Part I – Financial Information

Item 1. Consolidated Financial Statements (Unaudited)

Websense, Inc.
Consolidated Balance Sheets

(Unaudited and in thousands)

	June 30, 2008			December 31, 2007
				(See Note 1)
Assets
Current assets:
Cash and cash equivalents	$	65,074		$	66,383
Marketable securities	—			19,781
Accounts receivable, net	61,588			76,328
Prepaid income taxes	2,241			3,734
Current portion of deferred income taxes	30,279			22,870
Other current assets	12,922			10,109
Total current assets	172,104			199,205

Property and equipment, net	16,304			17,657
Intangible assets, net	129,496			152,906
Goodwill	376,135			385,916
Deferred income taxes, less current portion	35,258			19,048
Deposits and other assets	4,690			5,798
Total assets	$	733,987		$	780,530

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	1,640		$	3,255
Accrued compensation and related benefits	18,527			28,960
Other accrued expenses	26,936			30,463
Current portion of income taxes payable	15,934			1,531
Current portion of deferred tax liability	6,055			10,399
Current portion of deferred revenue	204,663			190,569
Total current liabilities	273,755			265,177
Income taxes payable, less current portion	9,661			12,264
Senior secured term loan	155,000			190,000
Deferred revenue, less current portion	97,878			96,116
Deferred tax liability, less current portion	11,582			20,964
Other long term liabilities	1,796			1,634
Total liabilities	549,672			586,155

Stockholders’ equity:
Common stock	519			515
Additional paid-in capital	282,281			267,164
Treasury stock, at cost	(149,829		)	(139,792		)
Retained earnings	53,377			67,808
Accumulated other comprehensive loss	(2,033		)	(1,320		)
Total stockholders’ equity	184,315			194,375
Total liabilities and stockholders’ equity	$	733,987		$	780,530

See accompanying notes.

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Websense, Inc.
Consolidated Statements of Operations

(Unaudited) (in thousands, except per share amounts)

	Three Months Ended					Six Months Ended
	June 30, 2008			June 30, 2007		June 30, 2008			June 30, 2007

Revenue	$	72,958		$	50,449	$	139,942		$	100,196

Cost of revenues:
Cost of revenues	8,587			4,805		17,454			8,833
Amortization of acquired technology	3,081			629		6,153			1,258
Total cost of revenues	11,668			5,434		23,607			10,091
Gross margin	61,290			45,015		116,335			90,105

Operating expenses:
Selling and marketing	44,338			25,127		87,159			50,040
Research and development	13,198			10,325		26,658			18,721
General and administrative	11,836			6,575		24,689			13,761
Total operating expenses	69,372			42,027		138,506			82,522

(Loss) income from operations	(8,082		)	2,988		(22,171		)	7,583

Interest expense	(2,941		)	—		(7,373		)	—
Other income, net	1,113			1,475		1,004			3,915

(Loss) income before income taxes	(9,910		)	4,463		(28,540		)	11,498

(Benefit) provision for income taxes	(1,716		)	2,334		(14,109		)	5,502

Net (loss) income	$	(8,194	)	$	2,129	$	(14,431	)	$	5,996

Net (loss) income per share:

Basic net (loss) income per share	$	(0.18	)	$	0.05	$	(0.32	)	$	0.13
Diluted net (loss) income per share	$	(0.18	)	$	0.05	$	(0. 32	)	$	0.13
Weighted average shares – basic	45,208			45,060		45,299			44,978
Weighted average shares – diluted	45,208			45,561		45,299			45,499

See accompanying notes.

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Websense, Inc.
Consolidated Statement of Stockholders’ Equity

(Unaudited and in thousands)

	Common stock				Additional			Treasury			Retained			Accumulated other comprehensive			Total stockholders’
	Shares		Amount		paid-in capital			stock			earnings			loss			equity
Balance at December 31, 2007	45,394		$	515	$	267,164		$	(139,792	)	$	67,808		$	(1,320	)	$	194,375

Issuance of common stock upon exercise of options	76		1		719			—			—			—			720

Issuance of common stock for ESPP purchase	190		2		2,901			—			—			—			2,903

Issuance of common stock from restricted stock units, net	28		1		—			(39		)	—			—			(38		)

Share-based compensation expense	—		—		12,175			—			—			—			12,175

Tax shortfall from stock option exercises	—		—		(678		)	—			—			—			(678		)

Purchase of treasury stock	(538	)	—		—			(9,998		)	—			—			(9,998		)

Other comprehensive income (loss):

Net loss	—		—		—			—			(14,431		)	—			(14,431		)

Net change in unrealized loss on interest rate swap and cap, net of tax	—		—		—			—			—			(68		)	(68		)

Cumulative translation adjustments	—		—		—			—			—			(645		)	(645		)

Comprehensive loss																	(15,144		)

Balance at June 30, 2008	45,150		$	519	$	282,281		$	(149,829	)	$	53,377		$	(2,033	)	$	184,315

See accompanying notes.

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Websense, Inc.
Consolidated Statements of Cash Flows

(Unaudited and in thousands)

	Six Months Ended
	June 30,			June 30,
	2008			2007
Operating activities:
Net (loss) income	$	(14,431	)	$	5,996
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization	31,490			3,913
In-process research and development	—			1,270
Share-based compensation	12,175			10,536
Deferred income taxes	(30,964		)	(4,645		)
Unrealized (gain) loss on foreign exchange	(71		)	1,078
Tax shortfall / windfall from stock option exercises	678			(685		)
Changes in operating assets and liabilities, net of effects from purchases of PortAuthority and SurfControl:
Accounts receivable	14,817			9,632
Other assets	(1,761		)	(7,101		)
Accounts payable	(1,660		)	(336		)
Accrued compensation and related benefits	(8,772		)	(735		)
Other liabilities	(5,293		)	4,542
Deferred revenue	16,582			(2,810		)
Income taxes payable	11,119			3,104
Net cash provided by operating activities	23,909			23,759

Investing activities:
Purchases of property and equipment	(4,109		)	(3,277		)
Cash paid for purchased technology (intangible assets)	(940		)	—
Cash refunded (paid) for acquisition of PortAuthority, net of cash acquired	147			(81,988		)
Cash paid for option contract on SurfControl acquisition	—			(4,590		)
Cash received from sale of CyberPatrol assets	1,400			—
Purchases of marketable securities	(20,160		)	(282,122		)
Maturities of marketable securities	39,963			293,422
Net cash provided by (used in) investing activities	16,301			(78,555		)

Financing activities:
Principal payments on senior secured term loan	(35,000		)	—
Repayment of PortAuthority loan	—			(4,214		)
Proceeds from exercise of stock options	720			2,388
Proceeds from issuance of common stock for stock purchase plan	2,903			2,212
Tax shortfall / windfall from stock option exercises	(678		)	685
Purchase of treasury stock	(9,998		)	—
Net cash (used in) provided by financing activities	(42,053		)	1,071
Effect of exchange rate changes on cash and cash equivalents	534			—
Decrease in cash and cash equivalents	(1,309		)	(53,725		)
Cash and cash equivalents at beginning of period	66,383			83,523
Cash and cash equivalents at end of period	$	65,074		$	29,798

Supplemental cash flow information:
Income taxes paid	$	3,945		$	7,983
Unrealized gain on marketable securities	$	—		$	14

See accompanying notes.

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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 (“GAAP”) 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 GAAP 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 results of operations for the interim periods presented.

These financial statements should be read in conjunction with the audited consolidated financial statements and notes for the fiscal year ended December 31, 2007, 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 six months ended June 30, 2008 are not necessarily indicative of the results that may be expected for any other interim period or for the fiscal year ending December 31, 2008. The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. Certain prior period amounts have been reclassified to conform to the current period presentation.

2. Net (Loss) Income Per Share

Websense computes net (loss) income per share (“EPS”) as permitted by the Financial Accounting Standards Board (“FASB”) with Statement of Financial Accounting Standards (“SFAS”) No. 128, Earnings Per Share (“SFAS 128”). Under the provisions of SFAS 128, basic EPS is computed by dividing the net (loss) income for the period by the weighted average number of common shares outstanding during the period. Diluted EPS 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 stock options and dilutive restricted stock units are calculated based on the average share price for each fiscal period using the treasury stock method. In accordance with SFAS 128, if, however, the Company reports a net loss, the diluted EPS is computed in the same manner as the basic EPS.

As the Company reported a net loss for the three and six months ended June 30, 2008, basic and diluted EPS were the same. During the three and six months ended June 30, 2007, the difference between the weighted average shares used in determining basic EPS versus diluted EPS related to dilutive securities which totaled 501,000 and 521,000 shares, respectively. Potentially dilutive securities totaling 8,784,000 and 6,342,000 shares for the three months ended June 30, 2008 and 2007, respectively, were excluded from the diluted EPS calculation because of their anti-dilutive effect. Potentially dilutive securities totaling 8,529,000 and 5,809,000 shares for the six months ended June 30, 2008 and 2007, respectively, were excluded from the diluted EPS calculation because of their anti-dilutive effect.

