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UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




---

Form 10-K

FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO

SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934


|           |  |                                                                                           
|---------- |  | ------------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                           
|          
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
	15(d)
	OF THE SECURITIES EXCHANGE ACT OF 1934    
|           |  | For the fiscal year ended December 31,
	2001
	or                                          
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
	15(d)
	OF THE SECURITIES EXCHANGE ACT OF 1934
|           |  | For the Transition Period
	from                     to                                    

Commission File Number 000-30093



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Websense, Inc.

(Exact name of registrant as specified in its
charter)


|                                                                |  |                                         
|--------------------------------------------------------------- |  | ----------------------------------------
|Delaware                                                        |  | 51-0380839                              
|(State or other jurisdiction of
	incorporation or organization) |  | (I.R.S. Employer
	Identification Number)

10240 Sorrento Valley Road

San Diego, California 92121


858-320-8000


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




---

Securities registered pursuant to
Section 12(b) of the Act:

None


Securities registered pursuant to
Section 12(g) of the Act:

Common Stock $0.01 par value


(Title of class)


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

Indicate by check mark if disclosure of
delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be
contained, to the best of registrants knowledge, in
definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment to
this
Form 10-K.     þ

The aggregate market value of the voting stock
held by non-affiliates of the registrant, as of
February 28, 2002 was approximately $464 million
(based on the closing price for shares of the registrants
Common Stock as reported by the Nasdaq National Market for that
date). Shares of Common Stock held by each officer, director and
holder of 10% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed affiliates.
Exclusion of shares held by any person should not be construed
to indicate that such person possesses the power, direct or
indirect, to direct or cause the direction of management or
policies of the Registrant, or that such person is controlled by
or under common control with the Registrant.

The number of shares outstanding of the
registrants Common Stock, $.01 par value, as of
February 28, 2002 was 20,823,208.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement to be
delivered to stockholders in connection with the Annual Meeting
of Stockholders to be held June 12, 2002 are incorporated
by reference into Part III.

Certain exhibits filed with the Registrants
prior registration statements and forms 10-K are incorporated
herein by reference into Part IV of this Report.



---






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TABLE OF CONTENTS



|              |                                                                                                         |  |  |  |  |  |  | 
|------------- | ------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  | 
|PART I       
|              | Item 1. Business                                                                                       
|              | Item 2. Properties                                                                                     
|              | Item 3. Legal Proceedings                                                                              
|              | Item 4. Submission of Matters to a Vote of Security Holders                                            
|              | Item 5. Market for Registrants Common Stock and Related Stockholder Matters                           
|              | Item 6. Selected Financial Data                                                                        
|              | Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations          
|              | Item 7A. Quantitative and Qualitative Disclosures About Market Risk                                    
|              | Item 8. Financial Statements and Supplementary Data                                                    
|              | Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure           
|PART III     
|              | Item 10. Directors and Executive Officers of the Registrant                                            
|              | Item 11. Executive Compensation                                                                        
|              | Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|              | Item 13. Certain Relationships and Related Transactions                                                
|PART IV      
|              | Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K                               
|SIGNATURES   
|EXHIBIT INDEX
|EXHIBIT 21.1 
|EXHIBIT 23.1 



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##### Table of Contents



WEBSENSE, INC.

FORM 10-K

For the Fiscal Year Ended December 31,
2001


TABLE OF CONTENTS

|         |  |                                                                                        |  |      |     | 
|-------- |  | -------------------------------------------------------------------------------------- |  | ---- | --- | 
|         |  |                                                                                        |  | Page
|         |  |                                                                                        |  |     
|PART I  
|        
|Item 1.  |  | Business                                                                               |  |      | 1   | 
|Item 2.  |  | Properties                                                                             |  |      | 11  | 
|Item 3.  |  | Legal Proceedings                                                                      |  |      | 11  | 
|Item 4.  |  | Submission of Matters to a Vote of Security
	Holders                                   |  |      | 11  | 
|PART II 
|        
|Item 5.  |  | Market for the Registrants Common Stock and
	Related Stockholder Matters              |  |      | 12  | 
|Item 6.  |  | Selected Financial Data                                                                |  |      | 13  | 
|Item 7.  |  | Managements Discussion and Analysis of
	Financial Condition and Results of Operations |  |      | 14  | 
|Item 7A. |  | Quantitative and Qualitative Disclosures About
	Market Risk                            |  |      | 30  | 
|Item 8.  |  | Financial Statements and Supplementary Data                                            |  |      | 31  | 
|Item 9.  |  | Changes in and Disagreements with Accountants on
	Accounting and Financial Disclosure  |  |      | 31  | 
|PART III
|        
|Item 10. |  | Directors and Executive Officers of the Registrant                                     |  |      | 31  | 
|Item 11. |  | Executive Compensation                                                                 |  |      | 31  | 
|Item 12. |  | Security Ownership of Certain Beneficial Owners
	and Management                        |  |      | 31  | 
|Item 13. |  | Certain Relationships and Related Transactions                                         |  |      | 31  | 
|PART IV 
|        
|Item 14. |  | Exhibits, Financial Statement Schedules, and
	Reports on Form 8-K                      |  |      | 32  | 
|         |  | Signatures                                                                             |  |      | 34  | 
|         |  | Financial Statements                                                                   |  |      | F-1 | 

