<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION

                            WASHINGTON, D.C.  20549

                                   FORM 10-Q

               Quarterly Report Pursuant to Section 13 or 15 (d)
                     of the Securities Exchange Act of 1934


For the quarterly period ended                            Commission File Number
March 31, 2001                                            000-26819
--------------                                            ---------

                         WATCHGUARD TECHNOLOGIES, INC.
                         -----------------------------
             (Exact Name of Registrant as Specified in Its Charter)


           Delaware                                       91-1712427
-------------------------------             ------------------------------------
(State or Other Jurisdiction of             (I.R.S. Employer Identification No.)
 Incorporation or Organization)


                        505 Fifth Ave. South, Suite 500
                        -------------------------------
                             Seattle WA 98104-3892
                             ---------------------
              (Address of Principal Executive Offices)  (Zip Code)

      Registrant's telephone number, including area code:  (206) 521-8340
                                                           --------------

                                  Not Applicable
           --------------------------------------------------------
             (Former name, former address and former fiscal year,
                        if changed since last report.)


     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 the
filing requirements for the past 90 days. Yes X  No
                                             ---   ---

               26,852,011 shares of WatchGuard common stock were
                        outstanding as of May 7, 2001.

                                     Page 1
<PAGE>

                         WATCHGUARD TECHNOLOGIES, INC.
                         QUARTERLY REPORT ON FORM 10-Q
                      FOR THE QUARTER ENDED MARCH 31, 2001

                               TABLE OF CONTENTS
<TABLE>
<CAPTION>
PART I.  FINANCIAL INFORMATION
<S>     <C>                                                                                           <C>
ITEM 1.   FINANCIAL STATEMENTS.......................................................................   3

          -  Consolidated Balance Sheets as of March 31, 2001 and December 31, 2000..................   3

          -  Consolidated Statements of Operations for the three months ended March 31, 2001 and 2000   4

          -  Consolidated Statements of Cash Flows for the three months ended March 31, 2001 and 2000   5

          -  Notes to Consolidated Financial Statements..............................................   6

ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS......   9

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.................................  26

PART II.  OTHER INFORMATION

ITEM 2.   CHANGES IN SECURITIES AND USE OF PROCEEDS..................................................  28
ITEM 6.   EXHIBITS AND REPORTS ON FORM 8-K...........................................................  28
</TABLE>

                                     Page 2
<PAGE>

                         PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS


                         WATCHGUARD TECHNOLOGIES, INC.

                          CONSOLIDATED BALANCE SHEETS
                          ---------------------------
                       (In thousands, except share data)

<TABLE>
<S>                                                                                <C>                    <C>
                                                                                        March 31,            December 31,
                                                                                          2001                   2000
                                                                                    -----------------      -----------------
                                                                                       (unaudited)
                                       ASSETS
Current assets:
 Cash and cash equivalents.......................................................         $ 18,878               $ 13,837
 Securities available for sale...................................................           95,946                101,278
 Trade accounts receivable, net..................................................           12,330                 15,271
 Inventories.....................................................................            6,110                  7,026
 Prepaid expenses and other receivables..........................................            3,544                  3,178
                                                                                    -----------------      -----------------
  Total current assets...........................................................          136,808                140,590
Property and equipment, net......................................................            7,448                  7,341
Goodwill.........................................................................           32,111                 33,947
Other intangibles and other assets...............................................           13,170                 14,052
                                                                                    -----------------      -----------------
Total assets.....................................................................         $189,537               $195,930
                                                                                    =================      =================

                         LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
 Accounts payable................................................................         $  4,698               $  7,256
 Accrued expenses................................................................            3,808                  4,395
 Deferred revenue................................................................           12,855                 11,874
                                                                                    -----------------      -----------------
Total current liabilities........................................................           21,361                 23,525

Stockholders' equity:
 Preferred stock, $0.001 par value:
   Authorized shares:  10,000,000
   No shares issued and outstanding..............................................               --                     --
 Common stock, $0.001 par value:
   Authorized shares:  80,000,000
   Shares issued and outstanding:  26,776,367 at March 31, 2001 and
      26,287,072 at December 31, 2000............................................               27                     26
 Additional paid-in capital......................................................          232,034                230,591
 Deferred stock-based compensation...............................................           (8,070)               (12,387)
 Accumulated other comprehensive gain (loss).....................................              268                   (222)
 Accumulated deficit.............................................................          (56,083)               (45,603)
                                                                                    -----------------      -----------------
Total stockholders' equity.......................................................          168,176                172,405
                                                                                    -----------------      -----------------
Total liabilities and stockholders' equity.......................................         $189,537               $195,930
                                                                                    =================      =================
</TABLE>
-----------------------------

See accompanying notes.

                                     Page 3
<PAGE>

                         WATCHGUARD TECHNOLOGIES, INC.
                         -----------------------------

                     CONSOLIDATED STATEMENTS OF OPERATIONS
                     -------------------------------------
                     (In thousands, except per share data)
                                  (unaudited)


<TABLE>
<CAPTION>
                                                                                  Three Months Ended
                                                                                       March 31,
                                                                         ---------------------------------------
<S>                                                                    <C>                   <C>
                                                                                2001                  2000
                                                                         -----------------     -----------------
Revenues:
 Product.............................................................     $     13,284          $      8,494
 Service.............................................................            3,818                 1,308
                                                                         -----------------     -----------------
    Total revenues...................................................           17,102                 9,802

Cost of revenues:
 Product.............................................................            5,267                 3,091
 Service.............................................................            1,376                   432
                                                                         -----------------     -----------------
    Total cost of revenues...........................................            6,643                 3,523
                                                                         -----------------     -----------------
Gross margin.........................................................           10,459                 6,279

Operating expenses:
 Sales and marketing (1).............................................            8,171                 5,559
 Research and development (2)........................................            5,271                 2,521
 General and administrative (3)......................................            1,870                 1,154
 Stock-based compensation............................................            4,520                   236
 Amortization of  goodwill, purchased technology and other
     intangible assets acquired......................................            2,724                   368
                                                                         -----------------     -----------------
    Total operating expenses.........................................           22,556                 9,838
                                                                         -----------------     -----------------
Operating loss.......................................................          (12,097)               (3,559)

Interest income, net.................................................            1,701                   863
                                                                         -----------------     -----------------
Loss before income taxes.............................................          (10,396)               (2,696)
                                                                         -----------------     -----------------
Provision for income taxes...........................................               84                     -
                                                                         -----------------     -----------------

Net loss.............................................................     $    (10,480)         $     (2,696)
                                                                         =================     =================

Basic and diluted net loss per share.................................     $      (0.40)         $      (0.13)
                                                                         =================     =================

Shares used in calculation of basic and diluted
 net loss per share..................................................           26,348                21,243
                                                                         =================     =================
</TABLE>
------------------------
(1)  Sales and marketing expenses exclude amortization of stock-based
     compensation of $12,000 and $51,000 for the three months ended March 31,
     2001 and 2000, respectively.
(2)  Research and development expenses exclude amortization of stock-based
     compensation of  $4,441,000 and $164,000 for the three months ended March
     31, 2001 and 2000, respectively.
(3)  General and administrative expenses exclude amortization of stock-based
     compensation of $67,000 and $21,000 for the three months ended March 31,
     2001 and 2000, respectively.


See accompanying notes.

                                     Page 4
<PAGE>

                         WATCHGUARD TECHNOLOGIES, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                     -------------------------------------
                                 (In thousands)
                                  (unaudited)
<TABLE>
<CAPTION>
                                                                                                  Three Months Ended
                                                                                                       March 31,
                                                                                      --------------------------------------------
                                                                                              2001                     2000
                                                                                      -------------------      -------------------
<S>                                                                                   <C>                      <C>
OPERATING ACTIVITIES:
 Net loss........................................................................           $(10,480)                $ (2,696)
 Adjustments to reconcile net loss to net cash used in operating activities:
   Depreciation and amortization of property and equipment.......................                514                      246
   Amortization of goodwill and other intangible assets..........................              2,724                      368
   Amortization of stock-based compensation......................................              4,520                      236
   Provision for sales returns and allowances....................................              1,252                      209
   Provision for bad debt expense................................................                276                      102
   Changes in operating assets and liabilities:
     (Increase) decrease in trade accounts receivable............................              1,413                   (2,895)
     (Increase) decrease in inventories..........................................                916                   (1,378)
     (Increase) in prepaid expenses and other receivables........................               (366)                  (1,001)
     (Increase) in goodwill, intangibles and other assets........................                 (6)                     (13)
     Increase (decrease) in accounts payable and accrued expenses................             (3,145)                   2,041
     Increase in deferred revenue................................................                981                    1,259
                                                                                      -------------------      -------------------
NET CASH USED IN OPERATING ACTIVITIES                                                         (1,401)                  (3,522)

INVESTING ACTIVITIES:
 Purchases of equipment and furniture............................................               (621)                    (403)
 Proceeds from sales and maturities of marketable securities.....................             70,524                    2,000
 Purchases of marketable securities..............................................            (64,702)                 (40,872)
                                                                                      -------------------      -------------------
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES..............................              5,201                  (39,275)

FINANCING ACTIVITIES:
 Principal repayments on line of credit and notes payable........................                 --                     (383)
 Proceeds from the sale of common stock, net of expenses.........................                 --                   90,437
 Proceeds from the exercise of common stock options and warrants, and the sale
     of common stock through the employee stock purchase plan....................              1,241                    1,122
                                                                                      -------------------      -------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES........................................              1,241                   91,176
                                                                                      -------------------      -------------------
NET INCREASE  IN CASH AND CASH EQUIVALENTS.......................................              5,041                   48,379

CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD.................................             13,837                    1,903
                                                                                      -------------------      -------------------

CASH AND CASH EQUIVALENTS AT END OF PERIOD.......................................           $ 18,878                 $ 50,282
                                                                                      ===================      ===================
</TABLE>
-------------------------

See accompanying notes.

