Websense (WBSN) 10-Q 2001 Q3 Quarterly report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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, 2001.

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 Number000-30093

Websense, Inc.
(Exact Name of Registrant as Specified in Its Charter)

Delaware
(State or Other Jurisdiction of
Incorporation or Organization) 51-0380839
(I.R.S. Employer
Identification No.)

10240 Sorrento Valley Road
San Diego, CA 92121
(858) 320-8000

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

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 /x/  No / /

The number of shares of the Registrant's common stock, $0.01 par value, outstanding as of October 31, 2001 was 20,353,967

Websense, Inc.
Table of Contents

			Page
Part I. Financial Information
	Item 1.    Financial Statements (unaudited)
		Consolidated Balance Sheets as of September 30, 2001 and December 31, 2000	3
		Consolidated Statements of Operations for the three and nine months ended September 30, 2001 and 2000	4
		Consolidated Statement of Stockholders' Equity for the nine months ended September 30, 2001	5
		Consolidated Statements of Cash Flows for the nine months ended September 30, 2001 and 2000	6
		Notes to Consolidated Financial Statements	7
	Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations		9
		Risks and Uncertainties	17
	Item 3.    Quantitative and Qualitative Disclosures About Market Risk		28
Part II. Other Information
	Item 1.    Legal Proceedings		28
	Item 2.    Changes in Securities and Use of Proceeds		28
	Item 3.    Defaults upon Senior Securities		29
	Item 4.    Submission of Matters to a Vote of Security Holders		29
	Item 5.    Other Information		29
	Item 6.    Exhibits and Reports on Form 8-K		29
Signatures			30

2

Part I—Financial Information

Item 1. Financial Statements (unaudited)

Websense, Inc.

Consolidated Balance Sheets

(in thousands)

			September 30, 2001			December 31, 2000
			(unaudited)
Assets
Current assets:
	Cash and cash equivalents		$	11,566		$	13,106
	Investments in marketable securities			82,239			68,153
	Accounts receivable, net			9,276			7,073
	Accounts receivable from a related party			821			525
	Other current assets			1,239			616
		Total current assets		105,141			89,473
Property and equipment, net				2,618			2,793
Deposits and other assets				420			188
Total assets			$	108,179		$	92,454
Liabilities and stockholders' equity
Current liabilities:
	Accounts payable		$	457		$	815
	Accrued payroll and related benefits			2,414			1,764
	Other accrued expenses			2,061			1,324
	Deferred revenue, current portion			25,866			16,551
		Total current liabilities		30,798			20,454
Deferred revenue, less current portion				9,760			7,936
Stockholders' equity:
	Common stock			202			197
	Additional paid in capital			87,060			86,111
	Deferred compensation			(640	)		(1,459	)
	Accumulated deficit			(19,337	)		(20,810	)
	Accumulated other comprehensive income			336			25
	Total stockholders' equity			67,621			64,064
Total liabilities and stockholders' equity			$	108,179		$	92,454

See accompanying notes.

3

Websense, Inc.

Consolidated Statements of Operations

(unaudited and in thousands, except per share amounts)

			Three Months Ended					Nine Months Ended
			September 30, 2001		September 30, 2000			September 30, 2001			September 30, 2000
Revenues:
	Subscriptions		$	9,489	$	4,522		$	24,326		$	11,080
	Other products and services			60		221			287			581
		Total revenues		9,549		4,743			24,613			11,661
Cost of revenues:
	Subscriptions			884		493			2,396			1,434
	Other products and services			27		187			169			529
		Total cost of revenues		911		680			2,565			1,963
Gross margin				8,638		4,063			22,048			9,698
Operating expenses:
	Selling and marketing			4,531		3,116			13,785			8,800
	Research and development			1,837		1,544			5,509			4,602
	General and administrative			1,186		920			3,855			2,387
	Amortization of stock-based compensation			210		429			655			1,571
		Total operating expenses		7,764		6,009			23,804			17,360
Income/(loss) from operations				874		(1,946	)		(1,756	)		(7,662	)
Interest income (expense), net				1,037		1,157			3,267			2,480
Net income (loss) before income taxes			$	1,911	$	(789	)	$	1,511		$	(5,182	)
Provision for income taxes				38		—			38			—
Net income (loss)			$	1,873	$	(789	)	$	1,473		$	(5,182	)
Basic net income (loss) per share			$	0.09	$	(0.04	)	$	0.07		$	(0.32	)
Diluted net income (loss) per share			$	0.08	$	(0.04	)	$	0.07		$	(0.32	)
Basic common shares				20,154		19,527			20,073			15,977
Diluted common shares				22,606		19,527			22,627			15,977

See accompanying notes.

4

Websense, Inc.

Consolidated Statement of Stockholders' Equity

(unaudited and in thousands)

		Common Stock												Accumulated other comprehensive income
					Additional paid-in capital			Deferred compensation			Accumulated deficit					Total stockholders' equity
		Shares	Amount
Balance at December 31, 2000		19,705	$	197	$	86,111		$	(1,459	)	$	(20,810	)	$	25	$	64,064
	Issuance of common stock upon exercise of options	510		5		650			—			—			—		655
	Issuance of common stock under employee stock purchase plan	44		—		463			—			—			—		463
	Deferred compensation (net of forfeitures)	—		—		(164	)		164			—			—		—
	Amortization of deferred compensation	—		—		—			655			—			—		655
	Net income	—		—		—			—			1,473			—		1,473
	Unrealized gain on securities available for sale	—		—		—			—			—			311		311
	Comprehensive net income	—		—		—			—			—			—		1,784
Balance at September 30, 2001		20,259	$	202	$	87,060		$	(640	)	$	(19,337	)	$	336	$	67,621

See accompanying notes.

5

Websense, Inc.

