##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549




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FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2003

OR

[_] 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 Number)


10240 Sorrento Valley Road
San Diego, California 92121
858-320-8000
(Address of principal executive offices, zip code and telephone number)



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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. (1) Yes [X] No [_] (2) Yes [X] No
[_]

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

The number of shares outstanding of the registrants Common Stock, $.01 par
value, as of October 31, 2003 was 22,374,542.





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TABLE OF CONTENTS



|                               |                                                                                               |                                                        |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------------------------ |  |  |  |  |  | 
|Part I  Financial Information
|                               | Item 1. Consolidated Financial Statements (Unaudited)                                        
|                               |                                                                                               | Consolidated Balance Sheets                           
|                               |                                                                                               | Consolidated Statements of Operations                 
|                               |                                                                                               | Consolidated Statement of Stockholders Equity        
|                               |                                                                                               | Consolidated Statements of Cash Flows                 
|                               |                                                                                               | NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
|                               | Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
|                               | Item 3. Quantitative and Qualitative Disclosures About Market Risk                           
|                               | Item 4. Controls and Procedures                                                              
|Part II  Other Information   
|                               | Item 1. Legal Proceedings                                                                    
|                               | Item 2. Changes in Securities and Use of Proceeds                                            
|                               | Item 3. Defaults upon Senior Securities                                                      
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                               | Item 5. Other Information                                                                    
|                               | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                    
|EXHIBIT 31.1                  
|EXHIBIT 31.2                  
|EXHIBIT 32.1                  
|EXHIBIT 32.2                  



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##### Table of Contents



Websense, Inc.
Form 10-Q
For the Period Ended September 30, 2003

TABLE OF CONTENTS

PagePart I. Financial InformationItem 1.
    
    Consolidated Financial Statements (Unaudited)Consolidated Balance Sheets as of September 30, 2003 and December 31,
2002
    
    
    1Consolidated Statements of Operations for the three and nine months ended
September 30, 2003 and 2002
    
    
    2Consolidated Statement of Stockholders Equity for the nine months ended
September 30, 2003
    
    
    3Consolidated Statements of Cash Flows for the nine months ended September 30, 2003
and 2002
    
    
    4Notes to Consolidated Financial Statements
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    9Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    19Item 4.
    
    Controls and Procedures
    
    
    19Part II. Other InformationItem 1.
    
    Legal Proceedings
    
    
    20Item 2.
    
    Changes in Securities and Use of Proceeds
    
    
    20Item 3.
    
    Defaults upon Senior Securities
    
    
    20Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    20Item 5.
    
    Other Information
    
    
    20Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    21Signatures
    
    
    
    
    22


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##### Table of Contents






Part I  Financial Information




Item 1. Consolidated Financial Statements (Unaudited)




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

September 30,
    
    December 31,2003
    
    2002(See Note 1)AssetsCurrent assets:Cash and cash equivalents
    
    $
    90,563
    
    
    $
    61,713Marketable securities
    
    
    76,734
    
    
    
    78,753Accounts receivable, net of allowance for
doubtful accounts
    
    
    21,601
    
    
    
    19,840Deferred income
taxes
    
    
    8,731
    
    
    
    8,731Other current
assets
    
    
    1,321
    
    
    
    1,184Total current assets
    
    
    198,950
    
    
    
    170,221Property and equipment,
net
    
    
    3,247
    
    
    
    2,967Deferred income taxes, less current portion
    
    
    6,701
    
    
    
    6,701Deposits and other
assets
    
    
    392
    
    
    
    299Total assets
    
    $
    209,290
    
    
    $
    180,188Liabilities and stockholders equityCurrent liabilities:Accounts
payable
    
    $
    551
    
    
    $
    761Accrued payroll and related
benefits
    
    
    5,152
    
    
    
    3,627Other accrued
expenses
    
    
    3,353
    
    
    
    3,440Income taxes
payable
    
    
    4,406
    
    
    
    970Current portion of deferred
revenue
    
    
    55,804
    
    
    
    46,964Total current
liabilities
    
    
    69,266
    
    
    
    55,762Deferred revenue, less current
portion
    
    
    22,464
    
    
    
    17,715Stockholders equity:Common
stock
    
    
    225
    
    
    
    217Additional paid-in
capital
    
    
    110,924
    
    
    
    107,058Treasury
stock
    
    
    (4,818
    )
    
    
    Deferred
compensation
    
    
    (7
    )
    
    
    (83
    )Retained earnings
(deficit)
    
    
    11,223
    
    
    
    (957
    )Accumulated other comprehensive
income
    
    
    13
    
    
    
    476Total stockholders equity
    
    
    117,560
    
    
    
    106,711Total liabilities and stockholders
equity
    
    $
    209,290
    
    
    $
    180,188


See accompanying notes.

