**FORM 10-Q**

 

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

 

| **(Mark One)**                                                                                                                                                                                                                                                                                      |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **                                                                                                                                                                                                                                                                                          |
| **ý****QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                               |
| ** **                                                                                                                                                                                                                                                                                          |
| **For the quarterly period ended March 31, 2006**                                                                                                                                                                                                                                                   |
| ** **                                                                                                                                                                                                                                                                                          |
| **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**                                                   | ** ** | **51-0380839**                       |
|----------------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of incorporation or organization) |       | (I.R.S. Employer Identification No.) |

 

**10240 Sorrento Valley Road**

**San Diego, California 92121**

**858-320-8000**

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

 

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

 

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

 
| Large Accelerated Filer ý |   | Accelerated Filer o |   | Non –Accelerated Filer o |
|--------------------------------|--------|---------------------|--------|-------------------------------|

 

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

 

The number of shares outstanding of the registrant’s Common Stock, $.005 par value, as of April 28, 2006 was 47,986,014.

 

 

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**Websense, Inc.**

**Form 10-Q**

**For the PeriodEnded March 31, 2006**

 

**TABLE OFCONTENTS**

 
| Part I. Financial Information | 1        |
|-------------------------------|----------|
|                          |     |   |   |
|                          | Item 1.  | Consolidated Financial  Statements (Unaudited) | 1 |
|                          |     | Consolidated Balance Sheets as of  March 31, 2006 and December 31, 2005 | 1 |
|                          |     | Consolidated Statements of  Income for the three months ended March 31, 2006 and 2005 | 2 |
|                          |     | Consolidated Statement of  Stockholders’ Equity for the three months ended March 31, 2006 | 3 |
|                          |     | Consolidated Statements of  Cash Flows for the three months ended March 31, 2006 and 2005 | 4 |
|                          |     | Notes to Consolidated  Financial Statements | 5 |
|                          | Item 2.  | Management’s Discussion and Analysis of Financial  Condition and Results of Operations | 13 |
|                          | Item 3.  | Quantitative and Qualitative Disclosures About Market  Risk | 20 |
|                          | Item 4.  | Controls and Procedures | 21 |
|                          |     |   |   |
| Part II. Other Information    | 22       |
|                          |     |   |   |
|                          | Item 1.  | Legal Proceedings | 22 |
|                          | Item 1A. | Risk Factors | 22 |
|                          | Item 2.  | Unregistered Sales of Equity Securities and Use of  Proceeds | 22 |
|                          | Item 3.  | Defaults upon Senior  Securities | 22 |
|                          | Item 4.  | Submission of Matters to a  Vote of Security Holders | 23 |
|                          | Item 5.  | Other Information | 23 |
|                          | Item 6.  | Exhibits | 23 |
|                          |     |   |   |
| Signatures                    | 24       |

 

i

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**Part I – Financial Information**

 

**Item 1. Consolidated FinancialStatements (Unaudited)**

 

**Websense,Inc.**

**ConsolidatedBalance Sheets**

**(Unaudited and in thousands)**

** **
| ** **                                                   | ** ** | **March 31,  2006** | ** ** | **December 31,   2005** | ** ** |
|--------------------------------------------------------------|------------|--------------------------|------------|-----------------------------------|------------|
| ** **                                                   | ** ** | ** **               | ** ** | **(See Note 1)**                  | ** ** |
| **Assets**                                                   |       |                     |       |                              |       |
| Current assets:                                              |       |                     |       |                              |       |
| Cash and cash equivalents                                    |       | $                        | 20,491     |                              | $          | 61,629 |   |
| Marketable securities                                        |       | 327,871                  |       | 258,760                           |       |
| Accounts receivable, net of allowance for  doubtful accounts |       | 30,365                   |       | 50,570                            |       |
| Prepaid income taxes                                         |       | 1,970                    |       | 1,962                             |       |
| Current portion of deferred income taxes                     |       | 15,772                   |       | 15,772                            |       |
| Other current assets                                         |       | 3,441                    |       | 3,467                             |       |
| Total current assets                                         |       | 399,910                  |       | 392,160                           |       |
|                                                         |       |                     |       |                              |       |
| Property and equipment, net.                                 |       | 5,439                    |       | 4,923                             |       |
| Deferred income taxes, less current portion                  |       | 7,243                    |       | 6,043                             |       |
| Deposits and other assets                                    |       | 573                      |       | 549                               |       |
| Total assets                                                 |       | $                        | 413,165    |                              | $          | 403,675 |   |
|                                                         |       |                     |       |                              |       |
| **Liabilities and stockholders’ equity**                |       |                     |       |                              |       |
| Current liabilities:                                         |       |                     |       |                              |       |
| Accounts payable                                             |       | $                        | 1,252      |                              | $          | 2,073 |   |
| Accrued payroll and related benefits                         |       | 7,632                    |       | 8,476                             |       |
| Other accrued expenses                                       |       | 6,165                    |       | 5,085                             |       |
| Income taxes payable                                         |       | 6,246                    |       | 2,305                             |       |
| Current portion of deferred revenue                          |       | 117,738                  |       | 119,118                           |       |
| Total current liabilities                                    |       | 139,033                  |       | 137,057                           |       |
|                                                         |       |                     |       |                              |       |
| Deferred revenue, less current portion                       |       | 58,787                   |       | 60,807                            |       |
|                                                         |       |                     |       |                              |       |
| Stockholders’ equity:                                   |       |                     |       |                              |       |
| Common stock                                                 |       | 251                      |       | 249                               |       |
| Additional paid-in capital                                   |       | 208,076                  |       | 198,077                           |       |
| Treasury stock                                               |       | (57,244                  | )          | (48,340                           | )          |
| Retained earnings                                            |       | 64,648                   |       | 56,449                            |       |
| Accumulated other comprehensive loss                         |       | (386                     | )          | (624                              | )          |
| Total stockholders’ equity                              |       | 215,345                  |       | 205,811                           |       |
|                                                         |       |                     |       |                              |       |
| Total liabilities and stockholders’ equity              |       | $                        | 413,165    |                              | $          | 403,675 |   |

 
| See accompanying notes. |   |   |   |   |   |
|-------------------------|--------|--------|--------|--------|--------|

 

1

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**Websense, Inc.**

**ConsolidatedStatements of Income**

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

** **
| ** **                             | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------|------------|
| ** **                             | ** ** | **March 31,**               | ** ** | **March 31,** | ** ** |
| ** **                             | ** ** | **2006**                         | ** ** | **2005** | ** ** |
|                                   |       |                             |       |   |   |
| Revenue                                |       | $                                | 42,434     |   | 34,182 |   |
|                                   |       |                             |       |   |   |
| Cost of revenue                        |       | 3,378                            |       | 2,500 |   |
|                                   |       |                             |       |   |   |
| Gross margin                           |       | 39,056                           |       | 31,682 |   |
|                                   |       |                             |       |   |   |
| Operating expenses:                    |       |                             |       |   |   |
| Selling and marketing                  |       | 18,014                           |       | 12,328 |   |
| Research and development               |       | 5,443                            |       | 4,024 |   |
| General and administrative             |       | 5,208                            |       | 2,871 |   |
| Total operating expenses               |       | 28,665                           |       | 19,223 |   |
|                                   |       |                             |       |   |   |
| Income from operations                 |       | 10,391                           |       | 12,459 |   |
|                                   |       |                             |       |   |   |
| Other income, net                      |       | 2,635                            |       | 954 |   |
|                                   |       |                             |       |   |   |
| Income before income taxes             |       | 13,026                           |       | 13,413 |   |
|                                   |       |                             |       |   |   |
| Provision for income taxes             |       | 4,827                            |       | 4,801 |   |
|                                   |       |                             |       |   |   |
| Net income                             |       | $                                | 8,199      |   | $ | 8,612 |   |
|                                   |       |                             |       |   |   |
| Net income per share:                  |       |                             |       |   |   |
|                                   |       |                             |       |   |   |
| Basic net income per share             |       | $                                | 0.17       |   | $ | 0.18 |   |
| Diluted net income per share           |       | $                                | 0.17       |   | $ | 0.17 |   |
| Weighted average shares – basic   |       | 47,948                           |       | 47,345 |   |
| Weighted average shares – diluted |       | 49,047                           |       | 49,483 |   |

 

Seeaccompanying notes. Specifically, Note 5 details the amount of share-basedcompensation included in net income for the three months ended March 31, 2006.