Consolidated Statements of Cash Flows

(unaudited and in thousands)

		Nine Months Ended September 30,
		2001			2000
Operating activities:
Net income (loss)		$	1,473		$	(5,182	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
	Depreciation		1,171			759
	Deferred revenue		11,139			8,012
	Amortization of deferred compensation		655			1,571
Changes in operating assets and liabilities:
	Accounts receivable		(2,499	)		(1,621	)
	Deposits and other assets		(855	)		(492	)
	Accounts payable		(358	)		(142	)
	Accrued payroll and related benefits		650			791
	Other accrued expenses		737			513
Net cash provided by operating activities			12,113			4,209
Investing activities:
Purchase of equipment			(996	)		(1,365	)
Purchase of marketable securities			(14,764	)		(66,616	)
Maturities of marketable securities			989			—
Net cash used in investing activities			(14,771	)		(67,981	)
Financing activities:
Repayments of notes payable			—			(1,497	)
Proceeds from issuance of common stock			1,118			65,754
Net cash provided by financing activities			1,118			64,257
Increase (decrease) in cash and cash equivalents			(1,540	)		485
Cash and cash equivalents at beginning of period			13,106			10,735
Cash and cash equivalents at end of period		$	11,566			11,220
Supplemental disclosures of cash flow information:
Interest paid		$	—		$	52

See accompanying notes.

6

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 financial statements and notes thereto for the year ended December 31, 2000, included in Websense, Inc.'s Annual Report on Form 10-K filed with the Securities and Exchange Commission. Operating results for the nine months ended September 30, 2001 are not necessarily indicative of the results that may be expected for any other interim period or for the year ending December 31, 2001. The balance sheet at December 31, 2000 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 (Loss) Per Share

    We compute net income/(loss) per share in accordance with SFAS No. 128,Earnings Per Share. Under the provisions of SFAS No. 128, basic net income (loss) per share is computed by dividing the net income (loss) for the period by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing the net income for the period by the weighted average number of common and common equivalent shares outstanding during the period. Diluted earnings per share are required to be calculated to include the potentially dilutive effect of the conversion of outstanding stock options.

3.  Amortization of Stock-based Compensation

    For the three- and nine-month periods ended September 30, 2001 and 2000, we recorded amortization of stock-based compensation. The allocation of the expense by operating expense category is as follows (in thousands):

	Three Months Ended September 30,				Nine Months Ended September 30,
	2001		2000		2001		2000
Selling and marketing	$	59	$	128	$	143	$	470
Research and development		37		62		108		278
General and administrative		114		239		404		823
	$	210	$	429	$	655	$	1,571

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4.  Recently Issued Accounting Standards

    In July 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard (SFAS) No.141, "Business Combinations" and SFAS No.142 "Goodwill and Other Intangible Assets." These statements drastically change the accounting for business combinations, goodwill, and intangible assets. SFAS 141 eliminates the pooling-of-interests method of accounting for business combinations. The requirements of SFAS 141 are effective for any business combination that is completed after June 30, 2001. Under SFAS 142, goodwill and indefinite lived intangible assets are no longer amortized but are reviewed annually (or more frequently if impairment indicators arise) for impairment. Separable intangible assets that are not deemed to have an indefinite life will continue to be amortized over their lives (but no maximum life). The amortization provisions of SFAS 142 apply to goodwill and intangible assets acquired after June 30, 2001. With respect to goodwill and intangible assets acquired prior to July 1, 2001, companies are required to adopt SFAS 142 in their fiscal year beginning after December 15, 2001. Because of the different transition dates for goodwill and intangible assets acquired on or before June 30, 2001 and those acquired after that date, pre-existing goodwill and intangible assets will be amortized during this transition period until adoption whereas new goodwill and indefinite intangible assets acquired after June 30, 2001 will not. We do not expect adoption of these standards to significantly impact our operating results or financial position since we have not engaged in any business combinations to date and have no goodwill.

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

    From time to time we have made and may continue to make "forward looking statements." This report on Form 10-Q may contain forward looking statements. These statements, which represent our expectations or beliefs concerning various future events, include but are not limited to statements concerning the following:

•

anticipated trends in revenue;



•

growth opportunities in domestic and international markets;



•

expected trends in operating expenses;



•

anticipated cash and capital requirements; and



•

intentions regarding investment of excess cash.

    Actual results may differ materially from results anticipated in such forward looking statements. We expressly disclaim any obligation to update any forward looking statements to reflect events or circumstances arising after the date hereof or otherwise.

    Readers are also urged to carefully review and consider the various disclosures made by us which attempt to advise interested parties of the factors which affect our business, including without limitation the disclosures made under the caption "Risks and Uncertainties," "Factors Affecting Our Operating Results" or "Risk Factors" and included herein and other reports and filings made with the Securities and Exchange Commission.

Overview

    We provide employee Internet management, or EIM, solutions that enable businesses to monitor, report and manage how their employees use the Internet. Our Websense Enterprise solution supports an organization's efforts to improve employee productivity, conserve network bandwidth and mitigate potential legal liability. We were founded in 1994 as NetPartners Internet Solutions, a reseller of computer network security solutions and related services. In 1996, we released our first software product, Websense Internet Screening System. Since 1998, we have refocused our business on developing and selling employee Internet management solutions, and no longer focus on the software resale and service business.

    In 1999, we changed our name to Websense, Inc. and completed our change in business strategy. In the same year, we expanded our senior management team, raised approximately $9.8 million in a private round of financing and further strengthened indirect sales channels and business relationships. In December 1999 we released version 4.0, a redesigned version of Websense Enterprise; our most recent version was released in June 2001. We currently derive a substantial majority of our revenues from subscriptions to this solution and expect this trend to continue in the future. 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. Upon entering into the subscription agreement, we promptly invoice our customers. Generally, payment is due for the full term of the subscription within 30 days of the invoice. We recognize revenue monthly on a straight-line basis over the term of the subscription agreement. We record amounts billed to customers in excess of recognizable revenue as deferred revenue on our balance sheet. Upon expiration of the subscription, customers who wish to re-subscribe must do so at our then-current rates to continue using Websense Enterprise. Our revenue is significantly influenced by subscription renewals, and a decrease in subscription renewals could negatively impact our revenue.

    We also derive a small portion of our revenues from professional services for the implementation of our products and from resale of hardware and software. We recognize revenues for these services

9

and products upon their completion or delivery. We expect these revenues to continue to decline as a percent of total revenues for the foreseeable future.