                                     Page 5
<PAGE>

                         WATCHGUARD TECHNOLOGIES, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 - DESCRIPTION OF BUSINESS AND BASIS OF PRESENTATION

     Description of Business

     WatchGuard Technologies, Inc. is a provider of Internet security solutions
designed to protect enterprises that use the Internet for electronic commerce
and secure communications.

     Interim Financial Information

     The accompanying unaudited financial statements of WatchGuard, which
include the December 31, 2000 balance sheet that was derived from audited
financial statements, have been prepared in accordance with generally accepted
accounting principles for interim financial information and with the
instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by generally accepted
accounting principles for complete financial statements. In the opinion of
management, the unaudited financial statements include all adjustments,
consisting of normal recurring accruals, necessary for a fair presentation.
Operating results for the three-month period ended March 31, 2001 are not
necessarily indicative of the results that may be expected for future quarters
or for the year ended December 31, 2001. The financial statements should be read
in conjunction with the financial statements and related notes for the year
ended December 31, 2000 included in WatchGuard's annual report on Form 10-K,
filed with the Securities and Exchange Commission (SEC) on March 28, 2001.

NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Revenue Recognition

     WatchGuard recognizes revenue in accordance with accounting standards for
software companies, including Statement of Position (SOP) 97-2, "Software
Revenue Recognition," as amended by SOP 98-9, and related interpretations,
including Technical Practice Aids.  In December 1999, the SEC issued Staff
Accounting Bulletin (SAB)  101, "Revenue Recognition in Financial Statements".
SAB 101 summarizes certain of the SEC's views in applying generally accepted
accounting principles to revenue recognition in financial statements.  The SEC
continues to issue further guidance with respect to adoption of specific issues
addressed by SAB 101.  WatchGuard believes its current revenue recognition
policies and practices are consistent with the current accounting standards and
guidance in SAB 101.

     WatchGuard generates revenues through sales of its Firebox products,
including related software licenses, and subscriptions for its LiveSecurity
Service, which includes threat responses, software updates and maintenance.
Software license revenues are generated from licensing the rights to use
WatchGuard's products directly to end-users, from sublicense fees from
resellers, distributors and from sales of its products to Internet service
providers (ISPs) and other managed service providers that utilize WatchGuard's
products to provide managed security services to their customers.

     Revenues from software license agreements are generally recognized upon
delivery of software if persuasive evidence of an arrangement exists, collection
is probable, the fee is fixed or determinable, and vendor-specific objective
evidence exists to allocate the total fee to undelivered elements of the
arrangement.  WatchGuard's payment terms typically range from 30 to 60 days.  A
limited number of WatchGuard's distributors have unlimited stock return and
rotation rights.  Revenues from these distribution arrangements are not
recognized until a sale to their customer occurs.  Vendor-specific objective
evidence is typically based on the price charged when an element is sold
separately or, if an element is not sold separately, on the price established by
authorized management, if it is probable that the price, once established, will
not change before market introduction. WatchGuard uses the residual method, as
defined in SOP 98-9, to allocate revenue to delivered elements once it has
established vendor-specific objective evidence for all undelivered elements.
Under the residual method, any discount in the arrangement is allocated to the
delivered element. WatchGuard provides for return rights and pricing protection
rights for some of its customers.  The return rights included in these customer
agreements are generally limited to a percentage of purchases by these customers
for the previous quarter.  The pricing protection rights in these agreements are
generally limited to 60 to 90 days after notification of a price change.
Revenues are reduced by the provision for estimated returns and allowances at
the time the sale is made. The reserves are reviewed and revised as needed.
Revenues from LiveSecurity subscriptions are recognized ratably over the term of
the contract, typically one year.

                                     Page 6
<PAGE>

     Principles of Consolidation

     The consolidated financial statements include the accounts of WatchGuard
and its wholly owned subsidiaries. All significant intercompany accounts and
transactions are eliminated in consolidation.

     Comprehensive Loss

     WatchGuard's investments consist of corporate and government debt
securities, are considered available-for-sale, and are stated at fair value,
with unrealized gains and losses included as a component of stockholders'
equity. During the first quarters of 2001 and 2000, there were no material
realized gains or losses on securities available-for-sale. All such investments
mature within two years, with the weighted average life of the investment
portfolio being approximately one year. The following table sets forth the
components of comprehensive loss (in thousands):

<TABLE>
                                                                                                Three Months Ended
                                                                                                     March 31,
                                                                                    ---------------------------------------------
                                                                                           2001                      2000
                                                                                    -------------------       -------------------
<S>                                                                               <C>                       <C>
        Net loss...............................................................           $(10,480)                  $(2,696)
        Unrealized gain (loss) on investments..................................                490                      (235)
                                                                                    -------------------       -------------------
        Comprehensive loss.....................................................           $ (9,990)                  $(2,931)
                                                                                    ===================       ===================
</TABLE>

     Reclassifications

     Certain prior-period items have been reclassified to conform to the
current-period presentation.

NOTE 3 - BALANCE SHEET ACCOUNT DETAIL (in thousands)

     Trade Accounts Receivable, Net

     Trade accounts receivable, net consisted of the following:
<TABLE>
                                                                            March 31,           December 31,
                                                                              2001                  2000
                                                                       -------------------    -------------------
<S>                                                                      <C>                   <C>
      Trade accounts receivable.....................................         $14,575               $16,869
      Reserve for returns and allowances............................          (1,466)                 (965)
      Allowance for uncollectible accounts..........................            (779)                 (633)
                                                                       -------------------    -------------------
                                                                             $12,330               $15,271
                                                                       ===================    ===================
</TABLE>

     Inventories

     Inventories consisted of the following:
<TABLE>
                                                                            March 31,           December 31,
                                                                              2001                  2000
                                                                       -------------------    -------------------
<S>                                                                      <C>                   <C>
      Finished goods................................................          $4,633                $4,077
      Components....................................................           2,056                 3,394
                                                                       -------------------    -------------------
                                                                               6,689                 7,471
      Inventory reserves............................................            (579)                 (445)
                                                                       -------------------    -------------------
                                                                              $6,110                $7,026
                                                                       ===================    ===================
</TABLE>

                                     Page 7
<PAGE>

NOTE 4 - INTERNATIONAL REVENUES

     WatchGuard licenses and markets its Internet security products and services
throughout the world and operates in a single industry segment.  While certain
expenses for sales and marketing activities are incurred in various geographical
regions, substantially all of WatchGuard's assets are located, and the majority
of its operating expenses are incurred, at its corporate headquarters.  Revenue
information by geographic region is as follows (in thousands):

<TABLE>
<CAPTION>
                                                                                              Three Months Ended
                                                                                                    March 31,
                                                                                    --------------------------------------------
<S>                                                                              <C>                      <C>
                                                                                            2001                     2000
                                                                                    -------------------      -------------------
     United States.............................................................            $ 7,434                   $4,533
     Rest of World.............................................................              9,668                    5,269
                                                                                    -------------------      -------------------
     Total.....................................................................            $17,102                   $9,802
                                                                                    ===================      ===================
</TABLE>

NOTE 5 - SUBSEQUENT EVENTS

     In April 2001, WatchGuard announced a restructuring plan designed to
streamline operations and reduce costs, in response to a recent decrease in
demand for its products and services.  This restructuring plan includes a
reduction in its workforce and a consolidation of excess facilities, in addition
to other cost-saving strategies.  As a result of this restructuring, WatchGuard
expects to incur a one-time charge of approximately $1.5 to $2.0 million during
the second quarter of 2001.

                                     Page 8
<PAGE>

ITEM 2.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

     The following discussion and analysis provides information that we believe
is relevant to an assessment and understanding of WatchGuard's results of
operations and financial condition. The discussion should be read in conjunction
with the financial statements and the notes to the financial statements.
References to "we," "our" and "us" in this quarterly report refer to WatchGuard
Technologies, Inc.

Forward-Looking Statements

     Our disclosure and analysis in this quarterly report on Form 10-Q contain
forward-looking statements, which provide our current expectations or forecasts
of future events. We use words such as "anticipates," "believes," "expects,"
"future" and "intends," and similar expressions, to identify forward-looking
statements, but the absence of these words does not mean that the statement is
not forward-looking. Forward-looking statements include statements about our
plans, objectives, expectations and intentions and other statements that are not
historical facts. They are subject to known and unknown risks and uncertainties
and inaccurate assumptions that could cause our actual results to differ
materially from those expected or implied by the forward-looking statements. Our
actual results could differ materially from those anticipated in the forward-
looking statements for many reasons, including the risks described under
"Factors Affecting Our Operating Results, Our Business and Our Stock Price."
You should not unduly rely on these forward-looking statements, which apply only
as of the date of this quarterly report.  We undertake no obligation to update
any forward-looking statements to reflect new information, circumstances or
events after the date of this report.

Overview

     WatchGuard is a leading provider of Internet security solutions designed to
protect enterprises that use the Internet for electronic commerce and secure
communications. Our award-winning products and services include firewalls for
access control, virtual private networks, or VPNs, for secure communications and
our new ServerLock products for server content and application security. Our
core market includes small- to medium-sized enterprises, or SMEs, large
Internet-distributed enterprises, or IDEs, with ultra-high-speed connections
supporting VPNs between the IDEs and their geographically dispersed branch
offices and telecommuters, small and home offices, or SOHOs, with broadband
connections, and telecommuters. Our recent acquisition of Qiave Technologies
Corporation allowed us to expand our product line with a software-based solution
designed to protect server content and applications from unauthorized and
unintentional access and manipulation. Our innovative subscription-based
LiveSecurity Service delivers threat responses, software updates, expert
editorials, support flashes and virus alerts over the Internet, which enables
enterprises to protect their data and communications in a continuously changing
environment, with minimal effort.

     Since our inception, we have invested heavily in the development of our
products and services and financed our operations as follows:

     .  In September 1996, we introduced our initial Firebox security appliance
        and began selling our products both domestically and internationally.