 

2

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**Websense, Inc.**

**ConsolidatedStatement of Stockholders’ Equity**

**(Unaudited and in thousands)**

 
| ** **                                                                                               | ** ** | **Common stock** | ** ** | **Additional**** ** | ** ** | **Treasury **       | ** ** | **Retained**** ** | ** ** | **Accumulated   other   comprehensive** | ** ** | **Total   stockholders’** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------|------------|--------------------------|------------|------------------------|------------|---------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                               | ** ** | **Shares**            | ** ** | **Amount**               | ** ** | **paid-in capital** | ** ** | **stock**              | ** ** | **earnings**                                      | ** ** | ** ****loss**                  | ** ** | **equity** | ** ** |
|                                                                                                     |       |                  |       |                     |       |                     |       |                   |       |                                              |       |                                |       |   |   |
| Balance at December 31, 2005                                                                             |       | 47,942                |       | $                        | 249        |                     | $          | 198,077                |       | $                                                 | (48,340    | )                                   | $          | 56,449 |   | $ | (624 | ) | $ | 205,811 |   |
| Issuance of common stock upon exercise of  options                                                       |       | 304                   |       | 2                        |       | 3,676                    |       | —                 |       | —                                            |       | —                              |       | 3,678 |   |
| Share-based compensation expense                                                                         |       | —                |       | —                   |       | 4,740                    |       | —                 |       | —                                            |       | —                              |       | 4,740 |   |
| Excess tax benefit of share-based  compensation                                                          |       | —                |       | —                   |       | 1,583                    |       | —                 |       | —                                            |       | —                              |       | 1,583 |   |
| Purchase of treasury stock                                                                               |       | (300                  | )          | —                   |       | —                   |       | (8,904                 | )          | —                                            |       | —                              |       | (8,904 | ) |
| Net income                                                                                               |       | —                |       | —                   |       | —                   |       | —                 |       | 8,199                                             |       | —                              |       | 8,199 |   |
| Net change in unrealized gain (loss) on  marketable securities, net of tax                               |       | —                |       | —                   |       | —                   |       | —                 |       | —                                            |       | 179                                 |       | 179 |   |
| Net change in unrealized gain (loss) on  fair market valuation of foreign currency contracts, net of tax |       | —                |       | —                   |       | —                   |       | —                 |       | —                                            |       | 59                                  |       | 59 |   |
| Comprehensive income                                                                                     |       |                  |       |                     |       |                     |       |                   |       |                                              |       |                                |       | 8,437 |   |
| Balance at March 31, 2006                                                                                |       | 47,946                |       | $                        | 251        |                     | $          | 208,076                |       | $                                                 | (57,244    | )                                   | $          | 64,648 |   | $ | (386 | ) | $ | 215,345 |   |

 

See accompanying notes.

 

3

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**Websense, Inc.**

**ConsolidatedStatements of Cash Flows**

**(Unaudited and in thousands)**

 
| ** **                                                                        | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                        | ** ** | **March 31,**               | ** ** | **March 31,** | ** ** |
| ** **                                                                        | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| **Operating activities:**                                                         |       |                             |       |   |   |
| Net income                                                                        |       | $                                | 8,199      |   | $ | 8,612 |   |
|                                                                              |       |                             |       |   |   |
| Adjustments to reconcile net income to net  cashprovided by operating activities: |       |                             |       |   |   |
| Depreciation                                                                      |       | 761                              |       | 603 |   |
| Share-based compensation                                                          |       | 4,740                            |       | — |   |
| Deferred revenue                                                                  |       | (3,400                           | )          | 1,291 |   |
| Unrealized gain (loss) on foreign exchange  contracts                             |       | 59                               |       | (18 | ) |
| Tax benefit from exercise of stock options                                        |       | —                           |       | 5,082 |   |
| Excess tax benefit from share-based  compensation                                 |       | (1,583                           | )          | — |   |
| Changes in operating assets and  liabilities:                                     |       |                             |       |   |   |
| Accounts receivable                                                               |       | 20,205                           |       | 11,910 |   |
| Prepaid income taxes                                                              |       | (8                               | )          | (516 | ) |
| Other current assets                                                              |       | 26                               |       | (1,640 | ) |
| Deposits and other assets                                                         |       | (24                              | )          | 1 |   |
| Deferred income taxes                                                             |       | (1,200                           | )          | — |   |
| Accounts payable                                                                  |       | (821                             | )          | 647 |   |
| Accrued payroll and related benefits                                              |       | (844                             | )          | (635 | ) |
| Other accrued expenses                                                            |       | 1,080                            |       | 594 |   |
| Income taxes payable                                                              |       | 5,524                            |       | (91 | ) |
| Net cash provided by operating activities                                         |       | 32,714                           |       | 25,840 |   |
|                                                                              |       |                             |       |   |   |
| **Investing activities:**                                                         |       |                             |       |   |   |
| Purchases of property and equipment                                               |       | (1,277                           | )          | (822 | ) |
| Purchases of marketable securities                                                |       | (233,277                         | )          | (59,119 | ) |
| Maturities of marketable securities                                               |       | 164,345                          |       | 40,135 |   |
| Sales of marketable securities                                                    |       | —                           |       | 1,042 |   |
| Net cash used in investing activities                                             |       | (70,209                          | )          | (18,764 | ) |
|                                                                              |       |                             |       |   |   |
| **Financing activities:**                                                         |       |                             |       |   |   |
| Proceeds from exercise of stock options                                           |       | 3,678                            |       | 6,149 |   |
| Excess tax benefit from share-based  compensation                                 |       | 1,583                            |       | — |   |
| Purchases of treasury stock                                                       |       | (8,904                           | )          | (7,078 | ) |
| Net cash used in financing activities                                             |       | (3,643                           | )          | (929 | ) |
|                                                                              |       |                             |       |   |   |
| Increase /(decrease) in cash and cash  equivalents                                |       | (41,138                          | )          | 6,147 |   |
|                                                                              |       |                             |       |   |   |
| Cash and cash equivalents at beginning of  period                                 |       | 61,629                           |       | 38,878 |   |
|                                                                              |       |                             |       |   |   |
| Cash and cash equivalents at end of period                                        |       | $                                | 20,491     |   | $ | 45,025 |   |
|                                                                              |       |                             |       |   |   |
| **Supplemental disclosures of cash flow  information:**                           |       |                             |       |   |   |
| Income taxes paid                                                                 |       | $                                | 195        |   | $ | 284 |   |
| Unrealized loss on marketable securities                                          |       | $                                | (360       | ) | $ | (752 | ) |

 

See accompanying notes.

 

4

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**Websense, Inc.**

** **

**Notes To Consolidated Financial Statements(Unaudited)**

 

1. *Basis of Presentation*

 

Theaccompanying unaudited consolidated financial statements have been prepared inconformity with accounting principles generally accepted in the United Statesfor interim financial statements and with the instructions to Form 10-Q andArticle 10 of Regulation S-X. Accordingly, certain information or footnote disclosuresnormally included in complete financial statements prepared in accordance withaccounting principles generally accepted in the United States have beencondensed or omitted pursuant to the rules and regulations of the Securitiesand Exchange Commission. In the opinion of management, the statements includeall adjustments necessary, which are of a normal and recurring nature, for thefair presentation of our financial position and of the results for the interimperiods presented.

 

Thesefinancial statements should be read in conjunction with the auditedconsolidated financial statements and notes thereto for the year ended December31, 2005, included in Websense, Inc.’s Annual Report on Form 10-K filed withthe Securities and Exchange Commission. Operating results for the three monthsended March 31, 2006 are not necessarily indicative of the results that may beexpected for any other interim period or for the year ending December 31, 2006.The balance sheet at December 31, 2005 has been derived from the audited financialstatements at that date but does not include all of the information andfootnotes required by accounting principles generally accepted in the UnitedStates for complete financial statements.

 

2. *Stock Split*

 

On January 31, 2006, the Company announcedthat the Board of Directors authorized a two-for-one stock split of the Company’scommon stock, to be effected in the form of a special dividend of one share ofits common stock for each share of its common stock outstanding. The additionalshares issued as a result of the stock split were distributed on March 17, 2006to stockholders of record at the close of business on February 13, 2006. Allprior year share and option amounts included in the accompanying consolidated financialstatements and related notes have been restated to reflect the stock split.

 

3. *Net Income Per Share*

 

Websense computes net incomeper share in accordance with Statement of Financial Accounting Standards (SFAS)No. 128, *Earnings Per Share* (EPS) (SFAS No. 128).Under the provisions of SFAS No. 128, basic net income per share is computed bydividing the net income for the period by the weighted average number of commonshares outstanding during the period. Diluted net income per share is computedby dividing the net income for the period by the weighted average number ofcommon and common equivalent shares outstanding during the period. Commonequivalent shares for all periods presented consist of dilutive stock optionsand restricted stock subject to vesting.

 

During thequarters ended March 31, 2006 and 2005, the difference between the weightedaverage shares used in determining basic EPS versus diluted EPS related todilutive stock options totaled 1,099,000 and 2,138,000 shares, respectively.Potentially dilutive securities totaling 3,367,000 and 76,000 shares for thequarters ended March 31, 2006 and 2005, respectively, were excluded fromhistorical basic and diluted earnings per share because of their anti-dilutiveeffect as a result of stock options which have exercise prices greater than theaverage market price of the common shares.