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 (Loss) Income			Shares	Per Share
	(Numerator)			(Denominator)	Amount
	(In thousands, except per share amounts)
For the Three Months Ended:
June 30, 2008:
Basic EPS	$	(8,194	)	45,208	$	(0.18	)
Effect of dilutive securities	—			—	—
Diluted EPS	$	(8,194	)	45,208	$	(0.18	)

June 30, 2007:
Basic EPS	$	2,129		45,060	$	0.05
Effect of dilutive securities	—			501	—
Diluted EPS	$	2,129		45,561	$	0.05

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For the Six Months Ended:
June 30, 2008:
Basic EPS	$	(14,431	)	45,299	$	(0.32	)
Effect of dilutive securities	—			—	—
Diluted EPS	$	(14,431	)	45,299	$	(0.32	)

June 30, 2007:
Basic EPS	$	5,996		44,978	$	0.13
Effect of dilutive securities	—			521	—
Diluted EPS	$	5,996		45,499	$	0.13

3. Comprehensive (Loss) Income

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

	Three Months Ended						Six Months Ended
	June 30, 2008			June 30, 2007			June 30, 2008			June 30, 2007
Net (loss) income	$	(8,194	)	$	2,129		$	(14,431	)	$	5,996
Net change in unrealized (loss) gain on marketable securities, net of tax	—			(22		)	—			14
Net change in unrealized gain on fair value of foreign currency contracts, net of tax	—			13			—			19
Net change in unrealized gain (loss) on interest rate swap and cap, net of tax	1,016			—			(68		)	—
Cumulative translation adjustment	(169		)	—			(645		)	—
Comprehensive (loss) income	$	(7,347	)	$	2,120		$	(15,144	)	$	6,029

4. Acquisitions

SurfControl

In October 2007, the Company completed the acquisition of SurfControl plc (“SurfControl”), a U.K.-based provider of Web and e-mail security solutions. The total purchase price of the acquisition was as follows (in thousands):

Cash paid for SurfControl	$	448,760
Transaction costs	12,114
Total purchase price	$	460,874

The purchase price allocation is preliminary and subject to revision as more detailed analyses are completed. Any change in the fair value of the net assets acquired will change the amount of the purchase price allocable to goodwill. The Company expects to finalize the purchase price by September 2008. The preliminary allocation of the purchase price as of June 30, 2008 is as follows (in thousands):

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Fair value of net tangible assets acquired and liabilities assumed:
Cash and cash equivalents	$	65,995
Accounts receivable	16,723
Other current assets	3,515
Property and equipment	10,676
Deferred income taxes	(33,051		)
Accounts payable and accrued expenses	(46,802		)
Deferred revenue	(19,729		)
				(2,673		)
Fair value of identifiable intangible assets acquired:
Technology	29,265
Customer relationships	128,500
				157,765
Goodwill				305,782
Total purchase price				$	460,874

In connection with the acquisition, the Company’s management approved plans to restructure the operations of the acquired company by terminating 320 of SurfControl’s employees and exiting certain SurfControl facilities. As of June 30, 2008, of the 320 employees originally identified for termination, 319 have been terminated and the one remaining employee is expected to be terminated by September 2008. These workforce reductions are across all functions and geographies and affected employees were, or will be, provided cash severance packages. Additionally, the Company has consolidated facilities and has exited, or will be exiting, leases in certain locations as well as reducing the square footage required to operate some locations. The Company will finalize its facility exit plans by September 2008 which could further result in adjustments to the fair value of the associated acquired liabilities. The Company has accrued the estimated costs associated with the employee severance and facility exit obligations as liabilities assumed in the acquisition of SurfControl and accordingly, these estimated costs are included as part of the purchase price of SurfControl. Changes to the estimates of these costs after September 2008 will be recorded as a reduction to goodwill or as an expense to the results of operations, as appropriate. As of June 30, 2008, $9.5 million of severance and facility exit obligations remain accrued for payments in future periods as follows (in thousands):

	Balance at December 31, 2007		Cash Payments			Adjustments			Foreign Exchange Adjustments		Balance at June 30, 2008

Severance costs	$	6,761	$	(4,379	)	$	(1,894	)	$	10	$	498
Facility exit costs	9,379		(397		)	(1		)	30		9,011
Total	$	16,140	$	(4,776	)	$	(1,895	)	$	40	$	9,509

The accruals for severance costs at June 30, 2008 primarily represent the amounts to be paid to employees that have been terminated or identified for termination as a result of the restructuring plan described above. These amounts are expected to be paid within fiscal year 2008.

The accruals for facility exit costs at June 30, 2008 represent the remaining fair value of lease obligations for exiting locations, as determined at the expected cease-use dates of those facilities, and will be paid out over the remaining lease terms, the last of which ends in fiscal year 2013. As of June 30, 2008, the facility exit accrual has not been reduced for any estimated sublease income nor have any adjustments been made due to favorable or unfavorable current lease terms as the Company has not yet obtained the information needed to make such an estimate. The Company anticipates such information will be obtained by September 2008 and will adjust the facility exit accrual accordingly.

During the first quarter of 2008, the Company completed certain integration activities in connection with the acquisition of SurfControl. As a result of the completion of the integration activities, the Company reassessed the functional currency designation of the SurfControl entities and determined that a change in functional currency designation was appropriate for certain SurfControl entities. The change in functional currency designation was made prospectively effective as of the beginning of the second quarter of 2008.

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5. Intangible Assets and Goodwill

Intangible assets subject to amortization consisted of the following as of June 30, 2008 (in thousands):

	Weighted Average Life (years)	Cost		Accumulated Amortization			Net

Technology	2.9	$	43,270	$	(11,534	)	$	31,736
Customer relationships	6.1	129,200		(31,797		)	97,403
Trade name	3.5	510		(153		)	357
Total		$	172,980	$	(43,484	)	$	129,496

As of June 30, 2008, remaining amortization expense is expected to be as follows (in thousands):

Years Ending December 31,
2008	$	24,929
2009	38,640
2010	25,831
2011	14,956
2012	8,261
Thereafter	16,879
Total	$	129,496

The following table summarizes the activity related to the carrying value of the Company’s goodwill during the six months ended June 30, 2008 (in thousands):

	Six Months Ended June 30, 2008
Balance at December 31, 2007	$	385,916
Reduction from sale of CyberPatrol assets	(2,148		)
Refund related to PortAuthority acquisition	(147		)
PortAuthority deferred income tax adjustment	(1,655		)
SurfControl deferred income tax adjustment	(4,681		)
Other SurfControl purchase accounting adjustments	(1,150		)
Balance at June 30, 2008	$	376,135

6. Senior Secured Credit Facility

In connection with the acquisition of SurfControl in October 2007, the Company entered into an amended and restated senior credit agreement (the “Senior Credit Agreement”). The $225 million senior secured credit facility consists of a five year $210 million senior secured term loan and a $15 million revolving credit facility. The senior secured term loan was fully funded on October 11, 2007, and the revolving line of credit remains unused. At June 30, 2008, the outstanding balance under the senior secured term loan was $155 million as a result of the Company making optional prepayments totaling $5 million in the quarter ended June 30, 2008 and $35 million in the six months ended June 30, 2008, as well as an optional $20 million prepayment on December 31, 2007. The senior secured credit facility is secured by substantially all of the assets of the Company, including pledges of stock of some of its subsidiaries (subject to limitations in the case of foreign subsidiaries) and by secured guarantees by the Company’s domestic subsidiaries. The senior secured term loan initially amortized at a minimum rate of 2.5%, 10%, 12.5%, and 15%, respectively, during the first four years of the term and 60% during the fifth year. In conjunction with the Company’s optional $20 million prepayment on December 31, 2007, the Company amended its Senior Credit Agreement to eliminate any additional mandatory payments until September 30, 2009. The senior secured term loan bears interest at a spread above LIBOR with the spread determined based upon the Company’s total leverage ratio, as defined in the Senior Credit Agreement. During the second quarter 2008, the annual interest rate was LIBOR plus 250 basis points (5.28% at June 30, 2008), and was subject to a potential step down in the spread over LIBOR based upon potential future improvements in the Company’s total leverage ratio. The unused portion of the revolving credit facility required a 50 basis points fee per annum, also subject to a step down based upon potential future improvements in the Company’s total leverage ratio. Based on the total leverage ratio as of June 30, 2008, the spread on both the senior secured term loan and revolving credit facility will be reduced for the third quarter of 2008 to LIBOR plus 225 basis points (5.03% as of June 30, 2008) per annum for the senior secured term loan and 25 basis points per annum for the

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unused portion of the revolving credit facility. 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.

