##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




---

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO
SECTIONS 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF
1934


|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                             
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the fiscal year ended December 31,
    2002                                             
|          
|or        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the Transition Period
    from          to                                              

Commission File Number 000-30093



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Websense, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                           |  |                                                     
|-------------------------------------------------------------------------- |  | ----------------------------------------------------
|Delaware(State or other jurisdiction of
    incorporation or organization) |  | 51-0380839(I.R.S.Employer Identification
    Number)

10240 Sorrento Valley Road

San Diego, California 92121


858-320-8000


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




---

Securities registered pursuant to
Section 12(b) of the Act: None

Securities registered pursuant to
Section 12(g) of the Act: Common Stock $0.01 par value
(Title of class)

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

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any
amendment to this
Form 10-K.    o

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12(b)-2):    Yes þ    No o

The aggregate market value of the voting stock
held by non-affiliates of the registrant, as of June 28,
2002 was approximately $540 million (based on the closing
price for shares of the registrants Common Stock as
reported by the Nasdaq National Market for that date). Shares of
Common Stock held by each officer, director and holder of 10% or
more of the outstanding Common Stock have been excluded in that
such persons may be deemed affiliates. Exclusion of shares held
by any person should not be construed to indicate that such
person possesses the power, direct or indirect, to direct or
cause the direction of management or policies of the Registrant,
or that such person is controlled by or under common control
with the Registrant.

The number of shares outstanding of the
registrants Common Stock, $.01 par value, as of
February 28, 2003 was 21,810,630.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be
delivered to stockholders in connection with the Annual Meeting
of Stockholders to be held June 11, 2003 are incorporated
by reference into Part III.

Certain exhibits filed with the Registrants
prior registration statements and forms 10-K are incorporated
herein by reference into Part IV of this Report.



---






---

TABLE OF CONTENTS



|                  |                                                                                                         |  |  |  |  |  |  | 
|----------------- | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|TABLE OF CONTENTS
|PART I           
|                  | Item 1. Business                                                                                       
|                  | Item 2. Properties                                                                                     
|                  | Item 3. Legal Proceedings                                                                              
|                  | Item 4. Submission of Matters to a Vote of Security Holders                                            
|PART II          
|                  | Item 5. Market for Registrants Common Equity and Related Stockholder Matters                          
|                  | Item 6. Selected Financial Data                                                                        
|                  | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations          
|                  | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                                    
|                  | Item 8. Financial Statements and Supplementary Data                                                    
|                  | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           
|PART III         
|                  | Item 10. Directors and Executive Officers of the Registrant                                            
|                  | Item 11. Executive Compensation                                                                        
|                  | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|                  | Item 13. Certain Relationships and Related Transactions                                                
|                  | Item 14. Control and Procedures                                                                        
|PART IV          
|                  | Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K                               
|SIGNATURES       
|CERTIFICATION    
|CERTIFICATION    
|EXHIBIT 21.1     
|EXHIBIT 23.1     
|EXHIBIT 99.1     



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##### Table of Contents



WEBSENSE, INC.

Form 10-K


For the Fiscal Year Ended December 31,
2002







TABLE OF CONTENTS


|               |  |                                                                                                        |    |      |    | 
|-------------- |  | ------------------------------------------------------------------------------------------------------ | -- | ---- | -- | 
|               |  |                                                                                                        |    | Page
|               |  |                                                                                                        |    |     
|PART I        
|Item 1.        |  | Business                                                                                               |    |      | 2  | 
|Item 2.        |  | Properties                                                                                             |    |      | 13 | 
|Item 3.        |  | Legal Proceedings                                                                                      |    |      | 13 | 
|Item 4.        |  | Submission of Matters to a Vote of Security
    Holders                                                |    |      | 13 | 
|PART II       
|Item 5.        |  | Market for Registrants Common Equity and
    Related Stockholder Matters                              |    |      | 14 | 
|Item 6.        |  | Selected Financial Data                                                                                |    |      | 14 | 
|Item 7.        |  | Managements Discussion and Analysis of
    Financial Condition and Results of Operations              |    |      | 15 | 
|Item 7A.       |  | Quantitative and Qualitative Disclosures About
    Market Risk                                         |    |      | 32 | 
|Item 8.        |  | Financial Statements and Supplementary Data                                                            |    |      | 33 | 
|Item 9.        |  | Changes in and Disagreements With Accountants on
    Accounting and Financial Disclosure               |    |      | 50 | 
|PART III      
|Item 10.       |  | Directors and Executive Officers of the Registrant                                                     |    |      | 50 | 
|Item 11.       |  | Executive Compensation                                                                                 |    |      | 50 | 
|Item 12.       |  | Security Ownership of Certain Beneficial Owners
    and Management
    and Related Stockholder Matters |    |      | 50 | 
|Item 13.       |  | Certain Relationships and Related Transactions                                                         |    |      | 51 | 
|Item 14.       |  | Controls and Procedures                                                                                |    |      | 51 | 
|PART IV       
|Item 15.       |  | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K                                   |    |      | 53 | 
|Signatures     |  |                                                                                                        | 55 |     
|Certifications |  |                                                                                                        | 56 |     

1



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PART I

Forward Looking Statements

From time to time we have made and may continue
to make forward looking statements within the
meaning of the federal securities laws. This report on
Form 10-K may contain forward-looking statements 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 expects,
anticipates, intends, plans,
believes, estimates, or other words
indicating future results. Such statements include but are not
limited to statements concerning the following:



| |   |                                                                
| | - | ---------------------------------------------------------------
| |  | anticipated trends in revenue;                                 
|
| |  | growth opportunities in domestic and
    international markets;
|
| |  | customer acceptance and satisfaction with our
    products;    
|
| |  | expected trends in operating expenses; and                     
|
| |  | anticipated cash and intentions regarding usage
    of cash.   

Actual results may differ materially from results
anticipated in such forward-looking statements. We assume no
obligation to update any forward-looking statements to reflect
events or circumstances arising after the date of this report.

You should carefully review and consider the
various disclosures in this report regarding factors that could
cause actual results to differ materially from anticipated
results, including those factors under the caption Risks
and Uncertainties under Item 7 below, and elsewhere
in this report.




Item 1.     Business

Overview

We provide employee Internet management
(EIM) products that enable businesses to analyze, report
and manage how their employees use computing resources at work,
including Internet access. Our primary product, Websense
Enterprise®, gives businesses the ability to rapidly
implement and configure Internet access policies in support of
their efforts to improve employee productivity, conserve network
bandwidth, mitigate potential legal liability, and enhance
network security. Websense Enterprise also serves as a platform
for related new and anticipated future Websense offerings, such
as Client Application Manager and Bandwidth
Optimizer.

Our flexible and easy-to-use software
applications operate in conjunction with our proprietary
Websense Master Database and Premium Group Databases, which are
available for daily incremental downloads. These databases are
organized into more than 80 categories and encompass more than
four million Web sites as of December 31, 2002,
representing more than one billion Web pages. Our Website
databases are updated with approximately 5,000 newly categorized
Web sites each business day using a proprietary process of
automated site content assessment and classification with manual
verification.

Websense Enterprise is easy to deploy and use,
and requires minimal support by an organizations
information technology department. Our products are integrated
with a wide range of network access platforms, including
market-leading firewalls, caching appliances, proxy-servers,
switches, routers and other network appliances, and can grow
with our customers needs across multi-location
corporations, regional and international offices. We currently
operate in one industry segment, as defined by generally
accepted accounting principles.

Our business was incorporated in 1994 as
NetPartners Internet Solutions, as a reseller of computer
network security products. In 1996, we released Websense
Internet Screening System, our first product as a software
developer. In 1999, we released Websense Enterprise Version 4, a
redesigned version of our software, and changed our name to
Websense, Inc. to reflect the shift in our business focus from a
value-added reseller

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of network security products to a developer of
EIM software solutions. The newest generation of our EIM
software, Websense Enterprise Version 5, was released in March
2003. Our principal offices are located at 10240 Sorrento Valley
Road, San Diego, CA 92121.


Industry Background

As a highly flexible network capable of carrying
almost any type of digital traffic, the Internet continues to
evolve as a critical business tool and an important
communications and commerce platform for enterprises worldwide.
As part of their overall business strategies, many organizations
are using the Internet to enable business applications that are
accessed over their corporate networks. Companies utilize the
Internet to optimize their extended supply chains, automate
their sales forces, track shipments and communicate with
employees, customers, partners and suppliers. Due to the
efficiencies, cost-savings and competitive advantages that can
be gained by leveraging the Internet, many businesses are
continuing to build out their computer networks and information
technology infrastructure. In order to accommodate a significant
number of simultaneous users and the increasing volume of data
transfer associated with enterprise Internet use, many
organizations continue to make substantial investments in
wide-bandwidth connections such as dedicated T-1 lines,
enabling high-speed Internet access.

The Internet has also become a highly popular
consumer medium for communication, entertainment, information
and commerce. Market research firm International Data Corp.
(IDC) has projected that the number of corporate Internet
users worldwide will grow from an estimated 250 million in
2002 to more than 409 million in 2005. This rapid adoption
of the Internet has been accompanied by remarkable growth in the
number of consumer-oriented content and commerce Web sites and
by an expanding assortment of Web-based consumer services.
Internet users today have the ability to communicate through
e-mail and instant messaging, retrieve news and information from
numerous Internet sources, make online purchases of goods and
services ranging from books to airline tickets, and otherwise
access a broad range of non-business content and commerce Web
sites. As the rapid evolution of Web content and technology
continues, the amount of data, types of data and size of files
traveling across the Internet have also grown. Consumers now
access and download large, complex files such as streaming audio
and video, MP3 music files, multi-player games and a variety of
other new media, all of which consume large amounts of network
bandwidth. In addition, consumers  including
employees, who have access to broadband connections in their
offices  are creating security risks by accessing Web
sites that offer free software downloads, pirated software and
peer-to-peer applications and may contain mobile malicious code
or spyware.

Internet access at work is fast, convenient and
essentially free to employees. According to recent data from
Internet research firm ComScore Networks, only approximately
28 percent of people accessing the Internet from home use a
high-speed connection, compared to 87 percent at work.
Therefore, in general, employees enjoy quicker and relatively
unrestricted Internet access from their desktop computers. As a
result, many employees use their employers Internet
connections for recreational surfing or personal
matters during business hours. However, unmanaged non-business
use of company computing and network resources, including
Internet access, by employees can result in lost employee
productivity, increased network bandwidth consumption, increased
network security risks, and potential legal liability. These
factors in turn contribute to higher costs for companies that
make computing and network resources available to their
employees.

Recent research and news reports widely document
the hidden costs of open Internet access in the workplace. This
non-business use of the Internet can consume large portions of
expensive network bandwidth and decrease employee productivity.
According to a recent study we commissioned with Harris
Interactive in December 2001, more than 75 percent of mid-
to large-sized companies surveyed had reprimanded or disciplined
employees for Internet misuse while at work, and nearly half of
those companies had terminated employees for inappropriate
Internet activity.

Businesses are increasingly recognizing the
problem of personal Internet use in the workplace, and
traditionally have attempted to manage or modify employee
behavior through written policies. These policies are easily
ignored and difficult to enforce. In order to monitor
compliance, managers may require their information technology
professionals to manually review the log files of Web pages
visited that are generated

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by company servers. This method of employee
Internet management is generally cumbersome and time consuming,
and often does not provide the company with useful information
regarding the actual content or category of Web sites visited.
Because this method does not proactively curtail undesirable
Internet activity, employers are forced to discipline employee
violations after the fact. Such disciplinary actions can be
expensive in terms of lost productivity, recruitment costs and
possible legal liability.


To address the problems associated with improper
Internet use in the workplace, many businesses have sought
products that enable them to proactively manage their
employees Internet access. Early Internet filtering
software for the enterprise was largely derived from products
that were originally developed to help parents prevent their
children from accessing adult content at home, and used keyword
matching and dynamic page review to block content. These
products, and other more recent products, lack the ability to
meet the needs of growing organizations, cannot operate on
multiple network platforms, do not provide the flexibility
required by management and can be labor-intensive to deploy,
consuming valuable information technology resources. In
addition, these applications generally do not operate in
conjunction with a comprehensive database that is consistently
refreshed. Moreover, many of these products databases have
typically focused on fewer categories such as sex, violence and
inappropriate language, ignoring the emergence of new Web
content and the subtleties within categories, such as sex and
sex education, for example.

Workplace management of non-business-related
Internet access is an increasingly important priority because of
its impact on employee productivity, network bandwidth
consumption, network and data security and potential legal
liability. Given the necessity of corporate Internet access and
consumers continuing adoption of the Web as a mass
communication, entertainment, information and commerce medium,
we believe there is a significant opportunity for an employee
Internet management solution that effectively addresses the
needs of businesses to manage employee usage. Additionally,
although the Web and e-mail are the primary drivers of Internet
traffic today, the rapid emergence of Internet-enabled
applications creates the need for software that applies
management policies to file types, applications, and protocols,
as well as Web content. As a result, enterprise requirements for
content filtering and reporting tools are expanding to include
policy-based bandwidth management and regulation of non-Web
applications such as instant messaging, peer- to-peer file
exchange tools, interactive games and desktop software
applications and executables. These solutions must also be
adaptable enough to manage new applications and technologies as
they are developed.

Our Employee Internet Management
Solutions

We provide employee Internet management products
that enable businesses to analyze, report, and manage how their
employees use the Internet. Our primary product is Websense
Enterprise, a software and database package that gives business
managers the ability to implement customized Internet access
policies for different users and groups within the business, and
supports an organizations efforts to improve employee
productivity, conserve network bandwidth, enhance network
security, and mitigate potential legal liability. The
application component of Websense Enterprise allows managers the
flexibility to select the types of Internet content they wish to
allow, block or defer access to based on the database categories
we have defined. Our software enforces these managerial
selections by comparing Web site requests with the addresses we
have categorized in our database. Websense Enterprise is sold on
a subscription basis. The principal benefits of our products
include:

Increased Employee Productivity.Websense Enterprise gives businesses
the ability to more effectively manage employee Internet access,
thereby reducing non-productive Internet use. Our software
enables organizations to identify the pattern and scope of
Internet use and to manage access to non-business related
content or particular categories of Internet content chosen by
an organization. In addition, our software allows managers to
permit or deny Internet access based on the employee, type of
user, time of day, amount of personal surfing time, and type of
content being accessed. Websense Enterprise may also be
configured to defer access until after work hours or set
time-based quotas for each employee, allowing for limited
personal surfing during the workday, limiting workplace
distractions but allowing appropriate use of the
organizations high-speed Internet connection.

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Conservation of IT Resources.We believe Websense Enterprise allows
organizations to reduce bandwidth consumption by managing
personal Internet use and access to Web sites, in particular
those which may contain bandwidth-intensive content, such as
streaming audio and video, MP3 music files, multi-player games
and other new media. Reducing the bandwidth consumed by
non-business-related Internet traffic allows an organization to
use its network more efficiently and effectively in performing
important business tasks. In addition, by limiting access to
these types of sites, organizations are able to save valuable
network storage space from being cluttered with MP3s, images and
other files. This avoids costs arising from the need to buy
additional networking equipment and storage servers.

Enhanced Network and Data Security.Websense Enterprise adds an additional
layer of protection to an organizations network and data
security by blocking employee access to security-risk sites such
as those containing malicious mobile code or spyware. This
allows an organization to proactively reduce the risk of
malicious mobile code attacks  such as Web-based
worms, viruses, Visual Basic scripts and more  or the
inadvertent downloading of spyware applications that send
corporate data outside the organization.

Reduced Exposure to Potential Legal
Liabilities.Websense Enterprise
supports organizations efforts to reduce exposure to legal
liability resulting from the improper use of the Internet in the
workplace. By implementing our products in conjunction with an
overall corporate Internet usage policy, organizations can
proactively curtail access to objectionable Internet content
such as adult entertainment, illegal activities, hate and racism.

In addition to the benefits above, our products
provide these key features:

Access to a Comprehensive Database.We provide access to proprietary
databases containing more than four million Web sites,
representing more than one billion unique Web pages. Our
databases are cataloged into more than 80 different categories
to enable organizations to determine the types of Internet
content that are appropriate for their workplace culture. We add
approximately 5,000 newly categorized Web sites each business
day to our databases and make these updates available to our
customers for daily incremental downloads, including refreshing
the databases to remove inactive links and irrelevant content
and to identify changing content and newly emerging sites. To
date, more than one million dead links have been eliminated.

Ability to Customize Employee Internet Access.Websense Enterprise allows
organizations to configure specific Internet access policies for
various groups, user types or individuals. Through our
easy-to-use browser interface, we allow managers to implement
Internet access policies with limited investment of information
technology resources and personnel. Organizations may choose
Internet access options which include blocking Web sites,
setting time periods for access, allowing access but generating
an exception report, allowing users a specified amount of
personal surfing, or deferring access until after work hours.

Ability to Adapt to our Customers
Employee Surfing Patterns.We utilize
our relationship with our customers to help our software adapt
to any companys evolving employee surfing patterns. We
accomplish this with WebCatcher, a feature by which
customers anonymously send uncategorized Web sites visited by
their employees to us for review and categorization into the
Websense Master Database.

Premium Group Database Additions for Emerging
Web Content.Websense has developed
Premium Group database additions that encompass emerging Web
content. Premium Group I focuses on productivity management
by allowing administrators to manage message boards and clubs,
advertisements, freeware/shareware, instant messaging, online
brokerage and trading, and pay-to-surf sites. Premium Group II
focuses on bandwidth management and features sites relating to
Internet radio and TV, peer-to-peer file sharing, personal
network storage/backup, Internet telephony and streaming media.
Premium Group III focuses on network security by
categorizing websites containing malicious mobile code and
spyware.

Ability to Scale and Operate on a Variety of
Network Platforms.Our software is
designed to have minimal impact on network performance. Websense
Enterprise is available on a broad range of network platforms,
and can support up to 50,000 users on a single server. Our
software works with popular proxy servers, firewalls, cache
engines, switches and routers offered by Internet infrastructure
providers such as Blue Coat Systems, Check Point, Cisco,
Inktomi, Microsoft, Netscreen, Network Appliance, and SonicWALL.

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Products And Services

We develop and market application software and
databases for managing employee use of computing resources at
work, including access to the Internet. Our products consist of
customizable software that references our proprietary databases.
Our databases of Web page addresses are organized into more than
80 categories, and are regularly updated and available for
incremental daily downloads. In addition to our Web filtering
offerings, in March 2003 we introduced two new products that
will provide enterprises with additional flexibility in managing
employee use of corporate computing resources: Client
Application Manager (manages software applications at the
desktop) and Bandwidth Optimizer (manages bandwidth consumption
on the network). These new products rely on the application
framework of the Websense Enterprise platform and additional
databases, which categorize file types, applications, and
protocols. We plan to continue to introduce and market new
products and services based on our Websense Enterprise platform.

Websense Enterprise.Websense Enterprise is the foundation of our software offerings
and includes our proprietary central policy engine and central
management console. Websense Enterprise integrates with an
organizations network server, proxy server, switch, router
or firewall and is designed to work in networks of virtually any
size and configuration. The table below describes the platforms
for which we currently offer our Websense Enterprise product.

|                                                                                                                                                                                                                                                                                                                                        |  |                                                                                                                                                                                                                                                                                                                                    
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| 3Com Webcache
     Blue Coat Systems Security Appliances
     Check Point FireWall-1
     Cisco Catalyst 6000 Switches
     Cisco Content Engine
     Cisco PIX Firewall
     Cisco Routers
     Dell PowerApp.cache
     F5 EDGE-FX
     HP ProLiant
     HP Web Cache
     IMimic DataReactor
     InfoLibria DynaCache |  |  Inktomi Traffic Server
     Lightspeed Total Traffic Control
     Microsoft ISA Server
     Microsoft Proxy Server
     NetScreen
     Network Appliance NetCache
     ServGate
     SLMsoft SecurIT
     SonicWALL Firewall
     Stratacache
     Sun ONE Web Proxy Server (formerly iPlanet)
     Volera Excelerator

We sell subscriptions to the Websense Enterprise
platform and databases based on the number of users to be
managed. Additional application modules and enhanced technical
support are priced separately. Revenues from sales of
subscriptions to Websense Enterprise accounted for 100% of total
revenues in 2002, 99% of total revenues in 2001 and 96% of total
revenues in 2000.

Internet Content Management.Websense Enterprise enables employers
to proactively analyze, report and manage employee Internet
access based on the content of the requested Web site. Our
software application gives managers the ability to customize,
implement and modify Internet access policies for various
groups, user types and individuals. An easy-to-use graphical
interface enables business managers to define the categories of
Web sites to which access will be managed. The filtering
software examines each Internet access request, determines the
category of the requested Web site and applies the policies that
have been defined by the company. Some examples of management
options include:



| |   |                                                                                                                                                                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Allow.The request
    is allowed to proceed, because the organization has chosen not
    to restrict access to the category applicable to the Web site.                                                                                                                  
|
| |  | Block.The requested
    Web site is in a category that is not allowed to be accessed
    according to the policy in effect.                                                                                                                                              
|
| |  | Time-based Quotas.Users are allowed a specified amount
    of personal surfing time within categories that are determined
    by the administrator. Once the user reaches his or her quota
    time, he or she is no longer able to access sites in those
    categories.

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| |   |                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Defer and Save.The
    user can bookmark the requested Web site to a personalized
    AfterWork.com Web page for access at a later time when the
    organizations access policy is less restrictive. This Web
    page can also be accessed from alternative locations, such as
    from the employees home.
|
| |  | Continue with Exception Report.The user is reminded about the
    organizations Internet usage policy, but can choose to
    access the requested Web site. Alternatively, the user can save
    the Web site as described above.                                                                             
|
| |  | Time of Day.Filtering options can be managed by
    time of day. For example, access to shopping sites could be
    blocked during business hours and permitted at all other times.                                                                                                                            

The Websense Master and Premium Group
Databases.We offer extensive and
regularly updated databases of Web sites. Our Master and Premium
Group databases currently catalog more than four million Web
sites, representing approximately one billion Web pages in
44 languages, cataloged into more than 80 categories.
Through proprietary techniques that create unique fingerprints
of individual Web pages, as well as customer features such as
WebCatcher, we add approximately 5,000 newly categorized Web
sites, representing approximately 500,000 Web page addresses,
per business day to our database and make these updates
available for incremental daily downloads. In addition, our
database is refreshed daily to remove dead links and irrelevant
content and to identify changing content and newly emerging
sites.