    In the first nine months of 2001, we derived 33% of revenues from international sales compared to 31% in the first nine months of 2000. We are continuing to expand our international operations, particularly in selected countries in the European and Asia Pacific markets, because we believe international markets represent a significant growth opportunity.

    We continue to sell solutions through indirect (92% of revenue in the first nine months of 2001) and direct (8% of revenue in the first nine months of 2001) channels; our strategy is to rely heavily on indirect sales channels. Domestically, we sell solutions through more than 740 Value Added Resellers, or VARs, and through our sales force. Internationally, we distribute Websense Enterprise through more than 180 distributors and resellers in over 83 countries who resell our solution through VARs and their resellers. In addition, we leverage the sales and marketing capabilities of the original equipment manufacturers, or OEMs, and other key providers of complementary hardware and software products.

    Because we derive revenues from subscription fees, we do not recognize the entire amount of subscription fees received in the month the subscription agreements are executed. However, we recognize operating expenses as they are incurred. Operating expenses have continued to increase on a year over year basis due to expanded selling and marketing efforts, research and development and investments in administrative infrastructure to support subscription sales that we will recognize as revenue in subsequent periods.

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Results of Operations

Three months ended September 30, 2001 compared to the three months ended September 30, 2000

    The following table sets forth, as a percentage of total revenues, certain income data for the periods indicated.

			Three Months Ended
			September 30, 2001		September 30, 2000
Revenues:
	Subscriptions		99	%	95	%
	Other products and services		1	%	5	%
		Total revenues	100	%	100	%
Cost of revenues:
	Subscriptions		9	%	10	%
	Other products and services		1	%	4	%
		Total cost of revenues	10	%	14	%
Gross margin			90	%	86	%
Operating expenses:
	Selling and marketing		48	%	66	%
	Research and development		19	%	33	%
	General and administrative		12	%	19	%
	Amortization of stock-based compensation		2	%	9	%
		Total operating expenses	81	%	127	%
Income/(loss) from operations			9	%	(41	%)
Interest income (expense), net			11	%	24	%
Net income (loss) before income taxes			20	%	(17	%)
Provision for income taxes			0	%	0	%
Net income (loss)			20	%	(17	%)

Revenues

    Subscriptions.  Subscription revenue increased $5 million, or 110%, to $9.5 million in the third quarter of 2001 from $4.5 million in the third quarter of 2000. Subscription revenue accounted for 99% of total revenues in the third quarter of 2001 compared to 95% in the third quarter of 2000. This increase was consistent with the strategy that transformed Websense from a network security services organization and reseller of third-party security software to a provider of Websense Enterprise, a high-margin, subscription-based Employee Internet Management solution.

    Other products and services.  Other products and services revenue decreased $161,000, or 73% to $60,000 in the third quarter of 2001 from $221,000 in the third quarter of 2000. Other products and services revenue accounted for 1% of revenues in the third quarter of 2001 compared to 5% in the third quarter of 2000. We expect this decline to continue.

Cost of Revenues

    Cost of subscriptions.  Cost of subscriptions consists of the costs of web site review, technical support and infrastructure costs associated with maintaining our database. Cost of subscriptions

11

increased $391,000 or 79% to $884,000 in the third quarter of 2001, from $493,000 in the third quarter of 2000. This increase was primarily due to additional personnel in our database and technical support groups. Costs of subscriptions, as a percentage of total revenue was 9% in the third quarter of 2001 as compared to 10% in the third quarter of 2000. The decrease in the percentage of subscription revenue was due to the increase in revenue and economies of scale achieved related to the associated costs.

    Cost of other products and services.  Costs of other products and services consist primarily of the cost of resale software and related hardware. Cost of other products and services decreased $160,000 or 86%, to $27,000 in the third quarter of 2001, from $187,000 in the third quarter of 2000. Cost of other products and services as a percentage of total revenue decreased to 1% in the third quarter of 2001 compared to 4% in the third quarter of 2000 as the associated revenue declined while total revenue increased.

Gross Margin

    Gross margin was $8.6 million, or 90% of revenues, for the third quarter 2001 compared to $4.1 million, or 86% of revenues, in third quarter 2000. Gross margin increased $4.6 million, or 113%, due to the continuing growth of subscription revenue, which generates higher margins as compared to other products and services.

Operating Expenses

    Selling and marketing.  Selling and marketing expenses consist primarily of salaries, commissions and benefits related to personnel engaged in selling, marketing and customer support functions, along with costs related to public relations, advertising, promotions, travel and allocated facilities and depreciation expenses. Selling and marketing expenses increased $1.4 million, or 45%, to $4.5 million in the third quarter of 2001, from $3.1 million in the third quarter 2000. The increase was primarily due to the addition of personnel, increased advertising and promotional activities in North America and our continuing expansion into Europe and Asia Pacific. We expect selling and marketing expenses to increase as more personnel are added to support our expanding selling and marketing efforts.

    Research and development.  Research and development expenses consist primarily of salaries and benefits for software developers, contract programmers, facilities costs and equipment depreciation. Research and development expenses increased $293,000, or 19%, to $1.8 million in the third quarter 2001 from $1.5 million in the third quarter 2000. Increased personnel costs associated with the release of Websense Enterprise v4.3 and Websense Reporter 6.2 and the growing number of product platforms drove the increase over the prior year's comparable quarter.

    General and administrative.  General and administrative expenses consist primarily of salaries, benefits and related expenses for executive and administrative personnel, third-party professional service fees and allocated facilities and depreciation expenses. General and administrative expenses increased $266,000, or 29%, to $1.2 million in the third quarter of 2001 from $920,000 in the third quarter of 2000. The increase was primarily due to personnel additions, increased taxes and increased costs related to our international expansion. We expect general and administrative expenses to increase in the future, reflecting continued growth in operations.

    Amortization of stock-based compensation.  We recognized $210,000 of stock-based compensation expense, net of forfeitures, in the third quarter 2001, compared to $429,000 in the third quarter 2000, a decrease of $219,000, or 51%. The decrease in the amortization expense primarily results from the accelerated method of amortization used.