As of June 30, 2008, future remaining minimum principal payments under the senior secured term loan will be as follows (in thousands):

Years Ending December 31,
2008	$	—
2009	5,099
2010	21,414
2011	25,697
2012	102,790
Total	$	155,000

The Senior Credit Agreement provides that the Company must maintain hedge agreements so that at least 50% of the aggregate principal amount of the senior secured credit facility is subject to fixed interest rate protection for a period of not less than 2.5 years. On October 11, 2007 in conjunction with the funding of the senior secured term loan, the Company entered into an interest rate swap agreement to pay a fixed rate of interest (4.85% per annum) and receive a floating rate interest payment (based on three month LIBOR) on an equivalent amount. The initial notional amount of the swap agreement was $105 million on October 11, 2007 and it amortizes each quarter down to $11 million on June 30, 2010. In addition, on October 11, 2007 the Company entered into an interest rate cap agreement to limit the maximum interest rate on a portion of its senior secured term loan to 6.5% per annum. The amount of principal protected by this agreement increases from $5 million at December 31, 2007 to $74.3 million on June 30, 2010. Both the interest rate swap and cap expire on September 30, 2010.

7. Foreign Currency Hedges

The Company uses derivative financial instruments to manage foreign currency risk relating to foreign exchange rates, fluctuations arising from the sale of products internationally in foreign currencies, and from expenses in foreign currencies to support those sales. The Company does not use these instruments 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. Derivative instruments are recognized as either assets or liabilities in the accompanying financial statements and are measured at fair value. Gains and losses resulting from changes in the fair values of those derivative instruments are recorded to earnings or other comprehensive (loss) income depending on the use of the derivative instrument and whether it qualifies for hedge accounting.

During the three and six months ended June 30, 2008 and 2007, 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 the three and six months ended June 30, 2008 and 2007 are included in other income, net, in the accompanying consolidated statements of operations and amounted to approximately $221,000 and $64,000 for the three months ended June 30, 2008 and 2007, respectively and $498,000 and $148,000 for the six months ended June 30, 2008 and 2007, respectively.

Notional and fair values of the Company’s Euro and British Pound hedging positions at June 30, 2008 and 2007 are presented in the table below (in thousands):

	June 30, 2008						June 30, 2007
	Notional Value Local Currency		Notional Value USD		Fair Value USD		Notional Value Local Currency		Notional Value USD		Fair Value USD
Euro	€	2,850	$	4,325	$	4,171	€	2,000	$	2,660	$	2,610
British Pound	£	—	—		—		£	950	1,886		1,900
Total			$	4,325	$	4,171			$	4,546	$	4,510

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8. Fair Value Measurements

SFAS No. 157

SFAS No. 157, Fair Value Measurements (“SFAS 157”) defines fair value, establishes a framework for measuring fair value and establishes a hierarchy that categorizes and prioritizes the sources to be used to estimate fair value. SFAS 157 also expands financial statement disclosures about fair value measurements. On February 12, 2008, the FASB issued FASB Staff Position 157-2 (“FSP 157-2”), which delays the effective date of SFAS 157 for one year for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. The Company elected a partial deferral of SFAS 157 under the provisions of FSP 157-2 related to the measurement of fair value used when evaluating nonfinancial assets and liabilities. The Company is currently evaluating the impact of FSP 157-2 on its financial statements. The impact of partially adopting SFAS 157 effective January 1, 2008 was not material to the Company’s financial statements.

Fair Value Measurements on a Recurring Basis

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurements. The Company’s assessment of the significance of a particular input to the fair value measurements requires judgment, and may affect the valuation of the assets and liabilities being measured and their placement within the fair value hierarchy.

The following table presents the balances of assets and liabilities measured at fair value on a recurring basis as of June 30, 2008 (in thousands):

	Level 1 (1)		Level 2 (2)		Level 3 (3)		Total
Assets:
Interest rate cap	$	—	$	72	$	—	$	72

Liabilities:
Interest rate swaps	$	—	$	1,790	$	—	$	1,790
Foreign currency forward contracts	—		154		—		154

(1) – quoted prices in active markets for identical assets or liabilities

(2) – observable inputs other than quoted prices in active markets for identical assets and liabilities

(3) – no observable pricing inputs in the market

Included in Other assets and in Other accrued expenses are derivative contracts, comprised of interest rate swaps and an interest rate cap as well as foreign currency forward contracts, that are valued using models based on readily observable market parameters for all substantial terms of the Company’s derivative contracts and thus are classified within Level 2.

Fair Value Measurements on a Nonrecurring Basis

As permitted by FSP 157-2, the Company elected to defer the fair value measurement disclosure of its nonfinancial assets and liabilities.

SFAS No. 159

SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities—Including an Amendment of SFAS 115 (“SFAS 159”), permits but does not require companies to measure financial instruments and certain other items at fair value. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. As the Company did not elect to fair value any of its financial instruments under the provisions of SFAS 159, the adoption of this statement effective January 1, 2008 did not have an impact on the Company’s financial statements.

9. Stockholders’ Equity

Share-Based Compensation

Employee Stock Purchase Plan

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

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	Number of Shares
Shares reserved for issuance at December 31, 2007	1,691,165
Shares reserved for issuance during 2008 based on automatic increase in shares authorized	453,936
Shares issued during six months ended June 30, 2008	(190,250	)
Shares reserved for issuance at June 30, 2008	1,954,851

Employee Stock Option Plans

The following table summarizes the Company’s stock option activity since December 31, 2007:

	Number of Shares		Weighted Average Exercise Price
Balance at December 31, 2007	9,086,786		$	22.62
Granted	2,034,750		18.41
Exercised	(75,876	)	9.50
Cancelled	(598,345	)	22.61
Balance at June 30, 2008	10,447,315		21.89

Shares reserved for future grants under the Company’s stock option plans are as follows:

	Number of Shares
Shares reserved for future grants at December 31, 2007	222,629
Shares reserved for future grants during 2008 based on the automatic increase in shares authorized	1,815,746
Shares granted during the six months ended June 30, 2008	(2,070,750	)
Shares cancelled during the six months ended June 30, 2008	598,345
Shares reserved for future grants at June 30, 2008	565,970

The results of operations for the three and six months ended June 30, 2008 and 2007 include share-based compensation expense in the following expense categories of the consolidated statements of operations (in thousands):

	Three Months Ended				Six Months Ended
	June 30, 2008		June 30, 2007		June 30, 2008		June 30, 2007
Share-based compensation in:
Cost of revenues	$	316	$	388	$	677	$	717
Total share-based compensation in cost of revenues	316		388		677		717

Selling and marketing	2,249		2,192		4,566		4,205
Research and development	1,199		954		2,323		1,886
General and administrative	2,241		1,780		4,609		3,728
Total share-based compensation in operating expenses	5,689		4,926		11,498		9,819
Total share-based compensation	$	6,005	$	5,314	$	12,175	$	10,536

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The Company used the following assumptions to estimate the fair value of the options granted:

	Three Months Ended				Six Months Ended
	June 30, 2008		June 30, 2007		June 30, 2008		June 30, 2007

Average expected life (years)	3.0		3.0		3.0		3.1
Average expected volatility factor	34.8	%	34.1	%	34.8	%	35.5	%
Average risk-free interest rate	2.7	%	4.7	%	2.6	%	4.7	%
Average expected dividend yield	—		—		—		—

Treasury Stock

The Company resumed repurchasing shares of its common stock during the first six months of 2008 as follows.

	Shares	Average Price Per Share
Shares repurchased through December 31, 2007	8,170,060	$	20.86
Shares repurchased during the six months ended June 30, 2008	537,904	$	18.57
Total shares repurchased through June 30, 2008	8,707,964	$	20.72

Under the terms of the Company’s Senior Credit Agreement, the Company is restricted from repurchasing its common stock for an aggregate purchase price that exceeds the sum of $25 million plus 50% of the aggregate amount of its consolidated net income, as defined in the Senior Credit Agreement, during the period from the effective date of the facility through the most recent quarter end for which quarterly financial statements have been filed. The remaining shares authorized for repurchase under the Company’s stock repurchase program as of June 30, 2008 was 3,292,036 shares. As of June 30, 2008, $33.4 million remained authorized for repurchase under the Company’s Senior Credit Agreement.

10. Tax Matters

The Company adopted FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), at the beginning of fiscal year 2007. At June 30, 2008, the Company had approximately $8.7 million of total gross unrecognized tax benefits. Included in this balance are $5.5 million of unrecognized tax benefits that, if recognized, would reduce the Company’s annual effective tax rate. 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 operations. The Company accrued potential penalties and interest of $0.3 million related to these unrecognized tax benefits during the six months ended June 30, 2008, and in total, as of June 30, 2008, the Company has recorded a liability for potential penalties and interest of $0.9 million.

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 2003. Substantially all material foreign income tax audits have been concluded for years through 2002. The federal income tax return for 2005 and California income tax returns for 2003 and 2004 are currently under examination. At June 30, 2008, the Company had net deferred tax assets of $47.9 million.

During the quarter ended March 31, 2008, the Company received a favorable ruling regarding unrecognized state income tax benefits, resulting in the reduction of the gross uncertain tax liability of $4.2 million. This favorable ruling resulted in approximately $2.7 million of net tax benefit being recognized in the consolidated statement of operations in the six months ended June 30, 2008 with the remaining $1.5 million being recorded as a reduction to the related deferred tax asset. In addition, due to the potential resolution of federal, state and foreign tax examinations, and the expiration of various statutes of limitations, it is reasonably possible that the Company’s gross unrecognized tax benefits balance may change within the next twelve months by a range of zero to $0.8 million.