The breadth and specificity of Web site
categories we have defined provide flexibility in selecting
which types of material should be allowed, blocked, deferred or
reported. We identify the types of content that we believe
employers would deem to be unacceptable, inappropriate or
undesirable in a work environment based on input we receive from
our customers, and define the categories accordingly. Categories
in our databases include the following:

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| Abortion
    Advocacy   Pro-Choice   Pro-Life
     Adult Material   Adult
    Content   Lingerie &
    Swimsuit   Nudity   Sex   Sex
    Education
     Advocacy Groups
     Business &
    Economy   Financial Data &
    Services
     Drugs   Abused
    Drugs   Marijuana   Prescribed
    Medications   Supplements/ Unregulated
    Compounds
     Education   Cultural
    Institutions   Educational
    Institutions   Educational
    Materials   Reference Materials
     Entertainment   MP3
     Gambling
     Games
     Government   Military   Political
    Groups |  |  Health
     Illegal/ Questionable
     Information
    Technology   Computer Security
    Information   Hacking   Proxy
    Avoidance Systems   Search Engines
    & Portals   URL Translation
    Sites   Web Hosting
     Internet
    Communication   Web
    Chat   Web-based Email
     Job Search
     Militancy/ Extremist
     News &
    Media   Alternative Journals
     Premium Group
    I   Advertisements   Freeware/
    Software Download   Instant
    Messaging   Message Boards &
    Clubs   Online Brokerage &
    Trading   Pay-to-Surf
     Premium Group II   Internet
    Radio & TV   Internet
    Telephony   Peer-to-Peer File
    Sharing   Personal Network Storage/
    Backup   Streaming Media

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|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |  |                                                                                                                                                          
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| Premium Group
    III   Malicious Web
    Sites   Spyware
     Racism/ Hate
     Religion   Non-Traditional
    Religions   Traditional Religions
     Shopping   Internet
    Auctions   Real Estate
     Social
    Organizations   Professional and Worker
    Organizations   Service and
    Philanthropic Organizations   Social
    and Affiliation Organizations
     Society &
    Lifestyles   Alcohol/
    Tobacco   Gay & Lesbian
    Issues   Hobbies   Personal
    Web Sites   Personals/
    Dating   Restaurants & Dining |  |  Special Events
     Sports   Sport Hunting/ Gun
    Clubs
     Tasteless
     Travel
     User-Defined
     Vehicles
     Violence
     Weapons

Websense Reporter.Websense Reporter is a reporting
application that is offered with Websense Enterprise. This
application assists managers in analyzing Internet use within
their organizations. Websense Reporter can generate more than 60
tabular and graphical reports based on an organizations
Internet use. It analyzes information from Internet monitoring
logs and builds visual charts in a variety of formats for easy
distribution to and interpretation by managers. Websense
Reporter enables managers to identify useful information,
including summaries of categories of Web sites visited, requests
to all destinations and details regarding individual destination
requests.

Client Application
Manager.Client Application Manager
allows customers to implement management policies, such as
block, allow or defer, for usage of software applications and
other executables on desktop computers, by application type, by
user type, or by individual user. Our Client Application Manager
database currently consists of more than 70,000 software
applications and other executables. We are expanding this
database as well as adapting the database to actual employee
computing patterns through the use of AppCatcher, a
feature by which customers anonymously send uncategorized
applications and other executables launched by their employees
to us for review and categorization into our Client Application
Manager database.

Bandwidth Optimizer.Bandwidth Optimizer allows customers
to dynamically manage network traffic by prioritizing business
and non-business related traffic flows. Customers can apply
management policies based on content category, protocols, user,
group or network segment. Bandwidth Optimizer relies on the
central policy engine in the Websense Enterprise platform, a
network agent that monitors network traffic and databases of
protocols, file types and content categories.

Websense Explorer.Expected to be released in the second
quarter of 2003, Websense ExplorerTM will be a
dynamic, Web-based reporting tool designed to provide
non-technical users with easy access to trend and risk data
associated with Internet access. Designed to provide more detail
than traditional summary level metrics, such as usage by user,
category, or time of day, Websense Explorer allows the user to
drill down within the collected data to provide a multitude of
user-defined information views.

Customers

Our more than 18,100 customers range from
companies with as few as 100 employees to members of the
Global 1000 to government agencies and educational institutions.
In total, these customers have subscribed to

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approximately 13.8 million seats. No
customer accounted for more than 10% of our total revenues in
2002, 2001 or 2000.


Sales, Marketing and Distribution

Sales.We sell our
products and services through both indirect and direct channels.
For 2002, indirect channel sales comprised more than 75% of
total revenues, while direct sales to customers accounted for
the remainder of our revenues. In the United States, we
typically sell our products through a network of more than
950 value added resellers. Internationally, we sell our
products through a multi-tiered distribution network of more
than 150 distributors and resellers in over 80 countries.

Our channel sales efforts are coordinated
worldwide through a sales team of approximately
80 individuals. Customers that buy direct from us are
typically large organizations that prefer a direct relationship
with us.

In 2002, we generated approximately 32% of our
total revenue from customers outside of the United States.
Revenue generated in the United Kingdom represented
approximately 8% of our total revenues and revenue generated in
Japan represented approximately 5% of our total revenues. We
expect international markets to provide increased opportunities
for our products in the future. Our current international
efforts are focused on expanding our indirect sales channels in
Asia/ Pacific, Europe, Latin America and Australia. Our
continuing reliance on sales in international markets exposes us
to risks attendant to foreign sales. See Item 7.
Risks and Uncertainties  Sales to customers outside
the United States have accounted for a significant portion of
our revenue, and we expect this trend to continue, which exposes
us to risks inherent in international sales.

Marketing.Our
marketing strategy is to raise awareness of the potential
problems associated with unmanaged employee use of corporate
computing resources, generate qualified sales leads for our
channel partners, build our brand awareness and increase
recognition of Websense as a provider of employee Internet
management solutions.

Our marketing efforts are targeted toward
operational executives and decision makers within businesses,
including information technology professionals, chief
executives, upper level management and human resource personnel.
We actively manage our public relations programs, communicating
directly with technology professionals and the media, in an
effort to promote greater awareness of the growing problems
caused by employee misuse of the Internet and other computing
resources at work. We also provide free trials of Websense
Enterprise to potential customers and channel partners,
typically for 30-day periods. Our additional marketing
initiatives include:



| |   |                                                                                                                                                                                                                                    
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | advertising in high-technology trade magazines,
    management journals and other business oriented periodicals;                                                                                                                   
|
| |  | participation in and sponsorship of trade shows
    and industry events;                                                                                                                                                           
|
| |  | hosting regional and international seminars and
    training sessions for our reseller partners;                                                                                                                                   
|
| |  | cooperative marketing efforts with our Internet
    infrastructure partners including Web link exchanges, joint
    press announcements, joint trade show activities, channel
    marketing campaigns, road shows and seminars; and
|
| |  | use of our Web site to communicate with our
    indirect sales channels and provide product and company
    information to interested parties.                                                                                     

Customer Service, Training and
Support

We believe that superior customer support is
critical to retaining and expanding our customer base. Our
technical support group provides dependable and timely
resolution of customer technical inquiries and is available to
customers by telephone, e-mail and over the Web. Our training
services group delivers education, training and pre-sales
support to our customers. We also offer online training to our
customers and resellers to provide them with the knowledge and
skills to successfully deploy, use and maintain our products. Our

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customer service team is responsible for handling
general customer inquiries, answering questions about the
ordering process, updating and maintaining customer account
information, investigating the status of orders and payments, as
well as processing customer orders. In addition, our customer
service team proactively updates customers on a variety of
topics, including release dates of new products and updates to
existing products.


Research and Development

We have invested significant time and resources
in creating a structured process for undertaking product and
database development projects. Our research and development
department is divided into several groups, which include
database production, software development, quality assurance and
documentation. Individuals are grouped along product lines and
work as part of cross-disciplined teams designed to provide a
framework for defining and addressing the activities required to
bring product concepts and development projects to market
successfully. Research and development expenses totaled
$11.0 million in 2002, $7.6 million in 2001 and
$6.3 million in 2000.

Technology

Software
Architecture.Websense Enterprise is a
server-based system designed to function in networks of
virtually any size and configuration. Websense Enterprise is
composed of a system of analyzing, reporting and management
applications integrated in a proprietary central policy engine.
It is designed to accommodate network growth without impairing
performance or requiring major infrastructure modifications and
can scale to support networks of up to 50,000 users on a single
server. Websense Enterprise integrates with major firewalls,
proxy servers, caching engines, network switches and routers. We
have designed our products to run on multiple network platforms
and in multiple locations. With the introduction of Websense
Enterprise Version 5 in March 2003, the server-based platform
has been augmented with agents at the desktop and on the network
that now allow customers to manage applications, protocols, and
network bandwidth, as well as Web site access.

Database Content Analysis and
Updating.We use a process of
automated content assessment and classification with manual
verification to gather and classify new Web sites for our
database. Our automated search technology uses Java-based tools
and proprietary pattern recognition systems to automatically
search the Internet to identify and catalog Web sites into one
of our more than 80 database categories. Additionally, the
optional WebCatcher and AppCatcher features of Websense
Enterprise collect unrecognized sites and desktop software
applications from customers and returns them to us for review
and categorization.

Competition

The market for our products is fragmented, highly
and increasingly competitive, quickly evolving and subject to
rapid technological change. Increased competition may result in
reduced market acceptance of our products, pricing pressure and
reduced gross margins, any of which could seriously harm our
business. Competitors vary in size and in the scope and breadth
of the products and services they offer. Our current principal
competitors include:



| |   |                                                                                                                                                                                                         
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | companies offering network filtering products,
    such as SurfControl plc, Secure Computing, Symantec Corporation,
    N2H2 Incorporated, 8e6 Technologies, Webwasher and Elron
    Software, Inc.; and
|
| |  | companies offering network reporting products,
    such as NetIQ and Wavecrest Computing.                                                                                                               

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 employee Internet management or other
competitive products with their offerings. We compete against
and expect increased competition from anti-virus software
developers, traditional network management software developers
and Web management service providers. We may face new
competition from companies offering quality of service
solutions, such as Packeteer, and companies with a direct
presence on computer desktops, such as Microsoft, as we
introduce new products, such as the Client Application Manager
and Bandwidth Optimizer. Many of

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our current and potential competitors have longer
operating histories and significantly greater financial,
technical, marketing or other resources than we do. They may
have significantly greater name recognition, established
marketing relationships and access to a larger installed base of
customers. In addition, current and potential competitors
have established or may establish cooperative relationships
among themselves or with third parties to increase the
functionality of their products to address customer needs.
Accordingly, new competitors or alliances among competitors may
emerge and rapidly acquire significant market share.


We believe that the principal competitive factors
in the market for our products include:



| |   |                                                                                   
| | - | ----------------------------------------------------------------------------------
| |  | a products ability to scale and support the
    requirements of complex networks;
|
| |  | quality of a large and professionally maintained
    category database;           
|
| |  | breadth of product line, giving customers a
    number of implementation choices; 
|
| |  | depth of monitoring, reporting and analysis
    capabilities;                     
|
| |  | capacity to integrate with key network providers;                                 
|
| |  | quality of customer support; and                                                  
|
| |  | price and payment methods.                                                        

Intellectual Property Rights

Our intellectual property rights are important to
our business. We rely on a combination of trademark, copyright,
patent 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
Websense brand. We have registered our Websense trademark in the
United States, Japan, the European Union, Canada,
Australia, China, Switzerland, Norway, Mexico, Colombia and
Turkey. We have also registered the Websense Enterprise
trademark in the United States, Japan, Canada, Australia
and China. In addition, we 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.

We currently have five patent applications
pending in the United States and eight pending
international patent applications that seek to protect our
proprietary database and filtering technologies. We do not have
any issued patents and our pending patent applications may not
result in issued patents.

Our policy is to enter into confidentiality and
invention assignment agreements with all employees and
consultants, and nondisclosure agreements with all other parties
to whom we disclose confidential information. These protections,
however, may not be adequate to protect our intellectual
property rights.

Employees

As of February 28, 2003, we had 329
employees. None of our employees is represented by a labor
union, and we have never experienced a work stoppage. We believe
that our relations with our employees are good.

Web Site Access to SEC Filings

We maintain an Internet website at
www.websense.com. We make available free of charge
through our Internet website our annual report on
Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and amendments to those reports filed
or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act as soon as reasonably practicable after we
electronically file such material with, or furnish it to,
the SEC.

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Executive Officers

Our executive officers and their ages as of
February 28, 2003 are as follows:

|                   |  |     |    |             |  |                                                  
|------------------ |  | --- | -- | ----------- |  | -------------------------------------------------
|Name               |  | Age |    | Position(s)
|                   |  |     |    |            
|John B. Carrington |  |     | 59 |             |  | Chairman of the Board and Chief Executive Officer
|Curtis H. Staker   |  |     | 43 |             |  | President                                        
|Douglas C. Wride   |  |     | 49 |             |  | Chief Financial Officer                          
|Harold M. Kester   |  |     | 56 |             |  | Chief Technology Officer                         
|Karen V. Goodrum   |  |     | 45 |             |  | Vice President of Finance and Administration     
|Ronald B. Hegli    |  |     | 42 |             |  | Vice President of Engineering                    
|Andrew Meyer       |  |     | 45 |             |  | Vice President of Marketing                      
|Michael A. Newman  |  |     | 33 |             |  | Vice President & General Counsel                 
|Kian Saneii        |  |     | 38 |             |  | Vice President of Business Development           

John B. Carrington has served as our Chief
Executive Officer since May 1999 and has served as a Director
and our Chairman since June 1999. Mr. Carrington also
served as our President from May 1999 to January 2003. Prior to
joining Websense, Mr. Carrington was Chairman, President
and Chief Executive Officer of Artios, Inc., a provider of
hardware and software design solutions to companies in the
packaging industry, from August 1996 until it was acquired by
BARCO n.a. in December 1998. From September 1991 to October
1995, Mr. Carrington was President and Chief Executive
Officer of Digitalk, Inc., a software development tools
company, which was merged to form ParcPlace-Digitalk, Inc. He
received his B.S. in Business Administration from the University
of Texas.

Curtis H. Staker has served as our President
since January 2003. Prior to that, he had served as our
Executive Vice President of Worldwide Sales since February 2001.
Prior to joining us, Mr. Staker was with Structural
Dynamics Research Corporation (SDRC) from July 1989 to
February 2001 serving in a variety of management positions,
including Vice President and General Manager of Americas
Operations (North and South America regions) and Vice President
and General Manager of Asia-Pacific Operations. SDRC, a provider
of e-business collaboration solutions, is now owned by
Electronic Data Systems (EDS). Mr. Staker began his career
as an engineer for Caterpillar Tractor Co. after receiving his
B.S. in Mechanical Engineering from Bradley University.

Douglas C. Wride has served as our Chief
Financial Officer since June 1999. From March 1997 to December
1998, Mr. Wride served as Chief Financial Officer of
Artios, Inc. Mr. Wride also served as Chief Operating
Officer of Artios from July 1997 to December 1998. From April
1996 to March 1997, Mr. Wride served as Chief Operating
Officer and Chief Financial Officer of NetCount, LLC, a provider
of Internet measurement and research services. From February
1992 to January 1996, Mr. Wride was Chief Financial Officer
at Digitalk, Inc. Mr. Wride has also held senior-level
positions with SSD Management, Inc., a developer of network
communications software for wide area networks and Accountants
Overload Group, an accounting, finance and data processing job
placement company, and spent 11 years in the
entrepreneurial technology group at Price Waterhouse & Co.
Mr. Wride is a C.P.A and received his B.S. in Business/
Accounting from the University of Southern California.

Harold M. Kester has served as our Chief
Technology Officer since June 1999. Prior to joining us, from
August 1993 to June 1999, Mr. Kester served as Vice
President of Encyclopedia Britannica, a provider of general
reference materials on a multitude of subjects, and General
Manager and Chief Scientist of its La Jolla Research
Laboratory. Prior to his employment with Encyclopedia
Britannica, Mr. Kester founded The Del Mar Group, a
provider of information retrieval software products.
Mr. Kester received his B.A. in Mathematics from California
State University, Long Beach.

Karen V. Goodrum has served as our Vice President
of Finance and Administration since August 2000. From January
1997 to February 2000, Ms. Goodrum served as Chief
Financial Officer for COMPS.Com, Inc., a provider of commercial
real estate information services. Ms. Goodrum previously
served as Vice President of Finance and Administration for
COMPS.Com, Inc. from September 1993 to January 1997.
Ms. Goodrum

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received her B.A. in Education from the
University of Maryland, College Park, and her M.B.A. from
San Diego State University.


Ronald B. Hegli has served as our Vice President
of Engineering since March 1999. Prior to joining us, from
August 1998 to March 1999, Mr. Hegli served as Director of
Product Development for Nuera Communications, an Internet
protocol telephony vendor. From March 1994 to April 1998,
Mr. Hegli served as Vice President of Engineering with
TriTeal Corp., a graphical user interface software developer.
TriTeal Corp. filed a bankruptcy petition in April 1999.
Mr. Hegli received his B.S. in Nuclear Engineering from
Oregon State University and an M.S. in Mechanical Engineering
from the University of California, Berkeley.

Andrew Meyer has served as our Vice President of
Marketing since August 1999. From November 1997 to August 1999,
Mr. Meyer served as Vice President of Marketing for Epicor
Software (formerly Platinum Software), a provider of enterprise
resource planning software. From September 1993 to November
1997, Mr. Meyer was Director of Marketing for
Scientific-Atlanta, a cable television and telecommunications
manufacturer. Mr. Meyer received his bachelors degree
in Mechanical Engineering from Georgia Tech and an M.B.A. from
the University of New Orleans.

Michael A. Newman has served as our Vice
President & General Counsel since September 2002. From April
1999 to September 2002, he served in various capacities in the
legal department of Gateway, Inc., a publicly-traded PC
manufacturer, most recently as Senior Staff Counsel, Securities,
Finance and Corporate Development. From February 1996 to April
1999, he practiced as an attorney in the San Diego office
of Cooley Godward, LLP, a law firm specializing in the
representation of high-growth information technology and life
sciences companies. Mr. Newman received his B.S. in
Business Administration from Georgetown University, and a J.D.
from Harvard Law School.

Kian Saneii has served as our Vice President of
Business Development since August 2001. From August 1999 to
February 2001, he was Senior Vice President of Worldwide
Marketing and Business Development at IPNet Solutions, Inc., a
provider of business-to-business integration and supply-chain
collaboration solutions. From July 1997 to July 1999, he served
as Senior Vice President of Worldwide Marketing for IMA
Corporation, a supplier of customer relationship management
solutions. From December 1995 to July 1997, he held key
positions in marketing management with FileNET Corporation, a
developer of software for e-process management. Mr. Saneii
received his B.S. in Computer Science from New York University,
and an M.S. in Computer Science from Rutgers University.






|        |           
|------- | ----------
|Item 2. | Properties

Our corporate headquarters and principal offices
are located in San Diego, California, where we lease
approximately 65,000 square feet. This lease expires in December
2007, with an option to extend the lease for an additional five
years. We believe that our current space is adequate for our
current and identified future needs. We lease office space in
the UK, Ireland, Japan and France in executive suite
arrangements on an annual basis.






|        |                  
|------- | -----------------
|Item 3. | Legal Proceedings

We are not a party to any material legal
proceedings.






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

There were no matters submitted to a vote of the
security holders during the fourth quarter of the fiscal
year-ended December 31, 2002.

13



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PART II






|        |                                                                          
|------- | -------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity
    and Related Stockholder Matters

Our Common Stock is traded on the Nasdaq National
Market under the symbol WBSN. The following table
sets forth the range of high and low closing prices on the
Nasdaq National Market of our Common Stock for the periods
indicated, as reported by Nasdaq. Such quotations represent
inter-dealer prices without retail markup, markdown or
commission and may not necessarily represent actual transactions.

|                             |  |      |       |     |  |   |       | 
|---------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|                             |  | High |       | Low
|                             |  |      |       |    
|Year Ended December 31, 2002 |  |      |       |     |  |   |       | 
|First Quarter                |  | $    | 34.03 |     |  | $ | 22.41 | 
|Second Quarter               |  |      | 30.09 |     |  |   | 21.51 | 
|Third Quarter                |  |      | 25.37 |     |  |   | 11.19 | 
|Fourth Quarter               |  |      | 27.41 |     |  |   | 10.84 | 
|Year Ended December 31, 2001 |  |      |       |     |  |   |       | 
|First Quarter                |  |      | 16.42 |     |  |   | 7.69  | 
|Second Quarter               |  |      | 20.00 |     |  |   | 9.09  | 
|Third Quarter                |  |      | 19.19 |     |  |   | 9.99  | 
|Fourth Quarter               |  |      | 33.60 |     |  |   | 10.54 | 

To date, we have neither declared nor paid any
dividends on the Common Stock. We currently intend to retain all
future earnings, if any, for use in the operation and
development of our business and, therefore, do not expect to
declare or pay any cash dividends on the Common Stock in the
foreseeable future. As of February 28, 2003, there were
approximately 5,500 holders of record of the Common Stock.

Use of Proceeds

On March 28, 2000, we completed our initial
public offering for the sale of 4,000,000 shares of common stock
at a price to the public of $18 per share, which resulted in net
proceeds of $65.7 million after payment of the
underwriters commissions and deductions of offering
expenses. The registration statement (No. 333-95619)
relating to our initial public offering was declared effective
on March 28, 2000. Subsequent to our initial public
offering, a portion of the offering proceeds were used to repay
the $1.5 million balance of our fixed term loan agreements with
financial institutions. The remaining proceeds have conformed
with our intended use outlined in the prospectus related to such
offering. We currently have approximately $64.2 million
remaining from our IPO proceeds.






|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

You should read the following selected financial
data in conjunction with our financial statements and related
notes and Managements Discussion and Analysis of
Financial Condition and Results of Operations appearing
elsewhere in this annual report. We derived the statement of
operations data for the years ended December 31, 2002, 2001
and 2000 and the balance sheet data as of December 31, 2002
and 2001 from our financial statements audited by Ernst &
Young LLP, which appear elsewhere in this report. We derived the
statement of operations data for the years ended
December 31, 1999 and 1998 and the balance sheet data as of
December 31, 2000, 1999 and 1998 from our financial
statements audited by Ernst & Young LLP, which are not
included in this annual report. Our historical results are not
necessarily indicative of operating results to be expected in
the future.