 

5

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

 
| ** **                      | ** ** | **Net Income**                                                   | ** **  | **Shares**        | ** ** | **Per Share** | ** ** |
|---------------------------------|------------|-----------------------------------------------------------------------|-------------|-------------------|------------|--------------------|------------|
| ** **                      | ** ** | **(Numerator)**                                                       | ** **  | **(Denominator)** | ** ** | **Amount**         | ** ** |
| ** **                      | ** ** | **(In thousands, except per share amounts)** | ** **  |
| **For the Three Months Ended:** | ** ** | ** **                                                            | ** **  | ** **        | ** ** | ** **         | ** ** |
| **March 31, 2006:**             | ** ** | ** **                                                            | ** **  | ** **        | ** ** | ** **         | ** ** |
| Basic EPS                       |       | $                                                                     |  8,199 |              | 47,948     |               | $          |  0.17 |   |
| Effect of stock options         |       | —                                                                |        | 1,099             |       | 0.00               |       |
| Diluted EPS                     |       | $                                                                     |  8,199 |              | 49,047     |               | $          |  0.17 |   |
| ** **                      | ** ** | ** **                                                            | ** **  | ** **        | ** ** | ** **         | ** ** |
| **March 31, 2005:**             | ** ** | ** **                                                            | ** **  | ** **        | ** ** | ** **         | ** ** |
| Basic EPS                       |       | $                                                                     |  8,612 |              | 47,345     |               | $          |  0.18 |   |
| Effect of stock options         |       | —                                                                |        | 2,138             |       | (0.01              | )          |
| Diluted EPS                     |       | $                                                                     |  8,612 |              | 49,483     |               | $          |  0.17 |   |

 

4. *Comprehensive Income*

 

The componentsof comprehensive income, as required to be reported by SFAS No. 130, *Reporting Comprehensive Income*, were as follows (inthousands):

 
| ** **                                                                                               | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                               | ** ** | **March 31,   2006**   | ** ** | **March 31,   2005** | ** ** |
|                                                                                                     |       |                             |       |   |   |
| Net income                                                                                               |       | $                                | 8,199      |   | $ | 8,612 |   |
| Net change in unrealized gain (loss) on  marketable securities, net of tax                               |       | 179                              |       | (325 | ) |
| Net change in unrealized gain (loss) on  fair market valuation of foreign currency contracts, net of tax |       | 59                               |       | (18 | ) |
| Comprehensive income                                                                                     |       | $                                | 8,437      |   | $ | 8,269 |   |

 

Accumulatedother comprehensive loss totaled ($386,000) and ($762,000) at March 31, 2006and March 31, 2005, respectively.

 

5. *Stockholders Equity*

 

**Share-Based Compensation**

 

ThroughDecember 31, 2005, the Company accounted for share-based employee compensationplans under the measurement and recognition provisions of Accounting PrinciplesBoard (APB) No. 25 (APB No. 25), and related Interpretations, as permittedby Financial Accounting Standards Board (FASB) SFAS No. 123 *Accounting for Stock-Based Compensation* (SFAS No. 123). Accordingly,the Company recorded no share-based employee compensation expense for optionsgranted under its Amended and Restated 2000 Stock Incentive Plan (2000 Plan) orits predecessor plans (or options granted as non-plan inducement options) duringthe three months ended March 31, 2005 as all other options granted had exerciseprices equal to the fair market value of the common stock on the date of grant.The Company also recorded no compensation expense in connection with theEmployee Stock Purchase Plan during the three months ended March 31, 2005 asthe purchase price of the stock was not less than 85% of the lower of the fairmarket value of the common stock at the beginning of each offering period or atthe end of each purchase period. In accordance with SFAS No. 123 and SFAS No.148, *Accounting for Stock-Based Compensation –Transition and Disclosure* (SFAS No. 148), the Company disclosed netincome or 

 

6

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lossand net income or loss per share as if the fair value-based method was appliedin measuring compensation expense for share-based incentive programs.

 

*Employee Stock Purchase Plan*

 

In February 2000, the Company adopted the 2000 Employee Stock PurchasePlan (Purchase Plan). The Purchase Plan provides for automatic annual increasesin 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 lastbusiness day in December of the calendar year immediately preceding or (ii)750,000 shares. The Purchase Plan is intended to qualify as an employee stockpurchase plan within the meaning of Section 423 of the Internal Revenue Code.Under the Purchase Plan, the Board of Directors may authorize participation byeligible employees, including officers, in periodic offerings followingcommencement of the Purchase Plan.

 

Unless otherwise determined by the Board or precluded by laws offoreign jurisdictions, employees are eligible to participate in the PurchasePlan provided they are employed for at least 20 hours per week and arecustomarily employed for at least five months per calendar year. Employees whoparticipate in an offering may have up to 15% of their earnings withheldpursuant to the Purchase Plan. The amount withheld is then used to purchaseshares of common stock on specified dates. The price of common stock purchasedpursuant to the Purchase Plan will be equal to 85% of the lower of the fairmarket value of the common stock at the commencement date of each offeringperiod or the relevant purchase date. Employees may end their participation inthe offering at any time during the offering period, and participation endsautomatically on termination of employment. At March 31, 2006, 1,679,830 shareswere available for issuance under the Purchase Plan.

 

During the three monthsended March 31, 2006 and March 31, 2005, the Company issued no sharesunder the Purchase Plan as shares are only issued in April and October ofeach year.

 

*Employee Stock Option Plan*

 

The Amended and Restated 2000 Stock Incentive Plan (2000 Plan) providesfor the grant of stock options to the Company’s directors, officers, employeesand consultants. The 2000 Plan provides for the grant of incentive andnon-statutory stock options, restricted stock units and rights to purchasestock to employees, directors or consultants of the Company. The 2000 Planprovides that incentive stock options will be granted only to employees and aresubject to certain limitations as to fair value during a calendar year.

 

In addition, the 2000 Plan provides for automatic annual increases inthe number of shares authorized and reserved for issuance thereunder (beginningin 2001) equal to the lesser of (i) 4% of the Company’s outstanding shares onthe last business day in December of the calendar year immediately preceding or(ii) 3,000,000 shares. At March 31, 2006, a total of 19,558,162 shares havebeen authorized for issuance under the 2000 Plan, of which 2,955,772 remainavailable for grant.

 

The exercise price of incentive stock options must equal at least thefair value on the date of grant and the exercise price of non-statutory stockoptions and the issuance price of common stock under the stock issuance programmay be no less than 85% of the fair value on the date of grant or issuance.Through April 2005, the option grants were generally exercisable for a periodof ten years, and beginning in May 2005, the option grants are generally exercisablefor a period of seven years after the date of grant and generally vest 25% oneyear from date of grant and ratably each month thereafter for a period of 36months. Unvested common shares obtained through early exercise of stock optionsare subject to repurchase by the Company at the original issue price. To date,only non-statutory stock options and restricted stock units have been grantedunder the 2000 Plan. Through March 31, 2006, the Company has granted 96,000restricted stock units. The unvested restricted stock 

 

7

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unitshave a weighted average grant date fair value of $32.24 and an aggregate intrinsicvalue of $2.6 million as of March 31, 2006.

 

In 2002, the Company issued stock options as an incentive for certainpersons to commence employment that were not covered under the 2000 Plan. Inaccordance with Section 4350(i) of the NASD Marketplace Rules for the NasdaqStock Market, the Company issued 354,000 such stock options, which havesubstantially the same terms as stock options issued under the 2000 Plan.

 

In January 2006, the Company entered into anemployment agreement with Gene Hodges to serve as the Company’s President andChief Executive Officer, reporting to the Company’s Board of Directors, withemployment continuing “at will” until either party gives notice of termination.In January 2006, Mr. Hodges was also granted non-qualified stock options topurchase an aggregate of 1,200,000 shares of the Company’s Common Stock outsidethe Company’s 2000 Plan (the “Options”) with an exercise price per share equalto the fair market value of the Company’s Common Stock on that date. In April2006, at the request of the Company, Mr. Hodges agreed to the cancellation ofthe Options and the immediate re-grant under the 2000 Plan of non-qualifiedstock options to purchase an aggregate of 1,200,000 shares of the Company’sCommon Stock with identical option terms, exercise prices, vesting schedulesand vesting commencement dates as the original Options. The Company requestedthe cancellation and re-grant to bring the Options under the 2000 Plan for U.S.federal income tax and accounting reasons and to better align Mr. Hodges’compensation with stockholder approved limitations on stock option issuances.Mr. Hodges received no income tax or other personal benefit from thecancellation and re-grant.

 

The following table summarizes stock option activity under the 2000Plan and the 1,554,000 stock options issued in 2002 and January 2006 notcovered under a formal plan and related information:

 
| ** **                    | ** ** | **Number of   Shares** | ** ** | **Weighted   Average   Exercise   Price** | ** ** |
|-------------------------------|------------|------------------------|------------|-------------------------------------------|------------|
| Balance at  December 31, 2005 |       | 5,214,702              |       | $                                         | 17.86      |   |
| Granted                       |       | 1,719,400              |       | 32.02                                     |       |
| Exercised                     |       | (303,842               | )          | 12.10                                     |       |
| Cancelled/forfeited/expired   |       | (66,996                | )          | 20.17                                     |       |
| Balance at  March 31, 2006    |       | 6,563,264              |       | 21.81                                     |       |
|                               |            |                        |            |                                           |            |  |

 

The weighted average fair value of stock options granted during thethree months ended March 31, 2006 was $17.14 per share. The total intrinsicvalue of stock options exercised during the three months ended March 31, 2006was $5.8 million.