1



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##### Table of Contents






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

Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,
    
    September 30,
    
    September 30,2003
    
    2002
    
    2003
    
    2002Revenue
    
    $
    21,006
    
    
    $
    16,005
    
    
    $
    59,034
    
    
    $
    43,590Cost of revenue
    
    
    1,412
    
    
    
    1,081
    
    
    
    4,007
    
    
    
    3,075Gross
margin
    
    
    19,594
    
    
    
    14,924
    
    
    
    55,027
    
    
    
    40,515Operating expenses:Selling and marketing
    
    
    8,236
    
    
    
    6,610
    
    
    
    22,417
    
    
    
    18,845Research and development
    
    
    3,224
    
    
    
    3,063
    
    
    
    9,548
    
    
    
    7,941General and administrative
    
    
    1,770
    
    
    
    1,503
    
    
    
    4,986
    
    
    
    4,548Amortization of
stock-based compensation
    
    
    11
    
    
    
    95
    
    
    
    76
    
    
    
    380Total operating expenses
    
    
    13,241
    
    
    
    11,271
    
    
    
    37,027
    
    
    
    31,714Income from operations
    
    
    6,353
    
    
    
    3,653
    
    
    
    18,000
    
    
    
    8,801Other income, net
    
    
    418
    
    
    
    665
    
    
    
    1,873
    
    
    
    2,066Income before income taxes
    
    
    6,771
    
    
    
    4,318
    
    
    
    19,873
    
    
    
    10,867Provision for income taxes
    
    
    2,539
    
    
    
    280
    
    
    
    7,693
    
    
    
    627Net income
    
    $
    4,232
    
    
    $
    4,038
    
    
    $
    12,180
    
    
    $
    10,240Net income per share:Basic net income per share
    
    $
    0.19
    
    
    $
    0.19
    
    
    $
    0.56
    
    
    $
    0.49Diluted net income per share
    
    $
    0.18
    
    
    $
    0.18
    
    
    $
    0.53
    
    
    $
    0.44Weighted average shares  basic
    
    
    22,072
    
    
    
    21,319
    
    
    
    21,917
    
    
    
    21,069Weighted average shares  diluted
    
    
    23,035
    
    
    
    22,913
    
    
    
    22,805
    
    
    
    23,170


See accompanying notes.

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##### Table of Contents






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

Common stockAccumulatedAdditional
    
    
    
    
    
    Deferred
    
    Accumulated
    
    other comprehensive
    
    Total stockholders'Shares
    
    Amount
    
    paid-in capital
    
    Treasury stock
    
    compensation
    
    deficit
    
    income
    
    equityBalance at December 31, 2002
    
    
    21,734
    
    
    $
    217
    
    
    $
    107,058
    
    
    $
    
    
    
    $
    (83
    )
    
    $
    (957
    )
    
    $
    476
    
    
    $
    106,711Issuance of common stock upon exercise of options
    
    
    716
    
    
    
    7
    
    
    
    3,014
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,021Issuance of common stock for ESPP purchase
    
    
    70
    
    
    
    1
    
    
    
    852
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    853Issuance of common stock upon exercise of warrant
    
    
    4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of deferred compensation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    76
    
    
    
    
    
    
    
    
    
    
    
    76Purchase of treasury stock
    
    
    (289
    )
    
    
    
    
    
    
    
    
    
    
    (4,818
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,818
    )Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,180
    
    
    
    
    
    
    
    12,180Net change in unrealized gain on marketable securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (463
    )
    
    
    (463
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,717Balance at September 30, 2003
    
    
    22,235
    
    
    $
    225
    
    
    $
    110,924
    
    
    $
    (4,818
    )
    
    $
    (7
    )
    
    $
    11,223
    
    
    $
    13
    
    
    $
    117,560


See accompanying notes.

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##### Table of Contents






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

Nine Months EndedSeptember 30,
    
    September 30,2003
    
    2002Operating activities:Net income
    
    $
    12,180
    
    
    $
    10,240Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation
    
    
    1,500
    
    
    
    1,448Amortization of deferred
compensation
    
    
    76
    
    
    
    380Deferred revenue
    
    
    13,589
    
    
    
    11,656Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,761
    )
    
    
    (2,844
    )Deposits and other assets
    
    
    (230
    )
    
    
    (347
    )Accounts payable
    
    
    (210
    )
    
    
    392Accrued payroll and related benefits
    
    
    1,525
    
    
    
    1,037Other accrued expenses
    
    
    (87
    )
    
    
    841Income taxes payable
    
    
    3,436
    
    
    
    437Net cash provided by operating activities
    
    
    30,018
    
    
    
    23,240Investing activities:Purchases of property and equipment
    
    
    (1,780
    )
    
    
    (1,558
    )Purchases of marketable securities
    
    
    (134,085
    )
    
    
    (66,143
    )Maturities and sales of marketable securities
    
    
    135,641
    
    
    