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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.

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;

· plans, strategies and objectives of management for future operations;

· risks associated with integrating acquired businesses and launching new product offerings;

· 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.

Overview

Since we commenced operations in 1994 as a reseller of computer security products, Websense has evolved into a leading provider of content security software solutions, including Web security, email and messaging security and data loss prevention (“DLP”) solutions. In today’s Web/enterprise hybrid computing environment, customers must deploy integrated Web, email and data security products to achieve effective protection against blended Web and email attacks, as well as from inadvertent data leaks due to faulty business processes. To expand our product offering to meet the changing demands of the security software industry, in January 2007, we entered the emerging market for DLP through our acquisition of PortAuthority Technologies, Inc. (“PortAuthority”), our technology development partner for DLP solutions. Additionally, in October 2007, we acquired SurfControl plc (“SurfControl”), a leading provider of Web and email security software solutions, which expanded our product portfolio to include email security software and hosted Web and email security solutions.

Today, we offer comprehensive Web, email and data security products, available as layered software or on-demand solutions. We have focused on integrating the intelligence from each of these product areas to protect organizations’ employees and critical business data from external Web-based and email-based attacks, and from internal employee-generated threats such as an employee error and malfeasance. Our customers use our software products to provide a secure and productive computing environment for employees, business partners and customers. Our products allow organizations to:

· prevent access to undesirable and dangerous elements on the Web, such as Web sites that contain inappropriate content or sites that download an ever-increasing variety of malicious code;

· filter unwanted emails or “spam” out of incoming email traffic;

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· filter viruses and other malicious attachments from email and instant messages;

· manage the use of non-Web Internet traffic, such as peer-to-peer communications and instant messaging;

· restrict the unauthorized use and loss of sensitive data, such as customer or employee information; and

· control misuse of an organization’s valuable computing resources, including unauthorized downloading of high-bandwidth content.

Collectively, our software products secure an organization’s confidential data and increase the productivity of its employees so they can safely conduct business electronically with partners and over the Internet. Fundamental to our products are:

· proactive discovery of Web and internal content, which is classified into highly granular database categories;

· proactive discovery and identification of Web-based threats, including spyware, hacking tools, keyloggers, phishing and pharming exploits;

· dynamic classification of uncategorized, high-risk Web content, including user-generated Web 2.0 content, based on our knowledge of the Web, email attack vectors, and malicious code characteristics; and

· policy software that automates enforcement of pre-defined business policies regarding acceptable users and uses of various Web and internal content categories.

During the six months ended June 30, 2008, we derived approximately 41% of our revenue from international sales, compared with approximately 39% for the six months ended June 30, 2007, with the United Kingdom comprising approximately 11% and 10% of our total revenue for the six months ended June 30, 2008 and 2007, respectively. 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, Latin American and Australian markets.

We sell our products primarily through two tier distribution channels. On occasion, we do sell products directly to value-added resellers or to customers, but sales through indirect channels currently account for more than 90% of our revenue.

As described elsewhere in this report, we recognize revenue from subscriptions to our products, including add-on modules, on a daily straight-line basis over the term of the subscription agreement, commencing on the first day of the subscription term. We recognize the operating expenses related to these sales as they are incurred. These operating expenses include sales commissions, which are based on the total amount of the subscription contract and are fully expensed in the period the subscription term begins. Operating expenses have continued to increase as compared with prior periods due to expanded selling and marketing efforts, continued product research and development and investments in administrative infrastructure to support subscription sales that we will recognize as revenue in subsequent periods.

In October 2007, we completed our acquisition of SurfControl and as a result we have incurred operating losses under U.S. generally accepted accounting principles (“GAAP”) since the acquisition closed. Similar to Websense, SurfControl sold products primarily under subscriptions whereby revenues were initially recorded as deferred revenue and recognized ratably over the term of the agreement. Under GAAP purchase accounting, we wrote off $97.4 million of the deferred revenue of SurfControl, leaving a balance of $19.7 million as the fair value of the obligation. This adjustment reflects the fair value of the post-contract technical support services that will be recognized daily in accordance with our revenue recognition policy. We do not expect to generate significant revenue from the installed SurfControl customer base until existing subscriptions are up for renewal. In connection with the acquisition, we have incurred restructuring costs primarily in connection with reducing SurfControl headcount and eliminating redundant facilities. We also immediately started to incur the expenses of managing the SurfControl operations as well as recording the amortization of the acquired intangibles. As a result, we expect to continue to operate at a loss under GAAP until we generate sufficient revenue from the subsequent renewal of subscriptions of the installed SurfControl customer base to offset these expenses. Given the average remaining term of the SurfControl subscriptions, we currently do not expect to operate at a profit under GAAP in fiscal year 2008. Our ability to retain SurfControl customers and maintain our overall pricing levels for our products will impact our results of operations and the timing of our return to profitability.

We allocate the total costs for human resources, employee benefits, payroll taxes, information technology, facilities and fixed asset depreciation to each of our functional areas based on headcount data. Our overall costs to be allocated have

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increased as a result of the growth in our headcount, increased personnel costs and the growth of our facilities costs and we expect this trend to continue.

In connection with the acquisition of SurfControl, we approved plans to restructure the operations of the acquired company by terminating 320 of SurfControl’s employees and exiting certain SurfControl facilities. As of June 30, 2008, of the 320 employees that we identified as being subject to the involuntary termination, 319 have been terminated and the one remaining employee is expected to be terminated by September 2008. These workforce reductions are across all functions and geographies and affected employees were, or will be, provided cash severance packages. Additionally, we have consolidated facilities and have exited, or will be exiting, leases in certain locations as well as reducing the square footage required to operate some locations. We will finalize our facility exit plans by September 2008. We have accrued the estimated costs associated with the employee severance and facility exit obligations as liabilities assumed in the acquisition of SurfControl and, accordingly, included the costs as part of the purchase price of SurfControl. Changes to the estimates of these costs after September 2008 will be recorded either as a reduction to goodwill or as an expense to the results of operations.

Critical Accounting Policies and Estimates

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 product subscription and provided throughout the subscription term. We recognize revenue on a daily straight-line basis commencing on the date the term of the subscription begins, and continuing over the term of the subscription agreement, provided the fee is fixed or determinable, persuasive evidence of an arrangement exists and collectability 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. We record amounts billed to customers in excess of recognizable revenue as deferred revenue on our balance sheet.

We record distributor marketing payments and channel rebates as an offset to revenue. We recognize distributor 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.

Acquisitions, Goodwill and Other Intangible Assets. We account for acquired businesses using the purchase method of accounting in accordance with SFAS No. 141, Business Combinations (“SFAS 141”), which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of net assets acquired is recorded as goodwill. The fair value of intangible assets, including acquired technology and customer relationships, is based on significant judgments made by management and accordingly we obtain the assistance from third party valuation specialists. The valuations and useful life assumptions are based on information available near the acquisition date and are based on expectations and assumptions that are considered reasonable by management. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed, as well as asset lives, can materially impact our results of operations.

In accordance with SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS 142”), 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. We amortize the cost of identified intangible assets using amortization methods that reflect the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up. In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS 144”), 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 external or internal, 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 144, which is generally based on the estimated future cash flows. Our analysis is based on available information and on assumptions and projections that we consider to be reasonable and supportable. 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.

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Results of Operations

Three months ended June 30, 2008 compared with the three months ended June 30, 2007

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

	Three Months Ended
	June 30, 2008		June 30, 2007
	(Unaudited)

Revenue	100	%	100	%

Cost of revenues:
Cost of revenues	12		10
Amortization of acquired technology	4		1
Total cost of revenues	16		11

Gross margin	84		89

Operating expenses:
Selling and marketing	61		50
Research and development	18		20
General and administrative	16		13
Total operating expenses	95		83

(Loss) income from operations	(11	)	6

Interest expense	(4	)	—
Other income, net	2		3

(Loss) income before income taxes	(13	)	9

(Benefit) provision for income taxes	(2	)	5

Net (loss) income	(11	)%	4	%

Revenue

Revenue increased to $73.0 million in the second quarter of 2008 from $50.4 million in the second quarter of 2007. The increase was a result primarily of the addition of new, renewed and upgraded subscriptions (including $16.0 million from new or renewed SurfControl seat subscriptions and $3.0 million of revenue recognized from the deferred revenue acquired from SurfControl in October 2007). For the remainder of 2008, we expect our revenue to increase over 2007 due to the addition of our acquired SurfControl business, our deferred revenue under existing subscriptions, our renewal business, planned growth in sales, partially offset by increased channel marketing payments and channel rebates, which are recorded as reductions to revenue. Until sufficient existing subscriptions for the installed SurfControl customer base are subsequently renewed, revenue contributed by the SurfControl products will be minimal as compared to SurfControl’s historic stand-alone revenue as we wrote down SurfControl’s deferred revenue by $97.4 million to its estimated fair value of $19.7 million at the date of acquisition as required under GAAP.

