquiring us, even if doing so would be beneficial to our stockholders. For example, our certificate of incorporation provides for a classified board, with each board member serving a staggered three-year term. It also provides that stockholders may not fill board vacancies, call stockholder meetings or act by written consent. Our bylaws further provide that advance written notice is required prior to stockholder proposals. Each of these provisions makes it more difficult for stockholders to obtain control of our board or initiate actions that are opposed by the then current board. Additionally, we have authorized preferred stock that is undesignated, making it possible for the board to issue up to 5,000,000 shares of preferred stock with voting or other rights and preferences that could impede the success of any attempted change of control. Delaware law also could make it more difficult for a third party to acquire us. Section 203 of the Delaware General Corporation Law has an anti-takeover effect with respect to transactions not approved in advance by our board, including discouraging attempts that might result in a premium over the market price of the shares of common stock held by our stockholders.

Our senior credit facility also accelerates and becomes payable in full upon our change of control, which is defined generally as a person or group acquiring 35% of our voting securities or a proxy contest that results in changing a majority of our board of directors.  These consequences may discourage third parties from attempting to acquire us.

We do not intend to pay dividends.

We have not declared or paid any cash dividends on our common stock since we have been a publicly traded company. We currently intend to retain any future cash flows from operations to fund growth and, do not expect to pay any cash dividends in the foreseeable future.  Moreover, we are not permitted to pay cash dividends under the terms of our senior credit facility.

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Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.    Defaults upon Senior Securities

None.

Item 4.  Submission of Matters to a Vote of Security Holders

None.

Item 5.    Other Information

None.

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Item 6.    Exhibits

Exhibits

2.1(1)	Transaction Agreement by and among Websense, Inc., Websense SC Operations Limited and SurfControl plc, dated April 26, 2007.
2.2(1)	Rule 2.5 Announcement.
3.1(2)	Amended and Restated Certificate of Incorporation.
3.2(3)	Amended and Restated Bylaws.
4.1(2)	Specimen Stock Certificate of Websense, Inc.
10.1(4)	$225,000,000 Amended and Restated Senior Credit Agreement, among Websense, Inc. as borrower, the lenders from time to time parties thereto, Morgan Stanley Senior Funding, Inc. as sole lead arranger and sole bookrunner, Morgan Stanley Senior Funding, Inc. as senior administrative agent, Bank of America, N.A., as syndication agent, Key Bank National Association, JP Morgan Chase Bank and Citibank, N.A., as co-documentation agents, Morgan Stanley Senior Funding, Inc. as senior administrative agent, and Morgan Stanley & Co. Incorporated, as senior collateral agent for the benefit of the secured parties.
10.2(4)	Amended and Restated 2000 Stock Incentive Plan.
31.1	Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).
31.2	Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).
32.1	Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).
32.2	Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).

(1)Filed as an Exhibit to our Current Report on Form 8-K (No 000-30093) filed on May 2, 2007.

(2)Filed as an Exhibit to our Registration Statement on Form S-1/A (No 333-95619) filed on March 3, 2000.

(3)Filed as an Exhibit to our Current Report on Form 8-K (No 000-30093) filed on April 19, 2007.

(4)Filed as an Exhibit to our Current Report on Form 8-K (No 000-30093) filed on October 17, 2007.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	WEBSENSE, INC.
Date: November 8, 2007		By:	/s/ GENE HODGES
			Gene Hodges
			Chief Executive Officer
Date: November 8, 2007		By:	/s/ DUDLEY MENDENHALL
			Dudley Mendenhall
			Chief Financial Officer

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EXHIBIT INDEX

2.1(1)	Transaction Agreement by and among Websense, Inc., Websense SC Operations Limited and SurfControl plc, dated April 26, 2007.
2.2(1)	Rule 2.5 Announcement.
3.1(2)	Amended and Restated Certificate of Incorporation.
3.2(3)	Amended and Restated Bylaws.
4.1(2)	Specimen Stock Certificate of Websense, Inc.
10.1(4)	$225,000,000 Amended and Restated Senior Credit Agreement, among Websense, Inc. as borrower, the lenders from time to time parties thereto, Morgan Stanley Senior Funding, Inc. as sole lead arranger and sole bookrunner, Morgan Stanley Senior Funding, Inc. as senior administrative agent, Bank of America, N.A., as syndication agent, Key Bank National Association, JP Morgan Chase Bank and Citibank, N.A., as co-documentation agents, Morgan Stanley Senior Funding, Inc. as senior administrative agent, and Morgan Stanley & Co. Incorporated, as senior collateral agent for the benefit of the secured parties.
10.2(4)	Amended and Restated 2000 Stock Incentive Plan.
31.1	Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).
31.2	Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).
32.1	Certification of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).
32.2	Certification of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. 1350).

(1)    Filed as an Exhibit to our Current Report on Form 8-K (No 000-30093) filed on May 2, 2007.

(2)Filed as an Exhibit to our Registration Statement on Form S-1/A (No 333-95619) filed on March 3, 2000.

(3)Filed as an Exhibit to our Current Report on Form 8-K (No 000-30093) filed on April 19, 2007.

(4)Filed as an Exhibit to our Current Report on Form 8-K (No 000-30093) filed on October 17, 2007.

EX-31.1

Exhibit 31.1

CERTIFICATION

I, Gene Hodges, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Websense, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 8, 2007	By:	/s/ GENE HODGES
		Gene Hodges
		Chief Executive Officer

EX-31.2

Exhibit 31.2

CERTIFICATION

I, Dudley Mendenhall, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Websense, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 8, 2007	By:	/s/ DUDLEY MENDENHALL
		Dudley Mendenhall
		Chief Financial Officer

EX-32.1

Exhibit 32.1

CERTIFICATION

Gene Hodges, Chief Executive Officer of Websense, Inc., hereby certifies pursuant to the requirement set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. § 1350) that, to the best of his knowledge:

1.The Quarterly Report on Form 10-Q of Websense, Inc. for the quarterly period ended September 30, 2007 (the “Quarterly Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act.

2.The information contained in the Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of Websense, Inc. for the period covered by the Quarterly Report.

Dated: November 8, 2007	By:	/s/ GENE HODGES
		Gene Hodges
		Chief Executive Officer

*A signed original of this written statement has been provided to Websense, Inc. and will be retained by Websense, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.  This written statement accompanies the Quarterly Report to which it relates, is not deemed filed with the Securities and Exchange Commission, and is not incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Exchange Act, irrespective of any general incorporation language contained in such filing.

EX-32.2

Exhibit 32.2

CERTIFICATION

Dudley Mendenhall, Chief Financial Officer of Websense, Inc., hereby certifies pursuant to the requirement set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. § 1350) that, to the best of his knowledge:

1.The Quarterly Report on Form 10-Q of Websense, Inc. for the quarterly period ended September 30, 2007 (the “Quarterly Report”) fully complies with the requirements of Section 13(a) or 15(d) of the Exchange Act.

2.The information contained in the Quarterly Report fairly presents, in all material respects, the financial condition and results of operations of Websense, Inc. for the period covered by the Quarterly Report.

Dated: November 8, 2007	By:	/s/ DUDLEY MENDENHALL
		Dudley Mendenhall
		Chief Financial Officer

*A signed original of this written statement has been provided to Websense, Inc. and will be retained by Websense, Inc. and furnished to the Securities and Exchange Commission or its staff upon request.  This written statement accompanies the Quarterly Report to which it relates, is not deemed filed with the Securities and Exchange Commission, and is not incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or the Exchange Act, irrespective of any general incorporation language contained in such filing.