    74,229Net cash provided by (used in) investing activities
    
    
    (224
    )
    
    
    6,528Financing activities:Proceeds from exercise of stock options
    
    
    3,021
    
    
    
    2,462Proceeds from issuance of common stock for
stock purchase plan
    
    
    853
    
    
    
    722Purchases of treasury stock
    
    
    (4,818
    )
    
    
    Net cash provided by (used in) financing
activities
    
    
    (944
    )
    
    
    3,184Increase in cash and cash equivalents
    
    
    28,850
    
    
    
    32,952Cash and cash equivalents at beginning of period
    
    
    61,713
    
    
    
    23,715Cash and cash equivalents at end of period
    
    $
    90,563
    
    
    $
    56,667


See accompanying notes.

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##### Table of Contents






WEBSENSE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. Basis of Presentation

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

These financial statements should be read in conjunction with the audited
consolidated financial statements and notes thereto for the year ended December
31, 2002, included in Websense, Inc.s Annual Report on Form 10-K filed with
the Securities and Exchange Commission. Operating results for the three and
nine months ended September 30, 2003 are not necessarily indicative of the
results that may be expected for any other interim period or for the year
ending December 31, 2003. The balance sheet at December 31, 2002 has been
derived from the audited financial statements at that date but does not include
all of the information and footnotes required by accounting principles
generally accepted in the United States for complete financial statements.

2. Net Income Per Share

Basic net income per common share (Basic EPS) excludes dilution and is
computed by dividing net income by the weighted average number of common shares
outstanding during the period. Diluted net income per common share (Diluted
EPS) reflects the potential dilution that could occur if stock options or
other contracts to issue common stock were exercised or converted into common
stock. The computation of Diluted EPS does not assume exercise or conversion of
securities that would have an anti-dilutive effect on net income per common
share.

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##### Table of Contents



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

Net Income
    
    Shares
    
    Per Share(Numerator)
    
    (Denominator)
    
    Amount(In thousands, except per share amounts)For the Three Months Ended:September 30, 2003:Basic EPS
    
    $
    4,232
    
    
    
    22,072
    
    
    $
    0.19Effect of options
    
    
    
    
    
    
    963
    
    
    
    (0.01
    )Diluted EPS
    
    $
    4,232
    
    
    
    23,035
    
    
    $
    0.18September 30, 2002:Basic EPS
    
    $
    4,038
    
    
    
    21,319
    
    
    $
    0.19Effect of options
    
    
    
    
    
    
    1,594
    
    
    
    (0.01
    )Diluted EPS
    
    $
    4,038
    
    
    
    22,913
    
    
    $
    0.18For the Nine Months Ended:September 30, 2003:Basic EPS
    
    $
    12,180
    
    
    
    21,917
    
    
    $
    0.56Effect of options
    
    
    
    
    
    
    888
    
    
    
    (0.03
    )Diluted EPS
    
    $
    12,180
    
    
    
    22,805
    
    
    $
    0.53September 30, 2002:Basic EPS
    
    $
    10,240
    
    
    
    21,069
    
    
    $
    0.49Effect of options
    
    
    
    
    
    
    2,101
    
    
    
    (0.05
    )Diluted EPS
    
    $
    10,240
    
    
    
    23,170
    
    
    $
    0.44


For the three months ended September 30, 2003 and 2002, there were
outstanding options to purchase 1,283,000 and 1,669,000 shares, respectively,
that had an exercise price greater than the average market price of the common
shares for the respective quarters. Therefore, these shares were excluded from
the above calculations as they would have had an anti-dilutive effect on EPS.

For the nine months ended September 30, 2003 and 2002, there were
outstanding options to purchase 1,504,000 and 1,065,000 shares, respectively,
that had an exercise price greater than the average market price of the common
shares for the respective nine months. Therefore, these shares were excluded
from the above calculations as they would have had an anti-dilutive effect on
EPS.

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3. Amortization of Stock-Based Compensation

For the three- and nine-month periods ended September 30, 2003 and 2002,
the Company recorded amortization of stock-based compensation. The allocation
of the expense by operating expense category is as follows (in thousands):

Three Months Ended
    
    Nine Months EndedSeptember
30,2003
    
    September 30,2002
    
    September 30,2003
    
    September 30,2002Selling and marketing
    
    $
    5
    
    
    $
    26
    
    
    $
    29
    
    
    $
    100Research and development
    
    
    3
    
    
    
    16
    
    
    
    15
    
    
    
    62General and administrative
    
    
    3
    
    
    
    53
    
    
    
    32
    
    
    
    218Total amortization
of stock-based
compensation
    
    $
    11
    
    
    $
    95
    
    
    $
    76
    
    
    $
    380


4. Comprehensive Income

Components of comprehensive income were as follows (in thousands):