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 and costs associated with providing our hosted security services. Cost of revenues increased to $8.6 million in the second quarter of 2008 from $4.8 million in the second quarter of 2007. The increase of $3.8 million was primarily due to additional personnel in our technical support and database groups, including the increased headcount attributable to the acquisition of SurfControl, the addition of hosted services and allocated costs. Our headcount in cost of revenue departments increased from 163 employees at June 30, 2007 to 217 employees at

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June 30, 2008. We allocate the costs for human resources, employee benefits, payroll taxes, information technology, facilities and fixed asset depreciation to each of our functional areas based on headcount data. As a percentage of revenue, cost of revenues increased to 12% from 10% during the second quarter of 2008 compared to 2007. We expect cost of revenue to remain higher in absolute dollars for the remainder of 2008 as compared to 2007 in order to support the growth and maintenance of our databases and due to costs associated with providing our hosted security services as well as the technical support needs of our customers.

Amortization of acquired technology. Amortization of acquired technology primarily relates to the developed technology acquired from the PortAuthority acquisition in January 2007 and SurfControl acquisition in October 2007. The increase of $2.5 million in amortization of acquired technology from the second quarter of 2007 to the second quarter of 2008 was primarily due to the acquisition of SurfControl in October 2007. The acquired technology is being amortized over a weighted average period of 2.9 years. We expect to incur $6.2 million in amortization expense of acquired technology during the remainder of 2008.

Gross Margin

Gross margin increased to $61.3 million in the second quarter of 2008 from $45.0 million in the second quarter of 2007. As a percentage of revenue, gross margin decreased to 84% in the second quarter of 2008 from 89% in the second quarter of 2007 due to the increased costs described in the preceding Cost of Revenues section. We expect that gross margin as a percentage of revenue will remain in excess of 80% of revenue for the remainder of 2008.

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, amortization of acquired customer relationships 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 $44.3 million, or 61% of revenue, in the second quarter of 2008, from $25.1 million, or 50% of revenue, in the second quarter of 2007. Approximately $9.3 million of the increase was due to the amortization of acquired intangibles (customer relationships) which resulted from the acquisition of SurfControl in October 2007. The acquired customer relationships intangible assets are being amortized over a weighted average period of approximately 6.1 years. In addition to the amortization of acquired intangible assets, the increase in selling and marketing expenses was primarily due to increased personnel costs and related travel, including new personnel added from the SurfControl acquisition in October 2007 and allocated costs. Our headcount in sales and marketing increased from 380 employees at June 30, 2007 to 519 employees at June 30, 2008. We expect selling and marketing expenses to increase in absolute dollars for the remainder of 2008 as compared to 2007 due to having a full year of amortization of acquired intangibles, having a full year of additional sales and marketing personnel to support our expanding selling and marketing efforts worldwide, and increased sales resulting in higher overall sales commission expenses. We expect amortization of acquired intangibles of $18.7 million for the remainder of 2008 as a result of the amortization of acquired intangibles from the SurfControl and PortAuthority acquisitions.

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 $13.2 million, or 18% of revenue, in the second quarter of 2008 from $10.3 million, or 20% of revenue, in the second quarter of 2007. The increase of $2.9 million in research and development expenses was primarily due to increased personnel cost, including adding new full time employees due to the SurfControl acquisition in October 2007, and increased hiring to support our managed release of our Web content gateway, data loss prevention endpoint module and enhancements to our other products as well as to support our expanding list of technology partners and allocated costs. Our headcount increased in research and development from 193 employees at June 30, 2007 to 351 employees at June 30, 2008. We expect future research and development expenses to increase in absolute dollars for the remainder of 2008 as compared to 2007 due to having a full year of additional engineering personnel and an expanded base of product offerings. We are managing the increase in our absolute research and development expense by operating research and development facilities in multiple international locations, including Beijing, China, that have lower costs than our operations in the United States.

General and administrative. General and administrative expenses consist primarily of salaries, benefits and related expenses for our executive, finance and administrative personnel, third party professional service fees and allocated costs. General and administrative expenses increased to $11.8 million, or 16% of revenue, in the second quarter of 2008 from $6.6 million, or 13% of revenue, in the second quarter of 2007. The $5.2 million increase in general and administrative expense was primarily due to additional personnel needed to support our growing operations, including the acquisition of SurfControl

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in October 2007 and allocated costs. Our headcount increased in general and administrative departments from 66 employees at June 30, 2007 to 112 employees at June 30, 2008. We expect general and administrative expenses to increase in absolute dollars for the remainder of 2008 as compared to 2007 due to having a full year of additional personnel due to the SurfControl acquisition and to support growth in operations and expansion of our international operations.

Interest Expense

Interest expense represents the interest incurred on our senior secured term loan that we utilized to pay for a portion of the SurfControl purchase price in October 2007. Also included in the interest expense is $325,000 of amortization of deferred financing fees that were capitalized as part of the senior secured credit facility. Interest expense will increase for the remainder of 2008 as compared to 2007 due to having the senior secured term loan outstanding for the full year of 2008. The amount of interest expense will fluctuate due to changes in the outstanding principal balance and due to changes in LIBOR and changes in our applicable spread to LIBOR based upon improvements in our leverage ratio in accordance with our senior secured credit facility agreement. Interest expense should decline in the remaining quarters of fiscal 2008 as compared to the second quarter of 2008 due to the lower outstanding principal amount and lower marginal interest rate.

Other Income, Net

Other income, net decreased to $1.1 million in the second quarter of 2008 from $1.5 million in the second quarter of 2007. The decrease was due primarily to reduced interest income of approximately $1.0 million in the second quarter of 2008 compared to the second quarter of 2007 as a result of our use of approximately $245 million in cash, cash equivalents and marketable securities to fund the acquisition of SurfControl in October 2007, offset by foreign exchange re-measurement gains of approximately $691,000 due to favorable movements in the foreign exchange rates during the second quarter of 2008 compared to the second quarter of 2007. Due to the reduced cash, cash equivalents and marketable securities as a result of the acquisition of SurfControl as well as the prepayments on our senior secured term loan and stock repurchases, we expect other income, net to decrease in absolute dollars during the remainder of 2008 as compared to 2007.

Provision for Income Taxes

We recognized an income tax benefit of $1.7 million and an income tax expense of $2.3 million for the three months ended June 30, 2008 and 2007, respectively. Our effective tax rates were a tax benefit of 17.3% and a tax provision of 52.3% for the three months ended June 30, 2008 and June 30, 2007, respectively.

Our effective tax rate decreased from the second quarter of 2007 to the second quarter of 2008 primarily due to significant book losses in foreign jurisdictions with lower statutory rates, an increase in foreign withholding taxes and the impact that non-deductible items, primarily share-based compensation had on the amount of tax benefit recorded on our losses from operations. In addition, the Company’s effective tax rate in the second quarter of 2007 was impacted by the unrealized loss on a foreign currency option contract purchased in connection with the SurfControl acquisition and tax exempt interest income that did not recur in 2008.

Our effective tax rate may change in future periods due to the composition of taxable income between domestic and international operations along with the potential changes or interpretations in tax rules and legislation, or corresponding accounting rules.

In accordance with the provisions of SFAS 109, we assess, on a quarterly basis, the realizability of our deferred income tax assets. Realization of deferred income tax assets is dependent upon taxable income in prior carryback years, estimates of future taxable income, tax planning strategies and reversals of existing taxable temporary differences. Based on our assessment of these items during the second quarter of 2008, it is more likely than not that we will be able to fully utilize our deferred tax assets.

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Six months ended June 30, 2008 compared with the six months ended June 30, 2007

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

	Six Months Ended
	June 30, 2008		June 30, 2007
	(Unaudited)

Revenue	100	%	100	%

Cost of revenues:
Cost of revenues	13		9
Amortization of acquired technology	4		1
Total cost of revenues	17		10

Gross margin	83		90

Operating expenses:
Selling and marketing	62		50
Research and development	19		18
General and administrative	18		14
Total operating expenses	99		82

(Loss) income from operations	(16	)	8

Interest expense	(5	)	—
Other income, net	1		3

(Loss) income before income taxes	(20	)	11

(Benefit) provision for income taxes	(10	)	5

Net (loss) income	(10	)%	6	%

Revenue

Revenue increased to $139.9 million in the first six months of 2008 from $100.2 million in the first six months of 2007. The increase was a result primarily of the addition of new, renewed and upgraded subscriptions (including $26.0 million from new or renewed SurfControl seat subscriptions and $7.0 million of revenue recognized from the deferred revenue acquired from SurfControl in October 2007).

Cost of Revenues

Cost of revenues. Cost of revenues increased to $17.5 million in the first six months of 2008 from $8.8 million in the first six months of 2007. The increase of $8.7 million was primarily due to additional personnel in our technical support and database groups, including the increased headcount attributable to the acquisition of SurfControl, and the addition of DLP products, hosted services and allocated costs. Our headcount in cost of revenue departments increased from 163 employees at June 30, 2007 to 217 employees at June 30, 2008.