 

The following table summarizes all stock options outstanding andexercisable by price range as of March 31, 2006:

 

8

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| ** **                              | ** ** | **Options Outstanding** | ** ** | **Options Exercisable**                                           | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------------------------------------------------------|------------|
| **Range of  Exercise Prices** | ** ** | **Number of  Shares**   | ** ** | **Weighted  Average  Remaining  Contractual Life  In Years** | ** ** | **Weighted  Average  Exercise Price** | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
| $  0.10-$13.58                |       | 1,418,627                    |       | 6.10                                                                   |       | $ | 8.33 |   | 989,170 |   | $ | 8.08 |   |
| $13.59-$19.86                           |       | 1,378,344                    |       | 7.59                                                                   |       | 16.75 |   | 652,819 |   | 15.71 |   |
| $19.96-$25.63                           |       | 1,327,226                    |       | 6.91                                                                   |       | 24.79 |   | 67,732 |   | 23.42 |   |
| $25.69-$31.91                           |       | 896,467                      |       | 7.43                                                                   |       | 28.40 |   | 79,743 |   | 28.19 |   |
| $32.24-$33.85                           |       | 1,542,600                    |       | 8.00                                                                   |       | 32.35 |   | — |   | — |   |
|                                    |       |                         |       |                                                                   |       |   |   |   |   |   |   |
|                                    |       | 6,563,264                    |       | 7.21                                                                   |       | 21.81 |   | 1,789,464 |   | 12.34 |   |
|                                         |            |                              |            |                                                                        |            |  |  |  |  |  |  |  |  |

 

The Company defines in-the-money stock options at March 31, 2006 asstock options that had exercise prices that were lower than the $27.58 marketprice of our common stock at that date. The aggregate intrinsic value of all stockoptions outstanding and in-the-money at March 31, 2006 was $46.4 million. Theaggregate intrinsic value of exercisable stock options outstanding andin-the-money at March 31, 2006 was $27.4 million. There were 4.5 million stockoptions in-the-money at March 31, 2006, of which 1.7 million were exercisable.

 

The following table shows net income and earningsper share for the three months ended March 31, 2006, which includes share-basedcompensation in accordance with the provisions of Statement of FinancialAccounting Standards No. 123 (revised 2004) *Share-Based Payment* (SFAS No. 123(R)) (in thousands, exceptper share amounts):

 

| ** **                   | ** ** | **Three Months  Ended** | ** ** |
|------------------------------|------------|------------------------------|------------|
| ** **                   | ** ** | **March 31,  2006**     | ** ** |
| Net income                   |       | $                            | 8,199      |   |
|                         |       |                         |       |
| Basic net income per share   |       | $                            | 0.17       |   |
|                         |       |                         |       |
| Diluted net income per share |       | $                            | 0.17       |   |

 

The following table illustrates the effect on netincome and earnings per share if the Company had expensed share-basedcompensation in accordance with the provisions of SFAS No. 123 for the threemonths ended March 31, 2005 (in thousands, except per share amounts):

 

| ** **                                                                                                  | ** ** | **Three Months  Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|
| ** **                                                                                                  | ** ** | **March 31,  2005**     | ** ** |
| Net income as reported                                                                                      |       | $                            | 8,612      |   |
| Deduct: share-based compensation expense  determined under fair value method for all awards, net of tax (1) |       |                         | (2,388     | ) |
| Pro forma net income                                                                                        |       | $                            | 6,224      |   |
|                                                                                                        |       |                         |       |
| Basic net income per share as reported                                                                      |       | $                            | 0.18       |   |
| Pro forma basic net income per share                                                                        |       | $                            | 0.13       |   |
|                                                                                                        |       |                         |       |
| Diluted net income per share as reported                                                                    |       | $                            | 0.17       |   |
| Pro forma diluted net income per share                                                                      |       | $                            | 0.13       |   |

 

----

(1)  The Company had an effectivetax rate of 36% in the three months ended March 31, 2005.

 

EffectiveJanuary 1, 2006, the Company adopted the fair value recognition provisionsof SFAS No. 123(R), using the modified prospective transition method. Underthat transition method, compensation expense that the Company recognizedbeginning on that date includes: (a) compensation expense for allshare-based payments granted prior to, but not yet vested as of January 1,2006, based on the grant date fair value estimated in accordance with theoriginal provisions of SFAS No. 123, and (b) compensation expense for allshare-based payments granted on or after January 1, 2006, based on the grantdate fair value estimated in accordance with the provisions of SFAS No. 123(R).Results for prior periods will not be restated. The results for the threemonths ended March 31, 2006 include share-based compensation expense of $4.7 (excludingtax effects) million in the following expense categories of the consolidatedstatement of income.

 

| ** **                                            | ** ** | **Three Months Ended** | ** ** |
|-------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                            | ** ** | **March 31,   2006**   | ** ** | **March 31,   2005** | ** ** |
| Share-based compensation in:                          |       |                             |       |   |   |
| Cost of revenue                                       |       | $                                | 326        |   | $ | — |   |
| Total share-based compensation in cost of  revenue    |       | 326                              |       | — |   |
|                                                  |       |                             |       |   |   |
| Selling and marketing                                 |       | 1,951                            |       | — |   |
| Research and development                              |       | 841                              |       | — |   |
| General and administrative                            |       | 1,622                            |       | — |   |
| Total share-based compensation in operating  expenses |       | 4,414                            |       | — |   |
| Total share-based compensation                        |       | $                                | 4,740      |   | $ | — |   |

 

9

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AtMarch 31, 2006, there was $60.3 million of total unrecognizedcompensation cost related to share-based compensation arrangements grantedunder all equity compensation plans (excluding tax effects). That totalunrecognized compensation cost will be adjusted for future changes in estimatedforfeitures. The Company expects to recognize that cost over a weighted averageperiod of approximately 3 years.

 

TheCompany estimates the fair value of options granted using the Black-Scholesoption valuation model and the assumptions shown in the table below. TheCompany estimates the expected term of options granted based on the history ofgrants and exercises in the Company’s option database. The Company estimatesthe volatility of its common stock at the date of grant based on both thehistorical volatility as well as the implied volatility of publicly tradedoptions on its common stock, consistent with SFAS No. 123(R) and Securities andExchange Commission Staff Accounting Bulletin No. 107. The Company basesthe risk-free interest rate that is used in the Black-Scholes option valuationmodel on the implied yield in effect at the time of option grant on U.S.Treasury zero-coupon issues with equivalent remaining terms. The Company hasnever paid any cash dividends on its common stock and does not anticipatepaying any cash dividends in the foreseeable future. Consequently, the Companyuses an expected dividend yield of zero in the Black-Scholes option valuationmodel. The Company amortizes the fair value ratably over the vesting period ofthe awards, which is typically four years. The Company uses historical data toestimate pre-vesting option forfeitures and records share-based expense onlyfor those awards that are expected to vest. For purposes of calculating proforma information under SFAS No. 123 for periods prior to January 1, 2006, theCompany accounted for forfeitures as they occurred.

 

The Company used the following assumptions toestimate the fair value of stock options granted for the three months endedMarch 31, 2006 and 2005:

 

| ** **                         | ** ** | **Stock Options  Three Months Ended** | ** ** |
|------------------------------------|------------|------------------------------------------------------|------------|
| ** **                         | ** ** | **March 31,   2006**                       | ** ** | **March 31,   2005** | ** ** |
| Average expected life (years)      |       | 4.6                                                  |       | 5.0 |   |
| Average expected volatility factor |       | 59.4                                                 | %          | 44.1 | % |
| Average risk-free interest rate    |       | 4.6                                                  | %          | 4.2 | % |
| Average expected dividend yield    |       | —                                               |       | — |   |

 

**Treasury Stock**

 

On April 3, 2003, the Company announcedthat its Board of Directors authorized a stock repurchase program of up to 4million shares of its common stock. On August 15, 2005, the Companyannounced that its Board of Directors increased the size of the stockrepurchase program by an additional 4 million shares, for a total program sizeof up to 8 million shares. The repurchases will be made from time to time onthe open market at prevailing market prices or in privately negotiatedtransactions. Depending on market conditions and other factors, purchases underthis program may be commenced or suspended at any time, or from time totime, without prior notice. As of March 31, 2006, the Company hadrepurchased 4,170,060 shares of its common stock under this program, for anaggregate of $87.9 million at an average price of $21.08 per share.

 

As of December 31, 2004, the Companyretired all 2,012,000 shares of its common stock that had been repurchasedprior to that date. In accordance with APB 6, *Status ofAccounting Research Bulletins*, the treasury stock retirement waseffected by reducing the following on the Company’s Consolidated BalanceSheet:  treasury stock by $30.7 million,common stock by $0.1 million, additional paid-in capital by $6.4 million andretained earnings by $24.2 million. There was no effect to the Company’soverall equity position as a result of the retirement.

 

6.*Foreign Currency Hedges*

 

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

 

During 2005, the Company utilized Euro foreign currency forward contracts and British Pound foreign currency forward contracts. During 2006, the Company utilized Euro foreign currency forward contracts and British Pound zero-cost collar contracts to hedge anticipated expenses. All such contracts entered into were designated as either fair value hedges or cash flow hedges and were considered effective, as defined by SFAS No. 133, *Accounting for Derivative Instruments and Hedging Activities*(SFAS No. 133), as amended. None of the contracts were terminated prior to settlement. Net realized losses related to the contracts designated as fair value hedges settled during the quarter are included in other income, net, in the accompanying consolidated income statements and amounted to ($47,000) and ($7,000) in the three months ending March 31, 2006 and 2005, respectively. Net realized losses related to the contracts designated as cash flow hedges settled during the quarter are included in the respective operating categories the Company hedges its British Pound 

 

10

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expenditures against in the accompanying consolidated income statements and amounted to ($20,000) in the three months ending March 31, 2006. There were no such gains or losses in the three months ended March 31, 2005.

