The following discussion and analysis should be read in conjunction with the financial statements and related notes contained elsewhere in this report. See "Risk Factors" under Part II, Item 1A below regarding certain factors known to us that could cause reported financial information not to be necessarily indicative of future results.

Forward-Looking Statements

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

• anticipated trends in revenue;

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

• growth opportunities in domestic and international markets;

• new and enhanced reliance on channels of distribution;

• customer acceptance and satisfaction with our products, services and fee structures;

• changes in domestic and international market conditions;

• risks associated with the effects of remediation plans on the effectiveness of internal controls;

• risks associated with fluctuations in foreign currency exchange rates;

• the impact of macro-economic conditions on our customers;

• expected trends in operating and other expenses;

• anticipated cash and intentions regarding usage of cash, including risks related to the required use of cash for debt servicing;

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

• changes in effective tax rates, tax laws and tax interpretations and statements relating to tax audits;

• risks related to changes in accounting interpretations;

• anticipated product enhancements or releases;

• the volatile and competitive nature of the Internet and security industries; and

• the success of our brand development efforts.

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

Overview

Company Overview

We are a leading provider of solutions for Web filtering and Web security, data loss prevention ("DLP"), and email security. Our products and services prevent malicious applications and inappropriate content from accessing our customers' networks and prevent critical business data from improperly leaving the network, allowing organizations to provide a secure and productive computing environment for employees, business partners and customers. Our portfolio of Web filtering, Web security, DLP and email anti-spam and messaging security software allows organizations to:

• prevent access to undesirable and dangerous elements on the Web, such as Web sites that contain inappropriate content or sites that download viruses, spyware, keyloggers, and an ever-increasing variety of malicious code, spam and malware, including Web sites with dynamic or user-generated content (Web 2.0 sites);

• identify and remove malicious applications from incoming Web traffic;

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

• filter "spam" out of incoming email traffic;

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

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

• control misuse of an organization's valuable computing resources, including unauthorized downloading of high-bandwidth content and sites that employees can otherwise access to utilize hacking tools.

Since we commenced operations in 1994, Websense has evolved from a reseller of computer security products to a leading provider of content security software solutions, including Web filtering and security, DLP, email and messaging security solutions. Our first Web filtering software product was released in 1996 and prevented access to inappropriate Web content. Since then, we have focused on adapting our Web filtering capabilities to address changing Internet use patterns and the growing incidence of Web-based criminal activity. Our current solutions share our ThreatseekerTMsecurity intelligence and offer integrated policy enforcement options to protect against Web and email attacks and prevent the inappropriate or malicious transmission of data.

Additionally, our Web Security Gateway ("WSG") product provides real time classification of dynamic end user generated content embedded in Web 2.0 Web sites, providing organizations with the same policy management options available with traditional static content Web sites, while still enabling the latest Web-based tools and applications. Our V10000 appliance, a Websense-branded server with pre-installed Websense software, offers our customers another alternative for implementing our software products by providing centralized management of Web security, proxy and cache, and application controls to manage and secure our customers in Web 2.0 environments. We expect the availability of the V10000 appliance to help generate additional new and upgraded subscriptions to our software, particularly our WSG product.

During the three and nine months ended September 30, 2009, we derived approximately 49% and 50%, respectively of our revenue from international sales, compared with approximately 50% and 44% for the three and nine months ended September 30, 2008, respectively. The United Kingdom comprised approximately 14% and 17% of our total revenue for the three months ended September 30, 2009 and 2008, respectively, and 15% and 14% for the nine months ended September 30, 2009 and 2008, respectively. We believe international markets continue to represent a significant growth opportunity and we are continuing to expand our international operations, particularly in selected countries in the European, Asia/Pacific and Latin American markets.

We distribute our products through a global network of distributors and value-added resellers to leverage our internal sales and marketing resources. Sales through indirect channels currently account for more than 90% of our revenue. We utilize a two-tier distribution strategy in North America to sell our products, with an objective of increasing the number of value-added resellers selling our products and further extending our reach into the small and medium sized business market segment. Our distribution strategy outside North America also relies on a multi-tiered system of distributors and value-added resellers.