Gross Margin

Gross margin increased to $116.3 million in the first six months of 2008 from $90.1 million in the first six months of 2007. As a percentage of revenue, gross margin decreased to 83% in the first six months of 2008 from 90% in the first six

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months of 2007 due to the increased costs described in the preceding Cost of Revenues section.

Operating Expenses

Selling and marketing. Selling and marketing expenses increased to $87.2 million, or 62% of revenue, in the first six months of 2008, from $50.0 million, or 50% of revenue, in the first six months of 2007. Approximately $18.6 million of the increase was due to the amortization of acquired intangibles (customer relationships) which resulted from the acquisition of SurfControl in October 2007. In addition to the amortization of acquired intangible assets, the increase in selling and marketing expenses was primarily due to increased personnel costs and related travel, including new personnel added from the SurfControl acquisition in October 2007 and allocated costs. Our headcount in sales and marketing increased from 380 employees at June 30, 2007 to 519 employees at June 30, 2008.

Research and development. Research and development expenses increased to $26.7 million, or 19% of revenue, in the first six months of 2008 from $18.7 million, or 18% of revenue, in the first six months of 2007. The increase of $8.0 million in research and development expenses was primarily due to increased personnel cost, including adding new full time employees due to the SurfControl acquisition in October 2007, and increased hiring for our managed release of our Web content gateway, data loss prevention endpoint module and developing enhancements to our other products, as well as to support our expanding list of technology partners and allocated costs. Included in research and development for the first six months of June 30, 2007 was $1.3 million of in-process research and development related to our PortAuthority acquisition in January 2007. Our headcount increased in research and development from 193 employees at June 30, 2007 to 351 employees at June 30, 2008.

General and administrative. General and administrative expenses increased to $24.7 million, or 18% of revenue, in the first six months of 2008 from $13.8 million, or 14% of revenue, in the first six months of 2007. The $10.9 million increase in general and administrative expense was primarily due to additional personnel needed to support our growing operations, including the acquisition of SurfControl in October 2007 and allocated costs. Our headcount increased in general and administrative departments from 66 employees at June 30, 2007 to 112 employees at June 30, 2008.

Interest Expense

Other Income, Net

Other income, net decreased to $1.0 million in the first six months of 2008 from $3.9 million in the first six months of 2007. The decrease was due primarily to reduced interest income of approximately $2.9 million in the first six months of 2008 compared to the first six months of 2007 as a result of our use of approximately $245 million in cash, cash equivalents and marketable securities to fund the acquisition of SurfControl in October 2007.

Provision for Income Taxes

We recognized an income tax benefit of $14.1 million and an income tax expense of $5.5 million for the six months ended June 30, 2008 and 2007, respectively. Our effective tax rates were a tax benefit of 49.4% and a tax provision of 47.9% for the six months ended June 30, 2008 and June 30, 2007, respectively. The significant changes in our effective tax rate reflect the favorable impact of a ruling regarding unrecognized state income taxes and the release of a valuation allowance plus the unfavorable impact of less tax exempt interest income and a higher effective state income tax rate.

In accordance with the provisions of SFAS 109, we assess, on a quarterly basis, the realizability of our deferred income tax assets. A valuation allowance must be established when, based upon the evaluation of all available evidence, it is more likely than not that all or a portion of the deferred income tax asset will not be realized. During fiscal year 2007, a $4.7 million valuation allowance was recorded against the deferred tax assets of SurfControl at acquisition and an additional $4.3 million was recorded related to the increase of deferred tax assets arising from the operations of SurfControl reflected in our fiscal year 2007 consolidated statement of operations. Realization of deferred income tax assets is dependent upon taxable income in prior carryback years, estimates of future taxable income, tax planning strategies and reversals of existing taxable temporary differences. Based on our assessment of these items during the first six months of 2008, it is more likely than not that we will be able to fully utilize our deferred tax assets. Accordingly, we released the valuation allowance and recorded a

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credit to goodwill of $4.7 million and a credit to income tax provision of approximately $4.3 million.

Liquidity and Capital Resources

As of June 30, 2008, we had cash and cash equivalents of $65.1 million and retained earnings of $53.4 million. During the first six months of 2008, we used our cash, cash equivalents and marketable securities primarily to pay down $35 million on our senior secured term loan as optional prepayments and approximately $10.0 million for stock repurchases.

Net cash provided by operating activities was $23.9 million in the first six months of 2008 compared with $23.8 million in the first six months of 2007. The minimal change in cash provided by operating activities was primarily due to the net loss with higher non-cash items recorded in the first six months of 2008 offset by the net increase in the change in operating assets and liabilities compared to the first six months of 2007. The first six months of 2008 cash flows from operations was negatively impacted by cash payments for restructuring related items as well as payment for a class-action litigation that was settled in the first quarter of 2008. Our operating cash flow is significantly influenced by new and renewed subscriptions, accounts receivable collections and changes in 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 provided by investing activities was $16.3 million in the first six months of 2008 compared with net cash used in investing activities of $78.6 million in the first six months of 2007. The $94.9 million increase of net cash provided by investing activities was primarily due to cash used of $82.0 million to purchase PortAuthority in January 2007, a $4.6 million payment for a currency option contract in connection with the SurfControl acquisition in the first six months of 2007 and an $8.5 million net increase in maturities over purchases of marketable securities during the first six months of 2008 compared to the first six months of 2007.

Net cash used in financing activities was $42.1 million in the first six months of 2008 compared with $1.1 million provided by financing activities in the first six months of 2007. The $43.2 million increase of net cash used in financing activities was primarily due to optional principal prepayments of $35.0 million on our senior secured term loan and share repurchases of $10.0 million in the first six months of 2008 compared to none in the first six months of 2007, partially offset by the repayment of $4.2 million of the PortAuthority loan in the first six months of 2007.

In connection with the acquisition of SurfControl in October 2007, we entered into an amended and restated senior credit agreement (the “Senior Credit Agreement”). The $225 million senior secured credit facility consists of a five year $210 million senior secured term loan and a $15 million revolving credit facility. The senior secured term loan was fully funded on October 11, 2007, and the revolving line of credit remains unused. Through June 30, 2008, we have made optional prepayments totaling $55 million on our senior secured term loan, reducing the outstanding balance to $155 million. The senior secured 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 senior secured term loan initially amortized at a minimum rate of 2.5%, 10%, 12.5%, and 15%, respectively, during the first four years of the term and 60% during the fifth year. In conjunction with our optional $20 million prepayment on December 31, 2007, we amended our Senior Credit Agreement to eliminate any additional mandatory payments until September 30, 2009. The senior secured term loan bears interest at a spread above LIBOR with the spread determined based upon our total leverage ratio. During the second quarter 2008, the annual interest rate was LIBOR plus 250 basis points (5.28% at June 30, 2008), and was subject to a potential step down in the spread over LIBOR based upon potential future improvements in our total leverage ratio. The unused portion of the revolving credit facility required a 50 basis points fee per annum, also subject to a step down based upon potential future improvements in our total leverage ratio. Based on the total leverage ratio as of June 30, 2008, the spread on both the senior secured term loan and revolving credit facility will be reduced for the third quarter of 2008 to LIBOR plus 225 basis points (5.03% as of June 30, 2008) per annum for the senior secured term loan and 25 basis points per annum for the unused portion of the revolving credit facility. 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.

The Senior Credit Agreement provides that we must maintain hedge agreements so that at least 50% of the aggregate principal amount of the senior secured credit facility is subject to fixed interest rate protection for a period of not less than 2.5 years. On October 11, 2007 in conjunction with the funding of the senior secured term loan, we entered into an interest rate swap agreement to pay a fixed rate of interest (4.85% per annum) and receive a floating rate interest payment (based on three month LIBOR) on an equivalent amount. The initial notional amount of the swap agreement was $105 million on October 11, 2007 and it amortizes each quarter down to $11 million on June 30, 2010. In addition, on October 11, 2007 we entered into an interest rate cap agreement to limit the maximum interest rate on a portion of our senior secured term loan to 6.5% per

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annum. The amount of principal protected by this agreement increases from $5 million at December 31, 2007 to $74.3 million on June 30, 2010. Both the interest rate swap and cap expire on September 30, 2010.

As of June 30, 2008 and 2007, 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.

Obligations and commitments. The following table summarizes our contractual payment obligations and commitments as of June 30, 2008 (in thousands):

	Payment Obligation by Year
	2008		2009		2010		2011		2012		Thereafter		Total
Senior secured term loan	$	—	$	5,099	$	21,414	$	25,697	$	102,790	$	—	$	155,000
Estimated interest and fees on senior secured term loan	4,943		9,235		7,627		6,167		3,378		—		31,350
Operating leases	3,308		4,398		3,997		3,379		3,188		4,537		22,807
Facility exit obligations	1,008		2,017		2,106		1,814		1,106		960		9,011
Severance obligations	498		—		—		—		—		—		498
Software licenses	292		585		97		—		—		—		974
Total	$	10,049	$	21,334	$	35,241	$	37,057	$	110,462	$	5,497	$	219,640

Obligations under our Senior Credit Agreement represent the future minimum principal debt payments due under the senior secured term loan. Estimated interest and fees represent interest and fees expected to be incurred on the senior secured term loan based on known rates as of June 30, 2008 (see Note 6 to the financial statements).