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Interest Income

    Net interest income decreased $120,000, or 10%, to $1.0 million in the third quarter of 2001 from $1.2 million in the third quarter of 2000. We experienced a decrease in interest income due to lower effective interest rates compared to the prior year as a result of a continued decline in interest rates, partially offset by increased invested balances.

Net Income/(Loss)

    Net income increased $2.7 million, or 337%, to $1.9 million (or $0.08 per diluted share) from a loss of $789,000 (or $0.04 loss per diluted share) in the third quarter 2000. This increase was due to a combination of an increase in gross margin of $4.6 million, or 113%, partially offset by a slight increase in operating expenses of $1.8 million, or 29% and decrease in interest income of $120,000, or 10%.

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Nine months ended September 30, 2001 compared to the nine months ended September 30, 2000

    The following table sets forth, as a percentage of total revenues, certain income data for the periods indicated.

			Nine Months Ended
			September 30, 2001		September 30, 2000
Revenues:
	Subscriptions		99	%	95	%
	Other products and services		1	%	5	%
		Total revenues	100	%	100	%
Cost of revenues:
	Subscriptions		10	%	12	%
	Other products and services		0	%	5	%
		Total cost of revenues	10	%	17	%
Gross margin			90	%	83	%
Operating expenses:
	Selling and marketing		56	%	75	%
	Research and development		22	%	40	%
	General and administrative		16	%	20	%
	Amortization of stock-based compensation		3	%	13	%
		Total operating expenses	97	%	148	%
Income/(loss) from operations			(7	%)	(65	%)
Interest income (expense), net			13	%	21	%
Net income (loss) before income taxes			6	%	(44	%)
Provision for income taxes			0	%	0	%
Net income (loss)			6	%	(44	%)

Revenues

    Subscriptions.  Subscription revenue increased $13.2 million, or 120% to $24.3 million in the nine months ended September 30, 2001 from $11.1 million in the nine months ended September 30, 2000. Subscription revenue accounted for 99% of total revenues in the nine months ended September 30, 2001 compared to 95% in the nine months ended September 30, 2000. This increase in subscription revenue in the first nine months of this year as compared to the prior year was a result of continued billings growth.

    Other products and services.  Other products and services revenue decreased $294,000, or 51% to $287,000 in the nine months ended September 30, 2001 from $581,000 in the nine months ended September 30, 2000. Other products and services revenue accounted for 1% of revenues in the nine months ended September 30, 2001 compared to 5% in the nine months ended September 30, 2000. We expect this decline as a percentage of revenues to continue as we focus on selling our Websense Enterprise product.

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Cost of Revenues

    Cost of subscriptions.  Cost of subscriptions increased $962,000 or 67% to $2.4 million in the nine months ended September 30, 2001, from $1.4 million in the nine months ended September 30, 2000. This increase was primarily due to additional personnel added to our database and technical support groups. Costs of subscriptions, as a percentage of total revenue was 10% in the nine months ended September 30, 2001 as compared to 12% in the nine months ended September 30, 2000. The decrease in the percentage of subscription revenue was due to the increase in revenue and economies of scale achieved related to the associated costs.

    Cost of other products and services.  Cost of other products and services decreased $360,000 or 68%, to $169,000 in the nine months ended September 30, 2001, from $529,000 in the nine months ended September 30, 2000. Cost of other products and services as a percentage of total revenue decreased to less than 1% in the first nine months of 2001 compared to 5% in the first nine months of 2000.

Gross Margin

    Gross margin was $22 million, or 90% of revenues, for the first nine months ended September 30, 2001 compared to $9.7 million, or 83% of revenues, in the nine months ended September 30, 2000. Gross margin increased $12.4 million, or 127%, due to the continuing growth of subscription revenue, which generates higher margins as compared to other products and services.

Operating Expenses

    Selling and marketing.  Selling and marketing expenses increased $5.0 million, or 57%, to $13.8 million in the nine months ended September 30, 2001, from $8.8 million in the same nine months of the prior year. The increase was primarily due to the addition of personnel, increased advertising and promotional activities in North America and our continuing expansion into Europe and Asia Pacific. We expect selling and marketing expenses to increase as more personnel are added to support our expanding selling and marketing efforts.

    Research and development.  Research and development expenses increased $907,000, or 20%, to $5.5 million in the nine months ended September 30, 2001 from $4.6 million in the nine months ended September 30, 2000. The increase in research and development expenses over the first nine months of 2000 was due primarily to additional headcount in the current year.

    General and administrative.  General and administrative expenses increased $1.5 million, or 61%, to $3.9 million in the nine months ended September 30, 2001 from $2.4 million in the nine months ended September 30, 2000. The increase was primarily due to personnel additions, increased allowance for bad debt expense, professional service fees, insurance and other costs associated with being a public company. We expect general and administrative expenses to increase in the future, reflecting continued growth in operations.

    Amortization of stock-based compensation.  We recognized $655,000 of stock-based compensation expense, net of forfeitures, in the nine months ended September 30, 2001 compared to $1.6 million in the nine months ended September 30, 2000 a decrease of $916,000, or 58%. The decrease in the amortization expense is primarily due to the accelerated method of amortization used as well as forfeitures amounting to $164,000.

Interest Income

    Net interest income increased $787,000, or 32%, to $3.3 million from $2.5 million in the nine months ended September 30, 2000. The increase is due primarily to a larger investment portfolio

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primarily as a result of returns on the proceeds from our initial public offering, which closed in March 2000, as well as continuing investment of positive operating cash flow.

Net Income/(Loss)

    Net income increased $6.7 million, or 128%, to $1.5 million (or $0.07 earnings per share) from a loss of $5.2 million (or $0.32 loss per share) in the nine months ended September 30, 2000. This increase was due to a combination of an increase in gross margin of $12.4 million, or 127%, and an increase in interest income of $787,000 offset by an increase in operating expenses of $6.4 million, or 37%. The return on our invested balances has declined in recent months as a result of continuing declines in interest rates.

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Liquidity and Capital Resources

    From our inception through March 2000, we financed our operations primarily through operating activities and the sale of preferred equity securities. In total, we raised approximately $15.5 million, net of fees and expenses, through the sale of preferred equity securities. In March 2000, we closed our initial public offering with proceeds, net of underwriting fees and offering expenses, of approximately $65.7 million. In the past, we have also utilized available financing for the purchase of capital equipment.