As described elsewhere in this report, we recognize revenue from subscriptions to our products on a daily straight-line basis over the term of the subscription agreement, commencing on the first day of the subscription term. In accordance with the accounting rules for software revenue recognition, we recognize revenue associated with original equipment manufacturer ("OEM") contracts ratably over the contractual period for which we are obligated to provide post-contract customer support. We generally recognize the operating expenses related to these sales as they are incurred. These operating expenses include sales commissions, which are based on the total amount of the subscription contract, and are fully expensed in the period the subscription term begins. We sell our appliances pre-loaded with our software on a subscription basis and recognize revenue from the appliance and the software as well as the cost of revenue on the appliance on a daily straight line basis over the term of the subscription.

Operating expenses for 2009 have declined compared with 2008 primarily as a result of the substantial completion of the SurfControl integration activities during 2008, a reduction in amortization of intangibles and the favorable impact of a stronger U.S. dollar. However, certain of our operating expenses are expected to increase in absolute dollars on a comparative quarter over quarter basis due to continued product research and development and investments in administrative infrastructure (such as headcount, facilities, equipment and software) to support subscription sales that we will recognize as revenue in subsequent periods and fluctuations in currency impacting operating expenses that we pay in non-U.S. dollars. In light of the impact of the global recession on our business and the expected increase in certain of our operating expenses, we continue to engage in various cost containment initiatives to minimize the expected increase in certain expenses. As part of these initiatives, we incurred severance charges of approximately $1.3 million during the third quarter of 2009 which offset some of our cost containment in that quarter.

In October 2007, we completed our acquisition of SurfControl. As a result of expenses related to the combination and certain purchase accounting adjustments, we incurred operating losses under GAAP from the fourth quarter of 2007 through the fourth quarter of 2008. Similar to Websense, SurfControl sold products primarily under subscriptions whereby revenues were initially recorded as deferred revenue and recognized ratably over the term of the agreement. Under GAAP purchase accounting, we wrote off $101.1 million of SurfControl's deferred revenue, leaving a balance of $19.7 million as the fair value of the post-contract technical support services that is being recognized daily in accordance with our revenue recognition policy. In connection with the acquisition, we incurred restructuring costs primarily in connection with reducing SurfControl headcount and eliminating redundant facilities. We also incurred the expenses of managing the SurfControl operations as well as recording the amortization of the acquired intangibles. Given the average remaining term of the SurfControl subscriptions we acquired, the renewal revenue from the SurfControl customers and the elimination of many of the non-recurring acquisition related expenses, we currently expect to report income from operations for fiscal 2009. Our ability to retain SurfControl customers when their existing product subscriptions expire and continue to renew Websense customers, the duration of our renewal contracts, our ability to sell upgraded subscriptions or new subscriptions and our ability to maintain our overall pricing levels for our products will impact our results of operations in future quarters.

Critical Accounting Policies and Estimates

Critical accounting policies are those that may have a material impact on our financial statements and also require management to exercise significant judgment due to a high degree of uncertainty at the time the estimate is made. Our senior management has discussed the development and selection of our accounting policies, related accounting estimates and disclosures with the Audit Committee of our Board of Directors. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Revenue Recognition. When a purchase decision is made for our products, including our new appliance product, customers enter into a subscription agreement, which is generally 12, 24 or 36 months in duration and for a fixed number of users. Other services such as upgrades/enhancements and standard post-contract technical support services are sold together with our product subscription and provided throughout the subscription term. We recognize revenue on a daily straight-line basis, including our new appliance product revenue, commencing on the date the term of the subscription begins, and continuing over the term of the subscription agreement, provided the fee is fixed or determinable, persuasive evidence of an arrangement exists, delivery has occurred and collectability is reasonably assured. Upon entering into a subscription arrangement for a fixed or determinable fee, we electronically deliver access codes to users, and in the case of our appliance product we ship the product with our software pre-installed on the product, and then promptly invoice customers for the full amount of their subscriptions. Payment is due for the full term of the subscription, generally within 30 to 60 days of the invoice. We record amounts billed to customers in excess of recognizable revenue as deferred revenue on our balance sheet. When we enter into a subscription agreement that is denominated and paid in a currency other than U.S. dollars, we record the subscription billing and deferred revenue in U.S. dollars based upon the currency exchange rate in effect on the last day of the previous month before the subscription agreement is effective. Changes in currency rates relative to the U.S. dollar may have a significant impact on the revenue that we will recognize under future contracts that are denominated in currencies other than U.S. dollars.