Three Months Ended
    
    Nine Months EndedSeptember
30,2003
    
    September 30,2002
    
    September 30,2003
    
    September 30,2002Net
income
    
    $
    4,232
    
    
    $
    4,038
    
    
    $
    12,180
    
    
    $
    10,240Change in
unrealized gain on
investments
    
    
    (53
    )
    
    
    300
    
    
    
    (463
    )
    
    
    466Translation
adjustment
    
    
    
    
    
    
    41
    
    
    
    
    
    
    
    Comprehensive
income
    
    $
    4,179
    
    
    $
    4,379
    
    
    $
    11,717
    
    
    $
    10,706


Accumulated other comprehensive income totaled $13,000 and $476,000 at
September 30, 2003 and December 31, 2002, respectively.

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5. Stock-Based Compensation

The Company accounts for its stock-based compensation plans under
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees. The pro forma information below is based on provisions of Statement
of Financial Accounting Standard (FAS) No. 123, Accounting for Stock-Based
Compensation,as amended by FAS 148, Accounting for Stock-Based Compensation 
Transition and Disclosure, issued in December 2002. The pro forma effects of
stock-based compensation on net income and net income per share have been
estimated at the date of grant using the Black-Scholes option pricing model
based on the following weighted average assumptions since the Companys initial
public offering in March of 2000: risk free interest rates of 2.36% to 6.0%,
dividend yields of 0%, expected volatility of 98% to 132%, and life of 5 years.

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

Three Months Ended
    
    Nine Months EndedSeptember 30,
2003
    

September 30,
2002
    

September 30,
2003
    

September 30,
2002Net income as
reported
    
    $
    4,232
    
    
    $
    4,038
    
    
    $
    12,180
    
    
    $
    10,240Stock-based
employee
compensation cost
included in
net income as reported, net of tax (1), (2)
    
    
    7
    
    
    
    89
    
    
    
    47
    
    
    
    358Compensation
expense under FAS
123, net of tax (2)
    
    
    (2,095
    )
    
    
    (2,797
    )
    
    
    (6,074
    )
    
    
    (7,566
    )Pro forma net
income
    
    $
    2,144
    
    
    $
    1,330
    
    
    $
    6,153
    
    
    $
    3,032Basic net income
per share as
reported
    
    $
    0.19
    
    
    $
    0.19
    
    
    $
    0.56
    
    
    $
    0.49Pro forma basic net
income per
share
    
    $
    0.10
    
    
    $
    0.06
    
    
    $
    0.28
    
    
    $
    0.14Diluted net income
per share as
reported
    
    $
    0.18
    
    
    $
    0.18
    
    
    $
    0.53
    
    
    $
    0.44Pro forma diluted
net income per
share
    
    $
    0.09
    
    
    $
    0.06
    
    
    $
    0.27
    
    
    $
    0.13




| | (1) |  | The Company is recognizing deferred stock-based compensation
expense on the deemed fair value of options granted prior to our
initial public offering in March 2000. This expense is being amortized
on a declining basis over approximately a four-year period which began
in March 2000.
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (2) |  | The Company had an effective tax rate of 38% and 6% in the three
months ended September 30, 2003 and 2002, respectively. The Company
had an effective tax rate of 39% and 6% in the nine months ended
September 30, 2003 and 2002, respectively.
| | --- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

For purposes of pro forma disclosures, the estimated fair value is
amortized to expense over the options vesting period. The effect of applying
SFAS 123 for purposes of providing pro forma disclosures may not be
representative of the effects on our operating results in future years.

6. Reclassifications

Certain reclassifications have been made for consistent presentation.

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##### Table of Contents






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

The following discussion and analysis should be read in conjunction with
the financial statements and related notes contained elsewhere in this report.
See Risks and Uncertainties regarding certain factors known to us that could
cause reported financial information not to be necessarily indicative of future
results.

Forward Looking Statements

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



| |  |  | anticipated trends in revenue;
| | - |  | ------------------------------



| |  |  | growth opportunities in domestic and international markets;
| | - |  | -----------------------------------------------------------



| |  |  | customer acceptance and satisfaction with our products;
| | - |  | -------------------------------------------------------



| |  |  | expected trends in operating expenses; and
| | - |  | ------------------------------------------



| |  |  | anticipated cash and intentions regarding usage of cash.
| | - |  | --------------------------------------------------------

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

Overview

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

During the nine months ended September 30, 2003, we derived approximately
29% of revenue from international sales compared with approximately 31% for the
nine months ended September 30, 2002. Despite the decline year-over-year as a
percentage of total revenue, international sales increased 27% in the third
quarter of 2003 over the third quarter of 2002, and we believe international
markets represent a significant growth opportunity and are continuing to expand
our international operations, particularly in selected countries in the
European, Latin American and Asia/Pacific markets.