 

Notional and fair values of the Company’s hedging position at March 31, 2006 and 2005 are presented in the table below (in thousands):

 
| ** **    | ** ** | **March 31, 2006**                           | ** ** | **March 31, 2005**         | ** ** |
|---------------|------------|--------------------------------------------------------|------------|--------------------------------------|------------|
| ** **    | ** ** | **Notional   Value   Local   Currency** | ** ** | **Notional   Value   USD** | ** ** | **Fair Value   USD** | ** ** | **Notional   Value   Local   Currency** | ** ** | **Notional   Value   USD** | ** ** | **Fair Value   USD** | ** ** |
|          |       |                                                   |       |                                 |       |   |   |   |   |   |   |   |   |
| Euro          |       | €                                                 | 2,350      |                                 | $          | 2,835 |   | $ | 2,819 |   | € | 450 |   | $ | 592 |   | $ | 584 |   |
| British Pound |       | £                                                 | 2,550      |                                 | 4,494      |   | 4,453 |   | £ | 600 |   | 1,142 |   | 1,140 |   |
| Total         |       |                                                   |       | $                                    | 7,329      |   | $ | 7,272 |   |   |   | $ | 1,734 |   | $ | 1,724 |   |

 

Euro forward contracts at March 31, 2006 weredesignated as fair value hedges and were not required to be tested foreffectiveness as hedge accounting was not desired. Euro forward contracts atMarch 31, 2005 were designated as cash flow hedges and determined effective.All Euro contracts will be settled before May 31, 2006. Realized gains or lossesrelated to the settlements, if any, will be recorded in other income, net atthe time of settlement.

 

All British Pound contracts were designated as cashflow hedges and were determined effective as of March 31, 2006 and 2005. AllBritish Pound contracts will be settled before September 30, 2006. Realizedgains and losses related to the settlements, if any, will be recorded in therespective operating categories the Company hedges its British Poundexpenditures against.

 

7. *Interest on Cash and MarketableSecurities*

 

TheCompany’s interest on cash and marketable securities, included as a componentof other income, net, is $2.6 million and $1.0 million for the quarters endedMarch 31, 2006 and 2005, respectively.

 

8. *Tax Matters*

 

From time to time, the Company is audited by various state, federal,and international authorities relating to tax matters. The Company fullycooperates with all audits, and defends its positions vigorously. The Company’saudits are in various stages of completion; however, no outcome for aparticular audit can be determined with certainty prior to the conclusion ofthe audit and appeals process. Adjustments, if any, are appropriately recordedin the Company’s financial statements in the period they became probable andestimable.

 

11

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9. *Recently Issued Accounting Standards*

 

On June 1, 2005 theFASB issued SFAS No. 154, *Accounting Changesand Error Corrections*(SFASNo. 154),**which replacesAPB No. 20, *Accounting Changes*(APB No. 20)*,*and SFAS No. 3, *ReportingAccounting Changes in Interim Financial Statements.*SFAS No. 154applies to all voluntary changes in accounting principle, and changes therequirements for accounting for and reporting of a change in accountingprinciple. SFAS No. 154 requires retrospective application to prior periods’financial statements of a voluntary change in accounting principle unless it isimpracticable. APB No. 20 previously required that most voluntary changes inaccounting principle be recognized by including in net income of the period ofthe change the cumulative effect of changing to the new accounting principle.SFAS No. 154 is effective for accounting changes made in fiscal years beginningafter December 15, 2005. Earlier application is permitted for accountingchanges made in fiscal years beginning after June 1, 2005. The Company'sadoption of this new standard in the first quarter of 2006 did not have amaterial impact on its financial position, results of operations or cash flows.

 

On February 16, 2006 the FASB issued SFAS No. 155, *Accounting for Certain Hybrid Instruments* (SFAS No. 155),which amends SFAS No. 133, and SFAS No. 140, *Accountingfor Transfers and Servicing of Financial Assets and Extinguishments ofLiabilities*(SFAS No. 140). SFAS No. 155 allows financialinstruments that have embedded derivatives to be accounted for as a whole ifthe holder elects to account for the whole instrument on a fair value basis.SFAS No. 155 also clarifies and amends certain other provisions of SFAS No. 133and SFAS No. 140. This statement is effective for all financial instrumentsacquired or issued in fiscal years beginning after September 15, 2006. TheCompany does not expect its adoption of this new standard in 2007 to have amaterial impact on its financial position, results of operations or cash flows.

 

10. *Reclassifications*

 

Certain reclassifications have been made for consistent presentation.

 

12

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

** **

**Thefollowing discussion and analysis should be read in conjunction with thefinancial statements and related notes contained elsewhere in this report. See “Risksand Uncertainties” regarding certain factors known to us that could causereported financial information not to be necessarily indicative of futureresults.**

** **

**Forward Looking Statements**

** **

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

** **

•                  anticipatedtrends in revenue;

•                  growthopportunities in domestic and international markets;

•                  new channels ofdistribution;

•                  customeracceptance and satisfaction with our products;

•                  expected trendsin operating and other expenses;

•                  anticipated cashand intentions regarding usage of cash;

•                  changes ineffective tax rates; and

•                  anticipatedproduct enhancements or releases.

 

**Theseforward-looking statements are subject to risks and uncertainties, includingthose risks and uncertainties described in our Annual Report on Form 10-K forthe fiscal year ended December 31, 2005 (our “2005 Annual Report”), that couldcause actual results to differ materially from those anticipated as of the dateof this report. We assume no obligation to update any forward-lookingstatements to reflect events or circumstances arising after the date of thisreport.**

** **

**Overview**

** **

**Weprovide employee internet management (EIM) and web security software productsthat enable organizations to reduce the risks associated with web-basedmalicious attacks, spyware, and phishing, as well as analyze, report and managehow their employees use computing resources. At the foundation of our productoffering is the Websense Enterprise® software application, which serves as acentral policy engine and management and reporting console and enables theextended functionality of our add-on products. Websense Enterprise givesorganizations the ability to enhance network security, improve employeeproductivity, mitigate potential legal liability and conserve network bandwidthby allowing organizations to identify potential risk areas and implement webaccess and application usage policies that reduce these risks. Over the past 10years, our products have evolved from software that prevents employees fromdownloading unacceptable content to products that prevent employee access tothe most undesirable and dangerous elements on the internet, such as websitesthat contain or will download viruses, spyware, keyloggers, phishing exploitsand an ever-increasing variety of malicious code.**

** **

**In 1996,we released our first software product, Websense Internet Screening System.Since that time, we have focused our business on developing and selling EIM andweb security solutions. Websense Enterprise and Websense Enterprise – CorporateEditionTM are our core web filtering solutions, providing fully featured webfiltering and serving as management platforms for related Websense add-onmodules, such as our Premium GroupsTM, Real Time Security UpdatesTM, BandwidthOptimizerTM, Instant Messaging (IM) Attachment ManagerTM, Client Policy ManagerTMand Remote Filtering. We have also created suites of some of our products toaddress specific customer needs, such as the Websense Web Security SuiteTM andWebsense Web Security Suite – Lockdown EditionTM. We currently derive all of**

 

13

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**ourrevenue from subscriptions to the Websense Enterprise-based solutions andexpect this to continue in the future as more offerings are added to the WebsenseEnterprise platforms. In October 2005, we announced an agreement with NortelNetworks to develop a web content filtering solution to protect GSM/UMTS mobilehandsets from receiving and accessing unwanted content. We expect fieldverification for the mobile handset filtering product to occur in mid 2006.**

** **

**Duringthe three months ended March 31, 2006, we derived 35% of revenue from internationalsales, compared with 32% for the three months ended March 31, 2005, with theUnited Kingdom comprising approximately 10% of our total revenue in both periods.We believe international markets continue to represent a significant growthopportunity and we are continuing to expand our international operations,particularly in selected countries in the European, Asia/Pacific and LatinAmerican markets.**

** **

**We sellWebsense Enterprise through both indirect channels and directly. Sales throughindirect channels currently account for more than 80% of our revenue, and ourstrategy is to increase the proportion of our sales made through indirectchannels.**

** **

**Asdescribed elsewhere in this report, we recognize revenue from subscriptions toWebsense Enterprise, including add-on modules, on a monthly straight-line basisover the term of the subscription. We recognize the operating expenses relatedto these sales as they are incurred. These operating expenses include salescommissions, which are based on the total amount of the subscription contractand are fully expensed in the period the product is delivered. Operatingexpenses have continued to increase as compared with prior periods due to expandedselling and marketing efforts, continued product research and development andinvestments in administrative infrastructure to support subscription sales thatwe will recognize as revenue in subsequent periods.**

** **

**Critical Accounting Policies**

** **

**Webelieve the following critical accounting policies affect our more significantjudgments and estimates used in the preparation of our consolidated financialstatements.**

** **

***Revenue Recognition.***When a purchasedecision is made for Websense Enterprise, customers enter into a subscriptionagreement, which is generally 12, 24 or 36 months in duration and for a fixednumber of users. Other services such as upgrades/enhancements and standardpost-contract technical support services are sold together with WebsenseEnterprise and provided throughout the subscription term. We recognize revenueon a monthly straight-line basis, commencing with the month the subscriptionbegins, over the term of the subscription agreement, provided collectibility isreasonably assured. Upon entering into a subscription arrangement for a fixedor determinable fee, we electronically deliver access codes to users and thenpromptly invoice customers for the full amount of their subscriptions. Paymentis due for the full term of the subscription, generally within 30 to 60 days ofthe invoice. We record amounts billed to customers in excess of recognizablerevenue as deferred revenue on our balance sheet. Upon expiration of thesubscription, customers who wish to re-subscribe typically must do so at the thencurrent rates to continue using Websense Enterprise. Our revenue issignificantly influenced by new and renewal subscriptions, and a decrease insubscription amounts could negatively impact our future revenue.