For our OEM contracts, we grant our OEM customers the right to incorporate certain of our web filtering products into their products for resale to end users. The OEM customer pays us a royalty fee for each resale of a subscription to our product to an end user over a specified period of time. In accordance with the accounting rules for software revenue recognition, we recognize revenue associated with the OEM contracts ratably over the contractual period for which we are obligated to provide our services. The timing of the OEM revenue recognition will vary for each OEM depending on the information available, such as underlying end user subscription periods, to determine the contractual obligation period.

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

Acquisitions, Goodwill and Other Intangible Assets. We account for acquired businesses using the acquisition method of accounting in accordance with the accounting rules for business combinations which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective fair values. Any excess of the purchase price over the estimated fair values of net assets acquired is recorded as goodwill. The fair value of intangible assets, including acquired technology and customer relationships, is based on significant judgments made by management. The valuations and useful life assumptions are based on information available near the acquisition date and are based on expectations and assumptions that are considered reasonable by management. The judgments made in determining estimated fair values assigned to assets acquired and liabilities assumed, as well as asset lives, can materially impact our results of operations.

We review goodwill that has an indefinite useful life for impairment at least annually in our fourth quarter, or more frequently if an event occurs indicating the potential for impairment. We amortize the cost of identified intangible assets using amortization methods that reflect the pattern in which the economic benefits of the intangible assets are consumed or otherwise used up. In accordance with the accounting rules for the impairment or disposal of long-lived assets, we review intangible assets that have finite useful lives when an event occurs indicating the potential for impairment. We review for impairment by facts or circumstances, either external or internal, indicating that we may not recover the carrying value of the asset. We measure impairment losses related to long-lived assets based on the amount by which the carrying amounts of these assets exceed their fair values. Under these accounting rules, we measure fair value generally based on the estimated future cash flows. Our analysis is based on available information and on assumptions and projections that we consider to be reasonable and supportable. If necessary, we perform subsequent calculations to measure the amount of the impairment loss based on the excess of the carrying value over the fair value of the impaired assets.

Share-Based Compensation. We account for share-based compensation under the fair value method. Share-based compensation expense related to stock options is recorded based on the fair value of the award on its grant date which we estimate using the Black-Scholes valuation model. Share-based compensation expense related to restricted stock unit awards is calculated based on the market price of our common stock on the date of grant.

At September 30, 2009, there was $50.2 million of total unrecognized compensation costs related to share-based compensation arrangements granted under all equity compensation plans (excluding tax effects). The total unrecognized compensation costs will be adjusted for estimated forfeitures as well as for future changes in estimated forfeitures. We expect to recognize those costs over a weighted average period of approximately 2.3 years.

We estimate the fair value of options granted using the Black-Scholes option valuation model and the assumptions described below. We estimate the expected term of options granted based on the history of grants and exercises in our options database. We estimate the volatility of our common stock at the date of grant based on both the historical volatility as well as the implied volatility of publicly traded options on our common stock. We base the risk-free interest rate that is used in the Black-Scholes option valuation model on the implied yield in effect at the time of option grant on U.S. Treasury zero-coupon issues with equivalent remaining terms. We have never paid any cash dividends on our common stock and do not anticipate paying any cash dividends in the foreseeable future. Consequently, we use an expected dividend yield of zero in the Black-Scholes option valuation model. We amortize the fair value ratably over the vesting period of the awards, which is typically four years. We use historical data to estimate pre-vesting option forfeitures and record share-based expense only for those awards that are expected to vest. We may elect to use different assumptions under the Black-Scholes option valuation model in the future or select a different option valuation model altogether, which could materially affect our results of operations in the future.

We determine the fair value of share-based payment awards on the date of grant using an option-pricing model that is affected by our stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and actual and projected employee stock option exercise behaviors. Option-pricing models were developed for use in estimating the value of traded options that have no vesting or hedging restrictions and are fully transferable. Because our employee stock options have certain characteristics that are significantly different from traded options, and because changes in the subjective assumptions can materially affect the estimated value, in management's opinion the existing valuation models may not provide an accurate measure of the fair value of our employee stock options. Although the fair value of employee stock options is determined using an option-pricing model, that value may not be indicative of the fair value observed in a willing buyer/willing seller market transaction.