    As of September 30, 2001, we had cash and cash equivalents of $11.6 million and investments in marketable securities of $82.2 million and an accumulated deficit of $19.3 million.

    Net cash provided by operating activities was $12.1 million in the nine months ended September 30, 2001 compared to $4.2 million in the nine months ended September 30, 2000. The relative increase in cash provided by operating activities is primarily due to net income in the current year versus a net loss in the prior year and cash payments received from increased sales of subscriptions (which are initially recorded as deferred revenue).

    Net cash used in investing activities was $14.8 million in the nine months ended September 30, 2001 compared to $68.0 million in the nine months ended September 30, 2000, reflecting a net decrease in the purchase of investments in marketable securities of $51.9 million in the first nine months of 2001 versus the first nine months of 2000. This decrease reflects an overall lengthening of our average investment terms in response to continued interest rate weakness.

    Net cash provided by financing activities was $1.1 million in the nine months ended September 30, 2001 compared to $64.3 million in the nine months ended September 30, 2000. This decrease is due to the proceeds we received upon completion in March 2000 of our initial public offering as compared to the proceeds from option exercises in the current year.

    In June 2000, we entered into a loan and security agreement with a bank for a credit facility of $1.5 million. At September 30, 2001 we had $1.0 million available for drawing under this facility and $500,000 allocated for existing or future letters of credit. We have operating lease commitments of $241,000 expiring in the last three months of 2001, $649,000 expiring in 2002 and $111,000 expiring in 2003.

    We believe that our cash and cash equivalents balances, investments in marketable securities and funds available under our existing credit facilities 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, high-grade commercial paper, corporate bonds and government securities. If existing cash is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain a larger credit facility. The sale of additional equity or convertible debt securities would result in additional dilution to our shareholders. 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

    You should carefully consider the following information in addition to other information in this report before you decide to purchase our common stock. The risks and uncertainties described below are those that we currently deem to be material and that we believe are specific to our company and our industry. If any of these or other risks actually occurs the trading price of our common stock could decline, and you may lose all or part of your investment.

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

    The third quarter of 2001 is the first quarter since 1996 in which we achieved profitability. In each of our previous 21 fiscal quarters we have experienced net losses, and as of September 30, 2001, we had an accumulated deficit of $19.3 million. We incurred net losses of $5.9 million and $9.3 million for the years ended December 31, 2000 and 1999, respectively. We may be unable to maintain profitability unless our revenues increase at a greater rate than our operating expenses. We currently expect our operating expenses to increase substantially, as we, among other things:

•

expand our Websense product offerings;



•

expand our domestic and international selling and marketing activities;



•

increase our research and development efforts to upgrade our existing products and develop new products and technologies;



•

develop and expand our proprietary database and systems;



•

upgrade our operational and financial systems, procedures and controls; and



•

hire additional personnel, including additional engineers and other technical staff.

    We will need to significantly increase our revenues to maintain profitability. If we fail to increase revenues from subscription fees for Websense Enterprise, we may experience losses in future quarters. If we continue to grow, we also may fail to accurately estimate and assess the associated increase in our operating expenses. If our operating expenses exceed our expectations, our financial performance will be adversely affected, which could cause the price of our common stock to decline.

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

    Substantially all of our revenues come from subscriptions to Websense Enterprise, and we expect this trend will continue for the foreseeable future. Subscription revenues accounted for 99% of our total revenues in first nine months of 2001. As a result, if for any reason revenues from Websense Enterprise decline or do not grow as rapidly as we anticipate, our operating results and our business will be significantly impaired. If Websense Enterprise fails to meet the needs of our existing and target customers, or if it does not compare favorably in price and performance to competing products, our growth will be limited. Websense Enterprise may not achieve continued market acceptance. Our future financial performance also will depend, in part, on our ability to diversify our offerings by successfully developing, introducing and gaining customer acceptance of new products and enhanced versions of Websense Enterprise. We may not be successful in achieving market acceptance of any new products that we develop or of enhanced versions of Websense Enterprise. Any failure or delay in diversifying our existing offerings could harm our business, results of operations and financial condition.

The market for employee Internet management products is emerging, and if we are not successful in promoting awareness of the need for Websense Enterprise and of our Websense brand, our growth may be limited.

    Based on our experience with potential customers, we believe that many corporations are unaware of the existence or scope of problems caused by employee misuse of the Internet. In addition, there may be a time-limited opportunity to achieve and maintain a significant share of the market for employee Internet management products due in part to the emerging nature of this market and the substantial resources available to our existing and potential competitors. We have committed approximately $1.4 million of our marketing communications resources in 2001 to promote awareness

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of the problems caused by employee misuse of Internet access in the workplace, but we may not be successful in this effort. If employers do not recognize or acknowledge these problems, then the market for Websense Enterprise may develop more slowly than we expect, which could adversely affect our operating results. Developing and maintaining awareness of our Websense brand is critical to achieving widespread acceptance of our existing and future employee Internet management products. Furthermore, we believe that the importance of brand recognition will increase as competition in our market develops. Successful promotion of our Websense brand will depend largely on the effectiveness of our marketing efforts and on our ability to develop reliable and useful products at competitive prices. If we fail to successfully promote our Websense brand, or if our expenses to promote and maintain our Websense brand are greater than anticipated, our results of operations and financial condition could suffer.

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

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

    Our future success also depends on our ability to sell further subscriptions to existing customers in order to obtain additional seats within their respective organizations. We believe that approximately 20% of our customers' Internet-enabled employees are covered by Websense Enterprise. As a result, to increase our revenues we must sell our existing customers additional subscriptions for Websense Enterprise to get greater coverage of their workforces. This may require increasingly sophisticated sales efforts targeting senior management and other management personnel associated with our customers' Internet infrastructure.

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

    We expect that a substantial majority of our future revenues will come from subscriptions to Websense Enterprise. Upon execution of a subscription agreement, we invoice our customers for the full term of the subscription agreement. We then recognize revenue from customers over the terms of their subscription agreements which generally have durations of 12, 24 or 36 months. As a result, a majority of the revenue we report in each quarter is deferred revenue from subscription agreements entered into and paid for during previous quarters. Because of this model, the revenues we report in any quarter or series of quarters may mask significant downturns in sales and the market acceptance of Websense Enterprise.