     .  In 1997, we significantly expanded our worldwide sales and marketing
        efforts.

     .  In 1998, we launched our managed security offering for Internet service
        providers and other managed service providers and introduced our second-
        generation security appliance, which added significant functionality to
        our existing product lines.

     .  In February 1999, we launched the broadcast portion of our LiveSecurity
        Service.

     .  In July 1999, we raised net proceeds of $40.7 million in the initial
        public offering of our common stock.

     .  In October 1999, we acquired BeadleNet, LLC, a developer of Internet
        security solutions for SOHOs.

                                     Page 9
<PAGE>

     .  In January 2000, we announced the introduction of our security solutions
        for SOHOs and telecommuters, which we began shipping in the first
        quarter of 2000.

     .  In February 2000, we raised net proceeds of $90.4 million in a follow-on
        public offering of our common stock.

     .  In October 2000, we acquired Qiave, a developer of digital information
        security systems, which allowed us to expand our product line with
        ServerLock, which protects server content and applications against
        unauthorized or unintentional changes.

     .  In February 2001, we announced the introduction of our ServerLock
        products, which we began shipping in the first quarter of 2001.

     .  In May 2001, we introduced a higher performance third-generation
        security appliance targeted at the larger enterprise and the large
        internet-distributed enterprise markets.

Sources of Revenues and Revenue Recognition Policy

     We generate revenues through

     .  sales of products and service subscriptions indirectly through our
        distribution network at a discount from list price;

     .  sales of products and service subscriptions directly and, from time to
        time, indirectly through our distributors, to our service provider
        customers at volume pricing rates; and

     .  sales of service subscription renewals directly to our end-users.

     Product revenues include the perpetual software license fees for our
Firebox System and the sale of our security appliance as part of our security
solutions; the sales of software options, such as VPN; the sales of our network
operations center, or NOC, security suite software license and our security
appliance as part of LiveSecurity for MSS; and the sales of our new ServerLock
products.

     Service revenues include the annual fee for our LiveSecurity Service, which
is sold as part of our security solution, and for LiveSecurity subscription
renewals from our enterprise customers and end-users. These services provide
access to our LiveSecurity Service for product updates, security threat
responses, general security information and technical support. These services
also provide our service provider customers access to the LiveSecurity Service
and the ability to manage and update a specific number of their customers'
security appliances.

     We recognize revenues only when a contract or agreement has been executed,
delivery has occurred, the fee is fixed and determinable and we believe
collection is probable. While we generally recognize product revenues upon
shipment, we defer revenues on product sales for two of our major distributors
until these distributors have sold the product to their customers. Service
subscription revenues are recognized ratably on a monthly basis, generally over
periods ranging between one and two years.

                                    Page 10
<PAGE>

Results of Operations

The following table provides financial data for the periods indicated as a
percentage of total revenues:

<TABLE>
                                                                                          Three Months Ended
                                                                                               March 31,
                                                                                ----------------------------------------
                                                                                       2001                   2000
                                                                                -----------------      -----------------
<S>                                                                           <C>                    <C>
Revenues:
 Product....................................................................             77.7 %                 86.7 %
 Service....................................................................             22.3                   13.3
                                                                                -----------------      -----------------
    Total revenues..........................................................            100.0                  100.0

Cost of revenues:
 Product....................................................................             30.8                   31.5
 Service....................................................................              8.0                    4.4
                                                                                -----------------      -----------------
    Total cost of revenues..................................................             38.8                   35.9
                                                                                -----------------      -----------------
Gross margin................................................................             61.2                   64.1

Operating expenses:
 Sales and marketing........................................................             47.8                   56.7
 Research and development...................................................             30.8                   25.7
 General and administrative.................................................             10.9                   11.8
 Stock-based compensation...................................................             26.5                    2.4
 Amortization of  goodwill, purchased technology and other
     intangible assets acquired.............................................             15.9                    3.8
                                                                                -----------------      -----------------
    Total operating expenses................................................            131.9                  100.4
                                                                                -----------------      -----------------
Operating loss..............................................................            (70.7)                 (36.3)
Interest income, net........................................................              9.9                    8.8
                                                                                -----------------      -----------------
Loss before income taxes....................................................            (60.8)                 (27.5)
Provision for income taxes..................................................              0.5                    0.0
                                                                                -----------------      -----------------
Net loss....................................................................            (61.3)%                (27.5)%
                                                                                =================      =================
</TABLE>

     Beginning in the fourth quarter of 2000 and continuing through the first
quarter of 2001, we saw a general downturn in the global economy, which has
affected the demand for our products and services.  We generated revenues of
$17.1 million in the first quarter of 2001, an increase of 74% from $9.8 million
in revenues for the first quarter of 2000 and a decrease of 14% from $19.9
million in revenues for the fourth quarter of 2000.  Our net loss for the first
quarter of 2001 was ($10.5 million), or ($0.40) per share, compared to a net
loss of ($2.7 million), or ($0.13) per share, for the first quarter of 2000.
Our net loss was adversely affected by amortization of intangibles and deferred
stock-based compensation primarily related to our purchase of Qiave in October
2000 as well as a reduction in revenues for the first quarter of 2001 as
compared to the fourth quarter of 2000.  The decrease in revenues between the
fourth quarter of 2000 and the first quarter of 2001 and the resulting operating
loss for the three month period ended March 31, 2001 is a result of the current
economic slowdown, which has caused a deferral or decrease in capital spending
for information technology products.

     On April 4, 2001, we announced a restructuring plan designed to streamline
operations and reduce costs and better align our infrastructure to near-term
reduced revenue volumes.  We have streamlined WatchGuard's operations to focus
on our core business of firewalls, VPNs and server security for business
customers.  As part of this reorganization, we have exited the consumer business
which includes various OEM agreements and reduced our staff by approximately 50
people, or 16% of our workforce.  We have also consolidated our development and
product marketing activities into product-specific areas to better focus on our
business customers.  We believe that the staff reduction, which impacted all
functional areas of the company, will allow us to reduce our break-even point to
drive improved profitability.  We will continue to invest in the research and

                                    Page 11
<PAGE>

development efforts necessary to ensure we maintain our leadership position in
providing enterprises with Internet security and VPN solutions that are easy to
install and manage.

Three Months Ended March 31, 2001 and 2000

Revenues

     Total revenues, which consist of product revenues and service revenues,
increased from $9.8 million in the three months ended March 31, 2000 to $17.1
million in the three months ended March 31, 2001, an increase of 74%. The
increase in total revenues was primarily due to increases in sales volume caused
by increased distribution in the European, Asia/Pacific and North American
markets.  Total international revenues represented approximately 54% of total
revenues in the three months ended March 31, 2000 and 57% in the three months
ended March 31, 2001. In the first quarter of 2000, no one customer accounted
for more than 10% of total revenues.  However, in the first quarter of 2001,
worldwide revenues from one of our distributors, Ingram Micro, Inc., were $2.4
million, or 14% of total revenues.

     Product revenues include: (1) perpetual software license fees for our
Firebox System and the sale of our security appliance as part of our security
solutions; (2) sales of software options, such as VPN; (3) sales of our NOC,
security suite software license and our security appliance as part of
LiveSecurity for MSS; and (4) sales from our new ServerLock product line, which
is based on technology acquired in conjunction with our purchase of Qiave.
Product revenues increased from $8.5 million in the three months ended March 31,
2000 to $13.3 million in the three months ended March 31, 2001, an increase of
56%. Our sales volume and growth rate of product revenues was lower than
expected in the first quarter 2001 as compared to the prior quarter, but lower
sales and growth was somewhat offset by increased service revenues and a broader
subscription base. As a result, product revenues as a percentage of total
revenues decreased from 87% in the three months ended March 31, 2000 to 78% in
the three months ended March 31, 2001. Given the current economic uncertainty
and slowdown in capital spending, it is difficult to predict revenue levels in
future quarters, which may be more variable than usual.

     Service revenues include the annual fee for our LiveSecurity broadcast
service, which is sold as part of the Firebox System and LiveSecurity for MSS.
Service revenues increased from $1.3 million in the three months ended March 31,
2000 to $3.8 million in the three months ended March 31, 2001, an increase of
192%.  As a percentage of total revenues, service revenues increased from 13% in
the three months ended March 31, 2000 to 22% in the three months ended March 31,
2001, which reflects an increased base of customers renewing their LiveSecurity
service subscriptions, and a reduced growth rate for product sales.

     We have established a returns and allowances reserve to address the return
rights and pricing protection rights of some of our customers.  The provision
for sales returns and allowances was $209,000, or 2% of total revenues before
returns and allowances, in the three months ended March 31, 2000 and $1.3
million, or 7% of total revenues, before returns and allowances, in the three
months ended March 31, 2001.  The increase in the provision as a percentage of
total revenues reflects the expected return rates of current products that may
originate from the introduction of new products we are introducing during the
second quarter of 2001.  We expect to continue to introduce new products each
year, which may impact our reserve for sales returns and allowances.

Cost of Revenues and Gross Margin

     Total cost of revenues, which includes product and service costs, increased
from $3.5 million in the three months ended March 31, 2000 to $6.6 million in
the three months ended March 31, 2001, an increase of 89%.  As a percentage of
total revenues, cost of revenues increased from 36% in the three months ended
March 31, 2000 to 39% in the three months ended March 31, 2001.  Gross margins
are impacted by various factors, including the volume discount level contained
in our channel partner agreements, the cost of our Firebox appliances, the mix
of product and service sales, which may include hardware and software products
and service subscriptions or both, the cost of royalties associated with our
products, and the costs of our technical support organization and LiveSecurity
Service.