** **

*Accounting for Share-Based Compensation.***Through December 31, 2005, we accounted forshare-based employee compensation plans under the measurement and recognitionprovisions of Accounting Principles Board (APB) No. 25 (APB No. 25), andrelated Interpretations, as permitted by Financial Accounting Standards Board(FASB) SFAS No. 123 *Accounting for Stock-BasedCompensation* (SFAS No. 123). Accordingly, we recorded no share-basedemployee compensation expense for options granted under our Amended andRestated 2000 Stock Incentive Plan (2000 Plan) or its predecessor plans (oroptions granted as non-plan inducement options) during the three months endedMarch 31, 2005 as all other options granted had exercise prices equalto the fair market value of the common stock on the date of grant. We alsorecorded no compensation expense in connection with the Employee Stock PurchasePlan as the purchase price of the stock was not less than 85% of the lower ofthe fair market value of the common stock at the beginning of each offeringperiod or at the end of each purchase period. In accordance with SFAS No. 123and SFAS No. 148, *Accounting for Stock-Based Compensation –Transition and Disclosure* (SFAS No. 148), we disclosed 

 

14

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netincome or loss and net income or loss per share as if the fair value-basedmethod was applied in measuring compensation expense for share-based incentiveprograms.

 

EffectiveJanuary 1, 2006, we adopted the fair value recognition provisions of SFASNo. 123(R), using the modified prospective transition method. Under thattransition method, compensation expense that we recognized beginning on thatdate includes: (a) compensation expense for all share-based paymentsgranted prior to, but not yet vested as of January 1, 2006, based on the grantdate fair value estimated in accordance with the original provisions of SFASNo. 123, and (b) compensation expense for all share-based payments grantedon or after January 1, 2006, based on the grant date fair value estimated inaccordance with the provisions of SFAS No. 123(R). Results for prior periodswill not be restated. The results for the three months ended March 31, 2006include share-based compensation expense of $4.7 million (excluding taxeffects). Compensation expense related to share-based awards is generallyamortized over the vesting period in the related expense categories of theconsolidated statement of income.

 

AtMarch 31, 2006, there was $60.3 million of total unrecognizedcompensation cost related to share-based compensation arrangements grantedunder all equity compensation plans (excluding tax effects). That totalunrecognized compensation cost will be adjusted for future changes in estimatedforfeitures. We expect to recognize that cost over a weighted average period ofapproximately 3 years.

 

Weestimate the fair value of options granted using the Black-Scholes optionvaluation model and the assumptions described below. We estimate the expectedterm of options granted based on the history of grants and exercises in ouroption database. We estimate the volatility of our common stock at the date ofgrant based on both the historical volatility as well as the implied volatilityof publicly traded options on our common stock, consistent with SFAS No. 123(R)and Securities and Exchange Commission Staff Accounting Bulletin No. 107. Webase the risk-free interest rate that is used in the Black-Scholes optionvaluation model on the implied yield in effect at the time of option grant onU.S. Treasury zero-coupon issues with equivalent remaining terms. We have neverpaid any cash dividends on our common stock and do not anticipate paying anycash dividends in the foreseeable future. Consequently, we use an expecteddividend yield of zero in the Black-Scholes option valuation model. We amortizethe fair value ratably over the vesting period of the awards, which istypically four years. We use historical data to estimate pre-vesting optionforfeitures and record share-based expense only for those awards that areexpected to vest. For purposes of calculating pro forma information under SFAS No.123 for periods prior to January 1, 2006, we accounted for forfeitures as theyoccurred. We may elect to use different assumptions under the Black-Scholesoption valuation model in the future or select a different option valuationmodel altogether, which could materially affect our net income or loss and netincome or loss per share in the future.

 

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

** **

*Deferred Tax Assets.* As required by Statement ofFinancial Accounting Standards No. 109 *Accounting for IncomeTaxes* (SFAS No. 109), we recognize tax assets on the balance sheetif it is “more likely than not” that they will be realized on future taxreturns. At March 31, 2006, we had deferred tax assets of $23.0 million. Webelieve that it is more likely than not that our deferred tax assets will berealized. Factors considered by us included: our earnings history, projectedearnings based on current operations, and projected future taxable income inexcess of stock option deductions. However, should we determine that we wouldnot be able to realize all or part of our deferred tax assets in thefuture, anadjustment to the deferred tax assets would be charged against income in theperiod such determination was made.

 

*Income Tax Provision and Tax Contingency Reserve*. Significant judgment is required in determining our consolidated incometax provision and evaluating our U.S. and foreign tax positions. It is 

 

15

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our policy to maintain taxcontingency reserves for tax audit issues that are probable to occur and canreasonably be estimated. We review the reserves as circumstances warrant andadjust the reserves as events occur that affect our potential liability foradditional taxes, such as lapsing of applicable statutes of limitations,conclusion of tax audits, additional exposure based on current calculations, identificationof new issues or rendering of court decisions affecting a particular tax issue.Tax reserve contingencies and changes to the reserves are evaluated andrecorded in our tax provision in the period in which the above noted eventsoccur.

 

# **Resultsof Operations**

# ** **

***Three months ended March31, 2006 compared with the three months ended March 31, 2005***

 

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

 
| ** **                 | ** ** | **Three Months Ended** | ** ** |
|----------------------------|------------|----------------------------------|------------|
| ** **                 | ** ** | **March 31, 2006**     | ** ** | **March 31, 2005** | ** ** |
| ** **                 | ** ** | **(Unaudited)**                  | ** ** |
|                       |       |                             |       |   |   |
| Revenue                    |       | 100                              | %          | 100 | % |
|                       |       |                             |       |   |   |
| Cost of revenue            |       | 8                                | *     | 7 |   |
|                       |       |                             |       |   |   |
| Gross margin               |       | 92                               |       | 93 |   |
|                       |       |                             |       |   |   |
| Operating expenses:        |       |                             |       |   |   |
| Selling and marketing      |       | 43                               | *     | 36 |   |
| Research and development   |       | 13                               | *     | 12 |   |
| General and administrative |       | 12                               | *     | 9 |   |
| Total operating expenses   |       | 68                               |       | 57 |   |
|                       |       |                             |       |   |   |
| Income from operations     |       | 24                               |       | 36 |   |
|                       |       |                             |       |   |   |
| Other income, net          |       | 6                                |       | 3 |   |
|                       |       |                             |       |   |   |
| Income before income taxes |       | 30                               |       | 39 |   |
|                       |       |                             |       |   |   |
| Provision for income taxes |       | 11                               |       | 14 |   |
|                       |       |                             |       |   |   |
| Net income                 |       | 19                               | %          | 25 | % |

 

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* Includes share-based compensation expense. Total share-basedcompensation was $4.7 million, or 11% of revenue, for the three months endedMarch 31, 2006.

 

# **Revenue**

# ** **

# **Revenueincreased to $42.4 million in the first quarter of 2006, from $34.2 million inthe first quarter of 2005. The increase was primarily a result of the additionof new, renewed and upgraded subscriptions from our customers that resulted inan increase in the number of seats under subscription on March 31, 2005 toMarch 31, 2006 of 3.8 million seats. Approximately 65% of subscription revenuerecognized in the first quarters of 2006 and 2005 was derived from renewalbusiness. We expect total**

 

16

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# **revenue growth amounts in 2006 toexceed total revenue growth in 2005, although the percentage revenue growthrate may be lower in 2006 than in 2005 as a result of the increasing overallrevenue base and unanticipated sales execution issues in North America that weexperienced in the first quarter of 2006.**

# ** **

# **Cost of Revenue**

# ** **

# **Cost ofrevenue consists of the costs of content review, technical support andinfrastructure costs associated with maintaining our databases. Cost of revenueincreased to $3.4 million in the first quarter of 2006, from $2.5 in the first quarterof 2005. The increase was due to the costs associated with share-basedcompensation expense of $0.3 million relating to our adoption of SFAS No. 123(R)on January 1, 2006, as well as additional personnel in our technical supportand database groups and allocated costs. We allocate the total costs for humanresources, employee benefits, payroll taxes, information technology,facilities, fixed asset depreciation and legal costs to each of our functionalareas based on salaries and headcount data. We expect cost of revenue toincrease in the future due to share-based compensation expense and to supportthe growth and maintenance of our databases as well as the technical supportneeds of our customers. As a percentage of revenue, cost of revenue increased to8% during the first quarter of 2006 from 7% in 2005. We expect that cost ofrevenue, as a percentage of revenue, will remain below 10% of revenue for theforeseeable future.**

# ** **

# **Gross Margin**

# ** **

# **Grossmargin increased to $39.1 million in the first quarter of 2006, from $31.7million in the first quarter of 2005. The increase was due to increasedrevenue. As a percentage of revenue, gross margin decreased to 92% in the firstquarter of 2006 from 93% in the first quarter of 2005.**Weexpect that gross margin, as a percentage of revenue, will remain in excess of90% of revenue for the foreseeable future.