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We currently sell Websense Enterprise, including premium products and
application modules, through both indirect and direct channels; however, sales
through indirect channels currently account for more than 80% of our revenue
and we expect this trend to continue.

As described below, we recognize revenue from subscriptions to Websense
Enterprise, including premium products and application modules, on a monthly
straight-line basis over the term of the subscription. We recognize the
operating expenses related to these sales as they are incurred. These operating
expenses include commissions relating to the sale of new and renewal
subscriptions, which are based on the total amount of the subscription contract
and are fully expensed in the period a subscription key for the product is
delivered. Operating expenses have continued to increase as compared with prior
periods due to expanded selling and marketing efforts, continued product
research and development and investments in administrative infrastructure to
support subscription sales that we will recognize as revenue in future periods.

Critical Accounting Policies

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

Revenue Recognition.When a purchase decision is made, customers enter
into a subscription agreement, which is generally 12, 24 or 36 months in
duration and for a fixed number of users. We promptly invoice customers for the
full amount of their subscriptions at the time a subscription is activated.
Payment is due for the full term of the subscription generally within 30 days
of the invoice. We recognize revenue on a monthly straight-line basis over the
term of the subscription agreement. We record amounts billed to customers in
excess of recognizable revenue as deferred revenue on our balance sheet. Upon
expiration of the subscription, customers who wish to renew typically must do
so at then current rates to continue using Websense Enterprise. Our revenue is
significantly influenced by subscription renewals, and a decrease in
subscription renewals amounts could negatively impact our future revenue.

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

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

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Results of Operations

Three months ended September 30, 2003, compared with the three months ended
September 30, 2002

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

Three Months EndedSeptember 30, 2003
    
    September 30, 2002(Unaudited)Revenue
    
    
    100
    %
    
    
    100
    %Cost of revenue
    
    
    7
    
    
    
    7Gross margin
    
    
    93
    
    
    
    93Operating expenses:Selling and marketing
    
    
    39
    
    
    
    41Research and development
    
    
    15
    
    
    
    19General and administrative
    
    
    9
    
    
    
    9Amortization of stock-based compensation
    
    
    
    
    
    
    1Total operating expenses
    
    
    63
    
    
    
    70Income from operations
    
    
    30
    
    
    
    23Other income, net
    
    
    2
    
    
    
    4Income before income taxes
    
    
    32
    
    
    
    27Provision for income taxes
    
    
    12
    
    
    
    2Net income
    
    
    20
    %
    
    
    25
    %


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Revenue

Revenue increased to $21.0 million in the third quarter of 2003 from $16.0
million in the third quarter of 2002. This increase was primarily a result of
the addition of new customers. Approximately 40% of subscription revenue
recognized in the third quarter of 2003 was derived from sales to first-time
customers, who initially purchased one-, two-, or three-year subscriptions to
Websense Enterprise in 2003 or prior years. The remaining 60% of subscription
revenue was generated from renewal business with existing customers. We expect
revenue to grow at a slower rate in 2003 than 2002, principally as a result of
the larger revenue base at September 30, 2003 compared with September 30, 2002
and uncertain global economic factors.

Cost of Revenue

Cost of revenue consists of the costs of content review, technical support
and infrastructure costs associated with maintaining our databases. Cost of
revenue increased to $1.4 million in the third quarter of 2003 from $1.1
million in the third quarter of 2002. The increase was primarily due to the
costs associated with additional personnel in our technical support and
database groups. We expect cost of revenue to increase in the future as we
support the growth and maintenance of our databases as well as the technical
support needs of our customers. As a percentage of revenue, cost of revenue
remained unchanged at 7% during the third quarters of 2003 and 2002. We expect
that cost of revenue, as a percentage of revenue, will remain below 10% of
revenue for the foreseeable future.

Gross Margin

Gross margin increased to $19.6 million in the third quarter of 2003 from
$14.9 million in the third quarter of 2002. The increase was primarily due to
increased revenue. As a percentage of revenue, gross margin remained unchanged
at 93% in the third quarters of 2003 and 2002. We expect that gross margin, as
a percentage of revenue, will remain in excess of 90% of revenue for the
foreseeable future.

Operating Expenses

Selling and marketing. Selling and marketing expenses consist primarily of
salaries, commissions and benefits related to personnel engaged in selling,
marketing and customer support functions; costs related to public relations,
investor relations, advertising, promotions and travel; and allocated
facilities costs and depreciation expenses. Selling and marketing expenses
increased to $8.2 million in the third quarter of 2003 from $6.6 million in the
third quarter of 2002. The increase in selling and marketing expenses of $1.6
million was primarily due to increased headcount costs as well as higher
commission expenses related to higher sales levels. We expect selling and
marketing expenses to increase in the future as more personnel are added to
support our expanding selling and marketing efforts worldwide.