     Cost of product revenues, which includes the cost of manufacturing our
security appliance, product packaging and third-party product licensing fees,
increased from $3.1 million in the three months ended March 31, 2000 to $5.3
million in the three months ended March 31, 2001, an increase of 70%.  The
increase was primarily due to greater sales volume.  As a percentage of total
revenues, cost of product revenues decreased from 32% in the three months ended
March 31, 2000 to 31% in the three months ended March 31, 2001.  Cost of product
revenues as a percentage of total product revenues increased from

                                    Page 12
<PAGE>

36% in the three months ended March 31, 2000 to 39% in the three months ended
March 31, 2001. The increase in cost of product revenues as a percentage of
product revenues primarily reflects lower sales volume and a change in product
mix, in which the sales volume of some of our lower-margin products increased on
a relative basis from the first quarter of 2000 as compared to the first quarter
of 2001. We expect product mix changes which will result from the addition of
software products such as ServerLock, to have a positive impact on gross
margins. Cost savings and product mix changes that improve gross margins,
however, may be offset in the short term by heightened price competition. In
addition, we recently introduced several new products and plan to introduce
additional new products in the future. In the near term, we expect our gross
margins to be approximately 60% as we introduce our new products and liquidate
inventories related to older products. We expect gross margins to gradually
improve during the latter half of 2001 as a result of increased revenues
generated from sales of higher-margin software products and expected reductions
in manufacturing costs.

     Cost of service revenues, which includes the costs of our technical support
organization and costs associated with our LiveSecurity Service, increased from
$432,000 in the three months ended March 31, 2000 to $1.4 million in the three
months ended March 31, 2001, an increase of 219%. As a percentage of total
revenues, cost of service revenues increased from 4% in the three months ended
March 31, 2000 to 8% in three months ended March 31, 2001.  As a percentage of
total service revenues, cost of service revenues increased from 33% in the first
quarter of 2000 to 36% in the first quarter of 2001.  This increase reflects an
investment in our customer support organization to assist the growing number of
customers who are implementing VPNs in a more complex environment, as well as a
broader customer base.  We expect service costs to continue to increase in total
dollar amount as our user base expands.  In the longer term, as revenues from
LiveSecurity subscriptions increase and account for a greater percentage of
total revenues, we expect our service margins to increase.

Operating Expenses

     Sales and Marketing.   Sales and marketing expenses include salaries,
commissions and employee-related expenses and certain variable marketing
expenses, including distributor promotional costs, public relations costs,
marketing collateral and trade show expenses.  Total sales and marketing
expenses increased from $5.6 million in the three months ended March 31, 2000 to
$8.1 million in the three months ended March 31, 2001, an increase of 47%.  As a
percentage of total revenues, sales and marketing expenses decreased from 57% in
the three months ended March 31, 2000 to 48% in the three months ended March 31,
2001.  The dollar increase in sales and marketing expenses was primarily due to
recruiting and supporting a greater number of current and prospective resellers
and distributors and, to a lesser extent, to increased efforts to establish
brand recognition of our products and services.  Specifically, major components
of the increase included

     .  an increase in salaries, commissions, recruiting and related expenses
        from $2.1 million to $2.9 million;

     .  an increase in variable marketing costs from $2.3 million to $2.7
        million; and

     .  an increase in travel, annual sales conferences and related expenses
        from $859,000 to $1.7 million.

     The decrease in sales and marketing expenses as a percentage of total
revenues reflects both increased productivity of and efficiencies in managing
our indirect channel network and realization of our previous investments to
expand distribution, capture market share and establish brand recognition of our
products. We will continue to invest in sales and marketing programs designed to
increase distribution.

     Because we expect our sales and marketing expenses, as well as the other
expenses we describe below, to increase at a slower rate than revenues, we
expect to see a gradual reduction over time in each of these types of expenses
as a percentage of total revenues.

     Research and Development.  Research and development expenses include
salaries, noncapitalized equipment and software tools, depreciation from capital
equipment and software, nonrecurring costs associated with our security
appliance prototypes and payments to designers and contractors.  Research and
development expenses increased from $2.5 million in the three months ended March
31, 2000 to $5.3 million in the three months ended March 31, 2001, an increase
of 109%.  As a percentage of total revenues, research and development expenses
increased from 26% in the three months ended March 31, 2000 to 31% in the three
months ended March 31, 2001.  The increase in research and development expenses
reflects the growth of our research and development organization to expand and
enhance our Firebox System and Live Security for MSS product lines, including
our  SOHO and ServerLock products, and our efforts to respond to new and
emerging worldwide Internet security threats through our LiveSecurity Service.
Specifically, major components of the increase included

                                    Page 13
<PAGE>

     .  an increase in payroll and related expenses from $1.7 million to $3.4
        million, a portion of which is related to the acquisition of Qiave and
        resulting costs of development personnel within our ServerLock products
        organization; and

     .  an increase in consulting and security appliance prototype engineering
        costs from $243,000 to $696,000, reflecting increased expenses for
        enhancements of our existing products and costs related to future
        expansion of our product offerings in 2001.

     We will continue to increase our research and development expenses in total
dollar amounts to enhance and expand our current product offerings, develop new
products and enhance our rapid response team, which analyzes and addresses
Internet security threats, and our advisory council, which provides continuing
education and editorials on Internet security.

     General and Administrative.  General and administrative expenses include
costs of executive, human resource, finance and administrative support
functions, provision for uncollectible accounts and legal and accounting
professional services.  General and administrative expenses increased from $1.2
million in the three months ended March 31, 2000 to $1.9 million in the three
months ended March 31, 2001, an increase of 62%.  As a percentage of total
revenues, general and administrative expenses decreased from 12% in the three
months ended March 31, 2000 to 11% in the three months ended March 31, 2001.
The dollar increase in general and administrative expenses reflects the
expansion of our infrastructure to manage the growth of our operations and costs
associated with being a public company, an increase in payroll and related
expenses and increases in other general and administrative areas such as bad
debt.  Specifically, major components of the increase included

     .  an increase in payroll and related expenses from $517,000 to $884,000;
        and

     .  an increase in bad debt expense from $102,000 to $276,000. As a percent
        of total revenues, bad debt expenses increased from 1.0% in the three
        months ended March 31, 2000 to 1.6% in the three months ended March 31,
        2001, reflecting both an increase in risk associated with a broader
        customer base and the uncertain economy.

     Stock-based Compensation.  Stock-based compensation arises from
amortization of previously deferred stock-based compensation over the vesting
periods of the common stock subject to repurchase and stock options. Stock-based
compensation expense was $236,000 in the three months ended March 31, 2000 and
$4.5 million in the three months ended March 31, 2001. The allocation of the
stock-based compensation expense associated with the functional operating
expense categories of sales and marketing, research and development, and general
and administrative was $51,000, $164,000 and $21,000 in the three months ended
March 31, 2000 and $12,000, $4.4 million, and $67,000 in the three months ended
March 31, 2001.

     Deferred stock-based compensation is recorded as a component of
stockholders' equity as the difference between the exercise price of options and
the fair value of our common stock on the date of grant, and for the value of
common stock subject to repurchase that we issued in connection with our 1999
acquisition of BeadleNet and our October 2000 acquisition of Qiave. We recorded
$19.3 million of deferred stock-based compensation in 2000 in connection with
the Qiave acquisition, which included charges related to the issuance of common
stock subject to repurchase and the assumption of unvested Qiave employee stock
options outstanding at the time of the merger. We recorded $912,000 of deferred
stock-based compensation in 1999, which included charges related to the
BeadleNet acquisition.

     Amortization of goodwill, purchased technology and other intangible assets
acquired. Amortization of goodwill, purchased technology and other intangibles
consists of the amortization of goodwill and other intangibles related to our
acquisitions of BeadleNet in 1999 and Qiave in 2000.  The intangible assets
recorded in connection with the above acquisitions, including goodwill and
purchased technology, are being amortized on a straight-line basis over useful
lives ranging from two to five years.  We recorded amortization charges related
to these assets of $368,000 in the three months ended March 31, 2000, and $2.7
million in the three months ended March 31, 2001.  The increase in amortization
in 2001 resulted primarily from recording amortization of intangibles associated
with our acquisition of Qiave in October 2000.

Interest Income (Expense)

     Interest income is generated from the investment of proceeds from the sale
of common stock in our initial public offering in 1999 and our public offering
in February 2000. Interest income increased from $911,000 in the three months
ended March 31, 2000 to $1.8 million in the three months ended March 31, 2001.
This increase resulted primarily from the full quarter's investment of the
proceeds of our public offering in 2000, in addition to the investment of the
proceeds from our initial public

                                    Page 14
<PAGE>

offering. Interest income was offset slightly by interest expense of $48,000 for
the three months ended March 31, 2000 and $73,000 for the three months ended
March 31, 2001.

Income Taxes

     Income tax expense of $84,000 for the three months ended March 31, 2001
primarily relates to our provision for foreign income taxes associated with our
international operations.  We have experienced losses since inception, resulting
in a net operating loss carryforward position for federal income tax purposes of
approximately $135.5 million as of March 31, 2001.  These carryforwards, if not
utilized, will begin to expire in 2011, and may be subject to limitations under
Section 382 of the Internal Revenue Code.

Quarterly Results of Operations

     The following tables provide our unaudited results of operations both in
dollar amounts and expressed as a percentage of total revenues for each quarter
in the five-quarter period ended March 31, 2001.  In our opinion, this unaudited
information has been prepared on the same basis as our audited consolidated
financial statements.  This information includes all adjustments, consisting
only of normal recurring adjustments, necessary for a fair presentation of the
information for the quarters presented, when read in conjunction with our
consolidated financial statements and the notes to the consolidated financial
statements.  The results of operations for any quarter are not necessarily
indicative of our future results.