14



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|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |       |       | 
|--------------------------------- | ---------------------------------------- | ----------------------------------------- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | ------ | ----- | ------ | - | ------ | ----- | ----- | 
|                                  |                                          |                                          
|                                  |                                          | Years Ended December 31,                 
|                                  |                                          |                                          
|                                  |                                          | 2002                                      |        | 2001   |        | 2000 |        | 1999   |        | 1998
|                                  |                                          |                                           |        |        |        |      |        |        |        |     
|                                  |                                          |                                          
|                                  |                                          | (in thousands, except for per share data)
|Statement of Operations Data:     |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Revenues                          |                                          | $                                         | 60,965 |        |        | $    | 35,893 |        |        | $    | 17,441 |        |        | $ | 8,647  |       |        | $ | 6,919  |      
|Cost of revenues                  |                                          |                                           | 4,170  |        |        |      | 3,602  |        |        |      | 2,707  |        |        |   | 2,275  |       |        |   | 4,460  |      
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Gross margin                      |                                          |                                           | 56,795 |        |        |      | 32,291 |        |        |      | 14,734 |        |        |   | 6,372  |       |        |   | 2,459  |      
|Operating expenses:               |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|                                  | Selling and marketing                    |                                           |        | 26,201 |        |      |        | 19,707 |        |      |        | 12,726 |        |   |        | 6,311 |        |   |        | 4,597 |      
|                                  | Research and development                 |                                           |        | 10,957 |        |      |        | 7,642  |        |      |        | 6,287  |        |   |        | 3,913 |        |   |        | 1,789 |      
|                                  | General and administrative               |                                           |        | 5,960  |        |      |        | 5,358  |        |      |        | 3,491  |        |   |        | 3,805 |        |   |        | 1,715 |      
|                                  | Amortization of stock-based compensation |                                           |        | 448    |        |      |        | 860    |        |      |        | 1,938  |        |   |        | 1,822 |        |   |        |      |      
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|                                  |                                          | Total operating expenses                  |        |        | 43,566 |      |        |        | 33,567 |      |        |        | 24,442 |   |        |       | 15,851 |   |        |       | 8,101 | 
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Income (loss) from operations     |                                          |                                           | 13,229 |        |        |      | (1,276 | )      |        |      | (9,708 | )      |        |   | (9,479 | )     |        |   | (5,642 | )    
|Other income, net                 |                                          |                                           | 2,711  |        |        |      | 4,500  |        |        |      | 3,761  |        |        |   | 225    |       |        |   | 33     |      
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Income (loss) before income taxes |                                          |                                           | 15,940 |        |        |      | 3,224  |        |        |      | (5,947 | )      |        |   | (9,254 | )     |        |   | (5,609 | )    
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Provision for income taxes        |                                          |                                           | (797   | )      |        |      | 108    |        |        |      |       |        |        |   |       |       |        |   |       |      
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Net income (loss)                 |                                          | $                                         | 16,737 |        |        | $    | 3,116  |        |        | $    | (5,947 | )      |        | $ | (9,254 | )     |        | $ | (5,609 | )    
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Net income (loss) per share:      |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Basic                             |                                          | $                                         | 0.79   |        |        | $    | 0.16   |        |        | $    | (0.35  | )      |        | $ | (1.25  | )     |        | $ | (0.80  | )    
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Diluted                           |                                          | $                                         | 0.72   |        |        | $    | 0.14   |        |        | $    | (0.35  | )      |        | $ | (1.25  | )     |        | $ | (0.80  | )    
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Weighted average shares  basic   |                                          |                                           | 21,211 |        |        |      | 20,082 |        |        |      | 16,882 |        |        |   | 7,403  |       |        |   | 7,000  |      
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      
|Weighted average shares  diluted |                                          |                                           | 23,338 |        |        |      | 22,780 |        |        |      | 16,882 |        |        |   | 7,403  |       |        |   | 7,000  |      
|                                  |                                          |                                           |        |        |        |      |        |        |        |      |        |        |        |   |        |       |        |   |        |      

|                                     |  |                    |         |      |  |      |         |      |  |      |        |  |  |   |        |  |  |   |        |  
|------------------------------------ |  | ------------------ | ------- | ---- |  | ---- | ------- | ---- |  | ---- | ------ |  |  | - | ------ |  |  | - | ------ | -
|                                     |  |                   
|                                     |  | As of December 31,
|                                     |  |                   
|                                     |  | 2002               |         | 2001 |  | 2000 |         | 1999 |  | 1998
|                                     |  |                    |         |      |  |      |         |      |  |     
|                                     |  |                   
|                                     |  | (in thousands)    
|Balance Sheet Data:                  |  |                    |         |      |  |      |         |      |  |      |        |  |  |   |        |  |  |   |        |  
|Cash and cash equivalents            |  | $                  | 61,713  |      |  | $    | 23,715  |      |  | $    | 13,106 |  |  | $ | 10,735 |  |  | $ | 1,753  |  
|Investments in marketable securities |  |                    | 78,753  |      |  |      | 79,393  |      |  |      | 68,153 |  |  |   |       |  |  |   |       |  
|Working capital (deficit)            |  |                    | 114,459 |      |  |      | 79,846  |      |  |      | 69,019 |  |  |   | 5,222  |  |  |   | (377   | )
|Total assets                         |  |                    | 180,188 |      |  |      | 119,812 |      |  |      | 92,454 |  |  |   | 16,756 |  |  |   | 4,355  |  
|Deferred revenue                     |  |                    | 64,679  |      |  |      | 43,478  |      |  |      | 24,487 |  |  |   | 11,593 |  |  |   | 4,236  |  
|Debt                                 |  |                    |        |      |  |      |        |      |  |      |       |  |  |   | 1,497  |  |  |   | 496    |  
|Total stockholders equity (deficit) |  |                    | 106,711 |      |  |      | 70,680  |      |  |      | 64,064 |  |  |   | 1,642  |  |  |   | (1,217 | )






|        |                                                                                          
|------- | -----------------------------------------------------------------------------------------
|Item 7. | 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 Risks and
Uncertainties regarding certain factors known to us that
could cause reported financial information not to be necessarily
indicative of future results.

Forward Looking Statements

From time to time we have made and may continue
to make forward looking statements within the
meaning of the federal securities laws. This report on
Form 10-K may contain forward-looking statements 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

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such as expects,
anticipates, intends, plans,
believes, estimates, or other words
indicating future results. Such statements include but are not
limited to statements concerning the following:




| |   |                                                                
| | - | ---------------------------------------------------------------
| |  | anticipated trends in revenue;                                 
|
| |  | growth opportunities in domestic and
    international markets;
|
| |  | customer acceptance and satisfaction with our
    products;    
|
| |  | expected trends in operating expenses; and                     
|
| |  | anticipated cash and intentions regarding usage
    of cash.   

Actual results may differ materially from results
anticipated in such forward-looking statements. We assume no
obligation to update any forward-looking statements to reflect
events or circumstances arising after the date of this report.

Overview

We provide Employee Internet Management, or EIM,
solutions that enable businesses to analyze, report and manage
how their employees use computing resources at work, including
the Internet. Our primary product, Websense Enterprise, gives
businesses the ability to rapidly implement and configure
Internet access policies in support of their efforts to improve
employee productivity, conserve network bandwidth, mitigate
potential legal liability and enhance network security. In 1996,
we released our first software product, Websense Internet
Screening System, and since that time, we have focused our
business on developing and selling EIM solutions. In December
1999, we released Websense Enterprise Version 4, which was sold
through fiscal year 2002. We launched the next generation of
Websense software  Websense Enterprise Version
5  in March 2003, including enhanced EIM capabilities
and new network and application management technology such as
Client Application Manager and Bandwidth Optimizer. We currently
derive nearly all of our revenue from subscriptions to the
Websense Enterprise solution and expect this trend to continue
in the future as more offerings are added to the Websense
Enterprise platform.

During 2002, we derived approximately 32% of
revenue from international sales compared with approximately 35%
for 2001. Despite the decline year-over-year as a percentage of
total revenue, international sales increased 55% in 2002 and we
believe international markets represent a significant growth
opportunity and are continuing to expand our international
operations, particularly in selected countries in the European
and Asia/ Pacific markets.

We currently sell Websense Enterprise through
both indirect and direct channels; however, sales through
indirect channels currently account for more than 75% of our
revenue and our strategy is to continue to rely on indirect
sales channels for a significant majority of our sales.

As described below, we recognize revenue from
subscriptions to Websense Enterprise on a monthly straight-line
basis over the term of the subscription. We recognize the
operating expenses related to these sales as they are incurred.
These operating expenses include commissions relating to the
sale of new subscriptions, which are based on the total amount
of the subscription contract and are fully expensed in the
period the product is delivered. 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.

Critical Accounting Policies

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

Revenue Recognition.When a purchase decision is made,
customers enter into a subscription agreement, which is
generally 12, 24 or 36 months in duration and for a fixed
number of users. We promptly invoice customers for the full
amount of their subscriptions at the time a subscription is
activated. Payment is due for

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the full term of the subscription generally
within 30 days of the invoice. We recognize revenue on a
monthly straight-line basis over the term of the subscription
agreement. We record amounts billed to customers in excess of
recognizable revenue as deferred revenue on our balance sheet.
Upon expiration of the subscription, customers who wish to
re-subscribe typically must do so at then current rates to
continue using Websense Enterprise. Our revenue is significantly
influenced by subscription renewals, and a decrease in
subscription renewals amounts could negatively impact our
revenue.


Allowance for Doubtful Accounts.We maintain an allowance for doubtful
accounts for estimated losses resulting from the inability or
unwillingness of our customers to make required payments. If the
financial condition of our customers were to deteriorate,
resulting in an impairment of their ability to make payments,
additional allowances may be required.

Deferred Tax Assets.As required by Statement of Financial
Accounting Standards No. 109 (FAS 109), we
recognize tax assets on the balance sheet if it is more
likely than not that they will be realized on future tax
returns. At December 31, 2001, we had provided a full
valuation allowance against accumulated deferred tax assets of
$14.3 million, reflecting the uncertainty associated with
our future profitability. During 2002, we reassessed the
valuation allowance previously established against U.S. deferred
tax assets. Factors considered by us included: our earnings
history, projected earnings based on current operations, and
projected future taxable income in excess of stock option
deductions. Based on this evidence, we concluded that it is more
likely than not that the U.S. deferred tax assets would be
realized. Accordingly, we released the full valuation allowance
of $14.3 million, which resulted in an income tax benefit
of approximately $9.3 million. The remaining
$5.0 million was credited to additional paid-in capital as
it related to the tax benefit of stock option deductions.
However, should we determine that we would not be able to
realize all or part of our deferred tax assets in the future, an
adjustment to the deferred tax assets would be charged against
income in the period such determination was made. As of
December 31, 2002, we had $15.4 million in deferred
tax assets. See Note 9 of Notes to the Consolidated Financial
Statements for an explanation of our deferred tax assets.

Results of Operations

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

|                                     |                                          |                          |     |      |    |      |     |    |    |   |     |    |     |  
|------------------------------------ | ---------------------------------------- | ------------------------ | --- | ---- | -- | ---- | --- | -- | -- | - | --- | -- | --- | -
|                                     |                                          |                         
|                                     |                                          | Years ended             
|                                     |                                          | December 31,            
|                                     |                                          |                         
|                                     |                                          | 2002                     |     | 2001 |    | 2000
|                                     |                                          |                          |     |      |    |     
|Revenues                             |                                          |                          | 100 | %    |    |      | 100 | %  |    |   | 100 | % 
|Cost of revenues                     |                                          |                          | 7   | %    |    |      | 10  | %  |    |   | 16  | % 
|                                     |                                          |                          |     |      |    |      |     |    |    |   |     |   
|Gross margin                         |                                          |                          | 93  | %    |    |      | 90  | %  |    |   | 84  | % 
|Operating expenses:                  |                                          |                          |     |      |    |      |     |    |    |   |     |   
|                                     | Selling and marketing                    |                          |     | 43   | %  |      |     | 55 | %  |   |     | 73 | %  
|                                     | Research and development                 |                          |     | 18   | %  |      |     | 21 | %  |   |     | 36 | %  
|                                     | General and administrative               |                          |     | 9    | %  |      |     | 15 | %  |   |     | 20 | %  
|                                     | Amortization of stock-based compensation |                          |     | 1    | %  |      |     | 2  | %  |   |     | 11 | %  
|                                     |                                          |                          |     |      |    |      |     |    |    |   |     |   
|                                     |                                          | Total operating expenses |     |      | 71 | %    |     |    | 93 | % |     |    | 140 | %
|                                     |                                          |                          |     |      |    |      |     |    |    |   |     |   
|Income (loss) from operations        |                                          |                          | 22  | %    |    |      | (3  | %) |    |   | (56 | %)
|Other income, net                    |                                          |                          | 4   | %    |    |      | 12  | %  |    |   | 22  | % 
|                                     |                                          |                          |     |      |    |      |     |    |    |   |     |   
|Income (loss) before income taxes    |                                          |                          | 26  | %    |    |      | 9   | %  |    |   | (34 | %)
|Provision (benefit) for income taxes |                                          |                          | (1  | %)   |    |      | 0   | %  |    |   | 0   | % 
|                                     |                                          |                          |     |      |    |      |     |    |    |   |     |   
|Net income (loss)                    |                                          |                          | 27  | %    |    |      | 9   | %  |    |   | (34 | %)
|                                     |                                          |                          |     |      |    |      |     |    |    |   |     |   

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Years ended December 31,
2002 and 2001

Revenue

Revenue increased from $35.9 million in 2001
to $61.0 million in 2002. This increase was primarily a
result of the addition of new customers. Approximately 53% of
subscription revenue recognized in 2002 was derived from sales
to first-time customers, who initially purchased one-, two-, or
three-year subscriptions to Websense Enterprise in 2002 or prior
years. The remaining 47% of subscription revenue was generated
from renewal business with existing customers. We expect revenue
to grow at a slower rate in 2003 than we did in 2002,
principally as a result of the larger revenue base at year-end
2002 compared with year-end 2001 and declining global economic
factors.

Cost of Revenue

Cost of revenue consists of the costs of content
review, technical support and infrastructure costs associated
with maintaining our databases. Cost of revenue increased from
$3.6 million in 2001 to $4.2 million in 2002. The
increase was primarily due to the costs associated with
additional personnel in our technical support group. We expect
cost of revenue to increase in the future as we support the
growth and maintenance of our databases as well as the technical
support needs of our customers. As a percentage of revenue, cost
of revenue decreased from 10% in 2001 to 7% in 2002. This
decrease was primarily due to benefits derived from the
automation of database search and support processes as well as
the leveraging of database and technical support costs over a
larger revenue base. We expect that cost of revenue, as a
percentage of revenue, will remain below 10% of revenue for the
foreseeable future.

Gross Margin

Gross margin increased from $32.3 million in
2001 to $56.8 million in 2002. The increase was primarily
due to increased revenue. As a percentage of revenue, gross
margin increased from 90% in 2001 to 93% in 2002. This increase
was primarily due to benefits derived from the automation of
database search and support processes as well as the leveraging
of database and technical support costs over a larger revenue
base. We expect that gross margin, as a percentage of revenue,
will remain in excess of 90% of revenue for the foreseeable
future.

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, along with costs related to public relations,
investor relations, advertising, promotions and travel as well
as allocated facilities costs and depreciation expenses. Selling
and marketing expenses increased from $19.7 million in 2001
to $26.2 million in 2002. The increase in selling and
marketing expenses of $6.5 million was primarily due to
increased headcount costs and increased advertising and
promotional activities in North America, Europe and Asia. We
expect selling and marketing expenses to increase in the future
as more personnel are added to support our expanding selling and
marketing efforts worldwide.

Research and development.Research and development expenses
consist primarily of salaries and benefits for software
developers, contract programmers, allocated facilities costs and
equipment depreciation. Research and development expenses
increased from $7.6 million in 2001 to $11.0 million
in 2002. The increase of $3.4 million in research and
development expenses was primarily a result of personnel and
consultants added since 2001 to support our expanded list of
technology partners, enhancements of Websense Enterprise,
including the development of Websense Enterprise Version 5, and
additional products. We expect research and development expenses
to increase in the future, as more personnel are added to
support additional technology partners, enhancements of Websense
Enterprise and expansion of our product offerings.

General and
administrative.General and
administrative expenses consist primarily of salaries, benefits
and related expenses for our executive, finance, human resources
and administrative personnel, third party professional service
fees and allocated facilities and depreciation expenses. General
and administrative

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expenses increased from $5.4 million in 2001
to $6.0 million in 2002. The $0.6 million increase in
general and administrative expenses in 2002 is primarily due to
the addition of personnel to support our growing operations,
both domestically and internationally, higher state sales tax
expenses, higher foreign income tax consulting expenses, as well
as higher infrastructure costs in Europe. We expect general and
administrative expenses to increase in future periods,
reflecting growth in operations and increasing expenses
associated with being a public company and expansion of our
international operations.


Amortization of stock-based
compensation.Amortization of
stock-based compensation decreased from $860,000 in 2001 to
$448,000 in 2002. The decrease in the amortization expense in
2002 is primarily resulting from the accelerated method of
amortization used that resulted in higher expense in 2001 as
compared with 2002. We expect amortization of stock-based
compensation to decrease in future periods as a result of using
the accelerated method of amortization.

Other Income, Net

Net other income decreased from $4.5 million
in 2001 to $2.7 million in 2002. The decrease is due
primarily to lower interest income due to lower interest rates
earned by our cash, cash equivalents and marketable securities
despite increased balances as of December 31, 2002 as
compared with December 31, 2001.

Provision for Income
Taxes

In 2001, provision for income taxes of $108,000
related to our wholly-owned subsidiary in the United Kingdom.
During 2002, we recorded an income tax benefit of $797,000,
primarily attributable to the release of the valuation allowance
against our deferred tax assets. Our 2002 provision for income
taxes includes income taxes related to our wholly-owned
subsidiaries in the United Kingdom, Japan and Australia as well
as several domestic state income taxes. The release of our
valuation allowance offset these taxes as well as the provision
for federal and California income taxes. The result was a net
benefit of $797,000 and an effective benefit rate of 5% for 2002.

We expect an effective tax rate of 40% in 2003 as
a result of the full utilization of our deferred tax assets in
2002. Subsequent to 2003, we anticipate that our effective tax
rate may decrease over time due to benefits derived from lower
tax rates associated with foreign income.

Years ended December 31,
2001 and 2000

Revenue

Revenue increased from $17.4 million in 2000
to $35.9 million in 2001. This increase was primarily a
result of the addition of new customers. Approximately 66% of
subscription revenue recognized in 2001 was derived from sales
to first-time customers, who initially purchased one-, two-, or
three-year subscriptions to Websense Enterprise in 2001 or prior
years. The remaining 34% of subscription revenue was generated
from renewal business with existing customers.

Cost of Revenue

Cost of revenue increased from $2.7 million
in 2000 to $3.6 million in 2001. This increase was
primarily due to the costs associated with additional personnel
in our database and technical support groups. Cost of revenue as
a percentage of revenue decreased to 10% in 2001 from 16% in
2000. The decrease in the percentage of revenue was due to the
increase in revenue and economies of scale achieved relative to
the associated costs.

Gross Margin

Gross margin increased from $14.7 million in
2000 to $32.3 million in 2001. The increase was primarily
due to increased revenue and, to a lesser extent, the leveraging
of database and technical support costs over a larger revenue
base.

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Operating Expenses

Selling and
marketing.Selling and marketing
expenses increased from $12.7 million in 2000 to
$19.7 million in 2001. The increase in selling and
marketing expenses in 2001 of $7.0 million was primarily
due to increased headcount costs, increased commission expenses
resulting from increased sales of pre-paid subscriptions (also
referred to as billings), and increased advertising and
promotional activities in North America, Europe and Asia Pacific.

Research and
development.Research and development
expenses increased from $6.3 million in 2000 to
$7.6 million in 2001. The increase of $1.3 million in
research and development expenses was primarily a result of
personnel added in 2001 to support our expanding list of
technology partners as well as the growing feature set of
Websense Enterprise.

General and
administrative.General and
administrative expenses increased from $3.5 million in 2000
to $5.4 million in 2001. The $1.9 million increase in
general and administrative expenses in 2001 was primarily due to
increased professional service fees, increased personnel and
facility costs related to our wholly-owned subsidiary in the
United Kingdom, increased third-party administrative and
accounting costs related to our wholly-owned international
subsidiaries, and also included increased compensation costs for
our executive officers, increased insurance premiums, increased
bad debt expense and other increased costs associated with being
a public company.

Amortization of stock-based
compensation.Amortization of
stock-based compensation decreased from $1.9 million in
2000 to $860,000 in 2001. The decrease in the amortization
expense in 2001 was primarily due to the accelerated method of
amortization used that resulted in higher expense in 2000 as
compared with 2001.

Other Income, Net

Net other income increased from $3.8 million
in 2000 to $4.5 million in 2001. The increase was due
primarily to higher interest income. The higher interest income
was driven by larger invested balances resulting from the
interest earned on the net proceeds from our initial public
offering, which closed in March 2000 (net proceeds were invested
for 12 months in 2001 as compared with 9 months in
2000), as well as investment of our positive operating cash flow.

Provision for Income
Taxes

In 2000, there was no provision for income taxes.
During 2001, we incurred estimated income taxes of $108,000
related to our wholly-owned subsidiary in the
United Kingdom. We did not incur income taxes related to
our operations in the United States due to the utilization
of our deferred tax assets that we recorded in prior periods.

Liquidity and Capital
Resources

From our inception through March 2000, we
financed our operations primarily through the sale of preferred
equity securities. In total, we raised approximately
$15.5 million, net of fees and expenses, through the sale
of preferred equity securities. In March 2000, we closed
our initial public offering with proceeds, net of underwriting
fees and offering expenses, of approximately $65.7 million.

As of December 31, 2002, we had cash and
cash equivalents of $61.7 million and investments in
marketable securities of $78.8 million and an accumulated
deficit of $957,000.

Net cash provided by operating activities was
$33.6 million in 2002 compared with $20.8 million in
2001 and $7.7 million in 2000. In 2002, cash provided by
operating activities was primarily due to an increase in net
income, which includes interest earnings on our invested cash,
and an increase in our subscriptions (which are initially
recorded as deferred revenue). In 2001 and 2000, cash provided
by operating activities was primarily due to an increase in our
subscriptions and interest earnings on our invested cash. Our
operating cash flow and

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revenue are significantly influenced by
subscription renewals, and a decrease in subscription renewals
would negatively impact our operating cash flow and revenue.


Net cash used in investing activities was
$1.1 million in 2002 compared with $12.8 million in
2001 and $70.2 million in 2000. The relative decrease in
cash used in investing activities in 2002 is primarily due to
maturities of marketable securities exceeding purchases of
marketable securities. The relative decrease in cash used in
investing activities in 2001 is primarily due to purchases of
marketable securities mainly using positive operating cash flow
whereas we utilized the proceeds of our initial public offering
in March 2000 as well as positive operating cash flow to
purchase marketable securities during 2000.

Net cash provided by financing activities was
$5.5 million in 2002 compared with $2.6 million in
2001 and $64.9 million in 2000. Cash provided by financing
activities in 2002 and 2001 was primarily due to proceeds
received from the exercise of stock options as well as the
issuance of common stock pursuant to our employee stock purchase
plan. Cash provided by financing activities in 2000 was
primarily due to net proceeds of $65.7 million from the
completion in March 2000 of our initial public offering,
reduced by the $1.5 million repayment of our outstanding
equipment financing notes payable in the second quarter of 2000.

At December 31, 2002, existing or future
letters of credit totaled $64,000. We have operating lease
commitments of $1.1 million in 2003, $1.2 million in 2004,
$1.2 million in 2005, $1.2 million in 2006 and
$1.3 million in 2007. A significant majority of our
operating lease commitments are related to our corporate
headquarters lease, which was renewed in April 2002. The lease
renewal incentives resulted in no rent payments in the third and
fourth quarters of 2002 and escalating rent payments from 2004
to 2007. The rent expense related to our corporate headquarters
lease renewal will be recorded monthly on a straight-line basis
in accordance with generally accepted accounting principles.