Research and development.Research and development expenses consist
primarily of salaries and benefits for software developers, contract
programmers, and allocated facilities costs and depreciation expenses. Research
and development expenses increased to $3.2 million in the third quarter of 2003
from $3.1 million in the third quarter of 2002. The increase of $100,000 in
research and development expenses was primarily a result of personnel added
since the third quarter of 2002. We expect research and development expenses to
increase in the future, as more personnel are added to support additional
technology partners, product enhancements, and the expansion of our product
offerings.

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General and administrative. General and administrative expenses consist
primarily of salaries, benefits and related expenses for our executive,
finance, human resources and administrative personnel, third party professional
service fees, allocated facilities costs and depreciation expenses. General and
administrative expenses increased to $1.8 million in the third quarter of 2003
from $1.5 million in the third quarter of 2002. The $300,000 increase in
general and administrative expenses is primarily a result of an increase in
state sales tax expenses and additional personnel needed to support our growing
operations, both domestically and internationally. We expect general and
administrative expenses to increase in future periods, reflecting growth in
operations and increasing expenses associated with being a public company and
expansion of our international operations.

Amortization of stock-based compensation.Amortization of stock-based
compensation decreased to $11,000 in the third quarter of 2003 from $95,000 in
the third quarter of 2002. The decrease in the amortization expense is
primarily due to the accelerated method of amortization that we have applied
since our initial public offering. The remaining deferred stock-based
compensation balance of $7,000 will be completely amortized as of December
2003.

Other Income, Net

Other income decreased to $418,000 in the third quarter of 2003 from
$665,000 in the third quarter of 2002. The decrease is due primarily to lower
interest rates generated by our cash and cash equivalents and marketable
securities despite increased balances as of September 30, 2003 as compared with
September 30, 2002. The lower interest rates are substantially the result of
the lower interest rate environment combined with our strategy to
maximize the after-tax return on our investments by purchasing lower
interest tax-exempt investments beginning in the second quarter of 2003. As of
September 30, 2003, the majority of our total cash and cash equivalents and
marketable securities were tax-exempt, compared to no such investments at
September 30, 2002. We expect the majority of our cash and cash equivalents and
marketable securities will continue to be held in tax-exempt investments during
the fourth quarter of 2003.

Provision for Income Taxes

In the
third quarter of 2002, our provision for income taxes is related to
our wholly-owned subsidiaries in the United Kingdom and Japan as well as
domestic state income taxes. Beyond these domestic state income taxes, we did
not provide for any other income taxes related to our U.S. operations due to
the partial utilization of our deferred tax assets in the third quarter of
2002. Our provision for income taxes in the third quarter of 2003 relates to
our wholly-owned subsidiaries in the United Kingdom, Japan, Australia, France
and Germany as well as U.S. federal and state income taxes. We expect an
effective tax rate of approximately 38% for 2003. Subsequent to 2003, our
effective tax rate may decrease over time due to benefits derived from lower
tax rates associated with foreign income.

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Nine months ended September 30, 2003, compared to the nine months ended
September 30, 2002

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

Nine Months EndedSeptember 30, 2003
    
    September 30, 2002(Unaudited)Revenue
    
    
    100
    %
    
    
    100
    %Cost of revenue
    
    
    7
    
    
    
    7Gross margin
    
    
    93
    
    
    
    93Operating expenses:Selling and marketing
    
    
    38
    
    
    
    43Research and development
    
    
    16
    
    
    
    18General and administrative
    
    
    9
    
    
    
    10Amortization of stock-based
compensation
    
    
    
    
    
    
    1Total operating expenses
    
    
    63
    
    
    
    72Income from operations
    
    
    30
    
    
    
    21Other income,net
    
    
    3
    
    
    
    4Income before income taxes
    
    
    33
    
    
    
    25Provision for income taxes
    
    
    13
    
    
    
    1Net income
    
    
    20
    %
    
    
    24
    %


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Revenue

Revenue increased to $59.0 million in the first nine months of 2003 from
$43.6 million in the first nine months of 2002. This increase was primarily a
result of the addition of new customers. Approximately 42% of subscription
revenue recognized in the first nine months of 2003 was derived from sales to
first-time customers, who initially purchased one-, two-, or three-year
subscriptions to Websense Enterprise in 2003 or prior years. The remaining 58%
of subscription revenue was generated from renewal business with existing
customers. We expect revenue to grow at a slower rate in 2003 than 2002,
principally as a result of the larger revenue base at September 30, 2003
compared with September 30, 2002 and uncertain global economic factors.

Cost of Revenue

Cost of revenue increased to $4.0 million in the first nine months of 2003
from $3.1 million in the first nine months of 2002. The increase was primarily
due to the costs associated with additional personnel in our technical support
and database groups. We expect cost of revenue to increase in the future as we
support the growth and maintenance of our database as well as the technical
support needs of our customers. As a percentage of revenue, cost of revenue
remained unchanged at 7% during the first nine months of 2003 and 2002. We
expect that cost of revenue, as a percentage of revenue, will remain below 10%
of revenue for the foreseeable future.