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

    We have only a limited operating history upon which to base an evaluation of our current business and future prospects. We began offering our employee Internet management software in September 1996, but only since May 1998, when we released our first version of Websense Enterprise as a significant enhancement to our original product, have we directed a majority of our focus on this market. We introduced the most recent version of Websense Enterprise in June 2001. As a result, the revenue and income potential of our business and our market are unproven. In addition, we have very limited historical data with respect to subscription renewals because we sell subscriptions that range from one to three years in length and have been selling Websense Enterprise for less than four years. Further, because of our limited operating history and because the market for employee Internet management products is relatively new and rapidly evolving, we have limited insight into trends that may emerge and affect our business. We may make errors in predicting and reacting to relevant business trends, which could harm our business. Before investing, you should consider an investment in our stock in light of the risks, uncertainties and difficulties frequently encountered by early-stage companies in new and rapidly evolving markets such as ours. We may not be able to successfully address any or all of these risks. Failure to adequately do so could cause our business, results of operations and financial condition to suffer.

We may not be able to develop acceptable new products or enhancements to our existing products at a rate required by our rapidly changing market.

    Our future success depends on our ability to develop new products or enhancements to our existing products that keep pace with rapid technological developments and that address the changing needs of our customers. Although Websense Enterprise is designed to operate with a variety of network hardware and software platforms, we will need to continuously modify and enhance Websense Enterprise to keep pace with changes in Internet-related hardware, software, communication, browser and database technologies. We may not be successful in either developing such products or timely introducing them to the market. In addition, uncertainties about the timing and nature of new network platforms or technologies, or modifications to existing platforms or technology, could increase our research and development expenses. The failure of our products to operate effectively with the existing and future network platforms and technologies will limit or reduce the market for our products, result in customer dissatisfaction and seriously harm our business, results of operations and financial condition.

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

    We currently sell our products both indirectly and directly; however, we intend to rely increasingly on our indirect sales channels. We depend on our indirect sales channels, including value-added resellers, distributors, original equipment manufacturers and Internet service providers, to offer Websense Enterprise to a larger customer base than we can reach through our direct sales efforts. We will need to expand our existing relationships and enter into new relationships to increase our current and future market share and revenue. We may be unable to maintain and expand our existing relationships or enter into new relationships on commercially reasonable terms or at all. If we are unable to maintain and expand our existing relationships or enter into new relationships, we would lose customer introductions and co-marketing benefits and our operating results could suffer.

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

    Our indirect sales channels accounted for approximately 92% of our revenues in the nine months ended September 30, 2001. We anticipate that sales from our various indirect sales channels, including value-added resellers, distributors, original equipment manufacturers, Internet service providers and others, will account for an increasing percentage of our total revenues in future periods. None of these parties is obligated to continue selling our products or to make any purchases from us. Our ability to generate increased revenue depends significantly upon the ability and willingness of our indirect sales channels to market and sell our products to organizations worldwide. If they are unsuccessful in their efforts, our operating results will suffer. We cannot control the level of effort these parties expend or the extent to which any of them will be successful in marketing and selling our products. Many of our indirect sales channels also market and sell products that compete with Websense Enterprise or may decide to do so in the future. We may not be able to prevent these parties from devoting greater resources to support our competitors' products and/or eliminating their efforts to sell Websense Enterprise.

We face increasing competition from better-established companies that may have significantly greater resources, which could prevent us from increasing revenue or maintaining profitability.

    The market for our products is intensely competitive and is likely to become even more so in the future. Increased competition could result in pricing pressures, reduced sales, reduced margins or the failure of Websense Enterprise to achieve or maintain more widespread market acceptance, any of which would have a material adverse effect on our business, results of operations and financial condition. Our current principal competitors include:

•

companies offering network filtering products, such as SurfControl, Secure Computing, Symantec, webwasher.com, TrendMicro, Telemate.Net, N2H2, Elron Software and RuleSpace;



•

companies offering network reporting products, such as the WebTrends business acquired by NetIQ in 2001; and



•

companies offering client-based software filtering products, such as 8e6 Technologies.

    We also face current and potential competition from vendors of Internet servers, operating systems and networking hardware, many of which now, or may in the future, develop and/or bundle employee Internet management products with their products. We also compete against, and expect increased competition from, traditional network management software developers and Web management service providers. We also face potential competition from our own indirect sales channels, who may decide to develop or sell competing products. Many of our current and potential competitors enjoy substantial competitive advantages, such as:

•

greater name recognition and larger marketing budgets and resources;



•

established marketing relationships and access to larger customer bases; and



•

substantially greater financial, technical and other resources.

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

21

Other vendors may develop products similar to ours for incorporation into their hardware or software, and thereby reduce demand for Websense Enterprise.

    In the future, vendors of Internet-related hardware and software may enhance their products or develop separate products that include functions that are currently provided by Websense Enterprise. If employee Internet management functions become standard features of Internet-related hardware or software, the demand for Websense Enterprise will decrease. Furthermore, even if Websense Enterprise provides greater functionality and is more effective than the products offered by vendors of Internet-related hardware or software, potential customers might accept this limited functionality in lieu of purchasing our Websense Enterprise.

Negative economic conditions, terrorism and acts of hostility in the United States and in the other countries and geographic areas in which we offer our products may negatively impact our ability to maintain profitability.

    In the nine months ended September 30, 2001 we have seen a rapid and increasingly severe economic downturn in the United States and in the other international markets in which we offer our products. In addition, we have seen acts of hostility and terrorism which may increase or prolong this economic downturn. This downturn may impact our ability to sustain profitability by:

•

negatively affecting growth in demand for our products and services;



•

causing some of our customers to be unable to pay for subscriptions they have ordered; and



•

decreasing the renewal rate of subscriptions by our existing customers.