We believe that our cash and cash equivalents
balances and investments in marketable securities will be
sufficient to satisfy our cash requirements for at least the
next 12 months. We intend to continue to invest our cash in
excess of current operating requirements in interest bearing,
investment-grade securities. If existing cash is insufficient to
satisfy our liquidity requirements, we may seek to sell
additional equity or debt securities. The sale of additional
equity or convertible debt securities would result in additional
dilution to our stockholders. Additional debt would result in
increased expenses and could result in covenants that would
restrict our operations. We have not made arrangements to obtain
additional financing and there is no assurance that financing,
if required, will be available in amounts or on terms acceptable
to us, if at all.

Summarized Quarterly Data
(Unaudited)

The following tables present unaudited quarterly
financial information for the eight quarters ended
December 31, 2002. We believe this information reflects all
adjustments (consisting only of normal recurring adjustments)
that we consider necessary for a fair presentation of such
information in accordance with generally accepted accounting
principles. The results for any quarter are not necessarily
indicative of results for any future period.

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|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|---------------------------------- |  | ------------------------------------- | ------ | ----------- |  | ----------- | ------ | ----------- |  | - | ------ |  |  | - | ------ | 
|                                   |  | 1st Quarter                           |        | 2nd Quarter |  | 3rd Quarter |        | 4th Quarter
|                                   |  |                                       |        |             |  |             |        |            
|                                   |  |                                      
|                                   |  | (In thousands, except per share data)
|2002                               |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|Net revenue                        |  | $                                     | 13,035 |             |  | $           | 14,550 |             |  | $ | 16,005 |  |  | $ | 17,375 | 
|Gross margin                       |  |                                       | 12,102 |             |  |             | 13,489 |             |  |   | 14,924 |  |  |   | 16,280 | 
|Income from operations             |  |                                       | 2,029  |             |  |             | 3,119  |             |  |   | 3,653  |  |  |   | 4,428  | 
|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|Net income                         |  | $                                     | 2,656  |             |  | $           | 3,546  |             |  | $ | 4,038  |  |  | $ | 6,497  | 
|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|Basic income per share(1)          |  | $                                     | 0.13   |             |  | $           | 0.17   |             |  | $ | 0.19   |  |  | $ | 0.30   | 
|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|Diluted income per share(1)        |  | $                                     | 0.11   |             |  | $           | 0.15   |             |  | $ | 0.18   |  |  | $ | 0.28   | 
|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|2001                               |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|Net revenue                        |  | $                                     | 6,861  |             |  | $           | 8,203  |             |  | $ | 9,549  |  |  | $ | 11,280 | 
|Gross margin                       |  |                                       | 6,044  |             |  |             | 7,366  |             |  |   | 8,638  |  |  |   | 10,243 | 
|Income (loss) from operations      |  |                                       | (1,458 | )           |  |             | (1,224 | )           |  |   | 845    |  |  |   | 561    | 
|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|Net income (loss)                  |  | $                                     | (387   | )           |  | $           | (13    | )           |  | $ | 1,873  |  |  | $ | 1,643  | 
|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|Basic income (loss) per share(1)   |  | $                                     | (0.02  | )           |  | $           | (0.00  | )           |  | $ | 0.09   |  |  | $ | 0.08   | 
|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 
|Diluted income (loss) per share(1) |  | $                                     | (0.02  | )           |  | $           | (0.00  | )           |  | $ | 0.08   |  |  | $ | 0.07   | 
|                                   |  |                                       |        |             |  |             |        |             |  |   |        |  |  |   |        | 






|    |                                                                                                                                                                                                                                                                                                                                                
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Basic and diluted net income (loss) per
    share computations for each quarter are independent and may not
    add up to the net loss per share computation for the respective
    year. See Note 1 of Notes to the Consolidated Financial
    Statements for an explanation of the determination of basic and
    diluted net loss per share.

Risks and Uncertainties

You should carefully consider the following
information in addition to other information in this report
before you decide to purchase our common stock. 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. If any of these or other risks actually
occurs, the trading price of our common stock could decline, and
you may lose all or part of your investment.



| |                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Because we expect to derive substantially all
    of our future revenue from subscription fees for Websense
    Enterprise, any failure of this product to satisfy customer
    demands or to achieve more widespread market acceptance will
    seriously harm our business.

Substantially all of our revenue comes from
subscriptions to Websense Enterprise and we expect this trend
will continue for the foreseeable future. As a result, if for
any reason revenue from Websense Enterprise declines or does not
grow as rapidly as we anticipate, our operating results and our
business will be significantly impaired. If Websense Enterprise
fails to meet the needs of our existing and target customers, or
if it does not compare favorably in price and performance to
competing products, our growth will be limited. Many of our
competitors are seeking to compete with us by aggressively
reducing the price of their products. Websense Enterprise may
not achieve continued market acceptance. Our future financial
performance also will depend, in part, on our ability to
diversify our offerings by successfully developing, introducing
and gaining customer acceptance of new products and enhanced
versions of Websense Enterprise, including Websense Enterprise
Version 5 which was released in March 2003 and add-on
application modules such as Client Application Manager and
Bandwidth Optimizer. We may not be successful in achieving
market acceptance of any new products that we develop or of
enhanced versions of Websense Enterprise. Any failure or delay
in diversifying our existing offerings could harm our business,
results of operations and financial condition.

22



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| |                                                                                                                                      
| | -------------------------------------------------------------------------------------------------------------------------------------
| | Our future success depends on our existing
    customers renewing and purchasing additional subscriptions to
    Websense Enterprise.

Our future success depends on achieving
substantial revenue from customer renewals for subscriptions to
Websense Enterprise. Subscriptions for Websense Enterprise
typically have durations of 12, 24 or 36 months. Our
customers have no obligation to renew their subscriptions upon
expiration. We may be unable to generate significant revenue
from renewals. In order to maintain our revenue we must be
successful in selling renewal subscriptions.

Our future success also depends on our ability to
sell further subscriptions to existing customers in order to add
additional seats within their respective organizations. As a
result, to increase our revenue we must sell our existing
customers additional subscriptions for Websense Enterprise to
get greater coverage of their workforces. This may require
increasingly costly sales efforts targeting senior management
and other management personnel associated with our
customers Internet infrastructure.



| |                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We face increasing competition, which has
    placed pressure on our pricing and which could prevent us from
    increasing revenue or maintaining profitability. In addition, we
    may face competition from better-established 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 competitors frequently offer their
products at a significantly lower price than Websense
Enterprise, which has resulted in pricing pressures on sales of
our product and potentially could result in the commoditization
of employee Internet management, or EIM, products. If we are
unable to maintain the current pricing on sales of Websense
Enterprise or increase our pricing in the future, our
profitability could be negatively impacted. In addition, pricing
pressures and increased competition generally could result in
reduced sales, reduced margins or the failure of Websense
Enterprise 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 network filtering products,
    such as SurfControl plc, Secure Computing, Symantec Corporation,
    N2H2 Incorporated, 8e6 Technologies, Webwasher and Elron
    Software, Inc.; and
|
| |  | companies offering network reporting products,
    such as NetIQ and Wavecrest Computing.                                                                                                               

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 EIM or other competitive products with
their products. We compete against, and expect increased
competition from, anti-virus software developers, traditional
network management software developers and Web management
service providers. As we introduce new products, such as Client
Application Manager and Bandwidth Optimizer, we may face new
competition from companies offering quality of service solutions
(such as Packeteer) and companies with a direct presence on
computer desktops (such as Microsoft). If EIM functions become
standard features of Internet-related hardware or software, the
demand for Websense Enterprise will decrease. Furthermore, even
if Websense Enterprise provides greater functionality and is
more effective than certain other competitive products,
potential customers might accept this limited functionality in
lieu of purchasing Websense Enterprise. In addition, our own
indirect sales channels may decide to develop or sell competing
products instead of Websense Enterprise. Many of our potential
competitors enjoy substantial competitive advantages, such as:



| |   |                                                                                 
| | - | --------------------------------------------------------------------------------
| |  | 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, they may be able to respond more
quickly and effectively than we can to new or changing
opportunities, technologies, standards or customer requirements.
For all of the foregoing reasons, we may not be able to compete
successfully against our current and future competitors.

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| |                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Sales to customers outside the United States
    have accounted for a significant portion of our revenue, and we
    expect this trend to continue, which exposes us to risks
    inherent in international sales.

We market and sell our products outside the
United States through value-added resellers, distributors and
other resellers. International sales represented approximately
32% of our total revenue in 2002 and approximately 35% in 2001,
although international sales increased 35% in absolute dollars
in 2002 compared with 2001. As a key component of our business
strategy, we intend to expand our international sales but, as
evidenced by the recent decline of our international sales as a
percentage of our total sales mix, success cannot be assured. In
addition to the risks associated with our domestic sales, our
international sales are subject to the following risks:



| |   |                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | dependence on foreign distributors and their
    sales channels;                                                                                            
|
| |  | localization of our Websense Enterprise products
    and our products ability to properly categorize and filter
    Web sites containing foreign languages;
|
| |  | laws and business practices favoring local
    competitors;                                                                                                 
|
| |  | compliance with multiple, conflicting and
    changing governmental laws and regulations, including tax laws
    and regulations;                           
|
| |  | foreign currency fluctuations;                                                                                                                              
|
| |  | longer accounts receivable payment cycles and
    other collection difficulties; and                                                                        
|
| |  | regional economic and political conditions.                                                                                                                 

Such factors could have a material adverse effect
on our future international sales. Any further reduction in
international sales, or our failure to further develop our
international distribution channels, could have a material
adverse effect on our business, results of operations and
financial condition. Our international revenue is currently
denominated in U.S. dollars. As a result, fluctuations in the
value of the U.S. dollar and foreign currencies may make
Websense Enterprise more expensive for international customers,
which could harm our business. We do not currently engage in
currency hedging activities to limit the risk of exchange rate
fluctuation.



| |                                                                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The market for our products continues to
    emerge, and if we are not successful in promoting awareness of
    the need for Websense Enterprise and of our Websense brand, our
    growth may be limited.

Based on our experience with potential customers,
we believe that many corporations do not recognize or
acknowledge the existence or scope of problems caused by
employee misuse of the Internet or of their computers. In
addition, there may be a time-limited opportunity to achieve and
maintain a significant share of the market for EIM and our other
products due in part to the emerging nature of these markets and
the substantial resources available to our existing and
potential competitors. If employers do not recognize or
acknowledge these problems, then the market for Websense
Enterprise may develop more slowly than we expect, which could
adversely affect our operating results. Developing and
maintaining awareness of our Websense brand is critical to
achieving widespread acceptance of our existing and future
products. Furthermore, we believe that the importance of brand
recognition will increase as competition in our market develops.
Successful promotion of our Websense brand will depend largely
on the effectiveness of our marketing efforts and on our ability
to develop reliable and useful products at competitive prices.
If we fail to successfully promote our Websense brand, or if our
expenses to promote and maintain our Websense brand are greater
than anticipated, our results of operations and financial
condition could suffer.



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

We expect that nearly all of our revenue for the
foreseeable future will come from subscriptions to Websense
Enterprise. Upon execution of a subscription agreement, we
invoice our customers for the full term of the subscription
agreement. We then recognize revenue from customers monthly over
the terms of their

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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 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
Websense Enterprise.




| |                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 Websense
Enterprise is designed to operate with a variety of network
hardware and software platforms, we will need to continuously
modify and enhance Websense Enterprise 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 timely introducing them to the
market. 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.



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

Our quarterly operating results have varied
significantly in the past, and will likely vary in the future
primarily as the result of fluctuations in our billings,
revenues and operating expenses. 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. 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:



| |   |                                                                                                                          
| | - | -------------------------------------------------------------------------------------------------------------------------
| |  | concentration of marketing expenses for
    activities such as trade shows and advertising campaigns;                    
|
| |  | concentration of general and administrative
    expenses, such as recruiting expenses and professional services
    fees;
|
| |  | concentration of research and development
    costs; and                                                                 
|
| |  | concentration of expenses associated with
    commissions paid on sales of subscriptions to Websense
    Enterprise.     

As a result, 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 Websense Enterprise, including
    fluctuations in subscription renewals;          
|
| |  | fluctuations in revenue from our indirect sales
    channels;                                 
|
| |  | changes in the pricing policies of our
    competitors; and                                   
|
| |  | changes in government regulations.                                                            

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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;                                                                       
|
| |  | quarterly variations in our revenues and
    operating expenses; and                                   
|
| |  | our technological capabilities to accommodate the
    future growth in our operations or our customers.

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.



| |                                                                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we acquire any companies or technologies in
    the future, they could prove difficult to integrate, disrupt our
    business, dilute stockholder value and adversely affect our
    operating results.

We may acquire or make investments in
complementary companies, services and technologies in the
future. We have not made any acquisitions or investments to
date, and therefore our ability as an organization to make
acquisitions or investments is unproven.

Acquisitions and investments involve numerous
risks, including:



| |   |                                                                                        
| | - | ---------------------------------------------------------------------------------------
| |  | difficulties in integrating operations,
    technologies, services and personnel;      
|
| |  | diversion of financial and management resources
    from existing operations;          
|
| |  | risk of entering new markets;                                                          
|
| |  | potential loss of key employees; and                                                   
|
| |  | inability to generate sufficient revenue to
    offset acquisition or investment costs.

In addition, if we finance acquisitions by
issuing convertible debt or equity securities, our existing
stockholders may be diluted which could affect the market price
of our stock. As a result, if we fail to properly evaluate and
execute acquisitions or investments, our business and prospects
may be seriously harmed.



| |                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------
| | We must develop and expand our indirect sales
    channels to increase revenue and improve our operating
    results.

We currently sell a significant majority of our
products indirectly. We intend to continue to rely on our
indirect sales channels for a significant majority of revenue.
We depend on our indirect sales channels, including value-added
resellers, distributors, and providers of managed Internet
services, to offer Websense Enterprise to a larger customer base
than can be reached through a direct sales effort. We will need
to expand our existing relationships and enter into new
relationships to increase our current and future market share
and revenue. We may be unable to maintain and expand our
existing relationships or enter into new relationships on
commercially reasonable terms or at all. If we are unable to
maintain and expand our existing relationships or enter into new
relationships, we would lose customer introductions and
co-marketing benefits and our operating results could suffer.



| |                                                                                                                                                                                                             
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our reliance on indirect sales channels could
    result in reduced revenue growth because we have little control
    over our value-added resellers, distributors and original
    equipment manufacturers.

Our indirect sales channels accounted for more
than 75% of our revenue in 2002 and for more than 80% of our
revenue in 2001. We anticipate that sales from our various
indirect sales channels, including value-

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added resellers, distributors, providers of
managed Internet services and others, will continue to account
for a significant majority of our total revenue in future
periods. None of these parties is obligated to continue selling
our products or to make any purchases from us. Our ability to
generate increased revenue depends significantly upon the
ability and willingness of our indirect sales channels to market
and sell our products to organizations worldwide. If they are
unsuccessful in their efforts or are unwilling or unable to
market and sell our new product offerings such as Client
Application Manager, our operating results will suffer. We
cannot control the level of effort these parties expend or the
extent to which any of them will be successful in marketing and
selling our products. A number of our value-added resellers and
distributors have been adversely affected by the current global
economic downturn and we believe that their financial
difficulties may negatively impact their ability to sell and
market Websense Enterprise. Some of our indirect sales channels
also market and sell products that compete with Websense
Enterprise or may decide to do so in the future. We may not be
able to prevent these parties from devoting greater resources to
support our competitors products and/or eliminating their
efforts to sell Websense Enterprise.




| |                                                                                                                                                           
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------
| | We have a history of losses and, because we
    expect our operating expenses to increase in the future, we may
    not be able to maintain profitability.

In 2001, we achieved profitability for the first
time since 1996. Prior to the third quarter of 2001, we had
experienced net losses in each of our previous 21 fiscal
quarters, and as of December 31, 2002, we had an
accumulated deficit of $957,000. We may be unable to maintain
profitability unless our revenue continues to increase at a
greater rate than our operating expenses. We currently expect
our operating expenses to increase substantially, as we, among
other things:



| |   |                                                                                                                                  
| | - | ---------------------------------------------------------------------------------------------------------------------------------
| |  | expand our domestic and international selling and
    marketing activities;                                                      
|
| |  | expand our product offerings;                                                                                                    
|
| |  | increase our research and development efforts to
    upgrade our existing products and develop new products and
    technologies;
|
| |  | develop and expand our proprietary database and
    systems;                                                                     
|
| |  | upgrade our operational and financial systems,
    procedures and controls; and                                                  
|
| |  | hire additional personnel, including sales and
    marketing personnel, engineers and other technical staff.                     

We will need to increase our revenue to maintain
profitability. If we fail to increase revenue from subscription
fees for Websense Enterprise, we may experience losses in future
quarters. If we continue to grow, we also may fail to accurately
estimate and assess the associated increase in our operating
expenses. If our operating expenses exceed our
expectations, our financial performance will be adversely
affected.



| |                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------
| | We are an early-stage company with an unproven
    business model, which makes it difficult to evaluate our current
    business and future prospects.

We have only a limited operating history upon
which to base an evaluation of our current business and future
prospects. We began offering our EIM software in September 1996,
but only since May 1998, when we released our first version of
Websense Enterprise as a significant enhancement to our original
product, have we directed a majority of our focus on this
market. We introduced Websense Enterprise Version 5 in March
2003 along with the add-on application modules Client
Application Manager and Bandwidth Optimizer, and we have very
little data concerning market acceptance of these new products.
As a result, the revenue and income potential of our business
and our market are unproven, particularly with respect to Client
Application Manager which represents a new area of business from
our traditional EIM products. In addition, we have very limited
historical data with respect to subscription renewals because we
sell subscriptions that range from one to three years in length
and have been selling Websense Enterprise for five years.
Further, because of our limited operating history and because
the market for our products is relatively new and rapidly
evolving, we have limited insight into trends that may emerge
and affect our business. We may make errors in predicting and
reacting to relevant business trends, which could harm our
business. In making an investment decision

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with respect to our stock, you should carefully
consider the risks, uncertainties and difficulties frequently
encountered by early-stage companies in new and rapidly evolving
markets such as ours. We may not be able to successfully address
any or all of these risks. Failure to adequately do so could
cause our business, results of operations and financial
condition to suffer.




| |                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Negative economic conditions in the United
    States and in the other countries and geographic areas in which
    we offer our products may negatively impact our ability to
    maintain profitability.

Since 2001, the United States and other
international markets in which we offer our products have
experienced a significant economic downturn. In addition, the
United States and other countries suffered significant acts of
hostility and terror, and are now facing the threat of future
acts of hostility. These or similar acts in the future, as well
as fears relating to the mere possibility of future acts of
hostility, may increase or prolong the negative economic
conditions. The economic downturn may impact our ability to
sustain profitability by:



| |   |                                                                                
| | - | -------------------------------------------------------------------------------
| |  | negatively affecting demand for our products and
    services;                 
|
| |  | decreasing the renewal rate of subscriptions by
    our existing customers; and
|
| |  | decreasing the strength of our indirect sales
    channels.                    

In addition, the economic downturn may force
companies to prioritize expenditures, and these companies may
decide not to purchase our product in a slowing economy. There
can be no certainty as to the degree or severity of the duration
of this downturn. We also cannot predict the extent and timing
of the impact of the economic downturn in the United States and
in other countries and geographic regions in which we conduct
our business.



| |                                                                                                                                                                     
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Any failure to protect our intellectual
    property rights could impair our ability to protect our
    proprietary technology and establish our Websense
    brand.

Intellectual property is critical to our success,
and we rely upon trademark, copyright and trade secret laws in
the United States and other jurisdictions as well as
confidentiality procedures and contractual provisions to protect
our proprietary technology and our Websense brand. Any of our
trademarks may be challenged by others or invalidated through
administrative process or litigation. We currently have no
issued patents and may be unable to obtain patent protection in
the future. In addition, any issued patents may not provide us
with any competitive advantages, or may be challenged by third
parties. Furthermore, legal standards relating to the validity,
enforceability and scope of protection of intellectual property
rights are uncertain. Effective patent, trademark, copyright and
trade secret protection may not be available to us in every
country in which our products are available. The laws of some
foreign countries may not be as protective of intellectual
property rights as United States 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 database of websites. Any such infringement or
misappropriation could have a material adverse effect on our
business, results of operations and financial condition.



| |                                                                                          
| | -----------------------------------------------------------------------------------------
| | We may be sued by third parties for alleged
    infringement of their proprietary rights.

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 the number of entrants into our
market increases, the possibility of an intellectual property
claim against us grows. Our technologies and products may not be
able to withstand any third-party claims or rights against their
use. Any intellectual property claims, with or without merit,
could be time-consuming and expensive to litigate or settle, and
could divert management attention from executing our business
plan.

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| |                                                                                                                                                                                                                                                                             
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our database categories and our process for
    classifying Web sites and software applications within those
    categories are subjective, and we may not be able to categorize
    Web sites and software applications in accordance with our
    customers expectations.

We may not succeed in accurately categorizing
Internet and application content to meet our customers
expectations. We rely upon a combination of automated filtering
technology and human review to categorize Web sites and software
applications in our proprietary databases. Our customers may not
agree with our determinations that particular Web sites and
software applications should be included or not included in
specific categories of our databases. In addition, it is
possible that our filtering processes may place objectionable
material in categories that are generally unrestricted by our
users Internet and computer access policies, which could
result in employees having access to such material in the
workplace. Any miscategorization could result in customer
dissatisfaction and harm our reputation. Furthermore, we select
our categories based on content we believe employers want to
manage. We may not now, or in the future, succeed in properly
identifying the categories of content that employers want to
manage. Any failure to effectively categorize and filter Web
sites and software applications according to our customers
expectations will impair the growth of our business and our
efforts to increase brand acceptance.



| |                                                                                                        
| | -------------------------------------------------------------------------------------------------------
| | Our databases may fail to keep pace with the
    rapid growth and technological change of the Internet.

The success of Websense Enterprise depends on the
breadth and accuracy of our databases. Although our databases
currently catalog more than four million Web sites and 67,000
software applications, they contain only a fraction of the
material available on the Internet. In addition, the total
number of Web sites and software applications is growing
rapidly, and we expect this rapid growth rate to continue in the
future. Our databases and database technologies may not be able
to keep pace with the growth in the number of Web sites and
software applications, especially the growing amount of content
utilizing foreign languages. Further, the ongoing evolution of
the Internet and computing environments will require us to
continually improve the functionality, features and reliability
of our databases. Because Websense Enterprise can only manage
access to Web sites and software applications included in our
databases, if our databases do not contain a meaningful portion
of relevant content, the effectiveness of Websense Enterprise
will be significantly diminished. Any failure of our databases
to keep pace with the rapid growth and technological change of
the Internet will impair the market acceptance of Websense
Enterprise, which in turn will harm our business, results of
operations and financial condition.



| |                                                                           
| | --------------------------------------------------------------------------
| | Future sales of our common stock may cause our
    stock price to decline.