<TABLE>
                                                                                  Three Months Ended
                                                      -------------------------------------------------------------------------
                                                       Mar. 31,      Dec. 31,      Sept. 30,        June 30,          Mar. 31,
                                                         2001          2000          2000             2000              2000
                                                      ----------    ----------    -----------      -----------       ----------
                                                                                     (In thousands)
Consolidated Statement of Operations Data:
<S>                                                  <C>           <C>           <C>              <C>              <C>
Revenues:
 Product...........................................    $ 13,284      $ 16,734       $ 14,782         $ 12,000         $ 8,494
 Service...........................................       3,818         3,192          2,453            1,740           1,308
                                                      ----------    ----------    -----------      -----------       ----------
  Total revenues...................................      17,102        19,926         17,235           13,740           9,802

Cost of revenues:
 Product...........................................       5,267         6,137          5,363            4,341           3,091
 Service...........................................       1,376         1,174            824              557             432
                                                      ----------    ----------    -----------      -----------       ----------
  Total cost of revenues...........................       6,643         7,311          6,187            4,898           3,523
                                                      ----------    ----------    -----------      -----------       ----------
Gross margin.......................................      10,459        12,615         11,048            8,842           6,279

Operating expenses:
 Sales and marketing...............................       8,171         6,838          5,849            5,967           5,559
 Research and development..........................       5,271         4,704          3,413            3,262           2,521
 General and administrative........................       1,870         1,895          1,703            1,249           1,154
 Stock-based compensation..........................       4,520         7,750            193              228             236
 Acquired in-process technology and amortization
  of goodwill, purchased technology
  and other intangible assets acquired.............       2,724         7,123            368              368             368
                                                      ----------    ----------    -----------      -----------       ----------
  Total operating expenses.........................      22,556        28,310         11,526           11,074           9,838
                                                      ----------    ----------    -----------      -----------       ----------
Operating loss.....................................     (12,097)      (15,695)          (478)          (2,232)         (3,559)
Interest income, net...............................       1,701         1,986          1,812            1,854             863
                                                      ----------    ----------    -----------      -----------       ----------
Income (loss) before income taxes..................     (10,396)      (13,709)         1,334             (378)         (2,696)
Provision for income taxes.........................          84           215             --               --              --
                                                      ----------    ----------    -----------      -----------       ----------
Net income (loss)..................................    $(10,480)     $(13,924)      $  1,334         $   (378)        $(2,696)
                                                      ==========    ==========    ===========      ============      ==========
</TABLE>

                                    Page 15
<PAGE>

<TABLE>
                                                                                   Three Months Ended
                                                        ---------------------------------------------------------------------------
                                                          Mar. 31,        Dec. 31,       Sept. 30,        June 30,        Mar. 31,
                                                            2001            2000            2000            2000            2000
                                                        ------------    ------------    ------------    ------------    -----------
<S>                                                     <C>              <C>           <C>            <C>            <C>
Consolidated Statement of Operations Data:
Revenues:
 Product...........................................          77.7 %         84.0 %         85.8 %           87.3 %         86.7 %
 Service...........................................          22.3           16.0           14.2             12.7           13.3
                                                        ------------    ------------    ------------    ------------    -----------
  Total revenues...................................         100.0          100.0          100.0            100.0          100.0

Cost of revenues:
 Product...........................................          30.8           30.8           31.1             31.6           31.5
 Service...........................................           8.0            5.9            4.8              4.1            4.4
                                                        ------------    ------------    ------------    ------------    -----------
  Total cost of revenues...........................          38.8           36.7           35.9             35.6           35.9
                                                        ------------    ------------    ------------    ------------    -----------
Gross margin.......................................          61.2           63.3           64.1             64.4           64.1

Operating expenses:
 Sales and marketing...............................          47.8           34.3           33.9             43.4           56.7
 Research and development..........................          30.8           23.6           19.8             23.7           25.7
 General and administrative........................          10.9            9.5            9.9              9.1           11.8
 Stock-based compensation..........................          26.5           38.9            1.1              1.7            2.4
 Acquired in-process technology and amortization
  of goodwill, purchased technology
   and other intangible assets acquired........              15.9           35.7            2.1              2.7            3.8
                                                        ------------    ------------    ------------    ------------    -----------
  Total operating expenses.........................         131.9          142.1           66.9             80.6          100.4
                                                        ------------    ------------    ------------    ------------    -----------
Operating loss.....................................         (70.7)         (78.8)          (2.8)           (16.2)         (36.3)
Interest income, net...............................           9.9           10.0           10.5             13.5            8.8
                                                        ------------    ------------    ------------    ------------    -----------
Income (loss) before income taxes..................         (60.8)         (68.8)           7.7             (2.8)         (27.5)
Provision for income taxes.........................           0.5            1.1            0.0              0.0            0.0
                                                        ------------    ------------    ------------    ------------    -----------
Net income (loss)..................................         (61.3)%        (69.9)%          7.7 %           (2.8)%        (27.5)%
                                                        ============    ============    ============    ============    ===========
</TABLE>

     As discussed above, we believe that global economic challenges and a
deceleration in corporate information technology spending have deferred the
demand for our products and services.   Like most companies in the technology
sector, we experienced a downturn in revenues during the quarter.  Revenues of
$17.1 million for the first quarter of 2001 were significantly lower than
revenues of $19.9 million which were recorded for the previous quarter.  Both
revenues and our quarterly operating results were negatively impacted by the
economic slowdown worldwide and an overall reduction in capital spending.
Revenue levels in future quarters are difficult to predict given the current
business climate, however, and may be more variable than usual.

     We have, in general, maintained our product gross margins over the past
year as we gained efficiencies in the production of our security appliances and
introduced product options with higher gross margins. However, gross margins in
first quarter of 2001 and the fourth quarter of 2000 were negatively impacted by
lower sales volumes and our sales product mix, in which lower-margin products
comprised a greater percentage of overall revenues. In addition, competitive
selling pressures in future quarters could adversely impact on our gross
margins. Finally, we have continued to make significant investments in our
customer support organization, leading to an overall increase in the cost of
service revenues. While these investments had a negative short-term impact on
our gross margins during recent quarters, we believe they are required to meet
the needs of our expanding customer base, and that service margins will improve
as our LiveSecurity subscription base expands.

     We also have continued to make large investments in our sales and marketing
organization, as reflected in the increased expenditure levels during the first
quarter of 2001 and the fourth quarter of 2000.  In addition, our first-quarter
expenses included significant charges associated with our annual sales and
partner conferences.  Other significant increases in operating expenses during
these two quarters, including research and development, stock-based
compensation, and the amortization of

                                    Page 16
<PAGE>

intangibles, were primarily related to our acquisition of Qiave in October 2000.
While our operating expenses, excluding amortization of goodwill, intangibles
and stock-based compensation, have continued to increase over time in dollar
amounts, these expenses continued to decrease as a percentage of total revenues
until the fourth quarter of 2000. Increased operating expenses as a percentage
of total revenues during the first quarter of 2001, compared to previous
quarters, resulted from the decrease in revenues discussed above.

     In light of the current economic slowdown and the uncertainty of market
conditions, we have implemented programs to increase efficiencies and reduce
costs within all areas of our organization, in an effort to better align our
expenses with near-term revenue projections. These programs include the
reduction in workforce discussed earlier, as well as a consolidation of excess
facilities and related fixed asset charges. Our quarterly operating results have
fluctuated significantly in the past and will probably continue to fluctuate.

Liquidity and Capital Resources

     We have financed our operations primarily through proceeds from private
placements of preferred stock and, more recently, proceeds from our initial
public offering in July 1999 and our follow-on public offering in February 2000.
To date, net proceeds from our private placements and public offerings have
totaled approximately $144.0 million.

     Through the first quarter of 2001, we had a working capital revolving line
of credit with a bank, secured by our accounts receivable. The line of credit
provided for borrowings not greater than $5.0 million or the amount of the
borrowing base. As of March 31, 2001, we had no borrowings on this line of
credit. However, our borrowing limit of $5.0 million as of March 31, 2001 was
reduced by a $3.0 million unconditional letter of credit we issued to our
landlord in September 2000 in conjunction with our building lease for our
corporate headquarters. Currently, our letter of credit is collateralized by
investments with our bank. We have chosen not to renew our line of credit, which
expired in April 2001.

     As of March 31, 2001, we had $114.8 million in cash, cash equivalents and
securities available for sale, invested primarily in high-quality money market
accounts and marketable securities.  We believe that the market risk arising
from our holdings of these financial instruments is not material.  Our working
capital as of March 31, 2001 was $115.4 million.

     Operating activities

     Our operating activities resulted in net cash outflows of $3.5 million in
the three months ended March 31, 2000 and $1.4 million in the three months ended
March 31, 2001. The operating cash outflows during these periods resulted
primarily from significant investments in sales and marketing and research and
development, all of which led to operating losses. Cash used in operating
activities was net of noncash charges totaling $1.2 million for the three months
ended March 31, 2000 and $9.3 million for the three months ended March 31, 2001.
These noncash charges were primarily associated with the amortization of
goodwill and other intangibles, depreciation and amortization of capital assets,
provisions for bad debts and sales returns and allowances, and compensation
charges resulting from the issuance of stock options and common stock subject to
repurchase by WatchGuard. Cash utilized by working capital components for
operating activities was $2.0 million for the three months ended March 31, 2000
and $207,000 for the three months ended March 31, 2001. In the three-month
period ended March 31, 2001, there were large fluctuations within some major
working capital components, as described below:

     (a)  Receivables decreased from $15.3 million at December 31, 2000 to $12.3
          million at March 31, 2001, reflecting the decrease in revenues from
          $19.9 million for the three months ended December 31, 2000 to $17.1
          million for the three months ended March 31, 2001. Days sales
          outstanding, or DSOs, were 69 days at December 31, 2000 and 65 days at
          March 31, 2001, as calculated on a quarterly basis. DSOs are impacted
          by the payment terms contained in our customer contracts, linearity in
          revenues in any particular quarter and the amount of deferred revenue
          contained in the receivable balance that has not been recognized as
          revenue. The decrease in DSOs for the first quarter of 2001 as
          compared to the fourth quarter of 2000 primarily reflects changes in
          our customer sales mix during the first quarter. Based on the current
          sales mix, the resulting timing differences arising from varying
          payment terms in our customer agreements, the linearity of revenues in
          any particular quarter and the growth of deferred revenue, we expect
          our DSOs to generally range from 55 days to 70 days.