We lease our facilities under operating lease agreements that expire at various dates through 2015. Approximately one-half 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 2008 to 2013.

Facility exit obligations represent estimated future lease and operating costs from facilities acquired from SurfControl that are being exited. These costs will be paid over the respective lease terms through 2013. These amounts are included in our consolidated balance sheet.

Severance obligations represent the estimated future severance payments in connection with the SurfControl employees who were or will be terminated.

Software license obligations represent purchase commitments for software licenses made in the ordinary course of business.

In addition, due to the uncertainty with respect to the timing of future cash flows associated with our unrecognized tax benefits at June 30, 2008, we are unable to make reasonably reliable estimates of the period of cash settlement with the respective taxing authorities. Therefore, $8.7 million of unrecognized tax benefits have been excluded from the contractual payment obligations table above.

In 2003, we announced that our Board of Directors authorized a stock repurchase program of up to 4 million shares of our common stock. In 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 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. In January 2008, we adopted a 10b5-1 plan that provides for quarterly purchases of up to $5 million in stock in open market 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. During the six months ended June 30, 2008, we repurchased 537,904 shares of our common stock for an aggregate of approximately $10.0 million at an average price of $18.57 per share. As of June 30, 2008, we have repurchased a total of 8,707,964 shares of our common stock under this program, for an aggregate of $180.4 million at an average price of $20.72 per share. Under the terms of the Senior Credit Agreement, we are restricted from repurchasing our common stock for an aggregate purchase price that

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exceeds the sum of $25 million plus 50% of the aggregate amount of our consolidated net income, as defined in our Senior Credit Agreement, during the period from the effective date of the facility through the most recent quarter end for which we have filed quarterly financial statements. As of June 30, 2008, we can repurchase up to $33.4 million of our common stock under our Senior Credit Agreement. We intend to repurchase shares during the remainder of 2008.

We believe that our cash and cash equivalents balances, revolving credit balances and our ongoing cash flow from operations will be sufficient to satisfy our cash requirements, including our capital expenditures, debt repayment obligations and stock repurchases, if any, for at least the next 12 months. During the first six months of 2008, we made voluntary prepayments on our senior secured term loan of $35 million and repurchased approximately $10 million of our common stock. 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 or to reduce our cost of capital through capital markets transactions or debt or private equity transactions as appropriate. We intend to continue to invest our cash in excess of current op erating and capital requirements in interest-bearing, investment-grade securities.

Off-Balance Sheet Arrangements

As of June 30, 2008, 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 senior secured term loan. We invest our excess cash in highly liquid short-term investments such as municipal bonds, government agency bonds 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 the interest expense incurred on our senior secured term loan and therefore impact our cash flows and results of operations.

We are exposed to changes in interest rates primarily from our short-term available-for-sale investments and from our borrowings under our variable rate senior secured term loan used in connection with the acquisition of SurfControl in October 2007. Our Senior Credit Agreement provides that we must maintain hedge agreements so that at least 50% of the aggregate principal amount of the senior secured term loan is subject to fixed interest rate protection for a period of not less than 2.5 years from the date of the initial funding of the loan.

A hypothetical 100 basis point adverse move in interest rates along the entire interest rate yield curve would materially affect our interest expense. Based on our outstanding senior secured term loan balance at June 30, 2008 and taking into consideration our interest rate swap and cap, our interest expense would increase by approximately $613,000 during the next 12 months if there were a 100 basis point adverse move in the interest rate yield curve.

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 investments at June 30, 2008. Changes in interest rates over time will, however, affect our interest income.

We utilize foreign currency forward contracts to hedge foreign currency market exposures of underlying assets and liabilities. We bill certain international customers in Euros, British Pounds, Australian Dollars, Chinese Yuan Renminbi and Japanese Yen. We also keep working funds necessary to facilitate the short-term operations of our subsidiaries 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.

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Notional and fair values of our Euro and British Pound hedging positions at June 30, 2008 and 2007 are presented in the table below (in thousands):

	June 30, 2008						June 30, 2007
	Notional Value Local Currency		Notional Value USD		Fair Value USD		Notional Value Local Currency		Notional Value USD		Fair Value USD
Euro	€	2,850	$	4,325	$	4,171	€	2,000	$	2,660	$	2,610
British Pound	£	—	—		—		£	950	1,886		1,900
Total			$	4,325	$	4,171			$	4,546	$	4,510

The approximate $1.7 million notional increase in our Euro hedged position at June 30, 2008 compared to June 30, 2007 is primarily due to the increase in Euro billings in 2008 compared to 2007. For the six months ended June 30, 2008, 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 2008.

The approximate $1.9 million notional decrease in our British Pound hedged position at June 30, 2008 compared to June 30, 2007 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 June 30, 2008 no British Pound contracts were outstanding. We do not expect to hedge the British Pound as we continue billing in the British Pound, as the billings create a natural hedge against our British Pound expenses.

Given our foreign exchange position at June 30, 2008, a 10% change in foreign exchange rates upon which these foreign exchange contracts are based would result in exchange gains and losses. In all material aspects, these exchange gains and losses would be fully offset by exchange gains and losses on the underlying net monetary exposures for which the contracts are designated as hedges. We do not expect material exchange rate gains and losses from un-hedged foreign currency exposures.

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.

Part II - Other Information

Item 1. Legal Proceedings

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 position, 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.

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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 May 9, 2008.

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 small and medium sized business (“SMB”) segment and maintain our subscription base in the large enterprise market through subscription renewals. We sell a product specifically targeted at the SMB segment, Websense Express, though we cannot assure that this product will ultimately increase sales to the SMB segment. We 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. In addition, we sell Websense Hosted Security Services to SMB customers. This is a new service offering for Websense in a relatively new market segment. 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 market segment. If Websense Express and the Websense Hosted Security Services do 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 and growth will be negatively affected.

Our revenue is derived almost entirely from sales through indirect channels and we depend upon these channels to create demand for our products.*

Our revenue has been 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. Although we rely upon these indirect channels of distribution, we also depend upon our internal sales force to generate sales leads and sell products through the reseller network. Ingram Micro, one or our broad-line distributors in North America, accounted for approximately 22% of our revenue during the six months ended June 30, 2008. Should Ingram Micro experience financial difficulties or otherwise delay or prevent our collection of accounts receivable from them, our revenue and cash flow would be significantly adversely affected. Our indirect sales model involves a number of additional risks, including:

· our resellers and distributors, including Ingram Micro, 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 newer product offerings such as our security-oriented offerings, our data loss prevention (“DLP”) offerings or our hosted security services;

· 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.

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

In October 2007 we acquired SurfControl plc (“SurfControl”) and we expect to continue to incur restructuring and other related expenses that will negatively affect our results of operations under U.S. generally accepted accounting principles (“GAAP”). As a result of the SurfControl acquisition, Websense became an unprofitable operating business under GAAP after more than five years as a profitable operating business under GAAP. Given our subscription model, we expect to continue to operate at a loss under GAAP until we generate sufficient revenue from the subsequent renewal of subscriptions from the installed SurfControl customer base to offset the expenses we began to incur as of the close of the SurfControl acquisition to operate the SurfControl business. Although we expect to continue to compete effectively for subscription renewals from the SurfControl customers, we face substantial competition and we may not retain as high a percentage of the SurfControl customer base as we expect.

The size and scope of the acquisition of SurfControl also increase both the scope and consequence of ongoing integration risks that would be associated with any acquired business. 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 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 and core businesses;

· 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 from newly acquired products and/or cost savings needed to offset acquisition related 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 for restructuring and other related expenses;

· become subject to intellectual property or other litigation; and

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

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

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The covenants in our senior secured 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 in October 2007, we entered into an amended and restated senior secured credit facility to provide financing for a substantial portion of the acquisition purchase price. Our senior secured 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 secured credit facility could allow the lenders to declare all amounts outstanding with respect to the senior secured 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 secured credit facility. If the amounts outstanding under the senior secured 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 secured credit 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.

In October 2007, we borrowed $210 million under the senior credit agreement and $155 million remained outstanding as of June 30, 2008. As a result, we are incurring interest expense for the amounts we borrowed under the senior secured term loan, and our income from our cash, cash equivalents and marketable securities has declined as we used a significant portion of our cash and marketable securities to fund a portion of the acquisition cost. This debt and the limitations our senior secured credit facility impose on us could have important consequences, including:

· it may be difficult for us to satisfy our obligations under the senior secured 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 for the second quarter ended June 30, 2008 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 remainder of 2008 will continue to be derived from our Web filtering and Web security products. We expect sales of our DLP products, hosted security services and other products under development to comprise a relatively small portion of our overall sales in 2008. If our Web filtering and Web 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 DLP products and hosted 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. We now sell the Websense Data Protection Suite, our DLP offering for the data security market, Websense Hosted Web Security and

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Websense Hosted Email Security, our hosted security services, and Websense Email Security, our email filtering solution. During the second quarter of 2008, we commenced a managed release of our next generation Web content gateway and our new DLP endpoint module and we are continuing to develop and release products in accordance with our announced product roadmap. 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 DLP 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 and our growth.