The market price of our common stock could
decline as a result of sales by our existing stockholders of
large numbers of shares of our common stock or the perception
that such sales could occur. These sales also might make it more
difficult for us to sell equity securities in the future at a
time and at a price that we deem appropriate.



| |                                                                                                             
| | ------------------------------------------------------------------------------------------------------------
| | Our systems may be vulnerable to security
    risks or service disruptions that could harm our
    business.

Although we have taken measures to secure our
systems against security risks and other causes of disruption of
electronic services, our servers are vulnerable to physical or
electronic break-ins and service disruptions, which could lead
to interruptions, delays, loss of data or the inability to
process customer requests. Such events could be very expensive
to remedy, could damage our reputation and could discourage
existing and potential customers from using our products. We may
experience break-ins in the future. Any such events could
substantially harm our business, results of operations and
financial condition.

Because our products are complex and are deployed
in a wide variety of complex network environments, they 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
Websense Enterprise, and we may find such errors in the future,
including in Websense Enterprise Version 5, Client Application
Manager or Bandwidth Optimizer. The occurrence of errors could
adversely affect sales of

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our products, divert the attention of engineering
personnel from our product development efforts and cause
significant customer relations problems.




| |                                                                 
| | ----------------------------------------------------------------
| | Evolving regulation of the Internet may affect
    us adversely.

As Internet commerce continues to evolve,
increasing regulation by federal, state or foreign agencies
becomes more likely. Such regulation is likely in the areas of
user privacy, pricing, content and quality of products and
services. Taxation of Internet use or other charges imposed by
government agencies or by private organizations for accessing
the Internet may also be imposed. Laws and regulations applying
to the solicitation, collection or processing of personal or
consumer information could affect our activities. Furthermore,
any regulation imposing fees for Internet use could result in a
decline in the use of the Internet and the viability of Internet
commerce, which could have a material adverse effect on our
business, results of operations and financial condition.



| |                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------
| | The success of our business depends on the
    continued growth and acceptance of the Internet as a business
    tool.

Expansion in the sales of Websense Enterprise
depends on the continued acceptance of the Internet as a
communications and commerce platform for enterprises. The
Internet may not prove to be a viable commercial medium due to
inadequate development of the necessary infrastructure, such as
a reliable network backbone, or timely development of
complementary products, such as high-speed modems. Additionally,
the Internet could lose its viability as a business tool due to
delays in the development or adoption of new standards and
protocols to handle increased demands of Internet activity,
security, reliability, cost, ease-of-use, accessibility, and
quality-of-service. If the Internet does not continue to become
a widespread communications medium and commercial platform, the
demand for Websense Enterprise could be significantly reduced,
which could have a material adverse effect on our business,
results of operations and financial condition.



| |                                                                                   
| | ----------------------------------------------------------------------------------
| | Our products create risks of potential
    negative publicity and legal liability.

Because customers rely on Websense Enterprise to
manage employee behavior, any significant defects or errors in
our products may result in negative publicity or legal claims.
Negative publicity or legal claims could seriously harm our
business, results of operations and financial condition. In
addition, Websense Enterprises capability to report
Internet data retrieval requests and software application
execution requests along with the workstations from which they
originated may result in negative publicity or legal claims
based on potential privacy violations.



| |                                                                                                                                                                    
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 and
development personnel. 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.



| |                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our growth could strain our personnel and
    infrastructure resources, and if we are unable to implement
    appropriate controls and procedures to manage our growth, we may
    not be able to successfully implement our business
    plan.

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We are currently experiencing a period of rapid
growth in our operations, which has placed, and will continue to
place, a significant strain on our management, administrative,
operational and financial infrastructure. Our future success
will depend in part upon the ability of our senior management to
manage growth effectively. This will require us to hire and
train additional personnel to manage our expanding operations.
In addition, we will be required to continue to improve our
operational, financial and management controls and our reporting
systems and procedures. If we fail to successfully manage our
growth, we will be unable to execute our business plan.



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

To execute our growth plan, we must attract and
retain highly qualified personnel. We need to hire additional
personnel in virtually all operational areas, including selling
and marketing, research and development, operations and
technical support, customer service and administration.
Competition for these personnel is intense, especially for
engineers with high levels of experience in designing and
developing software and Internet-related products. We may not be
successful in attracting and retaining qualified personnel. We
have from time to time in the past experienced, and we expect to
continue to experience in the future, difficulty in hiring and
retaining highly skilled employees with appropriate
qualifications. 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.



| |                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------
| | 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 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 may have 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.



| |                                   
| | ----------------------------------
| | We do not intend to pay dividends.

We have not declared or paid any cash dividends
on our common stock since we have been a publicly-traded
company. We currently intend to retain any future cash flows
from operations to fund growth and, therefore, do not expect to
pay any dividends in the foreseeable future.

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|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    About Market Risk

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

We are exposed to changes in interest rates
primarily from our short-term available-for-sale investments.
Under our current policies, we do not use interest rate
derivative instruments to manage exposure to interest rate
changes. A hypothetical 100 basis point adverse move in interest
rates along the entire interest rate yield curve would not
materially affect the fair value of our interest sensitive
financial instruments at December 31, 2002. Declines in
interest rates over time will, however, reduce our interest
income.

We mitigate our foreign currency risks
principally by contracting primarily in U.S. dollars and
maintaining only nominal foreign currency cash balances. Working
funds necessary to facilitate the short-term operations of our
subsidiaries are kept in the local currencies in which they do
business. For the year ended December 31, 2002, all of our
billings, including those billed by our operations in Ireland,
were denominated in our functional currency, which is the
U.S. dollar.

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|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

REPORT OF ERNST & YOUNG LLP, INDEPENDENT
AUDITORS

The Board of Directors and Stockholders

Websense, Inc.


We have audited the accompanying consolidated
balance sheets of Websense, Inc. as of December 31, 2002
and 2001 and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended December 31, 2002. Our audits
also included the financial statement schedule listed in the
Index at Item 15(a)(1). These financial statements and
schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for
our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Websense, Inc. at
December 31, 2002 and 2001, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended December 31, 2002, in conformity with
accounting principles generally accepted in the United States.
Also, in our opinion, the related financial statement schedule,
when considered in relation to the basic financial statements
taken as a whole, presents fairly in all material respects the
information set forth therein.



| |                      
| | ---------------------
| | /S/ ERNST & YOUNG LLP

San Diego, California

January 17, 2003


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Websense, Inc.

Consolidated Balance Sheets

|                                         |                                                                                                                                                  |                                            |        |         |         |  |        |         |         | 
|---------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------ | ------------------------------------------ | ------ | ------- | ------- |  | ------ | ------- | ------- | 
|                                         |                                                                                                                                                  |                                           
|                                         |                                                                                                                                                  | December 31,                              
|                                         |                                                                                                                                                  |                                           
|                                         |                                                                                                                                                  | 2002                                       |        | 2001   
|                                         |                                                                                                                                                  |                                            |        |        
|                                         |                                                                                                                                                  |                                           
|                                         |                                                                                                                                                  | (In thousands,                            
|                                         |                                                                                                                                                  | except per share amounts)                 
|ASSETS                                  
|Current assets:                          |                                                                                                                                                  |                                            |        |         |         |  |        |        
|                                         | Cash and cash equivalents                                                                                                                        |                                            | $      | 61,713  |         |  | $      | 23,715  |        
|                                         | Marketable securities                                                                                                                            |                                            |        | 78,753  |         |  |        | 79,393  |        
|                                         | Accounts receivable, net of allowance for
    doubtful accounts of $180 and $334 at December 31, 2002 and
    2001                               |                                            |        | 19,840  |         |  |        | 12,001  |        
|                                         | Accounts receivable from a related party                                                                                                         |                                            |        |        |         |  |        | 525     |        
|                                         | Deferred income taxes                                                                                                                            |                                            |        | 8,731   |         |  |        |        |        
|                                         | Other current assets                                                                                                                             |                                            |        | 1,184   |         |  |        | 1,084   |        
|                                         |                                                                                                                                                  |                                            |        |         |         |  |        |        
|                                         |                                                                                                                                                  | Total current assets                       |        |         | 170,221 |  |        |         | 116,718 | 
|                                         | Property and equipment, net                                                                                                                      |                                            |        | 2,967   |         |  |        | 2,710   |        
|                                         | Deferred income taxes, less current portion                                                                                                      |                                            |        | 6,701   |         |  |        |        |        
|                                         | Deposits and other assets                                                                                                                        |                                            |        | 299     |         |  |        | 384     |        
|                                         |                                                                                                                                                  |                                            |        |         |         |  |        |        
|                                         |                                                                                                                                                  | Total assets                               |        | $       | 180,188 |  |        | $       | 119,812 | 
|                                         |                                                                                                                                                  |                                            |        |         |         |  |        |        
|LIABILITIES AND STOCKHOLDERS
    EQUITY
|Current liabilities:                     |                                                                                                                                                  |                                            |        |         |         |  |        |        
|                                         | Accounts payable                                                                                                                                 |                                            | $      | 761     |         |  | $      | 640     |        
|                                         | Accrued payroll and related benefits                                                                                                             |                                            |        | 3,627   |         |  |        | 2,750   |        
|                                         | Other accrued expenses                                                                                                                           |                                            |        | 4,410   |         |  |        | 2,264   |        
|                                         | Current portion of deferred revenue                                                                                                              |                                            |        | 46,964  |         |  |        | 31,218  |        
|                                         |                                                                                                                                                  |                                            |        |         |         |  |        |        
|                                         |                                                                                                                                                  | Total current liabilities                  |        |         | 55,762  |  |        |         | 36,872  | 
|Deferred revenue, less current portion   |                                                                                                                                                  |                                            | 17,715 |         |         |  | 12,260 |        
|Stockholders equity:                    |                                                                                                                                                  |                                            |        |         |         |  |        |        
|                                         | Common stock  $0.01 par value; 100,000
    shares authorized; 21,734 and 20,596 shares issued and
    outstanding at December 31, 2002 and 2001 |                                            |        | 217     |         |  |        | 206     |        
|                                         | Additional paid-in capital                                                                                                                       |                                            |        | 107,058 |         |  |        | 88,639  |        
|                                         | Deferred compensation                                                                                                                            |                                            |        | (83     | )       |  |        | (531    | )      
|                                         | Accumulated deficit                                                                                                                              |                                            |        | (957    | )       |  |        | (17,694 | )      
|                                         | Accumulated other comprehensive income                                                                                                           |                                            |        | 476     |         |  |        | 60      |        
|                                         |                                                                                                                                                  |                                            |        |         |         |  |        |        
|                                         |                                                                                                                                                  | Total stockholders equity                 |        |         | 106,711 |  |        |         | 70,680  | 
|                                         |                                                                                                                                                  |                                            |        |         |         |  |        |        
|                                         |                                                                                                                                                  | Total liabilities and stockholders equity |        | $       | 180,188 |  |        | $       | 119,812 | 
|                                         |                                                                                                                                                  |                                            |        |         |         |  |        |        

See accompanying notes.

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Websense, Inc.

Consolidated Statements of
Operations

|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |        |        | 
|------------------------------------ | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | ------ | ------ | ------ | 
|                                     |                                                                                                                                                                                                          |                          
|                                     |                                                                                                                                                                                                          | Years ended December 31, 
|                                     |                                                                                                                                                                                                          |                          
|                                     |                                                                                                                                                                                                          | 2002                      |        | 2001   |        | 2000
|                                     |                                                                                                                                                                                                          |                           |        |        |        |     
|                                     |                                                                                                                                                                                                          |                          
|                                     |                                                                                                                                                                                                          | (In thousands,           
|                                     |                                                                                                                                                                                                          | except per share amounts)
|Revenues                             |                                                                                                                                                                                                          | $                         | 60,965 |        |        | $    | 35,893 |        |        | $ | 17,441 |       
|Cost of revenues                     |                                                                                                                                                                                                          |                           | 4,170  |        |        |      | 3,602  |        |        |   | 2,707  |       
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|Gross margin                         |                                                                                                                                                                                                          |                           | 56,795 |        |        |      | 32,291 |        |        |   | 14,734 |       
|Operating expenses:                  |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|                                     | Selling and marketing (exclusive of $121, $192
    and $589 for the years ended December 31, 2002, 2001 and
    2000, respectively, reported below as amortization of
    stock-based compensation)      |                           |        | 26,201 |        |      |        | 19,707 |        |   |        | 12,726 |       
|                                     | Research and development (exclusive of $73, $139
    and $359 for the years ended December 31, 2002, 2001 and
    2000, respectively, reported below as amortization of
    stock-based compensation)    |                           |        | 10,957 |        |      |        | 7,642  |        |   |        | 6,287  |       
|                                     | General and administrative (exclusive of $254,
    $529 and $990 for the years ended December 31, 2002, 2001
    and 2000, respectively, reported below as amortization of
    stock-based compensation) |                           |        | 5,960  |        |      |        | 5,358  |        |   |        | 3,491  |       
|                                     | Amortization of stock-based compensation                                                                                                                                                                 |                           |        | 448    |        |      |        | 860    |        |   |        | 1,938  |       
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|                                     |                                                                                                                                                                                                          | Total operating expenses  |        |        | 43,566 |      |        |        | 33,567 |   |        |        | 24,442 | 
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|Income/(loss) from operations        |                                                                                                                                                                                                          |                           | 13,229 |        |        |      | (1,276 | )      |        |   | (9,708 | )     
|Other income, net                    |                                                                                                                                                                                                          |                           | 2,711  |        |        |      | 4,500  |        |        |   | 3,761  |       
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|Income (loss) before income taxes    |                                                                                                                                                                                                          |                           | 15,940 |        |        |      | 3,224  |        |        |   | (5,947 | )     
|Provision (benefit) for income taxes |                                                                                                                                                                                                          |                           | (797   | )      |        |      | 108    |        |        |   |       |       
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|Net income (loss)                    |                                                                                                                                                                                                          | $                         | 16,737 |        |        | $    | 3,116  |        |        | $ | (5,947 | )     
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|Net income (loss) per share:         |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|                                     | Basic net income (loss) per share                                                                                                                                                                        |                           | $      | 0.79   |        |      | $      | 0.16   |        |   | $      | (0.35  | )     
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|                                     | Diluted net income (loss) per share                                                                                                                                                                      |                           | $      | 0.72   |        |      | $      | 0.14   |        |   | $      | (0.35  | )     
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|                                     | Weighted average shares  basic                                                                                                                                                                          |                           |        | 21,211 |        |      |        | 20,082 |        |   |        | 16,882 |       
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       
|                                     | Weighted average shares  diluted                                                                                                                                                                        |                           |        | 23,338 |        |      |        | 22,780 |        |   |        | 16,882 |       
|                                     |                                                                                                                                                                                                          |                           |        |        |        |      |        |        |        |   |        |       

See accompanying notes.

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Websense, Inc.

Consolidated Statements of Stockholders
Equity

|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |        |  
|------------------------------------------------------------- | ---------------------------------------------------------- | --------------- | ------ | ------------ |  | ---------- | --- | -------- |  | ----------- | ------ | ------------- |  | ------------- | --- | ------ |  | ------ | ------- | - |  | - | ------ | - |  | - | ------- | ------ | - | - | --- | --- |  | - | ------- | ------ | -
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |       
|                                                              |                                                            | Convertible     |        |              |  |            |     |          |  |             |        | Accumulated   |  |              
|                                                              |                                                            | preferred stock |        | Common stock |  | Additional |     |          |  |             |        | other         |  | Total        
|                                                              |                                                            |                 |        |              |  | paid-in    |     | Deferred |  | Accumulated |        | comprehensive |  | stockholders
|                                                              |                                                            | Shares          |        | Amount       |  | Shares     |     | Amount   |  | capital     |        | compensation  |  | deficit       |     | income |  | equity
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |       
|                                                              |                                                            |                
|                                                              |                                                            | (In thousands) 
|Balance at December 31, 1999                                  |                                                            |                 | 7,037  |              |  | $          | 70  |          |  |             | 8,357  |               |  | $             | 84  |        |  | $      | 18,936  |   |  | $ | (2,585 | ) |  | $ | (14,863 | )      |   | $ |    |     |  | $ | 1,642   |       
|Issuance of common stock, net of offering costs
    of $6,281 |                                                            |                 |       |              |  |            |    |          |  |             | 4,000  |               |  |               | 40  |        |  |        | 65,680  |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 65,720  |       
|Conversion of preferred stock to common stock                 |                                                            |                 | (7,037 | )            |  |            | (70 | )        |  |             | 7,037  |               |  |               | 70  |        |  |        |        |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   |        |       
|Issuance of common stock upon exercise of options             |                                                            |                 |       |              |  |            |    |          |  |             | 219    |               |  |               | 2   |        |  |        | 101     |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 103     |       
|Issuance of common stock upon exercise of warrant             |                                                            |                 |       |              |  |            |    |          |  |             | 55     |               |  |               | 1   |        |  |        | 15      |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 16      |       
|Issuance of common stock for stock purchase plan              |                                                            |                 |       |              |  |            |    |          |  |             | 37     |               |  |               |    |        |  |        | 567     |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 567     |       
|Deferred compensation (net of forfeitures)                    |                                                            |                 |       |              |  |            |    |          |  |             |       |               |  |               |    |        |  |        | 812     |   |  |   | (812   | ) |  |   |        |        |   |   |    |     |  |   |        |       
|Amortization of deferred compensation                         |                                                            |                 |       |              |  |            |    |          |  |             |       |               |  |               |    |        |  |        |        |   |  |   | 1,938  |   |  |   |        |        |   |   |    |     |  |   | 1,938   |       
|Comprehensive income (loss):                                  |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|                                                              | Net loss                                                   |                 |        |             |  |            |     |         |  |             |        |              |  |               |     |       |  |        |         |  |  |   |        |  |  |   |         | (5,947 | ) |   |     |    |  |   |         | (5,947 | )
|                                                              | Unrealized gain on marketable securities                   |                 |        |             |  |            |     |         |  |             |        |              |  |               |     |       |  |        |         |  |  |   |        |  |  |   |         |       |   |   |     | 25  |  |   |         | 25     |  
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|                                                              | Comprehensive loss                                         |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         | (5,922 | )
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|Balance at December 31, 2000                                  |                                                            |                 |       |              |  |            |    |          |  |             | 19,705 |               |  |               | 197 |        |  |        | 86,111  |   |  |   | (1,459 | ) |  |   | (20,810 | )      |   |   | 25  |     |  |   | 64,064  |       
|Issuance of common stock upon exercise of options             |                                                            |                 |       |              |  |            |    |          |  |             | 782    |               |  |               | 8   |        |  |        | 1,553   |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 1,561   |       
|Issuance of common stock upon exercise of warrant             |                                                            |                 |       |              |  |            |    |          |  |             | 23     |               |  |               |    |        |  |        | 70      |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 70      |       
|Issuance of common stock for stock purchase plan              |                                                            |                 |       |              |  |            |    |          |  |             | 86     |               |  |               | 1   |        |  |        | 973     |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 974     |       
|Deferred compensation (net of forfeitures)                    |                                                            |                 |       |              |  |            |    |          |  |             |       |               |  |               |    |        |  |        | (68     | ) |  |   | 68     |   |  |   |        |        |   |   |    |     |  |   |        |       
|Amortization of deferred compensation                         |                                                            |                 |       |              |  |            |    |          |  |             |       |               |  |               |    |        |  |        |        |   |  |   | 860    |   |  |   |        |        |   |   |    |     |  |   | 860     |       
|Comprehensive income:                                         |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|                                                              | Net income                                                 |                 |        |             |  |            |     |         |  |             |        |              |  |               |     |       |  |        |         |  |  |   |        |  |  |   |         | 3,116  |   |   |     |    |  |   |         | 3,116  |  
|                                                              | Net change in unrealized gain on marketable
    securities |                 |        |             |  |            |     |         |  |             |        |              |  |               |     |       |  |        |         |  |  |   |        |  |  |   |         |       |   |   |     | 35  |  |   |         | 35     |  
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|                                                              | Comprehensive income                                       |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         | 3,151  |  
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|Balance at December 31, 2001                                  |                                                            |                 |       |              |  |            |    |          |  |             | 20,596 |               |  |               | 206 |        |  |        | 88,639  |   |  |   | (531   | ) |  |   | (17,694 | )      |   |   | 60  |     |  |   | 70,680  |       
|Issuance of common stock upon exercise of options             |                                                            |                 |       |              |  |            |    |          |  |             | 1,029  |               |  |               | 10  |        |  |        | 4,013   |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 4,023   |       
|Issuance of common stock for stock purchase plan              |                                                            |                 |       |              |  |            |    |          |  |             | 109    |               |  |               | 1   |        |  |        | 1,469   |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 1,470   |       
|Deferred compensation (net of forfeitures)                    |                                                            |                 |       |              |  |            |    |          |  |             |       |               |  |               |    |        |  |        |        |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   |        |       
|Amortization of deferred compensation                         |                                                            |                 |       |              |  |            |    |          |  |             |       |               |  |               |    |        |  |        |        |   |  |   | 448    |   |  |   |        |        |   |   |    |     |  |   | 448     |       
|Tax benefit of stock options                                  |                                                            |                 |       |              |  |            |    |          |  |             |       |               |  |               |    |        |  |        | 12,937  |   |  |   |       |   |  |   |        |        |   |   |    |     |  |   | 12,937  |       
|Comprehensive income:                                         |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|                                                              | Net income                                                 |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |  |  |   |        |  |  |   |         | 16,737 |   |   |     |    |  |   |         | 16,737 |  
|                                                              | Net change in unrealized gain on marketable
    securities |                 |        |             |  |            |     |         |  |             |        |              |  |               |     |       |  |        |         |  |  |   |        |  |  |   |         |       |   |   |     | 416 |  |   |         | 416    |  
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|                                                              | Comprehensive income                                       |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         | 17,153 |  
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       
|Balance at December 31, 2002                                  |                                                            |                 |       |              |  | $          |    |          |  |             | 21,734 |               |  | $             | 217 |        |  | $      | 107,058 |   |  | $ | (83    | ) |  | $ | (957    | )      |   | $ | 476 |     |  | $ | 106,711 |       
|                                                              |                                                            |                 |        |              |  |            |     |          |  |             |        |               |  |               |     |        |  |        |         |   |  |   |        |   |  |   |         |        |   |   |     |     |  |   |         |       

See accompanying notes.

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Websense, Inc.