     (b)  Sales reserves for returns and allowance reserves were $965,000 at
          December 31, 2000 and $1.5 million at March 31, 2001, reflecting our
          estimate of returns and allowances associated with the return rights
          and price protection rights of some of our customers. We increased the
          sales reserve during the first quarter of 2001 to reflect the

                                    Page 17
<PAGE>

          potential for increased returns and pricing adjustments associated
          with new products introduced in May 2001 and products we expect to
          introduce which would follow in subsequent months. The reserve will
          continue to fluctuate from time to time depending on the timing of
          product introductions and pricing program changes.

     (c)  Inventories decreased from $7.0 million at December 31, 2000 to $6.1
          million at March 31, 2001. While inventory levels at March 31, 2001
          were higher than we anticipated, due to lower-than-expected revenues,
          the overall decrease in inventory reflects planned changes in
          inventory levels and a slowdown in manufacturing in preparation for
          our new product introductions. We maintain a reserve for inventory
          obsolescence and will continue to analyze the adequacy of our reserves
          on a periodic basis.

     (d)  Accounts payable and accrued expenses decreased from $11.7 million at
          December 31, 2000 to $8.5 million at March 31, 2001. This decrease
          resulted primarily from the timing of inventory purchases and other
          expenditures during the fourth quarter of 2000 as compared to the
          first quarter of 2001.

     (e)  Deferred revenue increased from $11.9 million at December 31, 2000 to
          $12.9 million at March 31, 2001, an increase of 8%. This increase
          reflects the deferral of revenue from bundled LiveSecurity
          subscriptions included in new product revenues and renewals of
          LiveSecurity subscriptions.

     Investing activities

     Cash used in investing activities was $39.3 million in the three months
ended March 31, 2000 and cash provided by investing activities was $5.2 million
in the three months ended March 31, 2001. These activities primarily relate to
short-term investing activity of the proceeds received from our public
offerings, and capital expenditures for equipment and furniture.

     Financing activities

     Cash provided by financing activities totaled $91.2 million in the three
months ended March 31, 2000 and $1.2 million in the three months ended March 31,
2001.  We received $90.4 million in proceeds from a public offering in the first
quarter of 2000.   We received cash in both periods from the exercise of
employee stock options and the purchase of common stock through our employee
stock purchase plan.

     We believe that existing cash and securities balances will be sufficient to
meet our anticipated cash needs for working capital, capital expenditures and
potential acquisitions or technology investments for at least the next 12
months. However, if the underlying assumed levels of spending for the potential
acquisition of or investment in complementary businesses or technologies prove
to be inaccurate, we may need to seek additional funding before that time
through public or private financings or other arrangements.

                                    Page 18
<PAGE>

Unaudited Pro Forma Operating Results

     Our management reviews our operating results on a pro forma basis in making
operating decisions, and we believe pro forma results provide additional
meaningful information.  The following table provides our pro forma results for
the three-month periods ended March 31, 2000 and 2001.

<TABLE>
                                                                   Three months ended March 31,
                                                                  -------------------------------
                                                                     2001                 2000
                                                                  -----------         -----------
<S>                                                           <C>                 <C>
Net loss................................................           $(10,480)            $(2,696)
Adjustments to reconcile net loss in the financial
 statements to pro forma net loss:
     Stock-based compensation...........................              4,520                 236
     Amortization of goodwill, purchased technology and
      other intangibles.................................              2,724                 368
                                                                  -----------         -----------
Pro forma net loss......................................           $ (3,236)            $(2,092)
                                                                  -----------         -----------
Pro forma basic and diluted net loss per share:                    $  (0.12)            $ (0.10)
                                                                  ===========         ===========

Shares used in calculating pro forma basic and diluted
    net loss per share:.................................             26,348              21,243
                                                                  ===========         ===========
</TABLE>
-------------------

Pro forma information is presented for informational purposes only and is not
prepared in accordance with generally accepted accounting principles.  Pro forma
results

     .  exclude the amortization of goodwill, purchased technology and other
        intangibles arising from WatchGuard's acquisition of BeadleNet in
        October 1999 and Qiave in October 2000; and

     .  exclude noncash stock-based compensation expenses originating from
        employee stock options granted at less than fair value, stock options
        granted to consultants and certain restricted common stock and common
        stock subject to repurchase issued in connection with the BeadleNet and
        Qiave acquisitions.

FACTORS AFFECTING OUR OPERATING RESULTS, OUR BUSINESS AND OUR STOCK PRICE

     In addition to the other information contained in this quarterly report,
you should carefully read and consider the following risk factors. If any of
these risks actually occur, our business, financial condition or operating
results could be harmed and the trading price of our common stock could decline.

We have incurred losses in the past and may not achieve or sustain consistent
profitability, which could result in a decline in the value of our common stock.

     Since inception through the first quarter of 2001, we incurred net losses
and experienced negative cash flows from operations in each quarter, except for
the third quarter of 2000. As of March 31, 2001, we had an accumulated deficit
of approximately $56.1 million. Although our revenues have increased each year
since we began operations, we do not believe that the historical percentage
growth rate of our revenues will be sustainable as our revenue base increases
and we may not achieve or sustain profitability in future periods. Moreover, we
currently expect to increase our operating expenses significantly in connection
with

     .  expanding into new geographic markets;

     .  expanding into new product markets;

     .  continuing to develop our technology;

     .  hiring additional personnel;

                                    Page 19
<PAGE>

     .  upgrading our information and internal control systems; and

     .  integrating acquisitions of businesses, products and technologies and
        pursuing additional strategic acquisitions.

If we are unable to achieve or sustain profitability in future quarters, the
trading price of our common stock could decline.

Our operating results fluctuate and could fall below expectations of securities
analysts and investors, resulting in a decline in our stock price.

     Our quarterly and yearly operating results have varied widely in the past
and will probably continue to fluctuate. For this reason, we believe that
period-to-period comparisons of our operating results may not be meaningful. In
addition, our limited operating history makes predicting our future performance
difficult. In the fourth quarter of 2000 and the first quarter of 2001, our
operating results fell below the expectations of securities analysts and
investors and our operating results for a future quarter or year may again fail
to meet market expectations. This could result in a decline in our stock price.

     Beginning in the fourth quarter of 2000 and continuing through the first
quarter of 2001, we saw a general economic downturn in the U.S. economy, and
more recently, the worldwide economy, which has affected the demand for our
products and services. We do not know how long this economic downturn will last
or how severe it will become. We also cannot predict the extent and timing, if
any, of the impact of the economic downturn in the United States on economies in
other countries and geographic regions in which we conduct business. To the
extent that this downturn continues or spreads to other geographic regions, the
Internet security industry and demand for our products and services are likely
to be adversely affected and could result in a decline in our stock price.

     We base our spending levels for product development, sales and marketing
and other operating expenses largely on our expected future revenues. Because
our expenses are largely fixed for a particular quarter or year, we may be
unable to adjust our spending in time to compensate for any unexpected quarterly
or annual shortfall in revenues. A failure to so adjust our spending in time
also could cause operating results to fall below the expectations of securities
analysts and investors, resulting in a decline in our stock price.

Because many potential customers remain unaware of the need for Internet
security or may perceive it as costly and difficult to implement, our products
and services may not achieve market acceptance.

     We believe that many potential customers, particularly SMEs, SOHOs and
telecommuters, are not fully aware of the need for Internet security products
and services. Historically, only enterprises having substantial resources have
developed or purchased Internet security solutions. Also, there is a perception
that Internet security is costly and difficult to implement. We will therefore
not succeed unless the market understands the need for Internet security and we
can convince our potential customers of our ability to provide this security in
a cost-effective and administratively feasible manner. Although we have spent,
and will continue to spend, considerable resources educating potential customers
about the need for Internet security and the benefits of our products and
services, our efforts may be unsuccessful.

If potential customers do not accept our Firebox and ServerLock products and
related LiveSecurity services, our business will not succeed.

     We currently expect all future revenues to be generated through sales of
our Firebox and ServerLock products and related LiveSecurity services,
including subscription fees, and we cannot succeed if the market does not accept
these products and services. Our success depends on our ability and the ability
of our distribution network, which includes distributors, value-added resellers
and ISPs and other managed service providers, to obtain and retain customers.
Some of our Firebox and ServerLock products and related LiveSecurity services,
however, are relatively new and unproven. The broadcast portion of our
LiveSecurity solution has been available only since February 1999, our Firebox
products for SOHOs and telecommuters have been available only since February
2000 and our ServerLock products were launched under the WatchGuard brand only
in February 2001. To receive our LiveSecurity Service, enterprises will be
required to pay an annual subscription fee, either to us or, if they obtain the
LiveSecurity Service through one of our channel partners, to the channel
partner. We are not aware of any other Internet security product that allows
enterprises to keep their security solution current by receiving software
updates and comprehensive security information over the Internet. Enterprises
may be unwilling to pay a subscription fee to keep their Internet security up to
date. Because our LiveSecurity Service is relatively new, we cannot accurately
predict the rate at which our customers will renew their annual subscriptions.
In addition, most businesses implementing security services have traditionally
managed their own Internet security rather than using the services of third-
party service providers. As a result, our products and services and the
outsourcing of Internet security to third parties may not achieve significant
market acceptance.

                                    Page 20
<PAGE>

Seasonality and concentration of revenues at the end of the quarter could cause
our revenues to fall below the expectations of securities analysts and
investors, resulting in a decline in our stock price.

     The growth rate of our domestic and international sales has been and may
continue to be lower in the summer months, when businesses often defer
purchasing decisions. Also, as a result of customer buying patterns and the
efforts of our sales force to meet or exceed quarterly and year-end quotas,
historically we have earned a substantial portion of a quarter's revenues during
its last month and, more recently, in the latter half of the last month. If
expected revenues at the end of any quarter are delayed, our revenues for that
quarter could fall below the expectations of securities analysts and investors,
resulting in a decline in our stock price.