Gross Margin

Gross margin increased to $55.0 million in the first nine months of 2003
from $40.5 million in the first nine months of 2002. The increase was primarily
due to increased revenue. As a percentage of revenue, gross margin remained
unchanged at 93% during the first nine months of 2003 and 2002. We expect that
gross margin, as a percentage of revenue, will remain in excess of 90% of
revenue for the foreseeable future.

Operating Expenses

Selling and marketing. Selling and marketing expenses increased to $22.4
million in the first nine months of 2003 from $18.8 million in the first nine
months of 2002. The increase in selling and marketing expenses of $3.6 million
was primarily due to increased headcount costs as well as higher commission
expenses related to higher sales levels. We expect selling and marketing
expenses to increase in the future as more personnel are added to support our
globally expanding selling and marketing efforts.

Research and development. Research and development expenses increased to
$9.5 million in the first nine months of 2003 from $7.9 million in the first
nine months of 2002. The increase of $1.6 million in research and development
expenses was primarily a result of personnel added since the first nine months
of 2002 to support our expanded list of technology partners, the enhancements
of Websense Enterprise, including the development of Websense Enterprise v5.0
and subsequent versions, and additional products such as Client Application
Manager and Bandwidth Optimizer. We expect research and development expenses
to increase in the future, as more personnel are added to support additional
technology partners, product enhancements and expansion of our product
offerings.

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General and administrative. General and administrative expenses increased
to $5.0 million in the first nine months of 2003 from $4.6 million in the first
nine months of 2002. The $400,000 increase in general and administrative
expenses is primarily due to an increase in personnel to support our growing
operations, both domestically and internationally. We expect general and
administrative expenses to increase in future periods, reflecting growth in
operations and increased expenses associated with being a public company and
expansion of our international operations.

Amortization of stock-based compensation. Amortization of stock-based
compensation decreased to $76,000 in the first nine months of 2003 from
$380,000 in the first nine months of 2002. The decrease in the amortization
expense is primarily due to the accelerated method of amortization that we have
applied since our initial public offering. The remaining deferred stock-based
compensation balance of $7,000 will be completely amortized as of December
2003.

Other Income, Net

Other income decreased to $1.9 million in the first nine months to 2003
from $2.1 million in the first nine months of 2002. The decrease is due
primarily to lower interest rates generated by our cash and cash equivalents
and marketable securities despite increased balances as of September 30, 2003
as compared with September 30, 2002. The lower interest rates are
substantially the result of the lower interest rate environment combined with
our strategy to maximize the after-tax return on our investments by purchasing lower interest tax-exempt investments beginning in the
second quarter of 2003. As of September 30, 2003, the majority of our total
cash and cash equivalents and marketable securities were tax-exempt, compared
to no such investments at September 30, 2002. We expect the majority of our
cash and cash equivalents and marketable securities will continue to be held in
tax-exempt investments during the fourth quarter of 2003.

Provision for Income Taxes

In the
first nine months of 2002, our provision for income taxes is related
to our wholly-owned subsidiaries in the United Kingdom and Japan as well as
domestic state income taxes. Beyond these domestic state income taxes, we did
not provide for any other income taxes related to our U.S. operations due to
the partial utilization of our deferred tax assets in the first nine months of
2002. Our provision for income taxes in the first nine months of 2003 relates
to our wholly-owned subsidiaries in the United Kingdom, Japan, Australia,
France and Germany as well as U.S. federal and state income taxes. We expect an
effective tax rate of approximately 38% for 2003. Subsequent to 2003, our
effective tax rate may decrease over time due to benefits derived from lower
tax rates associated with foreign income.

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##### Table of Contents



Liquidity and Capital Resources

As of September 30, 2003, we had cash and cash equivalents of $90.6
million and investments in marketable securities of $76.7 million and retained
earnings of $11.2 million.

Net cash provided by operating activities was $30.0 million in the first
nine months of 2003 compared with $23.2 million in the first nine months of
2002. The increase in cash provided by operating activities in the first nine
months of 2003 was primarily due to an increase in net income, an increase in
deferred revenue (our subscriptions are initially recorded as deferred revenue)
and an increase in income taxes payable. Our operating cash flow and revenue
are significantly influenced by subscription renewals. A decrease in
subscription renewals could negatively impact our revenue and operating cash
flow.

Net cash used by investing activities was $200,000 in the first nine
months of 2003 compared with net cash provided by investing activities of $6.5
million in the first nine months of 2002. The decrease in cash provided by
investing activities in the first nine months of 2003 was primarily due to less
maturities and sales of marketable securities to offset purchases of marketable
securities.