Consolidated Statements of Cash
Flows

|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |        |         |       | 
|-------------------------------------------------------------------------------------------- | -------------------------------------------- | ------------------------------------- | ----------------------------------------- | ------ | ------- | ------ | ------- | ------ | ------- | ------ | ------- | ------ | ------- | ----- | 
|                                                                                             |                                              |                                      
|                                                                                             |                                              | Years Ended December 31,             
|                                                                                             |                                              |                                      
|                                                                                             |                                              | 2002                                  |                                           | 2001   |         | 2000  
|                                                                                             |                                              |                                       |                                           |        |         |       
|                                                                                             |                                              |                                      
|                                                                                             |                                              | (In thousands)                       
|Operating activities:                                                                        |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Net income (loss)                                                                            |                                              | $                                     | 16,737                                    |        |         | $      | 3,116   |        |         | $      | (5,947  | )     
|Adjustments to reconcile net income
    (loss) to net cash provided by operating activities: |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|                                                                                             | Depreciation                                 |                                       |                                           | 1,929  |         |        |         | 1,700  |         |        |         | 1,280  |        
|                                                                                             | Amortization of deferred compensation        |                                       |                                           | 448    |         |        |         | 860    |         |        |         | 1,938  |        
|                                                                                             | Deferred revenue                             |                                       |                                           | 21,201 |         |        |         | 18,991 |         |        |         | 12,893 |        
|                                                                                             | Tax benefit from exercise of stock options   |                                       |                                           | 12,937 |         |        |         |       |         |        |         |       |        
|                                                                                             | Changes in operating assets and liabilities: |                                       |                                           |        |         |        |         |        |         |        |         |        |        
|                                                                                             |                                              | Accounts receivable                   |                                           |        | (7,314  | )      |         |        | (4,928  | )      |         |        | (4,022  | )    
|                                                                                             |                                              | Deposits and other assets             |                                           |        | (15     | )      |         |        | (664    | )      |         |        | (306    | )    
|                                                                                             |                                              | Deferred income taxes                 |                                           |        | (15,432 | )      |         |        |        |        |         |        |        |      
|                                                                                             |                                              | Accounts payable                      |                                           |        | 121     |        |         |        | (175    | )      |         |        | 242     |      
|                                                                                             |                                              | Accrued payroll and related benefits  |                                           |        | 877     |        |         |        | 986     |        |         |        | 871     |      
|                                                                                             |                                              | Other accrued expenses                |                                           |        | 2,146   |        |         |        | 940     |        |         |        | 766     |      
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|                                                                                             |                                              |                                       | Net cash provided by operating activities |        |         | 33,635 |         |        |         | 20,826 |         |        |         | 7,715 | 
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Investing activities:                                                                        |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Purchase of property and equipment                                                           |                                              |                                       | (2,186                                    | )      |         |        | (1,617  | )      |         |        | (2,126  | )     
|Purchases of marketable securities                                                           |                                              |                                       | (91,513                                   | )      |         |        | (67,942 | )      |         |        | (70,213 | )     
|Maturities of marketable securities                                                          |                                              |                                       | 92,569                                    |        |         |        | 56,737  |        |         |        | 2,085   |       
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|                                                                                             |                                              | Net cash used in investing activities |                                           |        | (1,130  | )      |         |        | (12,822 | )      |         |        | (70,254 | )    
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Financing activities:                                                                        |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Repayments on notes payable                                                                  |                                              |                                       |                                          |        |         |        |        |        |         |        | (1,497  | )     
|Proceeds from exercise of stock options                                                      |                                              |                                       | 4,023                                     |        |         |        | 1,631   |        |         |        | 120     |       
|Proceeds from issuance of common stock for stock
    purchase plan                           |                                              |                                       | 1,470                                     |        |         |        | 974     |        |         |        | 567     |       
|Proceeds from issuance of common stock                                                       |                                              |                                       |                                          |        |         |        |        |        |         |        | 65,720  |       
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Net cash provided by financing activities                                                    |                                              |                                       | 5,493                                     |        |         |        | 2,605   |        |         |        | 64,910  |       
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Increase in cash and cash equivalents                                                        |                                              |                                       | 37,998                                    |        |         |        | 10,609  |        |         |        | 2,371   |       
|Cash and cash equivalents at beginning of year                                               |                                              |                                       | 23,715                                    |        |         |        | 13,106  |        |         |        | 10,735  |       
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Cash and cash equivalents at end of year                                                     |                                              | $                                     | 61,713                                    |        |         | $      | 23,715  |        |         | $      | 13,106  |       
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Supplemental disclosures of cash flow
    information:                                       |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Interest paid                                                                                |                                              | $                                     |                                          |        |         | $      |        |        |         | $      | 48      |       
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       
|Income taxes paid                                                                            |                                              | $                                     | 687                                       |        |         | $      |        |        |         | $      | 1       |       
|                                                                                             |                                              |                                       |                                           |        |         |        |         |        |         |        |         |       

See accompanying notes.

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##### Table of Contents



Websense, Inc.

Notes to Consolidated Financial
Statements

December 31, 2002

1. Summary of Significant Accounting
Policies

Description of
Business

Websense, Inc. (Websense or the
Company) was founded in 1994. The Company provides
employee Internet management products that enable businesses to
analyze, report and manage how their employees use computing
resources at work, including Internet access. The Companys
Websense Enterprise solution supports an organizations
efforts to improve employee productivity, conserve network
bandwidth, mitigate potential legal liability, and enhance
network security.

Use of Estimates

The preparation of the consolidated financial
statements in conformity with accounting principles generally
accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results
could differ from those estimates.

Principles of
Consolidation

The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries in the
United Kingdom, Japan, Ireland, Australia, and France.
Significant intercompany accounts and transactions have been
eliminated in consolidation. Activities performed by the
subsidiaries are a direct and integral extension of the
Companys primary business.

Reclassifications

Certain reclassifications have been made for
consistent presentation.

Revenue
Recognition

The Company has adopted American Institute of
Certified Public Accountants Statement of Position
No. 97-2, Software Revenue Recognition (SOP 97-2) as
amended by SOP 98-9. These statements provide guidance for
recognizing revenue related to sales by software vendors.

The Company sells Websense Enterprise on a
subscription basis. A subscription is generally 12, 24 or
36 months in duration and for a fixed number of users. Upon
entering into a subscription arrangement, the Company invoices
customers. Generally, payment is due for the full term of the
subscription within 30 days of invoicing. The Company
recognizes revenue on a monthly straight-line basis over the
term of the subscription agreement. The Company records amounts
billed to customers in excess of recognizable revenue as
deferred revenue in the accompanying balance sheets.

Cash and Cash
Equivalents

The Company considers all highly liquid
investments with a maturity of three months or less when
purchased to be cash equivalents. The Company generally invests
its excess cash in debt instruments of the U.S. Treasury,
government agencies and corporations with strong credit ratings.
Such investments are made in accordance with the Companys
investment policy, which establishes guidelines relative to
diversification and maturities designed to maintain safety and
liquidity. These guidelines are periodically reviewed and
modified if necessary to take advantage of trends in yields and
interest rates. The Company has not experienced any losses on
its cash and cash equivalents.

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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

Marketable
Securities

Marketable securities at December 31, 2002
consist of high-grade commercial paper, auction rate notes,
government securities, and corporate bonds. The Company
currently classifies all investment securities as available for
sale. Securities available for sale are reported at fair value,
adjusted for other than temporary declines in value. Unrealized
holding gains and losses on securities available for sale are
reported as a net amount in a separate component of
stockholders equity until realized. Realized gains and
losses are recorded based on the specific identification method.

Disclosures About Fair Value of
Financial Instruments

The fair values of investment securities have
been determined using values supplied by independent pricing
services and are disclosed together with carrying amounts in
Note 2. The carrying value of cash and cash equivalents,
accounts receivable, accounts payable, accrued liabilities and
debt approximate their fair values.

Concentration of Credit
Risk

The Company sells its products to customers
primarily in the United States, Canada, Europe and Asia. The
Company maintains a reserve for potential credit losses and
historically such losses have been within managements
estimates.

Property and
Equipment

Property and equipment are stated at cost and are
depreciated using the straight-line method over their estimated
useful lives of three years.

Computer Software
Costs

In accordance with Statement of Financial
Accounting Standards (SFAS) No. 86, Accounting for the
Costs of Computer Software to be Sold, Leased, or Otherwise
Marketed, the Company capitalizes costs incurred, when
significant, in the development of specific computer software
products after establishment of technological feasibility and
marketability. There have been no such costs capitalized to date
as the costs incurred during the period between technological
feasibility to general release have not been significant.

Statement of Position 98-1, Accounting for Costs
of Computer Software Developed or Obtained for Internal Use (SOP
98-1), requires companies to capitalize qualifying computer
software costs, which are incurred during the application
development stage and amortize them over the softwares
estimated useful life. The Company adopted SOP 98-1 effective
January 1, 1999 with no material effect on the financial
statements.

Advertising
Expenses

Advertising costs are expensed as incurred. Total
advertising costs for the years ended December 31, 2002,
2001 and 2000 were $3.5 million, $2.0 million and
$1.3 million, respectively.

Stock-Based
Compensation

The Company has elected to follow Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25), and related interpretations
in accounting for its employee stock options because the
alternative fair value accounting provided for under SFAS
No. 123, Accounting for Stock-Based Compensation, requires
the use of option valuation models for traded options that were
not developed for use in valuing employee stock options which
have vesting restrictions and are not traded. Under APB 25, when
the exercise price of the Companys employee stock options
is not less than the fair value for the underlying stock

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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

on the date of grant no compensation expense is
recognized. At the time stock options were granted, the Company
believed that the exercise price was at a price not less than
the fair value of the underlying common stock. In conjunction
with the Companys initial public offering, the Company
reviewed its exercise prices and arrived at the deemed fair
value for each option grant during 1999. With respect to the
3,220,500 options granted during 1999 and through March 27,
2000, the Company recorded deferred compensation of
$5.4 million for the difference between the exercise price
per share and the deemed fair value per share at the grant date.
The approximate weighted-average exercise price per share and
the approximate weighted-average deemed fair value per share for
the options was $1.64 and $3.31, respectively. Deferred stock
compensation is recognized and amortized on an accelerated basis
in accordance with Financial Accounting Standards Board
(FASB) Interpretation No. 28 over the vesting period
of the related options, generally four years.

Deferred compensation for options and warrants
granted to non-employees has been determined at the grant date
in accordance with SFAS No. 123 and Emerging Issues Task
Force (EITF) No. 96-18, Accounting for Equity
Instruments that are Issued to Other than Employees for
Acquiring, or in Conjunction with Selling Goods or Services, and
has been recorded at the fair value of the consideration
received or the fair value of the equity instruments issued,
whichever is more reliably measured. Such deferred compensation
is recognized over the period the related services are rendered.

Pro forma information regarding net income
(loss) is required by SFAS 123 and has been determined as
if the Company has accounted for its employee stock options and
stock purchase plan under the fair value method of SFAS 123. The
fair value of each option grant prior to the Companys
initial public offering in March 2000 was estimated on the date
of grant using the minimum value method with the following
weighted-average assumptions; risk-free interest rate of 6%,
dividend yield of 0% and a weighted average expected life of
5 years. The fair value of each option grant during 2000
subsequent to the Companys initial public offering in
March 2000 was estimated on the date of grant using a
Black-Scholes option pricing model with the following
weighted-average assumptions: risk free interest rate of 6%;
dividend yield of 0%; volatility factor of 132%; and
weighted-average expected life for the option of 5 years.
The fair value of each option grant during 2001 was estimated on
the date of grant using a Black-Scholes option pricing model
with the following weighted-average assumptions: risk free
interest rate of 5% to 6%; dividend yield of 0%; volatility
factor of 111% to 132%; and weighted-average expected life for
the option of 5 years. The fair value of each option grant
during 2002 was estimated on the date of grant using a
Black-Scholes option pricing model with the following
weighted-average assumptions: risk free interest rate of 2.91%;
dividend yield of 0%; volatility factor of 103%; and
weighted-average expected life for the option of 5 years.
For purposes of pro forma disclosures, the estimated fair value
of the options is amortized to expense over the vesting period.

The Companys adjusted pro forma information
is as follows (in thousands, except per share amounts):

|                                                                                                                                     |  |                          |         |      |  |      |        |   |  |   |        |  
|------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------ | ------- | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                                                                                                                     |  |                         
|                                                                                                                                     |  | Years Ended December 31,
|                                                                                                                                     |  |                         
|                                                                                                                                     |  | 2002                     |         | 2001 |  | 2000
|                                                                                                                                     |  |                          |         |      |  |     
|Net income (loss) as reported                                                                                                        |  | $                        | 16,737  |      |  | $    | 3,116  |   |  | $ | (5,947 | )
|Deduct: Total stock-based compensation expense
    determined under fair value method for all awards, net of
    related tax effects |  |                          | (10,698 | )    |  |      | (5,495 | ) |  |   | (316   | )
|                                                                                                                                     |  |                          |         |      |  |      |        |   |  |   |        |  
|Pro forma net income (loss)                                                                                                          |  | $                        | 6,039   |      |  | $    | (2,379 | ) |  | $ | (6,263 | )
|                                                                                                                                     |  |                          |         |      |  |      |        |   |  |   |        |  
|Basic net income (loss) per share as reported                                                                                        |  | $                        | 0.79    |      |  | $    | 0.16   |   |  | $ | (0.35  | )
|Pro forma basic net income (loss) per share                                                                                          |  | $                        | 0.28    |      |  | $    | (0.12  | ) |  | $ | (0.37  | )
|Diluted net income (loss) per share as
    reported                                                                                  |  | $                        | 0.72    |      |  | $    | 0.14   |   |  | $ | (0.35  | )
|Pro forma diluted net income (loss) per share                                                                                        |  | $                        | 0.26    |      |  | $    | (0.12  | ) |  | $ | (0.37  | )

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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

The pro forma effect on net income
(loss) for 2002, 2001 and 2000 is not likely to be
representative of the pro forma effect on reported net income or
loss in future years because these amounts reflect less than
four years of vesting.

Comprehensive
Income

The Company has adopted SFAS No. 130,
Reporting Comprehensive Income, which requires that all
components of comprehensive income, including net income, be
reported in the financial statements in the period in which they
are recognized. Comprehensive income is defined as the change in
equity during a period from transactions and other events and
circumstances from non-owner sources. Net income (loss) and
other comprehensive income, including foreign currency
translation adjustments, and unrealized gains and losses on
investments, shall be reported, net of their related tax effect,
to arrive at comprehensive income (loss). Comprehensive income
(loss) for the years ended December 31, 2002, 2001 and
2000 was $17.2 million, $3.2 million and
($5.9 million), respectively. The difference from reported
net income (loss) is due to the changes in unrealized gains
on marketable securities for the years ended December 31,
2002, 2001 and 2000 of $416,000, $35,000 and $25,000,
respectively.

Net Income (Loss) Per
Share

Websense computes net income (loss) per
share in accordance with SFAS No. 128, Earnings Per Share
(EPS). Under the provisions of SFAS No. 128,
basic net income (loss) per share is computed by dividing
the net income (loss) for the period by the weighted
average number of common shares outstanding during the period.
Diluted net income (loss) per share is computed by dividing
the net income (loss) for the period by the weighted
average number of common and common equivalent shares
outstanding during the period. Common equivalent shares for all
periods presented consist of dilutive stock options and warrants
outstanding.

Dilutive securities include options, warrants and
preferred stock as if converted and restricted stock subject to
vesting. In 2002, the difference between the weighted average
shares used in determining basic EPS versus diluted EPS related
to dilutive stock options and warrants totaled 2,127,000.
Potentially dilutive securities totaling 1,413,000, 335,000 and
3,247,000 for the years ended December 31, 2002, 2001 and
2000, respectively, were excluded from historical basic and
diluted earnings per share because of their anti-dilutive effect.

The following is a reconciliation of numerator
and denominator of Basic EPS to the numerator and denominator of
Diluted EPS for all periods presented.

|                             |                   |                                          |        |               |  |           |        |       |  |   |      |       |  
|---------------------------- | ----------------- | ---------------------------------------- | ------ | ------------- |  | --------- | ------ | ----- |  | - | ---- | ----- | -
|                             |                   | Net Income                               |        | Shares        |  | Per Share
|                             |                   | (Numerator)                              |        | (Denominator) |  | Amount   
|                             |                   |                                          |        |               |  |          
|                             |                   |                                         
|                             |                   | (In thousands, except per share amounts)
|For the Twelve Months Ended: |                   |                                          |        |               |  |           |        |       |  |   |      |      
|December 31, 2002:           |                   |                                          |        |               |  |           |        |       |  |   |      |      
|Basic EPS                    |                   | $                                        | 16,737 |               |  |           | 21,211 |       |  | $ | 0.79 |      
|                             | Effect of options |                                          |        |              |  |           |        | 2,127 |  |   |      | (0.07 | )
|                             |                   |                                          |        |               |  |           |        |       |  |   |      |      
|Diluted EPS                  |                   | $                                        | 16,737 |               |  |           | 23,338 |       |  | $ | 0.72 |      
|                             |                   |                                          |        |               |  |           |        |       |  |   |      |      
|December 31, 2001:           |                   |                                          |        |               |  |           |        |       |  |   |      |      
|Basic EPS                    |                   | $                                        | 3,116  |               |  |           | 20,082 |       |  | $ | 0.16 |      
|                             | Effect of options |                                          |        |              |  |           |        | 2,698 |  |   |      | (0.02 | )
|                             |                   |                                          |        |               |  |           |        |       |  |   |      |      
|Diluted EPS                  |                   | $                                        | 3,116  |               |  |           | 22,780 |       |  | $ | 0.14 |      
|                             |                   |                                          |        |               |  |           |        |       |  |   |      |      

There were no reconciling items for the twelve
months ended December 31, 2000 as the Company realized a
net loss for the period.

41



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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

Recently Issued Accounting
Standards

In July 2002, the FASB issued SFAS No. 146
(SFAS 146), Accounting for Costs Associated with Exit or
Disposal Activities, which addresses financial accounting and
reporting for costs associated with exit or disposal activities
and nullifies EITF Issue No. 94-3, Liability Recognition
for Certain Employee Termination Benefits and Other Costs to
Exit an Activity (including Certain Costs Incurred in a
Restructuring). The principal difference between SFAS 146 and
Issue No. 94-3 relates to SFAS 146s requirements for
recognition of a liability for a cost associated with an exit or
disposal activity. SFAS 146 requires that a liability for a cost
associated with an exit or disposal activity be recorded as a
liability when incurred. Under Issue No. 94-3, a liability
for an exit cost as generally defined in Issue No. 94-3 was
recognized at the date of an entitys commitment to an exit
plan. The provisions of this statement are effective for exit or
disposal activities that are initiated after December 31,
2002 with early application encouraged. The Company does not
expect SFAS 146 to have a material impact on the Companys
consolidated financial statements.

In December 2002, the FASB issued SFAS
No. 148, Accounting for Stock-Based Compensation,
Transition and Disclosure. SFAS No. 148 provides
alternative methods of transition for a voluntary change to the
fair value based method of accounting for stock-based employee
compensation. SFAS No. 148 also requires that disclosures
of the pro forma effect of using the fair value method of
accounting for stock-based employee compensation be displayed
more prominently and in a tabular format. Additionally, SFAS
No. 148 requires disclosure of the pro forma effect in
interim financial statements. The transition and annual
disclosure requirements of SFAS No. 148 are effective
immediately. The interim disclosure requirements are effective
for the first quarter of 2003. The adoption of SFAS No. 148
did not have a material effect on the Companys
consolidated financial statements.

In January 2003, the FASB issued FASB
Interpretation No. 46 (FIN 46), Consolidation of Variable
Interest Entities, an Interpretation of Accounting Research
Bulletin (ARB) No. 51. FIN 46 requires certain
variable interest entities to be consolidated by the primary
beneficiary of the entity if the equity investors in the entity
do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity
to finance its activities without additional subordinated
financial support from other parties. FIN 46 is effective for
all new variable interest entities created or acquired after
January 31, 2003. For variable interest entities created or
acquired prior to February 1, 2003, the provisions of FIN
46 must be applied for the first interim or annual period
beginning after June 15, 2003. The Company does not expect
FIN 46 to have a material impact on the Companys
consolidated financial statements.

2. Marketable Securities

Investments in marketable securities consisted of
the following at December 31, 2002 (in thousands):

|                      |  |           |        |            |  |            |     |                |  |   |   |  |  |   |        | 
|--------------------- |  | --------- | ------ | ---------- |  | ---------- | --- | -------------- |  | - | - |  |  | - | ------ | 
|                      |  | Amortized |        | Unrealized |  | Unrealized |     | Estimated Fair
|                      |  | Cost      |        | Gains      |  | (Losses)   |     | Value         
|                      |  |           |        |            |  |            |     |               
|Commercial Paper      |  | $         | 4,032  |            |  | $          |    |                |  | $ |  |  |  | $ | 4,032  | 
|Government Securities |  |           | 54,223 |            |  |            | 296 |                |  |   |  |  |  |   | 54,519 | 
|Corporate Bonds       |  |           | 20,022 |            |  |            | 180 |                |  |   |  |  |  |   | 20,202 | 
|                      |  |           |        |            |  |            |     |                |  |   |   |  |  |   |        | 
|                      |  | $         | 78,277 |            |  | $          | 476 |                |  | $ |  |  |  | $ | 78,753 | 
|                      |  |           |        |            |  |            |     |                |  |   |   |  |  |   |        | 

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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

Investments in marketable securities consisted of
the following at December 31, 2001 (in thousands):

|                        |  |           |        |            |  |            |    |                |  |   |     |   |  |   |        | 
|----------------------- |  | --------- | ------ | ---------- |  | ---------- | -- | -------------- |  | - | --- | - |  | - | ------ | 
|                        |  | Amortized |        | Unrealized |  | Unrealized |    | Estimated Fair
|                        |  | Cost      |        | Gains      |  | (Losses)   |    | Value         
|                        |  |           |        |            |  |            |    |               
|Commercial Paper        |  | $         | 3,954  |            |  | $          |   |                |  | $ |    |   |  | $ | 3,954  | 
|Government Securities   |  |           | 58,338 |            |  |            | 65 |                |  |   |    |   |  |   | 58,403 | 
|Corporate Bonds         |  |           | 15,507 |            |  |            |   |                |  |   | (15 | ) |  |   | 15,492 | 
|Certificates of Deposit |  |           | 1,534  |            |  |            | 10 |                |  |   |    |   |  |   | 1,544  | 
|                        |  |           |        |            |  |            |    |                |  |   |     |   |  |   |        | 
|                        |  | $         | 79,333 |            |  | $          | 75 |                |  | $ | (15 | ) |  | $ | 79,393 | 
|                        |  |           |        |            |  |            |    |                |  |   |     |   |  |   |        | 

The amortized cost and estimated fair value of
the securities at December 31, 2002 and 2001, by
contractual maturity, are shown below (in thousands).

|                          |  |           |        |            |  |           |        |            |  |   |        |  |  |   |        | 
|------------------------- |  | --------- | ------ | ---------- |  | --------- | ------ | ---------- |  | - | ------ |  |  | - | ------ | 
|                          |  |           |        |           
|                          |  | 2002      |        | 2001      
|                          |  |           |        |           
|                          |  | Amortized |        |            |  | Amortized |        |           
|                          |  | Cost      |        | Fair Value |  | Cost      |        | Fair Value
|                          |  |           |        |            |  |           |        |           
|Due within 1 year         |  | $         | 34,678 |            |  | $         | 34,883 |            |  | $ | 41,137 |  |  | $ | 41,271 | 
|Due between 1 and 3 years |  |           | 43,599 |            |  |           | 43,870 |            |  |   | 38,196 |  |  |   | 38,122 | 
|                          |  |           |        |            |  |           |        |            |  |   |        |  |  |   |        | 
|                          |  | $         | 78,277 |            |  | $         | 78,753 |            |  | $ | 79,333 |  |  | $ | 79,393 | 
|                          |  |           |        |            |  |           |        |            |  |   |        |  |  |   |        | 

Realized gains from investments in marketable
securities were $8,000 in 2002, $53,000 in 2001 and $0
in 2000.