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

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

    We market and sell our products outside the United States through value-added resellers, distributors and other resellers. International sales represented approximately 33% of our total revenues in the nine months ended September 30, 2001. As a key component of our business strategy, we intend to expand our international sales. In addition to the risks associated with our domestic sales, our international sales are subject to the following risks:

•

dependence on foreign distributors and their sales channels;



•

the ability of our Websense Enterprise products to properly categorize and filter Web sites containing foreign languages;



•

laws and business practices favoring foreign competitors;



•

compliance with multiple, conflicting and changing governmental laws and regulations, including tax laws and regulations;



•

foreign currency fluctuations;



•

longer accounts receivable payment cycles and other collection difficulties; and



•

regional economic and political conditions.

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

We may need to raise additional funds in the future, which may not be available on acceptable terms or at all.

    We expect that our operating expenses will increase substantially over at least the next 12 months. In addition, we may experience a material decrease in liquidity due to unforeseen capital requirements or other events and uncertainties. As a result, we may need to raise additional funds, and such funds may not be available on favorable terms, if at all. If we cannot raise funds on acceptable terms, we may not be able to develop or enhance our software applications or database, execute on our business plan, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements. This may seriously harm our business, results of operations and financial condition.

We may seek to raise additional funds, and additional funding may be dilutive to stockholders or impose operational restrictions.

    An additional equity financing may be dilutive to our stockholders and debt financing, if available, may involve restrictive covenants, which may limit our operating flexibility. If additional funds are raised through the issuance of equity securities, the percentage of ownership of our existing stockholders will be reduced. These stockholders may experience additional dilution in net book value per share and any additional equity securities may have rights, preferences and privileges senior to those of the holders of our common stock.

Our common stock may not maintain an active, liquid trading market.

    We completed our initial public offering in March 2000. Prior to this offering, there was no public market for our common stock. We cannot predict whether an active trading market in our common stock will be maintained or how liquid that market may become.

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

    Our quarterly operating results have varied significantly in the past, and will likely vary in the future as the result of fluctuations in our operating expenses. We expect that our operating expenses will increase substantially in the future as we expand our selling and marketing activities, increase our research and development efforts and hire additional personnel. In addition, our operating expenses historically have fluctuated, and may continue to fluctuate in the future, as the result of the factors described below and elsewhere in this quarterly report:

•

concentration of marketing expenses for activities such as trade shows and advertising campaigns;



•

concentration of general and administrative expenses, such as recruiting expenses and professional services fees; and



•

concentration of research and development costs.

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    As a result, it is possible that in some future periods, our results of operations may not meet the expectations of current or potential investors. If this occurs, the price of our common stock may decline.

The market price of our common stock is likely to be highly volatile and subject to wide fluctuations.

    The market price of our common stock has been and likely will continue to be highly volatile and could be subject to wide fluctuations in response to a number of factors that are beyond our control, including:

•

announcements of technological innovations or new products or services by our competitors;



•

demand for Websense Enterprise, including fluctuations in subscription renewals;



•

fluctuations in revenues from our indirect sales channels;



•

changes in the pricing policies of our competitors; and



•

changes in government regulations.

    In addition, the market price of our common stock could be subject to wide fluctuations in response to:

•

announcements of technological innovations or new products or services by us;



•

changes in our pricing policies;



•

quarterly variations in our operating expenses; and



•

our technological capabilities to accommodate the future growth in our operations or our customers.

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    Further, the stock market has experienced significant price and volume fluctuations that have particularly affected the market price of the stock of many Internet-related companies, and that often have been unrelated or disproportionate to the operating performance of these companies. A number of publicly traded Internet-related companies have current market prices below their initial public offering prices. Market fluctuations such as these may seriously harm the market price of our common stock. In the past, securities class action suits have been filed following periods of market volatility in the price of a company's securities. If such an action were instituted, we would incur substantial costs and a diversion of management attention and resources, which would seriously harm our business, results of operations and financial condition.

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

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

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

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

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

    The success of Websense Enterprise depends on the breadth and accuracy of our database. Although our database currently catalogs approximately 2.6 million Web sites, it contains only a fraction of the material available on the Internet. In addition, the total number of Web sites is growing rapidly, and we expect this rapid growth rate to continue in the future. Our database and database technologies may not be able to keep pace with the growth in the number of Web sites, especially the growing number of Web sites containing foreign languages. Further, the ongoing evolution of the Internet will require us to continually improve the functionality, features and reliability of our database. Because Websense Enterprise can only manage access to Web sites included in our database, if our database does not contain a meaningful portion of relevant Web sites, the effectiveness of Websense Enterprise will be significantly diminished. Any failure of our database to keep pace with the rapid growth and technological change of the Internet will impair the market acceptance of Websense Enterprise, which in turn will harm our business, results of operations and financial condition.

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

    Intellectual property is critical to our success, and we rely upon trademark, copyright and trade secret laws in the United States and other jurisdictions as well as confidentiality procedures and

25

contractual provisions to protect our proprietary technology and our Websense brand. Any of our trademarks may be challenged by others or invalidated through administrative process or litigation. We currently have no issued patents and may be unable to obtain patent protection in the future. In addition, any issued patents may not provide us with any competitive advantages, or may be challenged by third parties. Furthermore, legal standards relating to the validity, enforceability and scope of protection of intellectual property rights are uncertain. Effective patent, trademark, copyright and trade secret protection may not be available to us in every country in which our products are available. The laws of some foreign countries may not be as protective of intellectual property rights as United States laws, and mechanisms for enforcement of intellectual property rights may be inadequate. As a result our means of protecting our proprietary technology and brands may not be adequate. Furthermore, despite our efforts, we may be unable to prevent third parties from infringing upon or misappropriating our intellectual property. Any such infringement or misappropriation could have a material adverse effect on our business, results of operations and financial condition.

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

    The software and Internet industries are characterized by the existence of a large number of patents, trademarks and copyrights and by frequent litigation based on allegations of patent infringement or other violations of intellectual property rights. As the number of entrants into our market increases, the possibility of an intellectual property claim against us grows. Our technologies and products may not be able to withstand any third-party claims or rights against their use. Any intellectual property claims, with or without merit, could be time-consuming and expensive to litigate or settle, and could divert management attention from executing our business plan.