Net cash used by financing activities was $900,000 in the first nine
months of 2003 compared with net cash provided by financing activities of $3.2
million in the first nine months of 2002. The decrease in cash from financing
activities in the first nine months of 2003 was primarily due to the use of
$4.8 million for the repurchase of 289,000 shares of our common stock.

We have operating lease commitments of approximately $300,000 during the
remainder of 2003, $1.2 million in 2004, $1.2 million in 2005, $1.2 million in
2006 and $1.3 million in 2007. A significant majority of our operating lease
commitments are related to our corporate headquarters lease, which was renewed
in April 2002. The lease renewal incentives resulted in no rent payments in the
third and fourth quarters of 2002 and escalating rent payments from 2004 to
2007. The rent expense related to our corporate headquarters lease renewal is
recorded monthly on a straight-line basis in accordance with generally accepted
accounting principles.

On April 3, 2003, we announced that our Board of Directors authorized a
stock repurchase program of up to 2 million shares of our common stock. The
repurchases will be made from time to time on the open market at prevailing
market prices or in privately negotiated transactions. Depending on market
conditions and other factors, purchases under this program may be commenced or
suspended at any time, or from time to time, without prior notice. As of
September 30, 2003, we had repurchased 289,000 shares of our common stock under
this program, totaling $4.8 million at an average price of $16.67 per share.

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

Risks and Uncertainties

Risks and uncertainties that could impact our business, consolidated
financial position, results of operations and cash flows and cause future
results to differ from our expectations include the following: customer
acceptance of our services, products and fee structures; the success of our
brand development efforts; the volatile and competitive nature of the Internet
industry; changes in domestic and international market conditions and the entry
into and development of international markets for our products; risks relating
to intellectual property ownership; as well as risks and uncertainties
identified in our Annual Report on Form 10-K for the fiscal year ended December
31, 2002 and other filings with the Securities
and Exchange Commission.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

We are exposed to changes in interest rates primarily from our short-term
available-for-sale investments. Under our current policies, we do not use
interest rate derivative instruments to manage exposure to interest rate
changes. A hypothetical 100 basis point adverse move in interest rates along
the entire interest rate yield curve would not materially affect the fair value
of our interest sensitive financial instruments at September 30, 2003. Declines
in interest rates over time will, however, reduce our interest income.

We mitigate our foreign currency risks principally by contracting
primarily in U.S. dollars and maintaining only nominal foreign currency cash
balances. Working funds necessary to facilitate the short term operations of
our subsidiaries are kept in the local currencies in which they do business.
For the quarter ended September 30, 2003, all of our billings, including those
billed by our operations in Ireland, were denominated in our functional
currency, which is the U.S. dollar.




Item 4. Controls and Procedures

Disclosure Controls and Procedures

We maintain disclosure controls and procedures designed to ensure that we
are able to collect the information we are required to disclose in the reports
we file with the Securities and Exchange Commission (SEC), and to record,
process, summarize and report this information within the time periods
specified in the rules of the SEC. Our Chief Executive and Chief Financial
Officers evaluated our disclosure controls and procedures as of the end of the
period covered by this report. Based on their evaluation, our Chief Executive
and Chief Financial Officers have concluded that these controls and procedures
are effective.

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

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

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Part II  Other Information




Item 1. Legal Proceedings

None.




Item 2. Changes in Securities and Use of Proceeds

(a) Not applicable.

(b) Not applicable.

(c) Not applicable.

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




Item 3. Defaults upon Senior Securities

None.




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

None.




Item 5. Other Information

None.

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Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

31.1 Certification of Principal Executive Officer pursuant to Exchange
Act Rules 13a-14(a) and 15d-14(a).

31.2 Certification of Principal Financial Officer pursuant to Exchange
Act Rules 13a-14(a) and 15d-14(a).

32.1 Certification of Principal Executive Officer pursuant to Exchange
Act Rules 13a-14(b) and 15d-14(b).

32.2 Certification of Principal Financial Officer pursuant to Exchange
Act Rules 13a-14(b) and 15d-14(b).

(b) Reports on Form 8-K

On July 7, 2003, the Company filed a Current Report on Form 8-K reporting
that preliminary financial results for its second quarter ended June 30,
2003 were available in a press release dated July 7, 2003.

On July 22, 2003, the Company filed a Current Report on Form 8-K
reporting that financial results for its second quarter ended June 30,
2003 were available in a press release dated July 22, 2003.

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SIGNATURES

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

WEBSENSE, INC.Date: November 13, 2003
    
    By:
    
    /s/ JOHN B. CARRINGTONJohn B. CarringtonChairman of the Board and
Chief Executive OfficerDate: November 13, 2003
    
    By:
    
    /s/ DOUGLAS C. WRIDEDouglas C. WrideChief Financial Officer


22