3. Property and Equipment

Property and equipment consist of the following
(in thousands):

|                               |  |              |         |              |  |      |        |   |  |   |        |  
|------------------------------ |  | ------------ | ------- | ------------ |  | ---- | ------ | - |  | - | ------ | -
|                               |  |              |         |             
|                               |  |              |         | December 31,
|                               |  | Estimated    |         |             
|                               |  | Useful Lives |         | 2002         |  | 2001
|                               |  |              |         |              |  |     
|Computer hardware and software |  |              | 3 years |              |  | $    | 6,973  |   |  | $ | 5,129  |  
|Office furniture and equipment |  |              | 3 years |              |  |      | 1,678  |   |  |   | 1,387  |  
|Other equipment                |  |              | 3 years |              |  |      | 267    |   |  |   | 216    |  
|                               |  |              |         |              |  |      |        |   |  |   |        |  
|                               |  |              |         |              |  |      | 8,918  |   |  |   | 6,732  |  
|Accumulated depreciation       |  |              |         |              |  |      | (5,951 | ) |  |   | (4,022 | )
|                               |  |              |         |              |  |      |        |   |  |   |        |  
|                               |  |              |         |              |  | $    | 2,967  |   |  | $ | 2,710  |  
|                               |  |              |         |              |  |      |        |   |  |   |        |  

4. Debt

In June 2000, the Company established an amended
and restated loan and security agreement which provides a line
of credit of $1,500,000 for working capital advances and
stand-by letters of credit. Advances bear interest at the
banks floating prime rate plus .25%. In May 2001, the
Company amended the loan and security agreement to extend the
maturity date to May 2002. The Company had no advances under the
line at May 2002 when the line expired and the Company did not
renew the line. Open letters of credit were $64,000 at
December 31, 2002.

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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

5. Geographic Information

The following illustrates revenues attributed to
customers located in the Companys country of domicile (the
United States) and those attributed to foreign customers (in
thousands):

|                               |  |                          |        |      |  |      |        |  |  |   |        | 
|------------------------------ |  | ------------------------ | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|                               |  |                         
|                               |  | Years Ended December 31,
|                               |  |                         
|                               |  | 2002                     |        | 2001 |  | 2000
|                               |  |                          |        |      |  |     
|United States                  |  | $                        | 41,456 |      |  | $    | 23,377 |  |  | $ | 11,940 | 
|Europe, Middle East and Africa |  |                          | 11,888 |      |  |      | 7,242  |  |  |   | 3,007  | 
|Asia/ Pacific                  |  |                          | 4,085  |      |  |      | 3,273  |  |  |   | 1,617  | 
|Canada and Latin America       |  |                          | 3,536  |      |  |      | 2,001  |  |  |   | 877    | 
|                               |  |                          |        |      |  |      |        |  |  |   |        | 
|                               |  | $                        | 60,965 |      |  | $    | 35,893 |  |  | $ | 17,441 | 
|                               |  |                          |        |      |  |      |        |  |  |   |        | 

6. Deferred Revenue

The Company will recognize revenues related to
subscriptions in existence as of December 31, 2002 as
follows (in thousands):

|      |  |   |        | 
|----- |  | - | ------ | 
|2003. |  | $ | 46,964 | 
|2004. |  |   | 12,670 | 
|2005. |  |   | 4,714  | 
|2006. |  |   | 329    | 
|2007. |  |   | 2      | 
|      |  |   |        | 
|      |  | $ | 64,679 | 
|      |  |   |        | 

7. Lease Commitments

The Company leases its facilities and certain
equipment under non-cancellable operating leases, which expire
at various dates through December 2007. The facilities leases
contain renewal options and are subject to cost increases.

Future minimum annual lease payments under
non-cancellable operating leases at December 31, 2002 are
as follows (in thousands):

|     |  |   |       | 
|---- |  | - | ----- | 
|2003 |  | $ | 1,105 | 
|2004 |  |   | 1,158 | 
|2005 |  |   | 1,193 | 
|2006 |  |   | 1,228 | 
|2007 |  |   | 1,253 | 
|     |  |   |       | 
|     |  | $ | 5,937 | 
|     |  |   |       | 

Rent expense totaled $1,950,000, $1,620,000 and
$882,000 for the years ended December 31, 2002, 2001 and
2000, respectively.

8. Stockholders Equity

Convertible Preferred
Stock

All previously issued preferred stock
automatically converted into common stock concurrent with the
closing of the Companys initial public offering of common
stock on March 28, 2000. The Company issued
7,037,036 shares of common stock upon conversion of
Series A and Series B convertible preferred stock.

44



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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

Warrants

In connection with the Companys
Series B convertible preferred stock offering between June
and September 1999, the Company issued warrants to purchase
62,500 shares of common stock for $3.00 per share to
financial consultants. The warrants are exercisable in whole or
in part at any time and from time to time until their expiration
in June 2004. In April 2000, a warrant to purchase
4,688 shares of common stock was exercised. In November
2001, a warrant to purchase 23,437 shares of common stock
was exercised. The Company has reserved 34,375 shares of
common stock for issuance upon exercise of the remaining
warrants.

Stock Option Plan

In May 1998, the Board of Directors elected to
replace the 1997 Stock Option/ Stock Issuance Plan with the 1998
Stock Option/ Stock Issuance Plan (the 1998 Stock
Plan) under which 4,600,000 shares of the Companys
common stock were authorized for future issuance, and reserved
for purchase upon exercise of options granted. The 1998 Stock
Plan provides for the grant of incentive and non-statutory
options and issuances of common stock to employees, directors
and consultants.

In February 2000, the Board of Directors replaced
the 1998 Stock Plan with the 2000 Stock Incentive Plan (the
2000 Plan) under which 4,500,000 shares of the
Companys common stock were initially authorized for future
issuance, and reserved for purchase upon exercise of options
granted. In addition, the 2000 Plan provides for automatic
annual increases in the number of shares reserved for issuance
thereunder (beginning in 2001) equal to the lesser of
(i) 4% of the Companys outstanding shares on the last
business day in December of the calendar year immediately
preceding or (ii) 1,500,000 shares. At December 31,
2002, 6,112,036 shares were authorized for issuance under the
2000 Plan.

The 2000 Plan provides for the grant of options
to the Companys directors, officers, employees and
consultants. The 2000 Plan provides for the grant of incentive
and nonstatutory stock options and rights to purchase stock to
employees, directors or consultants of the Company. The 2000
Plan provides that incentive stock options will be granted only
to employees and are subject to certain limitations as to fair
value during a calendar year.

The exercise price of incentive stock options
must equal at least the fair value on the date of grant and the
exercise price of non-statutory stock options and the issuance
price of common stock under the stock issuance program may be no
less than 85% of the fair value on the date of grant or
issuance. The options are exercisable for a period of up to ten
years after the date of grant and generally vest 25% one year
from date of grant and ratably each month thereafter for a
period of 36 months. Unvested common shares obtained
through early exercise of options are subject to repurchase by
the Company at the original issue price. To date only
nonstatutory options have been granted under the 2000 Plan.

In 2002, the Company issued options as an
incentive for certain persons to commence employment that were
not covered under the 2000 Plan. In accordance with Section
4350(i) of the NASD Marketplace Rules for the Nasdaq Stock
Market, the Company issued 177,000 such options which have
substantially the same terms as options issued under the 2000
Plan.

45



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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

The following table summarizes stock option
activity under the 1998 and 2000 Stock Plans and options issued
in 2002 not covered under a formal plan and related information
through December 31, 2002:

|                             |           |           |           |            |   |   |       |       | 
|---------------------------- | --------- | --------- | --------- | ---------- | - | - | ----- | ----- | 
|                             |           |           |           | Weighted  
|                             |           |           |           | Average   
|                             |           | Number of |           | Exercise  
|                             |           | Shares    |           | Price     
|                             |           |           |           |           
|Balance at December 31, 1999 |           |           | 3,161,551 |            |   | $ | 0.83  |      
|                             | Granted   |           |           | 641,000    |   |   | $     | 14.57 | 
|                             | Exercised |           |           | (218,780   | ) |   | $     | 0.47  | 
|                             | Cancelled |           |           | (175,086   | ) |   | $     | 1.99  | 
|                             |           |           |           |            |   |   |       |      
|Balance at December 31, 2000 |           |           | 3,408,685 |            |   | $ | 3.38  |      
|                             | Granted   |           |           | 1,567,600  |   |   | $     | 14.85 | 
|                             | Exercised |           |           | (781,876   | ) |   | $     | 1.99  | 
|                             | Cancelled |           |           | (252,641   | ) |   | $     | 8.02  | 
|                             |           |           |           |            |   |   |       |      
|Balance at December 31, 2001 |           |           | 3,941,768 |            |   | $ | 7.92  |      
|                             | Granted   |           |           | 1,592,050  |   |   | $     | 24.28 | 
|                             | Exercised |           |           | (1,028,554 | ) |   | $     | 3.91  | 
|                             | Cancelled |           |           | (242,428   | ) |   | $     | 18.59 | 
|                             |           |           |           |            |   |   |       |      
|Balance at December 31, 2002 |           |           | 4,262,836 |            |   | $ | 14.39 |      
|                             |           |           |           |            |   |   |       |      

The following table summarizes all options
outstanding and exercisable by price range as of
December 31, 2002:

|                |  |                     |           |                     |  |                |      |           |  |                |       |  |  |  |           |  |  |   |       | 
|--------------- |  | ------------------- | --------- | ------------------- |  | -------------- | ---- | --------- |  | -------------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|                |  |                     |           |                    
|                |  | Options Outstanding |           | Options Exercisable
|                |  |                     |           |                    
|                |  |                     |           | Weighted            |  |                |      |          
|                |  |                     |           | Average             |  |                |      |          
|                |  |                     |           | Remaining           |  | Weighted       |      |           |  | Weighted      
|Range of        |  | Number of           |           | Contractual Life    |  | Average        |      | Number of |  | Average       
|Exercise Prices |  | Shares              |           | In Years            |  | Exercise Price |      | Shares    |  | Exercise Price
|                |  |                     |           |                     |  |                |      |           |  |               
|$.20-$.75       |  |                     | 980,962   |                     |  |                | 6.29 |           |  | $              | 0.53  |  |  |  | 798,940   |  |  | $ | 0.52  | 
|$1.50-$12.63    |  |                     | 944,014   |                     |  |                | 7.87 |           |  | $              | 8.62  |  |  |  | 386,198   |  |  | $ | 7.24  | 
|$12.91-$18.77   |  |                     | 945,768   |                     |  |                | 8.56 |           |  | $              | 15.64 |  |  |  | 242,297   |  |  | $ | 16.02 | 
|$18.78-$27.86   |  |                     | 1,143,592 |                     |  |                | 9.08 |           |  | $              | 26.63 |  |  |  | 65,460    |  |  | $ | 26.21 | 
|$27.90-$34.25   |  |                     | 248,500   |                     |  |                | 8.92 |           |  | $              | 29.88 |  |  |  | 30,622    |  |  | $ | 29.11 | 
|                |  |                     |           |                     |  |                |      |           |  |                |       |  |  |  |           |  |  |   |       | 
|                |  |                     | 4,262,836 |                     |  |                | 8.05 |           |  | $              | 14.39 |  |  |  | 1,523,517 |  |  | $ | 6.37  | 
|                |  |                     |           |                     |  |                |      |           |  |                |       |  |  |  |           |  |  |   |       | 

The weighted average fair value of options
granted during 2002, 2001 and 2000 was $18.67, $7.54 and $8.85
per share, respectively.

Employee Stock Purchase
Plan

In February 2000, the Company adopted the 2000
Employee Stock Purchase Plan. In addition, the purchase plan
provides for automatic annual increases in the number of shares
reserved for issuance thereunder (beginning in 2001) equal to
the lesser of (i) 1% of the Companys outstanding
shares on the last business day in December of the calendar year
immediately preceding or (ii) 375,000 shares. The purchase plan
is intended to qualify as an employee stock purchase plan within
the meaning of Section 423 of the Internal Revenue Code.
Under the purchase plan, the Board of Directors may authorize
participation by

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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

eligible employees, including officers, in
periodic offerings following commencement of the purchase plan.
Shares issued and available for issuance as of December 31,
2002 are as follows:

|                                                                                                  |  |  |          |  
|------------------------------------------------------------------------------------------------- |  |  | -------- | -
|Shares reserved for issuance during 2000                                                          |  |  | 250,000  |  
|Shares issued during 2000                                                                         |  |  | (37,090  | )
|                                                                                                  |  |  |          |  
|Shares reserved for issuance at December 31,
    2000                                             |  |  | 212,910  |  
|Shares reserved for issuance during 2001 based on
    the automatic increase in shares authorized |  |  | 197,049  |  
|Shares issued during 2001                                                                         |  |  | (85,459  | )
|                                                                                                  |  |  |          |  
|Shares reserved for issuance at December 31,
    2001                                             |  |  | 324,500  |  
|Shares reserved for issuance during 2002 based on
    the automatic increase in shares authorized |  |  | 217,344  |  
|Shares issued during 2002                                                                         |  |  | (109,781 | )
|                                                                                                  |  |  |          |  
|Shares reserved for issuance at December 31,
    2002                                             |  |  | 432,063  |  
|                                                                                                  |  |  |          |  

Unless otherwise determined by the Board,
employees are eligible to participate in the purchase plan
provided they are employed for at least 20 hours per week and
are customarily employed for at least five months per calendar
year. Employees who participate in an offering may have up to
15% of their earnings withheld pursuant to the purchase plan.
The amount withheld is then used to purchase shares of common
stock on specified dates. The price of common stock purchased
pursuant to the plan will be equal to 85% of the lower of the
fair market value of the common stock at the commencement date
of each offering period or the relevant purchase date. Employees
may end their participation in the offering at any time during
the offering period, and participation ends automatically on
termination of employment.

Shares Reserved for Future
Issuance

The following shares of common stock are reserved
for future issuance as of December 31, 2002:

|               |                            |       |           |           |           | 
|-------------- | -------------------------- | ----- | --------- | --------- | --------- | 
|Stock options: |                            |       |           |          
|               | Granted and outstanding    |       |           | 4,262,836 |          
|               | Reserved for future grants |       |           | 72,729    |          
|               |                            |       |           |          
|               |                            |       | 4,335,565 |          
|Warrants       |                            |       | 34,375    |          
|               |                            |       |           |          
|               |                            | Total |           |           | 4,369,940 | 
|               |                            |       |           |          

47



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##### Table of Contents



Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

9. Income Taxes

The provision (benefit) for income taxes is
as follows:

|         |                              |                |         |        |   |      |     |     |  |  |   |   | 
|-------- | ---------------------------- | -------------- | ------- | ------ | - | ---- | --- | --- |  |  | - | - | 
|         |                              |               
|         |                              | December 31,  
|         |                              |               
|         |                              | 2002           |         | 2001   |   | 2000
|         |                              |                |         |        |   |     
|         |                              |               
|         |                              | (In thousands)
|Current  |                              |                |         |        |   |      |     |     |  |  |   |  
|         | Federal                      |                | $       | 7,255  |   |      | $   |    |  |  | $ |  | 
|         | Foreign                      |                |         | 557    |   |      |     | 108 |  |  |   |  | 
|         | State                        |                |         | 1,792  |   |      |     |    |  |  |   |  | 
|         |                              |                |         |        |   |      |     |     |  |  |   |  
|         |                              |                | 9,604   |        |   |      | 108 |     |  |  |  |  
|Deferred |                              |                |         |        |   |      |     |     |  |  |   |  
|         | Federal                      |                |         | (7,685 | ) |      |     |    |  |  |   |  | 
|         | Foreign                      |                |         |       |   |      |     |    |  |  |   |  | 
|         | State                        |                |         | (2,716 | ) |      |     |    |  |  |   |  | 
|         |                              |                |         |        |   |      |     |     |  |  |   |  
|         |                              |                | (10,401 | )      |   |      |    |     |  |  |  |  
|         |                              |                |         |        |   |      |     |     |  |  |   |  
|         | Income Tax Expense (Benefit) |                | $       | (797   | ) |      | $   | 108 |  |  | $ |  | 
|         |                              |                |         |        |   |      |     |     |  |  |   |  

The reconciliation of income tax computed at the
federal statutory rate to the provision (benefit) for
income taxes is as follows:

|                    |  |      |       |      |  |      |       |   |  |  |       |   
|------------------- |  | ---- | ----- | ---- |  | ---- | ----- | - |  |  | ----- | --
|                    |  | 2002 |       | 2001 |  | 2000
|                    |  |      |       |      |  |     
|Statutory Rate      |  |      | 35.0  | %    |  |      | 35.0  | % |  |  | (35.0 | %)
|Foreign tax         |  |      | 7.3   |      |  |      | 3.3   |   |  |  |      |   
|State tax           |  |      | 8.1   |      |  |      | 5.1   |   |  |  | (3.0  | ) 
|Valuation allowance |  |      | (54.6 | )    |  |      | (20.0 | ) |  |  | 45.8  |   
|Credits             |  |      | (0.8  | )    |  |      | (16.4 | ) |  |  | (10.8 | ) 
|Other               |  |      |      |      |  |      | (3.8  | ) |  |  | 3.0   |   
|                    |  |      |       |      |  |      |       |   |  |  |       |   
|                    |  |      | (5.0  | %)   |  |      | 3.2   | % |  |  |      |   
|                    |  |      |       |      |  |      |       |   |  |  |       |   

Significant components of the Companys
deferred tax assets and liabilities as of December 31, 2002
and 2001 are as follows:

|                                                         |                                             |                           |     |        |        |   |       |         |        | 
|-------------------------------------------------------- | ------------------------------------------- | ------------------------- | --- | ------ | ------ | - | ----- | ------- | ------ | 
|                                                         |                                             | 2002                      |     | 2001  
|                                                         |                                             |                           |     |       
|                                                         |                                             |                          
|                                                         |                                             | (In thousands)           
|Deferred tax assets Net operating loss
    carryforwards |                                             | $                         | 410 |        |        | $ | 2,472 |        
|                                                         | Tax credit carryforwards                    |                           |     | 2,571  |        |   |       | 1,808   |       
|                                                         | Capitalized research and development        |                           |     | 101    |        |   |       | 267     |       
|                                                         | Deferred revenue                            |                           |     | 11,359 |        |   |       | 8,772   |       
|                                                         | Foreign deferred taxes                      |                           |     | 490    |        |   |       |        |       
|                                                         | Other                                       |                           |     | 991    |        |   |       | 946     |       
|                                                         |                                             |                           |     |        |        |   |       |        
|                                                         |                                             | Total deferred tax assets |     |        | 15,922 |   |       |         | 14,265 | 
|                                                         | Valuation allowance for deferred tax assets |                           |     | (490   | )      |   |       | (14,265 | )     
|                                                         |                                             |                           |     |        |        |   |       |        
|                                                         | Net deferred taxes                          |                           | $   | 15,432 |        |   | $     |        |       
|                                                         |                                             |                           |     |        |        |   |       |        

During 2002, management reassessed the valuation
allowance previously established against U.S. net deferred tax
assets. Factors considered by management included: the
Companys earnings history, projected earnings based on
current operations, and projected future taxable income in
excess of stock option

48



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Websense, Inc.


Notes to Consolidated Financial Statements
 (Continued)

deductions. Based on this evidence, management
concluded that it is more likely than not that the U.S. deferred
tax assets would be realized. Accordingly, the Company released
approximately $14,265,000 of the valuation allowance against its
U.S. deferred tax assets, of which $5,031,000 related to the tax
benefit of stock options and was allocated to additional paid in
capital. In addition, the Company established a wholly-owned
subsidiary in Ireland during 2002 which generated net operating
losses, and a valuation allowance of $490,000 has been
established against these foreign deferred tax assets.

As of December 31, 2002, the Company has
federal and California research and development tax credit
carryforwards of approximately $1,677,000 and $1,258,000,
respectively. These credits will begin to expire in 2018 unless
previously utilized.

As of December 31, 2002, the Company has
federal and California tax net operating loss carryforwards of
approximately $645,000 and $3,197,000, respectively, which will
begin to expire in 2020 and 2005 respectively, unless previously
utilized. The difference between the federal and California tax
net operating loss carryforwards is primarily attributable to
California legislation which suspended the utilization of
California net operating loss carryforwards during 2002.

Pursuant to Internal Revenue Code
(IRC) Sections 382 and 383, use of the Companys
tax loss and credit carryforwards may be limited if a cumulative
change in ownership of more than 50% occurs within a three year
period. Based on IRC Sections 382 and 383, management
believes that a change in ownership may have occurred. However,
management does not believe that such change would have a
significant impact on the Companys ability to utilize its
tax loss and credit carryforwards.

As of December 31, 2002, the Company had
approximately $1,100,000 of undistributed earnings related to
its foreign subsidiaries. Management believes that these
earnings will be indefinitely reinvested; accordingly, the
Company has not provided for U.S. federal income taxes related
to these earnings. However, upon distribution of these earnings
in the form of dividends or otherwise, the Company would be
subject to both U.S. income taxes and withholding taxes payable
to the various foreign countries. It is impractical to estimate
the total tax liability, if any, until such distribution is made.

10. Employee Retirement Plan

Effective May 1, 1997, the Company
established a 401(k) defined contribution retirement plan
(401(k) Plan) covering substantially all employees. The 401(k)
Plan provides for voluntary employee contributions from 1% to
50% of annual compensation, as defined, and does not currently
provide for matching contributions from the Company.

49



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##### Table of Contents








|        |                                                                                         
|------- | ----------------------------------------------------------------------------------------
|Item 9. | Changes in and Disagreements with
    Accountants on Accounting and Financial Disclosure

None




PART III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

(a) Identification of Directors. Information
concerning our directors is incorporated by reference from the
section captioned Proposal 1: Election of
Directorscontained in our Proxy Statement related to
the Annual Meeting of Stockholders to be held on June 11,
2003.

(b) Identification of Executive Officers.
Information concerning our executive officers is set forth under
the section captioned Executive Officersin
Part I of this report.