# ** **

# **Operating Expenses**

# ** **

# ***Selling and marketing***. Sellingand marketing expenses consist primarily of salaries, commissions and benefitsrelated to personnel engaged in selling, marketing and customer supportfunctions, along with costs related to public relations, advertising,promotions and travel as well as allocated costs. Selling and marketingexpenses increased to $18.0 million in the first quarter of 2006, from $12.3million in the first quarter of 2005. The increase in selling and marketingexpenses of $5.7 million was due to share-based compensation expenses of $2.0million relating to our adoption of SFAS No. 123(R) on January 1, 2006, as wellas increased personnel costs and related travel, allocated costs, and highercommission expenses related to higher sales levels. We expect selling andmarketing expenses to increase in absolute dollars in the future drivenprimarily by share-based compensation expense, and also as more personnel areadded to support our expanding selling and marketing efforts worldwide and asincreased sales result in higher overall sales commission expenses.

# ** **

# ***Research and development.***Research and development expenses consist primarilyof salaries and benefits for software developers and allocated costs. Researchand development expenses increased to $5.4 million in the first quarter of 2006,from $4.0 million in the first quarter of 2005. The increase of $1.4 million inresearch and development expenses was primarily a result of share-based compensationexpense of $0.8 million relating to ouradoption of SFAS No. 123(R) on January 1, 2006, as well as increased personnel needed to supportour expanding list of technology partners, the enhancements of WebsenseEnterprise and additional products, and allocated costs.We expect research and development expenses toincrease in absolute dollars in future periods driven primarily by share-basedcompensation expense, andalso as aresult of our continued enhancements of our products.

# ** **

*General and administrative*.General and administrative expenses consist primarily of salaries, benefits andrelated expenses for our executive, finance, administrative personnel, thirdparty professional service fees, and allocated costs. General and administrativeexpenses increased to $5.2 million in the first 

 

17

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quarter of 2006, from $2.9 million in the first quarter of 2005. The $2.3million increase in general and administrative expenses was primarily a resultof share-based compensation expense of $1.6 million relating to our adoption ofSFAS No. 123(R) on January 1, 2006, as well as additional personnel needed tosupport our growing operations, and allocated costs. We expect general andadministrative expenses to increase in absolute dollars in future periodsdriven primarily by share-based compensation expense, growth in operations,increasing expenses associated with being a public company and expansion of ourinternational operations.

 

# **Other Income, Net**

# ** **

# **Otherincome, net increased to $2.6 million in the first three months of 2006, from$1.0 million in the first three months of 2005. The increase was due primarilyto higher interest rates realized on our increased balances of cash, cashequivalents and marketable securities as of March 31, 2006 compared with March31, 2005. The majority of our investments of cash and cash equivalents andmarketable securities are tax-exempt. We expect that the majority of our cashand cash equivalents and marketable securities will continue to be held intax-exempt investments during the foreseeable future.**

# ** **

# **Provision for Income Taxes**

# ** **

# **In thefirst quarter of 2006, United States and foreign income tax expense remainedunchanged at $4.8 million for the first quarters of 2006 and 2005. Theeffective income tax rate increased to 37% in the first quarter of 2006 from36% in the first quarter of 2005. The increase in the tax rate was primarilydriven by the non-availability for tax deduction of certain share-basedcompensation expenses under SFAS No. 123(R). The increase in the tax rate waspartially offset by a higher percentage of income earned by our international operations,for which lower income tax rates generally apply, and an increase in tax-exemptinterest income. Our effective tax rate may change due to potential changes inthe mix of income within various domestic and international tax jurisdictionsalong with potential changes or interpretations in tax rules and legislation,or corresponding accounting rules.**

# ** **

**Liquidity and Capital Resources**

 

As of March 31, 2006, we had cash and cashequivalents of $20.5 million, investments in marketable securities of $327.9million and retained earnings of $64.6 million. As of December 31, 2005, we hadcash and cash equivalents of $61.6 million, investments in marketablesecurities of $258.8 million and retained earnings of $56.4 million.

 

**Net cashprovided by operating activities was $32.7 million in the first three months of2006, compared with $25.8 million in the first three months of 2005. The $6.9 millionincrease in cash provided by operating activities in the first three months of2006 was primarily due to a decrease in our accounts receivable balance. Ouroperating cash flow is significantly influenced by subscription renewals andaccounts receivable collections, and a decrease in subscription renewals oraccounts receivable collections would negatively impact our operating cashflow.**

** **

Net cash used in investing activities was $70.2million in the first three months of 2006, compared with net cash used ininvesting activities of $18.8 million in the first three months of 2005. The $51.4million increase of cash used in investing activities for the first threemonths of 2006 was primarily due to purchases of marketable securities with fewermaturities and sales of marketable securities to offset the purchases.

 

Net cash used by financing activities was $3.6million in the first three months of 2006, compared with net cash used byfinancing activities of $0.9 million in the first three months of 2005. The $2.7million increase in net cash used by financing activities in the first threemonths of 2006 was primarily due to share repurchases of 300,000 shares of ourcommon stock for $8.9 million in the first three months of 2006, compared with 250,000shares for $7.1 million in the first three months of 2005, and fewer proceedsfrom exercises of employee stock options.

 

We have operating lease and software license commitmentsof approximately $1.7 million during the remainder of 2006, $2.0 million in 2007,and $0.3 million in 2008. A majority of our operating lease 

 

18

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commitments are related to our corporate headquarters lease, which extendsthrough 2008. Our corporate headquarters lease includes escalating rentpayments from 2006 to 2008. The rent expense related to our corporateheadquarters lease is recorded monthly on a straight-line basis in accordancewith generally accepted accounting principles.

 

Future minimum annual payments undernon-cancelable operating leases and software licenses at March 31, 2006 are asfollows (in thousands):

 
| ** ** | ** ** | **Operating   Leases** | ** ** | **Software   Licenses** | ** ** | **Total** | ** ** |
|------------|------------|-----------------------------|------------|------------------------------|------------|-----------|------------|
| 2006       |       | $                           | 1,420      |                         | $          | 236       |       | $ | 1,656 |   |
| 2007       |       | 1,937                       |       | 79                           |       | 2,016     |       |
| 2008       |       | 325                         |       | —                       |       | 325       |       |
|       |       | $                           | 3,682      |                         | $          | 315       |       | $ | 3,997 |   |

 

As of March31, 2006 and 2005, we did not have any relationships with unconsolidatedentities or financial partners, such as entities often referred to asstructured finance or special purpose entities, which would have beenestablished for the purpose of facilitating off-balance sheet arrangements orother contractually narrow or limited purposes. As such, we are not exposed toany financing, liquidity, market or credit risk that could arise if we hadengaged in such relationships.

 

On April 3, 2003, we announced that our Boardof Directors authorized a stock repurchase program of up to 4 million shares ofour common stock. On August 15, 2005, we announced that our Board of Directors increasedthe size of the stock repurchase program by an additional 4 million shares, fora total program size of up to 8 million shares. The repurchases will be madefrom time to time on the open market at prevailing market prices or in privatelynegotiated transactions. Depending on market conditions and other factors,purchases under this program may be commenced or suspended at any time, or fromtime to time, without prior notice. As of March 31, 2006, we had repurchased 4,170,060shares of our common stock under this program, for an aggregate of $87.9 millionat an average price of $21.08 per share.

 

As of December 31, 2004, we retired all 2,012,000 shares of our commonstock that had been repurchased prior to that date. In accordance with APB 6, *Status of Accounting Research Bulletins*, the treasury stockretirement was effected by reducing the following on our Consolidated BalanceSheet: treasury stock by $30.7 million, common stock by $0.1 million,additional paid-in capital by $6.4 million and retained earnings by $24.2million. There was no effect to our overall equity position as a result of theretirement. We do not expect to retire shares of our common stock that werepurchased during 2005 or 2006 in the foreseeable future.

 

We believe that our cash and cash equivalents balances and investments in marketable securities will be sufficient to satisfy our cash operating requirements for the foreseeable future. We intend to continue to invest our cash in excess of current operating requirements in interest-bearing, investment-grade securities.

 

19

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**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

** **

**Our market risk exposures are related to our cash, cashequivalents and investments. We invest our excess cash in highly liquidshort-term investments, municipal securities, commercial paper and corporatebonds. These investments are not held for trading or other speculativepurposes. Changes in interest rates affect the investment income we earn on ourinvestments and therefore impact our cash flows and results of operations.**

** **

**We are exposed to changes in interest rates primarily fromour short-term available-for-sale investments. Under our current policies, wedo not use interest rate derivative instruments to manage exposure to interestrate changes. A hypothetical 100 basis point adverse move in interest ratesalong the entire interest rate yield curve would not materially affect the fairvalue of our interest sensitive financial instruments at March 31, 2006.Changes in interest rates over time will, however, affect our interest income.**

** **

We utilize foreign currency forward contracts and zero-cost collarcontracts to hedge foreign currency market exposures of underlying assets andliabilities. In April 2005, we began billing customers in Euro-denominatedcountries in the Euro. In addition, working funds necessary to facilitate theshort-term operations of our subsidiaries are kept in the local currencies inwhich they do business. Our objective is to reduce the risk to earnings andcash flows associated with changes in foreign currency exchange rates. We donot use foreign currency contracts for speculative or trading purposes.