The integration of Qiave and any future acquisitions may be costly, difficult
and disruptive.

     In October 2000, we acquired Qiave Technologies Corporation, a privately
held provider of digital information security products. As part of our business
strategy, we may acquire other companies, products or technologies. The Qiave
acquisition, and any future acquisitions, will subject us to numerous
operational and financial risks and difficulties, including

     .  loss of key personnel;

     .  difficulties in assimilating the acquired company's technologies,
        products, personnel and operations;

     .  disruption of our ongoing business and diversion of management
        attention;

     .  assumption of known and unknown liabilities, higher-than-expected
        acquisition and integration costs and charges against earnings;

     .  potentially dilutive issuances of equity securities; and

     .  inability of our sales force, consultants and development staff to adapt
        to new product lines.

     We may be unable to successfully integrate Qiave or any future acquisition.
In addition, we may not gain any substantial benefit from the Qiave acquisition
or from any businesses, products or technologies that we acquire in the future,
notwithstanding the significant expenditure of time and financial, personnel and
other resources.

If our third-party channel partners fail to perform, our ability to sell our
products and services will be limited.

     We sell most of our products and services through our distribution network,
and we expect our success to continue to depend in large part on their
performance. Our channel partners have the ability to sell products and services
that are competitive with ours, to devote more resources to those competitive
products or to cease selling our products and services altogether. In the first
quarter of 2001, two channel partners, Ingram Micro and Tech Data, together
accounted for 23% of our revenues. The loss of one of these distributors, a
reduction in their sales or a loss or reduction in sales involving one or more
other channel partners, particularly if the reduction results in increased sales
of competitive products, could harm our business.

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<PAGE>

If we are unable to compete successfully in the highly competitive market for
Internet security products and services, our business will fail.

     The market for Internet security products is intensely competitive and we
expect competition to intensify in the future.  An increase in competitive
pressures in our market or our failure to compete effectively may result in
pricing reductions, reduced gross margins and loss of market share.  Currently,
the primary competitors in our industry include Cisco Systems, Inc., Check Point
Software Technologies Ltd., Nokia Corporation and SonicWALL Inc.  Other
competitors offering security products include hardware and software vendors
such as Netscreen Technologies Inc., Lucent Technologies, Inc. and Network
Associates, Inc., operating system vendors such as Microsoft Corporation,
Novell, Inc. and Sun Microsystems, Inc. and a number of smaller companies.  Many
of our competitors have longer operating histories, greater name recognition,
larger customer bases and significantly greater financial, technical, marketing
and other resources than we do.  In addition, our current and potential
competitors may establish cooperative relationships among themselves or with
third parties that may further enhance their resources.  As a result, they may
be able to adapt more quickly to new technologies and customer needs, devote
greater resources to the promotion or sale of their products and services,
initiate or withstand substantial price competition, take advantage of
acquisition or other opportunities more readily or develop and expand their
product and service offerings more quickly.  In addition, our competitors may
bundle products competitive with ours with other products that they may sell to
our current or potential customers.  These customers may accept these bundled
products rather than separately purchasing our products.

Product returns or retroactive price adjustments could exceed our allowances,
which could adversely affect our operating results.

     We provide some of our channel partners with product return rights for
stock rotation. We also provide some of our channel partners with price
protection rights for their inventories, which they may exercise if we lower our
prices for those products. We may experience significant returns and price
adjustments for which we may not have adequate allowances. The short life cycles
of our products and the difficulty of predicting future sales increase the risk
that new product introductions or price reductions by us or our competitors
could result in significant product returns or price adjustments. In September
1998, for example, when we introduced the Firebox II security appliance, we
experienced an increase in returns of previous products and product versions.
Provisions for returns and allowances for the years ended December 31, 1998,
1999, and 2000, were $1.7 million, $1.1 million and $1.9 million, or 13%, 5% and
3% of total revenues before returns and allowances. The provision for returns
and allowances was $209,000 or 2% of total revenues before returns and
allowances for the three month period ended March 31, 2000 and $1.3 million, or
7% of total revenues before returns and allowances, for the three months ended
March 31, 2001. While we increased our provision for returns and allowances
during the first quarter of 2001 to reflect the potential for increased returns
and pricing adjustments associated with new products introduced in May 2001 and
products we expect to introduce which would follow in subsequent months, the
provision may still be inadequate.

Failure to address strain on our resources caused by our rapid growth will
result in our inability to effectively manage our business.

     Our current systems, management and resources will be inadequate if we
continue to grow. Our business has grown rapidly in size and complexity. This
rapid expansion has placed significant strain on our administrative, operational
and financial resources and has resulted in ever-increasing responsibilities for
our management personnel. We will be unable to effectively manage our business
if we are unable to timely and successfully alleviate the strain on our
resources caused by our rapid growth.

We may be unable to adequately expand our operational systems to accommodate
growth, which could harm our ability to deliver our products and services.

     Our operational systems have not been tested at the customer volumes that
may be required in the future. We may encounter performance difficulties when
operating with a substantially greater number of customers. In implementing our
LiveSecurity products and services, we have experienced periodic interruptions
affecting all or a portion of our systems, and we believe that interruptions
will continue to occur from time to time. These interruptions could harm our
ability to deliver our products and services. An inability to add software and
hardware or to develop and upgrade existing technology or operational systems to
handle increased traffic may cause unanticipated system disruptions, slower
response times and poor customer service, including problems filling customer
orders.

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<PAGE>

Rapid changes in technology and industry standards could render our products and
services unmarketable or obsolete, and we may be unable to introduce new
products and services timely and successfully.

     To succeed, we must continually change and improve our products in response
to rapid technological developments and changes in operating systems, Internet
access and communications, application and networking software, computer and
communications hardware, programming tools, computer language technology and
hacker techniques. We may be unable to successfully and timely develop these new
products and services or achieve and maintain market acceptance. The development
of new, technologically advanced products and services is a complex and
uncertain process requiring great innovation and the ability to anticipate
technological and market trends. Because Internet security technology is
complex, it can require long development and testing periods. Releasing new
products and services prematurely may result in quality problems, and releasing
them late may result in loss of customer confidence and market share. In the
past, we have on occasion experienced delays in the scheduled introduction of
new and enhanced products and services, and we may experience delays in the
future. When we do introduce new or enhanced products and services, we may be
unable to manage the transition from the older products and services to minimize
disruption in customer ordering patterns, avoid excessive inventories of older
products and deliver enough new products and services to meet customer demand.

We may be required to defend lawsuits or pay damages in connection with the
alleged or actual failure of our products and services.

     Because our products and services provide and monitor Internet security and
may protect valuable information, we may face claims for product liability, tort
or breach of warranty relating to our products and services. Anyone who
circumvents our security measures could misappropriate the confidential
information or other property of end-users using our products and services or
interrupt their operations. If that happens, affected end-users or channel
partners may sue us. In addition, we may face liability for breaches caused by
faulty installation and implementation of our products by end-users or channel
partners. Although we attempt to reduce the risk of losses from claims through
contractual warranty disclaimers and liability limitations, these provisions may
be unenforceable. Some courts, for example, have found contractual limitations
of liability in standard software licenses to be unenforceable because the
licensee does not sign them. Defending a suit, regardless of its merit, could be
costly and could divert management attention. Although we currently maintain
business liability insurance, this coverage may be inadequate or may be
unavailable in the future on acceptable terms, if at all.

A breach of security could harm public perception of our products and services.

     We will not succeed unless the marketplace is confident that we provide
effective Internet security protection. Even networks protected by our software
products may be vulnerable to electronic break-ins and computer viruses. If an
actual or perceived breach of Internet security occurs in an end-user's systems,
regardless of whether the breach is attributable to us, the market perception of
the efficacy of our products and services could be harmed. This could cause us
or our channel partners to lose current and potential customers or cause us to
lose potential channel partners. Because the techniques used by computer hackers
to access or sabotage networks change frequently and generally are not
recognized until launched against a target, we may be unable to anticipate these
techniques.

If we are unable to prevent attacks on our internal network system by computer
hackers, public perception of our products and services will be harmed.

     Because we provide Internet security, we are a significant target of
computer hackers. We have experienced attacks by computer hackers in the past
and expect attacks to continue. If attacks on our internal network system are
successful, public perception of our products and services will be harmed.

We may be unable to adequately protect our operational systems from damage,
failure or interruption, which could harm our reputation and our ability to
attract and retain customers.

     Our operations, customer service, reputation and ability to attract and
retain customers depend on the uninterrupted operation of our operational
systems. Although we utilize limited off-site backup facilities and take other
precautions to prevent damage, failure or interruption of our systems, our
precautions may be inadequate. Any damage, failure or interruption of our
computer or communications systems could lead to service interruptions, delays,
loss of data and inability to accept and fill customer orders and provide
customers with the LiveSecurity Service.

                                    Page 23
<PAGE>

We may be unable to deliver our products and services if we cannot continue to
license third-party technology that is important for the functionality of our
products.

     Our success will depend in part on our continued ability to license
technology that is important for the functionality of our products. A
significant interruption in the supply of a third-party technology could delay
our development and sales until we can find, license and integrate equivalent
technology. This could damage our brand and result in loss of current and
potential customers. Although we believe that we could find other sources for
the technology we license, alternative technologies may be unavailable on
acceptable terms, if at all. We depend on our third-party licensors to deliver
reliable, high-quality products, develop new products on a timely and cost-
effective basis and respond to evolving technology and changes in industry
standards. We also depend on the continued compatibility of our third-party
software with future versions of our products.

We may be unable to deliver our products and services if component manufacturers
fail to supply component parts with acceptable quantity, quality and cost.