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 returning to 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 results of operations 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/Vontu, McAfee, Cisco Systems, Juniper Networks, MessageLabs, Trend Micro, Google/Postini, ScanSafe, Blue Coat Systems, Secure Computing, Aladdin, 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 Blue Coat Systems, Cisco Systems, McAfee, WatchGuard, Secure Computing, Check Point Software, St. Bernard Software, Barracuda, Juniper Networks, Trend Micro, Mi5 Networks, SonicWALL, Sophos and 8e6 Technologies;

· companies offering data loss prevention solutions, such as Symantec/Vontu, Verdasys, Vericept, EMC/Tablus, Secure Computing, IBM, Reconnex, Trend Micro/Provilla, Proofpoint, Palisade Systems, Orchestria, Raytheon, McAfee, Intrusion, Fidelis, GTB Technologies, Workshare, Check Point Software and Code Green Networks;

· companies offering messaging security, such as McAfee, Symantec/Vontu, Google/Postini, Cisco/Ironport, Barracuda, Secure Computing, SonicWALL, Tumbleweed, MessageLabs, MX Logic, Microsoft, Proofpoint, Clearswift and Borderware;

· companies offering on-demand e-mail and Web security services, such as Google/Postini, MessageLabs, McAfee, Symantec/Vontu, MX Logic, Email Systems/Webroot, St. Bernard Software, Trend Micro and Scansafe;

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

· companies offering proxy-based solutions such as Microsoft, Blue Coat Systems, Cisco Systems and Juniper Networks.

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As we develop and market our products with an increasing security-oriented emphasis, we also face growing 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. 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 or acquired engineering operations in Reading, England; Beijing, China; Sydney, Australia and Ra’anana, Israel.

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 so if the dollar weakens, our consolidated operating expenses would increase. Should foreign currency exchange rates fluctuate, our results of operations 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.

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International sales represented 41% of our total revenue generated during the quarter ended June 30, 2008 compared with 39% of our total revenue during the quarter ended June 30, 2007. As a key component of our business strategy to generate new business sales, we intend to continue 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;

· 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.

Some of our international revenue is denominated in U.S. dollars. In these markets, 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 also currently bill certain international customers in U.S. dollars, Euros, British Pounds, Australian Dollars, Chinese Yuan Renminbi and Japanese Yen. 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, but our foreign exchange 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 DLP products and our hosted security services. 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 DLP 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 executable files 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.

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We rely upon a combination of automated filtering technology and human review to categorize URLs and executable files in our proprietary databases. Our customers may not agree with our determinations that particular URLs and executable files should be included or not included in specific categories of our databases. In addition, it is possible that 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 executable files according to our customers’ expectations could 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 executable files, 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, are deployed in a wide variety of network environments and manage content in a dramatically changing Web 2.0 world. 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 executable files 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 to 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 DLP 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 accrue for uncertain tax positions according to our accounting policies based on judgment and estimates including historical audit activity. We believe sufficient accruals have been recorded for these tax exposures. 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 patent, 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 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 eleven issued patents in the United States and seven 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 and can change over time. 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 URLs and executable files. 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 loss 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.

Substantially all of our revenue comes from the sale of subscriptions to our products, including our hosted services. 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 are reflected by declining revenues. In addition, under GAAP purchase accounting, $97.4 million of the deferred revenue of SurfControl on the date of acquisition was written off with respect to the subscriptions to SurfControl products that were delivered prior to our acquisition of SurfControl. Therefore, the revenue that will be recognized post acquisition will be associated only with the fair value of post-acquisition technical services under these remaining subscriptions. As a result, the company can achieve short-term increases in revenue under GAAP even if subscription renewals for SurfControl customers decline in comparison to pre-acquisition periods, since the company will be able to recognize all of the revenue associated with any renewing SurfControl customer subscriptions.

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, 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, quarterly results may vary.

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 margins. Our operating expenses have increased as a result of the acquisition of SurfControl. The cost synergies we expect to achieve through the acquisition will be phased in through our integration process. 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;

· timing of expenses associated with commissions paid on sales of subscriptions to our products; and

· amortization of acquired intangible assets associated with our PortAuthority and SurfControl acquisitions in 2007.

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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.

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

Compliance with laws, regulations and standards relating to corporate governance, accounting principles and public disclosure, including the Sarbanes-Oxley Act of 2002, regulations and NASDAQ Global Select Market rules, have caused us to incur higher compliance costs and we expect to continue to incur higher compliance costs as a result of our increased global reach and obligation to ensure compliance with these laws as well as local laws in the jurisdictions where we do business. These 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 (“Section 404”) and the related regulations regarding our required assessment of our internal control over financial reporting has required the commitment of significant financial and managerial resources and we expect to incur expenses in 2008 in connection with achieving Section 404 compliance with respect to the SurfControl operations we acquired. 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, results of operations 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 and results of operations. 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. In 2007, 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 secured 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, pay down our senior secured term loan and repurchase shares of our common stock, and therefore 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 secured credit facility.

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

(a) Not applicable.

(b) Not applicable.

Month	Number of Shares Purchased During Month	Average Price Paid Per Share		Cumulative Number of Shares Purchased as Part of Publicly Announced Plan	Maximum Number of Shares that May Be Purchased Under the Plan
January 2008	—	$	—	8,170,060	3,829,940
February 2008	23,300	$	19.57	8,193,360	3,806,640
March 2008	241,100	$	18.82	8,434,460	3,565,540
April 2008	47,100	$	19.30	8,481,560	3,518,440
May 2008	110,300	$	18.26	8,591,860	3,408,140
June 2008	116,104	$	17.84	8,707,964	3,292,036

Total	537,904	$	18.57	8,707,964	3,292,036

1. The purchases were made in open-market transactions.

2. On April 3, 2003, we announced that our Board of Directors authorized a stock repurchase program of up to 4 million shares of our common stock. On August 15, 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. On July 25, 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. In January 2008, we adopted a 10b5-1 plan that provides for quarterly purchases of up to $5 million in stock in open market transactions. The remaining shares authorized for repurchase under our stock repurchase program as of June 30, 2008 was 3,292,036 shares.

Item 3. Defaults upon Senior Securities

None.

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

The Annual Meeting of Stockholders was held on Wednesday, June 4, 2008. The following matters were voted upon at the meeting and were adopted as indicated:

1. The stockholders elected two directors to hold office for a term expiring upon the 2011 Annual Meeting of Stockholders.

	Number of Shares
Name of Directors Elected	For	Withheld

Mark S. St.Clare	24,046,068	18,264,603
Peter C. Waller	39,261,918	3,048,753

The following individuals are continuing directors with terms expiring upon the 2009 Annual Meeting of Stockholders: Bruce T. Coleman, Gene Hodges and John F. Schaefer.

The following individuals are continuing directors with terms expiring upon the 2010 Annual Meeting of Stockholders: John B. Carrington and Gary E. Sutton.

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

Large accelerated filer x			Accelerated filer o
Non-accelerated filer o	(Do not check if a smaller reporting company)		Smaller reporting company o

For		39,926,726
Against		2,377,871
Abstain		6,074

3.1(1)		Amended and Restated Certificate of Incorporation.
3.2(2)		Amended and Restated Bylaws.
4.1(3)		Specimen Stock Certificate of Websense, Inc.
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).

	WEBSENSE, INC.

Date: August 8, 2008		By:		/s/ GENE HODGES
				Gene Hodges
				Chief Executive Officer

Date: August 8, 2008			By:	/s/ DUDLEY MENDENHALL
				Dudley Mendenhall
				Chief Financial Officer

			Page
Part I. Financial Information

	Item 1.	Consolidated Financial Statements (Unaudited)
		Consolidated Balance Sheets as of June 30, 2008 and December 31, 2007	3
		Consolidated Statements of Operations for the three and six months ended June 30, 2008 and 2007	4
		Consolidated Statement of Stockholders’ Equity for the six months ended June 30, 2008	5
		Consolidated Statements of Cash Flows for the six months ended June 30, 2008 and 2007	6
		Notes to Consolidated Financial Statements	7
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	27
	Item 4.	Controls and Procedures	28

Part II. Other Information

	Item 1.	Legal Proceedings	28
	Item 1A.	Risk Factors	29
	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	41
	Item 6.	Exhibits	42

Signatures			43


Dated: August 8, 2008	By:	/s/ GENE HODGES
		Gene Hodges
		Chief Executive Officer

Results of Operations

Revenue

Cost of Revenues

Gross Margin

Operating Expenses

Other Income, Net

Provision for Income Taxes

Revenue

Cost of Revenues

Gross Margin

Operating Expenses

Other Income, Net

Provision for Income Taxes

Liquidity and Capital Resources

SIGNATURES