 

Notional and fair values of our hedging positions at March 31, 2006 and 2005 are presented in the table below (in thousands):

 
| ** **    | ** ** | **March 31, 2006**                           | ** ** | **March 31, 2005**         | ** ** |
|---------------|------------|--------------------------------------------------------|------------|--------------------------------------|------------|
| ** **    | ** ** | **Notional   Value   Local   Currency** | ** ** | **Notional   Value   USD** | ** ** | **Fair Value   USD** | ** ** | **Notional   Value   Local   Currency** | ** ** | **Notional   Value   USD** | ** ** | **Fair Value   USD** | ** ** |
|          |       |                                                   |       |                                 |       |   |   |   |   |   |   |   |   |
| Euro          |       | €                                                 | 2,350      |                                 | $          | 2,835 |   | $ | 2,819 |   | € | 450 |   | $ | 592 |   | $ | 584 |   |
| British Pound |       | £                                                 | 2,550      |                                 | 4,494      |   | 4,453 |   | £ | 600 |   | 1,142 |   | 1,140 |   |
| Total         |       |                                                   |       | $                                    | 7,329      |   | $ | 7,272 |   |   |   | $ | 1,734 |   | $ | 1,724 |   |

 

The $2.2 million notional increase in our Euro hedged position isprimarily due to our billing customers in Euro-denominated countries in theEuro. All of the Euro hedging contracts will be settled before May 31, 2006. Forthe quarter-ended March 31, 2006, approximately 10% of our total billings weredenominated in the Euro. We do not expect foreign currency billings torepresent more than 15% of our total billings during 2006.

 

**The $3.4 million notional increase in our British Poundhedged position is primarily due to our decision to lengthen the period hedgedas well as increase the percentage of working funds hedged. All of the BritishPound hedging contracts will be settled before September 30, 2006. In 2006, weexpect an increase in British Pound expenditures and our corresponding hedgedcommitments to be consistent with our increase in overall operatingexpenditures.**

 

**Given our foreign exchange position, a 10% change in foreign exchangerates upon which these foreign exchange contracts are based would result inexchange gains and losses. In all material aspects, these exchange gains andlosses would be fully offset by exchange gains and losses on the underlying netmonetary exposures for which the contracts are designated as hedges. We do notexpect material exchange rate gains and losses from unhedged foreign currencyexposures.**

 

20

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**Item 4. Controls and Procedures**

** **

**Disclosure Controls and Procedures**

** **

**Wemaintain disclosure controls and procedures (as defined in Rules 13a – 15(e)and 15d – 15(e) of the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)) designed to ensure that we are able to collect the information we arerequired to disclose in the reports we file under the Exchange Act, and torecord, process, summarize and report this information within the time periodsspecified in the rules of the Securities and Exchange Commission.**Our Chief Executive Officer and ChiefFinancial Officer evaluated our disclosure controls and procedures as of theend of the period covered by this report. Based on their evaluation, our ChiefExecutive Officer and Chief Financial Officer have concluded that thesecontrols and procedures are effective.

** **

**Changes In Internal Control Over FinancialReporting**

** **

There have been nosignificant changes in our internal control over financial reporting or inother factors that could significantly affect our internal control overfinancial reporting, including any corrective actions with regard tosignificant deficiencies and material weaknesses, during the period covered bythis report.

 

21

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**Part II - Other Information**

** **

**Item 1.    Legal Proceedings**

 

None.

 

**Item 1A. Risk Factors**

** **

Risks and uncertaintiesthat could impact our business, consolidated financial position, results of operationsand cash flows and cause future results to differ from our expectations includethe following: customer acceptance of our services; the success of our salesexecution plans and strategies (including performance of our indirect saleschannels); the mix of domestic versus international sales; the success of ourbrand development efforts; the volatile and competitive nature of the internetindustry; changes in domestic and international market conditions and the entryinto and development of international markets for our products; risks relatingto intellectual property ownership; and the risks and uncertainties identifiedin our 2005 Annual Report and other filings with the Securities and ExchangeCommission. There have been no material changes in our “Risk Factors” aspreviously disclosed in our 2005 Annual Report.

 

**Item 2.    Unregistered Sales ofEquity Securities and Use of Proceeds**

 

**(a) Not applicable.**

** **

**(b) Not applicable.**

** **

**(c) Issuer Purchases of EquitySecurities**

** **
| **Month**     | ** ** | **Number of   shares   purchased   during month(1)** | ** ** | **Average   price paid per   share** | ** ** | **Cumulative   number of shares   purchased as part   of publicly   announced plan** | ** ** | **Maximum number   of shares that may   yet be purchased   under the plan(2)** | ** ** |
|---------------|------------|-------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------|------------|
| January 2006  |       | —                                                                        |       | —                                                   |       | 3,870,060                                                                                                                              |       | 4,129,940                                                                                                                             |       |
| February 2006 |       | 200,000                                                                       |       | $                                                        | 29.88      |                                                                                                                                   | 4,070,060  |                                                                                                                                  | 3,929,940  |   |
| March 2006    |       | 100,000                                                                       |       | $                                                        | 29.28      |                                                                                                                                   | 4,170,060  |                                                                                                                                  | 3,829,940  |   |
| Total         |       | 300,000                                                                       |       | $                                                        | 29.68      |                                                                                                                                   | 4,170,060  |                                                                                                                                  | 3,829,940  |   |

 

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**1.**               The purchases were made in open-markettransactions.

** **

**2.**               On April 3, 2003, we announced that ourBoard of Directors authorized a stock repurchase program of up to 4 millionshares of our common stock. On August 15, 2005, we announced that our Board ofDirectors increasedthe size of the stock repurchase program by an additional 4 million shares ofour common stock, for a total program size of up to 8 million shares of ourcommon stock.

** **

**Item 3.    Defaults upon Senior Securities**

** **

**None.**

 

22

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**Item 4. Submission ofMatters to a Vote of Security Holders**

** **

**None.**

** **

**Item 5.    Other Information**

** **

**None.**

** **

**Item 6.    Exhibits**

** **

**Exhibits**

** **

**3.1(1)**             Amendedand Restated Certificate of Incorporation.

**3.2(1)**             RestatedBylaws.

**4.1(1)**             SpecimenStock Certificate of Websense, Inc.

**10.1**                     Amendmentto Employment Agreement by and between Websense, Inc. and Gene Hodges, datedApril 13, 2006.

**10.2**                     Form ofStock Option Agreement under the 2000 Stock Incentive Plan for Gene Hodgesdated April 13, 2006.

**10.3**                     Amendedand Restated 2000 Stock Incentive Plan.

**31.1**                     Certificationof Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or15d-14(a).

**31.2**                     Certificationof Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or15d-14(a).

**32.1**                     Certificationof Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) or15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code(18 U.S.C. 1350).

**32.2**                     Certificationof Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code(18 U.S.C. 1350).

 

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**(1)**                Previouslyfiled as an exhibit to our Registration Statement on Form S-1, as amended,(File No 333-95619) and incorporated herein by reference.

 

23

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##### **SIGNATURES**

##### ** **

Pursuant to the requirementsof the Securities Exchange Act of 1934, the registrant has duly caused thisreport to be signed on its behalf by the undersigned, thereunto dulyauthorized.

 
|                    | **WEBSENSE, INC.** |
|-------------------------|--------------------|
|                    |               | ** ** |
| Date:  May 9, 2006 | By:                | /s/ GENE HODGES |   |
|                    |               | Gene Hodges |
| * *                | * *           | *President  and* |
| * *                | * *           | * Chief Executive Officer* |
|                    |               |   |
| Date:  May 9, 2006 | By:                | /s/ DOUGLAS C. WRIDE |   |
|                    |               | Douglas C. Wride |
| * *                | * *           | *Chief  Financial Officer* |
|                         |                    |  |  |  |

 

24

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**EXHIBIT INDEX**

 
| **Exhibit  Number** | ** ** | **Description**                                                                                                                                                                                  |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **          | ** ** | ** **                                                                                                                                                                                       |
| **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**            | ** ** | **Amendment  to Employment Agreement by and between Websense, Inc. and Gene Hodges, dated  April 13, 2006.**                                                                                     |
| **10.2**            | ** ** | **Form of  Stock Option Agreement under the 2000 Stock Incentive Plan for Gene Hodges  dated April 13, 2006.**                                                                                   |
| **10.3**            | ** ** | **Amended  and Restated 2000 Stock Incentive Plan.**                                                                                                                                             |
| **31.1**            | ** ** | **Certification  of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(a) or 15d-14(a).**                                                                                         |
| **31.2**            | ** ** | **Certification  of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(a) or  15d-14(a).**                                                                                        |
| **32.1**            | ** ** | **Certification  of Principal Executive Officer pursuant to Exchange Act Rules 13a-14(b) or  15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States  Code (18 U.S.C. 1350).** |
| **32.2**            | ** ** | **Certification  of Principal Financial Officer pursuant to Exchange Act Rules 13a-14(b) or  15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States  Code (18 U.S.C. 1350).** |

 

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**(1)**                Previouslyfiled as an exhibit to our Registration Statement on Form S-1, as amended,(File No 333-95619) and incorporated herein by reference.

 

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