(c) Compliance with Section 16(a) of
the Exchange Act. Information concerning compliance with
Section 16(a) of the Exchange Act is incorporated by
reference from the section captioned Section 16(a)
Beneficial Ownership Reporting Compliancecontained in
our Proxy Statement related to the Annual Meeting of
Stockholders to be held on June 11, 2003.






|         |                       
|-------- | ----------------------
|Item 11. | Executive Compensation

The information required by item 11 of
Form 10-K is incorporated by reference from the information
contained in the section captioned Executive
Compensation and Other Informationin our Proxy
Statement related to the Annual Meeting of Stockholders to be
held on June 11, 2003.






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The information required by item 12 concerning
security ownership of certain beneficial owners and management
is incorporated by reference from the information contained in
the section captioned Ownership of Securitiesin our Proxy Statement related to the Annual Meeting of
Stockholders to be held on June 11, 2003.

50



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##### Table of Contents



The following table provides information as of
December 31, 2002 with respect to the shares of the
Companys common stock that may be issued under the
Companys existing equity compensation plans:

|                                                                  |       |                         |           |                   |  |                         |       |       |  |  |         |         | 
|----------------------------------------------------------------- | ----- | ----------------------- | --------- | ----------------- |  | ----------------------- | ----- | ----- |  |  | ------- | ------- | 
|                                                                  |       |                         |           |                   |  | Number of securities   
|                                                                  |       |                         |           |                   |  | remaining available for
|                                                                  |       | Number of securities    |           | Weighted-average  |  | future issuance under  
|                                                                  |       | to be issued upon       |           | exercise price of |  | equity compensation    
|                                                                  |       | exercise of outstanding |           | outstanding       |  | plans (excluding       
|                                                                  |       | options, warrants       |           | options, warrants |  | securities reflected in
|Plan Category                                                     |       | and rights              |           | and rights        |  | column (a))            
|                                                                  |       |                         |           |                   |  |                        
|Equity compensation plans approved by security
    holders(1)     |       |                         | 4,085,836 |                   |  | $                       | 14.39 |       |  |  | 504,792 | (3)    
|Equity compensation plans not approved by
    security holders(2) |       |                         | 211,375   |                   |  | $                       | 12.42 |       |  |  | 0       |        
|                                                                  |       |                         |           |                   |  |                         |       |       |  |  |         |        
|                                                                  | Total |                         |           | 4,297,211         |  |                         | $     | 14.29 |  |  |         | 504,792 | 
|                                                                  |       |                         |           |                   |  |                         |       |       |  |  |         |        






|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Consists solely of the 2000 Stock Incentive Plan
    and the Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|(2) | Consists of 177,000 stock option grants made to
    certain new employees in 2002 in order to induce them to
    commence employment with the company and 34,375 warrants to
    purchase common stock issued to financial consultants in
    connection with the Companys Series B preferred stock
    offering in 1999. The stock options have substantially the same
    terms as stock options issued under the 2000 Stock Incentive
    Plan and have a weighted average exercise price of $14.25 per
    share. The warrants are exerciseable at any time prior to their
    expiration in June 2004 at an average exercise price of $3.00
    per share.                                                                                                                                                                                                                                                                                                                                        
|   
|(3) | Consists of shares available for future issuance
    under the Employee Stock Purchase Plan and the 2000 Stock
    Incentive Plan. As of December 31, 2002, an aggregate of
    432,063 shares of Common Stock were available for issuance
    under the Employee Stock Purchase Plan and 504,792 shares
    of Common Stock were available for issuance under the Employee
    Stock Purchase Plan and the 2000 Stock Incentive Plan. The
    number of shares of Common Stock available for issuance under
    the Employee Stock Purchase Plan and the 2000 Stock Incentive
    Plan automatically increases on the first trading day of January
    each calendar year by an amount equal to 1% and 4%,
    respectively, of the total number of shares of Common Stock
    outstanding on the last trading day of December in the
    immediately preceding calendar year but in no event will any
    such increase exceed 375,000 shares and
    1,500,000 shares, respectively, of Common Stock.




Item 13.     Certain
Relationships and Related Transactions

The information required by item 13 is
incorporated by reference from the information contained in the
section captioned Certain Relationships and Related
Transactionsin our Proxy Statement related to the
Annual Meeting of Stockholders to be held on June 11, 2003.




Item 14.     Control
and Procedures

Disclosure Controls and
Procedures

We maintain disclosure controls and procedures
designed to ensure that we are able to collect the information
we are required to disclose in the reports we file with the
Securities and Exchange Commission (SEC), and to record,
process, summarize and report this information within the time
periods specified in the rules of the SEC. Based on their
evaluation of our disclosure controls and procedures which took
place as of a date within 90 days of the filing date of
this report, our Chief Executive and Chief Financial Officers
have concluded that these controls and procedures are effective.

We also maintain a system of internal controls
designed to provide reasonable assurance that transactions are
executed in accordance with managements general or
specific authorization and that transactions are recorded as
necessary (1) to permit preparation of financial statements
in conformity with generally accepted accounting principles, and
(2) to maintain accountability for assets. Access to assets
is permitted only in

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##### Table of Contents



accordance with managements general or
specific authorization, and the recorded accountability for
assets is compared with the existing assets at reasonable
intervals and appropriate action is taken with respect to any
differences.


Since the date of the most recent evaluation of
our internal controls by our Chief Executive and Chief Financial
Officers, there have been no significant changes in our internal
controls or in other factors that could significantly affect our
internal controls, including any corrective actions with regard
to significant deficiencies and material weaknesses.

52



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PART IV






|         |                                                                    
|-------- | -------------------------------------------------------------------
|Item 15. | Exhibits, Financial Statement Schedules and
    Reports on Form 8-K

|                                                                                   |  |        |      | 
|---------------------------------------------------------------------------------- |  | ------ | ---- | 
|                                                                                   |  | Page  
|                                                                                   |  | Number
|                                                                                   |  |       
|(a) The
    following documents are filed as part of this report:                  |  |        |      | 
|1. Financial Statement Schedules.Schedule II Valuation and
    Qualifying Accounts |  |        | II-1 | 

Schedules not listed above have been omitted
because they are not applicable, not required, or the
information required to be set forth therein is included in the
consolidated financial statements or notes thereto.

2. Exhibits

|        |     |                         |  |                                                                                                                                                
|------- | --- | ----------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |     |                        
|Number  |     | Description of Document
|        |     |                        
|        | 3.  | 1(1)                    |  | Amended and Restated Certificate of Incorporation                                                                                              
|        | 3.  | 2(1)                    |  | Restated Bylaws                                                                                                                                
|        | 4.  | 1(1)                    |  | Specimen Stock Certificate of Websense, Inc.                                                                                                   
|        | 10. | 1(1)                    |  | Amended and Restated Registration Rights
    Agreement dated June 9, 1999                                                                      
|        | 10. | 2(1)                    |  | Form of Subscription Agreement regarding
    Series B Preferred Stock                                                                          
|        | 10. | 3(1)                    |  | Warrant to Purchase Common Stock between
    Websense, Inc. and Alps System Integration Co., Ltd., dated
    April 15, 1999                    
|        | 10. | 4(1)                    |  | Form of Warrant to Purchase Common Stock between
    Websense, Inc. and entities listed on Schedule A attached
    thereto, dated July 30, 1999
|        | 10. | 5(1)*                   |  | Employment Agreement by and between Websense,
    Inc. and John B. Carrington, dated May 10, 1999                                              
|        | 10. | 6(1)*                   |  | Employment Agreement by and between Websense,
    Inc. and Douglas C. Wride, dated June 11, 1999                                               
|        | 10. | 7(1)                    |  | Lease Agreement between Websense, Inc. and
    Legacy-RECP Sorrento OPCO, LLC, dated June 21, 1999, as
    amended                             
|        | 10. | 8(1)                    |  | 1998 Equity Incentive Plan                                                                                                                     
|        | 10. | 9(1)*                   |  | Standard Terms and Conditions Relating to
    Incentive Stock Option Under the 1998 Equity Incentive Plan                                      
|        | 10. | 10(1)*                  |  | 2000 Stock Incentive Plan                                                                                                                      
|        | 10. | 11(1)*                  |  | 2000 Stock Incentive Plan, Notice of Grant of
    Stock Option                                                                                 
|        | 10. | 12(1)*                  |  | 2000 Stock Incentive Plan, Form of Incentive
    Stock Option Agreement                                                                        
|        | 10. | 13(1)*                  |  | 2000 Employee Stock Purchase Plan                                                                                                              
|        | 10. | 14(1)                   |  | Form of Indemnification Agreement between
    Websense, Inc. and its directors                                                                 
|        | 10. | 15(1)                   |  | Form of Indemnification Agreement between
    Websense, Inc. and its officers                                                                  
|        | 10. | 16(2)                   |  | Lease Agreement between Websense, Inc. and
    Legacy-RECP Sorrento OPCO, LLC, dated February 12, 2000                                         
|        | 10. | 17(2)                   |  | First Amendment to Lease Agreement between
    Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated
    June 2, 2000                       
|        | 10. | 18(3)                   |  | Lease Agreement between Websense, Inc. and
    Legacy-RECP Sorrento OPCO, LLC, dated April 19, 2002                                            
|        | 21. | 1                       |  | Subsidiaries of the Registrant                                                                                                                 
|        | 23. | 1                       |  | Consent of Ernst & Young LLP, Independent
    Auditors                                                                                         
|        | 99. | 1                       |  | Certifications Pursuant to 18 U.S.C
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes  Oxley Act of 2002               






|    |                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|*   | Indicates management contract or compensatory
    plan or arrangement.                                                                             
|   
|(1) | Previously filed as an exhibit to our
    Registration Statement on Form S-1 (Registration
    No. 333-95619) and incorporated herein by reference.

53



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|    |                                                                                                                                     
|--- | ------------------------------------------------------------------------------------------------------------------------------------
|(2) | Previously filed as an exhibit to our
    Form 10-K for the period ended December 31, 2000 and
    incorporated herein by reference.
|   
|(3) | Previously filed as an exhibit to our
    Form 10-Q for the period ended June 30, 2002 and
    incorporated herein by reference.    

(b) Reports on Form 8-K.

We did not file any reports on Form 8-K
during the quarter ended December 31, 2002.

SUPPLEMENTAL INFORMATION

No Annual Report to stockholders or proxy
materials have been sent to stockholders as of the date of this
report. The Annual Report to stockholders and proxy material
will be furnished to our stockholders subsequent to the filing
of this report and we will furnish such material to the SEC at
that time.

54



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##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



| |               
| | --------------
| | WEBSENSE, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ DOUGLAS C. WRIDE

| |                        
| | -----------------------
| |                        
| | Douglas C. Wride       
| | Chief Financial Officer

Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|                                         |  |                                                                          |  |                |  | 
|---------------------------------------- |  | ------------------------------------------------------------------------ |  | -------------- |  | 
|                                         |  |                                                                          |  |               
|Signature                                |  | Title                                                                    |  | Date          
|                                         |  |                                                                          |  |               
|                                        
|/s/ JOHN B. CARRINGTONJohn B. Carrington |  | Chairman of the Board and
    Chief Executive Officer                    |  | March 28, 2003
|                                        
|/s/ DOUGLAS C. WRIDEDouglas C. Wride     |  | Chief Financial Officer (principal financial and
    accounting officer) |  | March 28, 2003
|                                        
|/s/ MARK ST. CLAREMark St. Clare         |  | Director                                                                 |  | March 28, 2003
|                                        
|/s/ BRUCE T. COLEMANBruce T. Coleman     |  | Director                                                                 |  | March 28, 2003
|                                        
|/s/ ROBERT J. LOARIERobert J. Loarie     |  | Director                                                                 |  | March 28, 2003
|                                        
|/s/ JOHN SCHAEFERJohn Schaefer           |  | Director                                                                 |  | March 28, 2003
|                                        
|/s/ GARY E. SUTTONGary E. Sutton         |  | Director                                                                 |  | March 28, 2003
|                                        
|/s/ PETER WALLERPeter Waller             |  | Director                                                                 |  | March 28, 2003

55



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CERTIFICATION

I, John B. Carrington, certify that:



| |                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. I have reviewed this annual report on
    Form 10-K of Websense, Inc.;                                                                                                                                                                                                                                                                      
|
| | 2. Based on my knowledge, this annual report
    does not contain any untrue statement of a material fact or omit
    to state a material fact necessary to make the statements made,
    in light of the circumstances under which such statements were
    made, not misleading with respect to the period covered by this
    annual report;
|
| | 3. Based on my knowledge, the financial
    statements, and other financial information included in this
    annual report, fairly present in all material respects the
    financial condition, results of operations and cash flows of the
    registrant as of, and for, the periods presented in this annual
    report;                   
|
| | 4. The registrants other certifying
    officers and I are responsible for establishing and maintaining
    disclosure controls and procedures (as defined in Exchange Act
    Rules 13a-14 and 15d-14) for the registrant and have:                                                                                                          



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) Designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) Evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) Presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                



| |                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5. The registrants other certifying
    officers and I have disclosed, based on our most recent
    evaluation, to the registrants auditors and the audit
    committee of registrants board of directors
    (or persons performing the equivalent function):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) All significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) Any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    



| |                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6. The registrants other certifying
    officers and I have indicated in this annual report whether or
    not there were significant changes in internal controls or in
    other factors that could significantly affect internal controls
    subsequent to the date of our most recent evaluation, including
    any corrective actions with regard to significant deficiencies
    and material weaknesses.

Date: March 28, 2003



| |     |                       
| | --- | ----------------------
| | By: | /s/ JOHN B. CARRINGTON

| |                        
| | -----------------------
| | John B. Carrington     
| | Chief Executive Officer

56



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##### Table of Contents






CERTIFICATION

I, Douglas C. Wride, certify that:



| |                                                                                                                                                                                                                                                                                                                                                
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1. I have reviewed this annual report on
    Form 10-K of Websense, Inc.;                                                                                                                                                                                                                                                                      
|
| | 2. Based on my knowledge, this annual report
    does not contain any untrue statement of a material fact or omit
    to state a material fact necessary to make the statements made,
    in light of the circumstances under which such statements were
    made, not misleading with respect to the period covered by this
    annual report;
|
| | 3. Based on my knowledge, the financial
    statements, and other financial information included in this
    annual report, fairly present in all material respects the
    financial condition, results of operations and cash flows of the
    registrant as of, and for, the periods presented in this annual
    report;                   
|
| | 4. The registrants other certifying
    officers and I are responsible for establishing and maintaining
    disclosure controls and procedures (as defined in Exchange Act
    Rules 13a-14 and 15d-14) for the registrant and have:                                                                                                          



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) Designed such disclosure controls and
    procedures to ensure that material information relating to the
    registrant, including its consolidated subsidiaries, is made
    known to us by others within those entities, particularly during
    the period in which this annual report is being prepared;
|
| | b) Evaluated the effectiveness of the
    registrants disclosure controls and procedures as of a
    date within 90 days prior to the filing date of this annual
    report (the Evaluation Date); and                                                                                                      
|
| | c) Presented in this annual report our
    conclusions about the effectiveness of the disclosure controls
    and procedures based on our evaluation as of the Evaluation Date;                                                                                                                                



| |                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 5. The registrants other certifying
    officers and I have disclosed, based on our most recent
    evaluation, to the registrants auditors and the audit
    committee of registrants board of directors
    (or persons performing the equivalent function):



| |                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | a) All significant deficiencies in the
    design or operation of internal controls which could adversely
    affect the registrants ability to record, process,
    summarize and report financial data and have identified for the
    registrants auditors any material weaknesses in internal
    controls; and
|
| | b) Any fraud, whether or not material, that
    involves management or other employees who have a significant
    role in the registrants internal controls; and                                                                                                                                                    



| |                                                                                                                                                                                                                                                                                                                                                                                                                  
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 6. The registrants other certifying
    officers and I have indicated in this annual report whether or
    not there were significant changes in internal controls or in
    other factors that could significantly affect internal controls
    subsequent to the date of our most recent evaluation, including
    any corrective actions with regard to significant deficiencies
    and material weaknesses.

Date: March 28, 2003



| |     |                     
| | --- | --------------------
| | By: | /s/ DOUGLAS C. WRIDE

| |                        
| | -----------------------
| | Douglas C. Wride       
| | Chief Financial Officer

57



---



##### Table of Contents



SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

WEBSENSE, INC.

|                                                          |                                 |                |   |            |  |            |   |              |  |            |   |     |     |  |   |     |     |  |   |     | 
|--------------------------------------------------------- | ------------------------------- | -------------- | - | ---------- |  | ---------- | - | ------------ |  | ---------- | - | --- | --- |  | - | --- | --- |  | - | --- | 
|                                                          |                                 |                |   |            |  |            |   |             
|A                                                         |                                 | B              |   | C          |  | D          |   | E           
|                                                          |                                 |                |   |            |  |            |   |             
|                                                          |                                 |                |   |            |  |            |   |             
|                                                          |                                 |                |   | Additions  |  |            |   |             
|                                                          |                                 |                |   |            |  |            |   |             
|                                                          |                                 |                |   |            |  | Charged to |   |              |  |           
|                                                          |                                 | Balance at     |   | Charged to |  | Other      |   |              |  | Balance at
|                                                          |                                 | beginning      |   | Costs and  |  | Accounts  |   | Deductions  |  | End of    
|Description                                               |                                 | of period      |   | Expenses   |  | Describe   |   | Describe     |  | Period    
|                                                          |                                 |                |   |            |  |            |   |              |  |           
|                                                          |                                 |               
|                                                          |                                 | (in thousands)
|YEAR ENDED DECEMBER 31, 2000                              |                                 |                |   |            |  |            |   |              |  |            |   |     |     |  |   |     |     |  |   |    
|Reserves and allowances deducted from
    asset accounts: |                                 |                |   |            |  |            |   |              |  |            |   |     |     |  |   |     |     |  |   |    
|                                                          | Allowance for doubtful accounts |                | $ | 253        |  |            | $ | 128          |  |            |   |    |     |  | $ | 256 | (1) |  | $ | 125 | 
|YEAR ENDED DECEMBER 31, 2001                              |                                 |                |   |            |  |            |   |              |  |            |   |     |     |  |   |     |     |  |   |    
|Reserves and allowances deducted from
    asset accounts: |                                 |                |   |            |  |            |   |              |  |            |   |     |     |  |   |     |     |  |   |    
|                                                          | Allowance for doubtful accounts |                | $ | 125        |  |            | $ | 226          |  |            | $ | 155 | (2) |  | $ | 172 | (1) |  | $ | 334 | 
|YEAR ENDED DECEMBER 31, 2002                              |                                 |                |   |            |  |            |   |              |  |            |   |     |     |  |   |     |     |  |   |    
|Reserves and allowances deducted from
    asset accounts: |                                 |                |   |            |  |            |   |              |  |            |   |     |     |  |   |     |     |  |   |    
|                                                          | Allowance for doubtful accounts |                | $ | 334        |  |            |   |             |  |            | $ | 250 | (2) |  | $ | 404 | (1) |  | $ | 180 | 






|    |                                                                                                                                                                                                                                        
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Uncollectible accounts written off, net of
    recoveries.                                                                                                                                                                             
|   
|(2) | Amount represents reserve recorded as a reduction
    of deferred revenue and represents customer balances deemed
    uncollectible. The reserve is amortized as a reduction of
    revenue over the average life of all subscriptions.

II-1



---



##### Table of Contents



EXHIBIT INDEX

|       |     |                         |  |                                                                                                                                                
|------ | --- | ----------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------
|Number |     | Description of Document
|       |     |                        
|       | 3.  | 1(1)                    |  | Amended and Restated Certificate of Incorporation                                                                                              
|       | 3.  | 2(1)                    |  | Restated Bylaws                                                                                                                                
|       | 4.  | 1(1)                    |  | Specimen Stock Certificate of Websense, Inc.                                                                                                   
|       | 10. | 1(1)                    |  | Amended and Restated Registration Rights
    Agreement dated June 9, 1999                                                                      
|       | 10. | 2(1)                    |  | Form of Subscription Agreement regarding
    Series B Preferred Stock                                                                          
|       | 10. | 3(1)                    |  | Warrant to Purchase Common Stock between
    Websense, Inc. and Alps System Integration Co., Ltd., dated
    April 15, 1999                    
|       | 10. | 4(1)                    |  | Form of Warrant to Purchase Common Stock between
    Websense, Inc. and entities listed on Schedule A attached
    thereto, dated July 30, 1999
|       | 10. | 5(1)*                   |  | Employment Agreement by and between Websense,
    Inc. and John B. Carrington, dated May 10, 1999                                              
|       | 10. | 6(1)*                   |  | Employment Agreement by and between Websense,
    Inc. and Douglas C. Wride, dated June 11, 1999                                               
|       | 10. | 7(1)                    |  | Lease Agreement between Websense, Inc. and
    Legacy-RECP Sorrento OPCO, LLC, dated June 21, 1999, as
    amended                             
|       | 10. | 8(1)                    |  | 1998 Equity Incentive Plan                                                                                                                     
|       | 10. | 9(1)*                   |  | Standard Terms and Conditions Relating to
    Incentive Stock Option Under the 1998 Equity Incentive Plan                                      
|       | 10. | 10(1)*                  |  | 2000 Stock Incentive Plan                                                                                                                      
|       | 10. | 11(1)*                  |  | 2000 Stock Incentive Plan, Notice of Grant of
    Stock Option                                                                                 
|       | 10. | 12(1)*                  |  | 2000 Stock Incentive Plan, Form of Incentive
    Stock Option Agreement                                                                        
|       | 10. | 13(1)*                  |  | 2000 Employee Stock Purchase Plan                                                                                                              
|       | 10. | 14(1)                   |  | Form of Indemnification Agreement between
    Websense, Inc. and its directors                                                                 
|       | 10. | 15(1)                   |  | Form of Indemnification Agreement between
    Websense, Inc. and its officers                                                                  
|       | 10. | 16(2)                   |  | Lease Agreement between Websense, Inc. and
    Legacy-RECP Sorrento OPCO, LLC, dated February 12, 2000                                         
|       | 10. | 17(2)                   |  | First Amendment to Lease Agreement between
    Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated
    June 2, 2000                       
|       | 10. | 18(3)                   |  | Lease Agreement between Websense, Inc. and
    Legacy-RECP Sorrento OPCO, LLC, dated April 19, 2002                                            
|       | 21. | 1                       |  | Subsidiaries of the Registrant                                                                                                                 
|       | 23. | 1                       |  | Consent of Ernst & Young LLP, Independent
    Auditors                                                                                         
|       | 99. | 1                       |  | Certifications Pursuant to 18 U.S.C.
    Section 1350, as adopted pursuant to Section 906 of
    the Sarbanes  Oxley Act of 2002              






|    |                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------
|*   | Indicates management contract or compensatory
    plan or arrangement.                                                                             
|   
|(1) | Previously filed as an exhibit to our
    Registration Statement on Form S-1 (Registration
    No. 333-95619) and incorporated herein by reference.
|   
|(2) | Previously filed as an exhibit to our
    Form 10-K for the period ended December 31, 2000 and
    incorporated herein by reference.               
|   
|(3) | Previously filed as an exhibit to our
    Form 10-Q for the period ended June 30, 2002 and
    incorporated herein by reference.