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

    Our servers are vulnerable to physical or electronic break-ins and service disruptions, which could lead to interruptions, delays, loss of data or the inability to process customer requests. Such events could be very expensive to remedy, could damage our reputation and could discourage existing and potential customers from using our products. We may experience break-ins in the future. Any such events could substantially harm our business, results of operations and financial condition.

    Because our products are complex and are deployed in a wide variety of complex network environments, they may have errors or defects that users identify after deployment, which could harm our reputation and our business.

    Products as complex as ours frequently contain undetected errors when first introduced or when new versions or enhancements are released. We have from time to time found errors in versions of Websense Enterprise, and we may find such errors in the future. The occurrence of errors could adversely affect sales of our products, divert the attention of engineering personnel from our product development efforts and cause significant customer relations problems.

Evolving regulation of the Internet may affect us adversely.

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

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

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

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

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

We are dependent on our management team, and the loss of any key member of this team may prevent us from implementing our business plan in a timely manner.

    Our success depends largely upon the continued services of our executive officers and other key management and development personnel. In particular, we rely on John B. Carrington, our President, Chief Executive Officer and Chairman. We are also substantially dependent on the continued service of our existing engineering personnel because of the complexity of our products and technologies. We do not have employment agreements with a majority of our executive officers, key management or development personnel and, therefore, they could terminate their employment with us at any time without penalty. We do not maintain key person life insurance policies on any of our employees. The loss of one or more of our key employees could seriously harm our business, results of operations and financial condition. In such an event we may be unable to recruit personnel to replace these individuals in a timely manner, or at all, on acceptable terms.

Our recent growth has strained our existing personnel and infrastructure resources, and if we are unable to implement appropriate controls and procedures to manage our growth, we may not be able to successfully implement our business plan.

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

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

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

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

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

    Acquisitions and investments involve numerous risks, including:

•

difficulties in integrating operations, technologies, services and personnel;



•

diversion of financial and management resources from existing operations;



•

risk of entering new markets;



•

potential loss of key employees; and



•

inability to generate sufficient revenues to offset acquisition or investment costs.

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

Our executive officers, directors and principal stockholders own a large percentage of our voting stock and could delay or prevent a change in our corporate control or other matters requiring stockholder approval, even if favored by our other stockholders.

    Our executive officers, directors and principal stockholders, and their respective affiliates, beneficially own approximately 26% of our outstanding common stock. These stockholders, if acting together, would be able to exert significant control over substantially all matters requiring approval by our stockholders, including the election of all directors and approval of significant corporate transactions.

It may be difficult for a third party to acquire us, even if doing so would be beneficial to our stockholders.

    Some provisions of our certificate of incorporation and bylaws, as well as some provisions of Delaware law, may discourage, delay or prevent third parties from acquiring us, even if doing so would be beneficial to our stockholders. For example, our certificate of incorporation provides for a classified board, with each board member serving a staggered three-year term. It also provides that stockholders may not fill board vacancies, call stockholder meetings or act by written consent. Our bylaws further provide that advance written notice is required prior to stockholder proposals. Each of these provisions

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makes it more difficult for stockholders to obtain control of our board or initiate actions that are opposed by the then current board. Additionally, we have authorized preferred stock that is undesignated, making it possible for the board to issue preferred stock with voting or other rights and preferences that could impede the success of any attempted change of control. Delaware law also could make it more difficult for a third party to acquire us. Section 203 of the Delaware General Corporation Law may have an anti-takeover effect with respect to transactions not approved in advance by our board, including discouraging attempts that might result in a premium over the market price of the shares of common stock held by our stockholders.

We do not intend to pay dividends.

    Since we terminated our election to be treated as an "S" corporation in January 1998, we have not declared or paid any cash dividends on our common stock. We currently intend to retain any future cash flows from operations to fund growth and, therefore, do not expect to pay any dividends in the foreseeable future.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

    In addition, we have a $1.5 million loan and security agreement with a financial institution. Interest on this credit facility is 6.25% at September 30, 2001. At September 30, 2001 we had no advances outstanding under this credit facility. If we were to draw advances under this facility changes in interest rates would affect the interest expense we would pay and could, therefore, impact our cash flows and results of operations.

Part II—Other Information

Item 1. Legal Proceedings

    We are currently not a party to any litigation that could have a material adverse effect on our results of operations, financial position or business.

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) related 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 $1.4 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 $64.3 million remaining from our IPO proceeds.

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Item 3. Defaults upon Senior Securities

    None.

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

    None

Item 5. Other Information

    Our President and Chief Executive Officer, John B. Carrington, and our Vice President and Chief Financial Officer, Douglas C. Wride, in order to diversify their investment portfolios while avoiding conflicts of interest or the appearance of any such conflict that might arise from their positions with the company, have established written plans in accordance with SEC Rule 10b5-1 for gradually liquidating a portion of their holdings of our common stock. Mr. Carrington intends to sell 6,057 shares of stock per week and Mr. Wride intends to sell 2,000 shares of stock per week during a period commencing in November 2001 and ending in November 2002. Both Mr. Carrington and Mr. Wride had similar plans for the period commencing November 2000 through November 2001.

Item 6. Exhibits and Reports on Form 8-K and S-8

(a)

Exhibits

    None

(b)

Reports on Form 8-K

    No reports on Form 8-K were filed by the Registrant during the quarter ended September 30, 2001.

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SIGNATURES

    In accordance with the requirements of the Securities Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	WEBSENSE, INC.
Date: November 14, 2001	By:	/s/ JOHN B. CARRINGTON   John B. Carrington Chairman of the Board, President, and Chief Executive Officer
	By:	/s/ DOUGLAS C. WRIDE   Douglas C. Wride Chief Financial Officer

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QuickLinks

Websense, Inc. Table of Contents
Websense, Inc. Consolidated Balance Sheets (in thousands)
Websense, Inc. Consolidated Statements of Operations (unaudited and in thousands, except per share amounts)
Websense, Inc. Consolidated Statement of Stockholders' Equity (unaudited and in thousands)
Websense, Inc. Consolidated Statements of Cash Flows (unaudited and in thousands)
WEBSENSE, INC. 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
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 and S-8

SIGNATURES