     We obtain the component parts for our hardware from a variety of
manufacturers. While our component vendors have produced parts for us in
acceptable quantities and with acceptable quality and cost in the past, they may
be unable to do so in the future. Companies in the electronics industry
regularly experience lower-than-required component allocations, and the industry
is subject to frequent component shortfalls. Although we believe that we could
find additional or replacement sources for our hardware components, our
operations could be disrupted if we have to add or switch to a replacement
vendor or if our component supply is interrupted for an extended period. This
could result in loss of customer orders and revenue.

We may need additional capital and our ability to secure additional funding is
uncertain.

     Our future revenues may be insufficient to support the expenses of our
operations and the expansion of our business. We may therefore need additional
equity or debt capital. We may seek additional funding through

     .  public or private equity financings, which could result in significant
        dilution to stockholders;

     .  public or private debt financings; and

     .  capital lease transactions.

We believe that existing cash and cash equivalent balances will be sufficient to
meet our capital required for at least the next 12 months. Our capital
requirements will depend on several factors, however, including

     .  the rate of market acceptance of our products and services;

     .  our ability to expand our customer base;

     .  the growth of our sales and marketing capabilities; and

     .  the cost of any acquisitions we may complete.

Financing may be unavailable to us when needed or on acceptable terms.

We may be unable to adequately protect our proprietary rights, which may limit
our ability to compete effectively.

     Despite our efforts to protect our proprietary rights, unauthorized parties
may misappropriate or infringe on our trade secrets, copyrights, trademarks,
service marks and similar proprietary rights. We face additional risk when
conducting business in countries that have poorly developed or inadequately
enforced intellectual property laws. While we are unable to determine the extent
to which piracy of our software products exists, we expect piracy to be a
continuing concern, particularly in international markets and as a result of the
growing use of the Internet.

     If we fail to obtain and maintain patent protection for our technology, we
may be unable to compete effectively. We have 12 patents pending, but our patent
applications may not result in issued patents. Even if we secure a patent, the
patent may not provide meaningful protection. In addition, we rely on unpatented
proprietary technology. Because this proprietary technology does not have patent
protection, we may be unable to meaningfully protect this technology from
unauthorized use or misappropriation by a third party. In addition, our
competitors may independently develop similar or superior technologies or
duplicate any unpatented technologies that we have developed, which could
significantly reduce the value of our proprietary technology or threaten our
market position.

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<PAGE>

Intellectual property claims and litigation could subject us to significant
liability for damages and invalidation of our proprietary rights.

     In the future, we may have to resort to litigation to protect our
intellectual property rights, to protect our trade secrets or to determine the
validity and scope of the proprietary rights of others. Any litigation,
regardless of its success, would probably be costly and require significant time
and attention of our key management and technical personnel. Litigation could
also force us to

     .  stop or delay selling, incorporating or using products that incorporate
        the challenged intellectual property;

     .  pay damages;

     .  enter into licensing or royalty agreements, which may be unavailable on
        acceptable terms; or

     .  redesign products or services that incorporate infringing technology.

Although we have not been sued for intellectual property infringement, we may
face infringement claims from third parties in the future. The software industry
has seen frequent litigation over intellectual property rights, and we expect
that participants in the Internet security industry will be increasingly subject
to infringement claims as the number of products, services and competitors grows
and functionality of products and services overlaps.

Undetected product errors or defects could result in loss of revenues, delayed
market acceptance and claims against us.

     Our products and services may contain undetected errors or defects,
especially when first released. Despite extensive testing, some errors are
discovered only after a product has been installed and used by customers. Any
errors discovered after commercial release could result in loss of revenues or
claims against us or our channel partners.

Governmental controls over the export or import of encryption technology could
cause us to lose sales.

     Any additional governmental regulation of imports or exports or failure to
obtain required export approval of our encryption technologies could adversely
affect our international and domestic sales. The United States and various other
countries have imposed controls, export license requirements and restrictions on
the import or export of some technologies, especially encryption technology. In
addition, from time to time governmental agencies have proposed additional
regulation of encryption technology, such as requiring the escrow and
governmental recovery of private encryption keys. Additional regulation of
encryption technology could delay or prevent the acceptance and use of
encryption products and public networks for secure communications. This, in
turn, could result in decreased demand for our products and services. In
addition, some foreign competitors are subject to less stringent controls on
exporting their encryption technologies. As a result, they may be able to
compete more effectively than we can in the U.S. and international Internet
security markets.

If we do not retain our key employees, our ability to execute our business
strategy will be impaired.

     Our future success will depend largely on the efforts and abilities of our
senior management and our key development, technical, operations, information
systems, customer support and sales and marketing personnel, and on our ability
to retain them. These employees are not obligated to continue their employment
with us and may leave us at any time.

If we do not expand our international operations and successfully overcome the
risks inherent in international business activities, the growth of our business
will be limited.

     Our ability to grow will depend in part on the expansion of our
international sales and operations, which are expected to continue to account
for a significant portion of our revenues. Sales to customers outside of the
United States accounted for approximately 35% of our revenues in 1998, 50% in
1999, 55% in 2000 and 57% in the first three months of 2001. The failure of our
channel partners to sell our products internationally would limit our ability to
increase our revenues. In addition, our international sales are subject to the
risks inherent in international business activities, including

     .  cost of customizing products for foreign countries;

     .  export and import restrictions, such as those affecting encryption
        commodities and software;

     .  difficulties in acquiring and authenticating customer information;

     .  reduced protection of intellectual property rights and increased
        liability exposure; and

                                    Page 25
<PAGE>

     .  regional economic and political conditions.

     Our international sales currently are U.S. dollar-denominated. As a result,
an increase in the value of the U.S. dollar relative to foreign currencies has
made and may continue to make our products less competitive in international
markets.

Our stock price is volatile.

     The trading price of our common stock could be subject to fluctuations for
a number of reasons, including

     .  actual or anticipated variations in quarterly or annual operating
        results;

     .  changes in analysts' earnings projections or recommendations;

     .  failure to meet analysts' revenue or earnings projections;

     .  our inability to successfully implement our business strategy;

     .  changes in business conditions affecting our customers, our competitors
        and us; and

     .  changes in accounting standards that adversely affect our revenues and
        earnings.

     In recent years, moreover, the stock market in general and the market for
Internet-related technology companies in particular have experienced extreme
price and volume fluctuations, often unrelated to the operating performance of
the affected companies. Our common stock has experienced, and is likely to
continue to experience, these fluctuations in price, regardless of our
performance.

Changes in or interpretations of accounting rules may adversely impact future
and past results of operations.

     We prepare our financial statements in conformity with accounting
principles generally accepted in the United States. These principles have
changed frequently and are subject to ongoing change and interpretation by the
Financial Accounting Standards Board, the Securities and Exchange Commission and
other agencies and organizations. A change in generally accepted accounting
principles could significantly affect our reported results of operations or the
reporting of transactions completed before a change is announced, which could
require us to restate our prior published financial statements. Accounting
standards that impact the technology and software sectors in which we operate
and that are currently under review include

     .  rules relating to revenue recognition, including rules affecting the
        recognition of revenue from the sale of software or related services;

     .  rules relating to the classification of costs related to marketing
        programs, which may impact sales discounts, cost of sales or marketing
        expenses; and

     .  accounting for stock-based compensation for employees and nonemployees.

     Any changes to these accounting principles or the way they are interpreted
or applied could significantly affect our reported financial results or the way
in which we conduct business.


ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     Interest Rate Risk

     We do not hold derivative financial instruments or derivative equity
securities in our investment portfolio.  Our cash equivalents and debt
securities available for sale consist of high-quality securities, as specified
in our investment policy guidelines.  Our policy limits the amount of credit
exposure to any one issue or issuer to a maximum of 20% of the total portfolio
or $5 million per issuer, with the exception of treasury securities and money
market funds, which are exempt from this size limitation.  Our policy limits all
investments to those that mature in two years or less, and our investments have
an average maturity of one year or less.  These securities are subject to
interest-rate risk and will decrease in value if interest rates increase.  The
fair value of our investment portfolio or related income would not be
significantly impacted by a 100-basis-point increase or decrease in interest
rates, due primarily to the short-term nature of most of our investment
portfolio.

                                    Page 26
<PAGE>

     Foreign Currency Risk

     All of our sales and the majority of our expenses are currently denominated
in U.S. dollars.  As a result, we have not experienced significant foreign
exchange gains and losses.  While we conducted some transactions in foreign
currencies during the first quarter of 2001 and expect to continue to do so in
the future, we do not anticipate that foreign exchange gains or losses will be
material to WatchGuard.  Although we have not engaged in foreign currency
hedging to date, we may do so in the future.

                                    Page 27
<PAGE>

                          PART II.  OTHER INFORMATION


ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS

(d)  Use of Proceeds
     ---------------

     On February 15, 2000 our registration statement on Form S-1 for our public
offering, file number 333-95049, became effective.  The offering terminated as a
result of all of the shares offered being sold.  After accounting for
approximately $5.3 million in underwriting discounts and commissions and
$600,000 in other expenses, we received proceeds of approximately $90.4 million.

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)  Exhibits
     --------

     3.1  Restated Certificate of Incorporation of WatchGuard Technologies, Inc.
          (incorporated by reference to Exhibit 3.1 to WatchGuard's Registration
          Statement on Form S-1 (file number 333-78813), filed July 30, 1999).

     3.2  Restated Bylaws of WatchGuard Technologies, Inc. (incorporated by
          reference to Exhibit 3.2 to WatchGuard's Registration Statement on
          Form S-1 (file number 333-78813), filed July 30, 1999).

    10.1  2000 Stock Option Plan, as amended January 9, 2001.

(b)  Reports on Form 8-K
     -------------------

     No reports on Form 8-K were filed during the quarter ended March 31, 2001.

                                    Page 28
<PAGE>

                                   SIGNATURES


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


May 15, 2001                           WATCHGUARD TECHNOLOGIES, INC



                                       By:  /s/ Michael E. McConnell
                                           ---------------------------------
                                           Michael E. McConnell

                                           Vice President, Chief Financial
                                            Officer and Treasurer
                                            (Principal Financial and Accounting
                                            Officer)

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