Income Tax Provision and Uncertain Tax Positions. We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. We establish reserves for tax-related uncertainties based on estimates of whether, and the extent to which, additional taxes will be due. These reserves for tax contingencies are established, to the extent that we believe that certain positions might be challenged successfully in whole or in part on audit, despite our belief that our tax return positions are consistent with prevailing law and practice. We adjust these reserves in light of changing facts and circumstances, such as the development of positions and outcome of tax audits. The provision for income taxes includes the impact of reserve provisions and changes to reserves that are considered appropriate.

Deferred tax assets are evaluated for future realization and reduced by a valuation allowance to the extent we believe a portion will not be realized. We consider many factors when assessing the likelihood of future realization of our deferred tax assets, including our recent cumulative earnings experience and expectations of future taxable income by taxing jurisdiction, the carry-forward periods available to us for tax reporting purposes, and other relevant factors.

We use a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which require periodic adjustments and which may not accurately anticipate actual outcomes.

In connection with our current audit examination by the U.S. federal tax authorities, several items are under review, including the cost sharing arrangement, including the amount of the cost sharing buy-in, and its subsequent operation between us and our Irish subsidiary. The U.S. federal tax authorities have identified cost sharing arrangements between domestic and international subsidiaries as a potential area for audit exposure for many companies. While we believe our cost sharing arrangement and cost sharing buy-in comply with all applicable laws and regulations, we cannot assure that U.S. federal tax authorities will not challenge this structure, the amount of the buy-in, the cost allocations subsequently used by us or propose an assessment against us. If U.S. federal tax authorities were to propose an adjustment to our taxes, we expect to continue to vigorously defend our positions, including as necessary and appropriate, utilizing our rights to appeal as well as other legal remedies. The audit examination by the U.S. federal tax authorities is ongoing and, other than Notices of Proposed Adjustments concerning the availability of research and development credits and deductions for equity compensation awards which represents total additional proposed tax of approximately $4.2 million (which excludes additional state income taxes, interest and penalties) a proposed adjustment for the cost sharing items has not been issued. As a result, it is not possible to estimate the potential impact on our financial statements or cash flows from this uncertainty at this time.

Allowance for Doubtful Accounts and Other Loss Contingencies. We maintain an allowance for doubtful accounts for estimated losses resulting from the inability or unwillingness of our customers to pay their invoices. Our allowance for doubtful accounts is based on a formula derived from our historical experience as well as our judgmental assessment based on the facts and circumstances of our existing customers. 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. Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires significant judgment by management based on the facts and circumstances of each matter.

Results of Operations

Three months ended September 30, 2009 compared with the three months ended
September 30, 2008

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



                                                   Three Months Ended
                                            September 30,       September 30,
                                                2009                2008
                                                       (Unaudited)
     Revenues                                         100 %               100 %
     Cost of revenues:
     Cost of revenues                                  13                  12
     Amortization of acquired technology                4                   4

     Total cost of revenues                            17                  16
     Gross margin                                      83                  84
     Operating expenses:
     Selling and marketing                             52                  58
     Research and development                          17                  18
     General and administrative                        12                  14

     Total operating expenses                          81                  90

     Income (loss) from operations                      2                  (6 )
     Interest expense                                  (2 )                (4 )
     Other income (expense), net                       -                   -

     Loss before income taxes                          -                  (10 )
     Provision (benefit) for income taxes               2                  (4 )

     Net loss                                          (2 )%               (6 )%

Revenues

Revenues increased to $78.6 million in the third quarter of 2009 from $74.9 million in the third quarter of 2008. The increase was primarily the result of increased revenue from new, renewed and upgraded subscriptions including software as a service ("SaaS") security products and OEM contract revenue from the third quarter of 2008 to the third quarter of 2009 and the revenue from the new V10000 appliance sales. The number of product seats under subscription decreased from 43.3 million as of September 30, 2008 to 42.9 million as of September 30, 2009 primarily due to the impact of the worldwide recession on the number of seats under subscription for renewals. Revenue from products sold in the United States accounted for $39.7 million or 51% of third quarter 2009 revenue compared to $37.2 million or 50% in the third quarter of 2008. Revenue from products sold internationally accounted for $38.9 million or 49% of third quarter 2009 revenue compared to $37.7 million or 50% in the third quarter of . . .