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PART I

Forward Looking Statements

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



| |   |                                                             
| | - | ------------------------------------------------------------
| |  | anticipated trends in revenue;                              
|
| |  | growth opportunities in domestic and
	international markets;
|
| |  | expected trends in operating
	expenses;                     
|
| |  | anticipated cash and capital requirements;
	and             
|
| |  | intentions regarding investment of excess
	cash.            

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

You should carefully review and consider the
various disclosures in this report regarding factors that could
cause actual results to differ materially from anticipated
results, including those factors under the caption Risks
and Uncertainties under Item 7 below, and elsewhere
in this report.




Item 1.Business

Overview

We provide employee Internet management
(EIM) products that enable businesses to manage how their
employees use the Internet at work. Our primary product,
Websense Enterprise, gives businesses the ability to rapidly
implement and configure Internet access policies in support of
their efforts to improve employee productivity, conserve network
bandwidth and storage space, and mitigate potential legal
liability. Our flexible and easy-to-use software applications
operate in conjunction with our proprietary Websense Master
Database, which is available for daily incremental downloads.
This database is organized into 79 categories and encompasses
more than 3 million Web sites as of December 31, 2001,
representing approximately 600 million Web pages. Our
database is updated with approximately 5,000 newly categorized
Web sites each business day using a proprietary process of
automated site content assessment and classification with manual
verification. Websense Enterprise is easy to deploy and use, and
requires minimal support by an organizations information
technology department. Our products run on a wide range of
integrations in the EIM industry, such as market-leading
firewalls, caching appliances, proxy-servers and other network
appliances, and can grow with our customers needs across
multi-location corporations, regional and international offices.
We currently operate in one industry segment, as defined by
generally accepted accounting principles.

Our business was incorporated in 1994 as
NetPartners Internet Solutions, as a reseller of computer
network security products. In 1996, we released Websense
Internet Screening System, our first product as a software
developer, and, in 1999, we changed our name to Websense, Inc.
Our principal offices are located at 10240 Sorrento Valley
Road, San Diego, CA 92121.

Industry Background

The Internet has emerged as a critical business
tool and an important communications and commerce platform for
enterprises worldwide. As part of their overall business
strategies, many organizations are using the Internet to enable
business applications that are accessed over their corporate
networks. Companies utilize the Internet to optimize their
extended supply chains, automate their sales forces, track
shipments and communicate with employees, customers, partners
and suppliers. Due to the efficiencies, cost-savings and

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competitive advantages that can be gained by
leveraging the Internet, many businesses are continuing to build
out their computer networks and information technology
infrastructure. In order to accommodate a significant number of
simultaneous users and the increasing volume of data transfer
associated with enterprise Internet use, many organizations are
making substantial investments in wide bandwidth connections
such as dedicated T-1 lines, enabling high-speed Internet access.


The Internet has also become a highly popular
consumer medium for entertainment, information and commerce.
Dataquest, a division of Gartner Group, has projected that the
number of corporate Internet users worldwide will grow from
178 million in 2001 to 304 million in 2004. This rapid
adoption of the Internet has been accompanied by the remarkable
growth in the number of consumer-oriented content and commerce
Web sites and by an expanding assortment of Web-based consumer
services. Internet users today have the ability to communicate
through e-mail, retrieve news and information from numerous
Internet sources, make online purchases of goods and services
ranging from books to airline tickets, and otherwise access a
broad range of non-business-related content and commerce Web
sites. As the rapid evolution of Web content and technology
continues, the amount of data, types of data and size of files
traveling across the Internet have also grown. Consumers now
access and download large, complex files such as streaming audio
and video, MP3 music files, multi-player games and a variety of
other new media, all of which consume large amounts of network
bandwidth. In addition, consumers  including
employees, who have access to broadband connections in their
offices  are creating security risks by accessing Web
sites that offer free software downloads, pirated software and
peer-to-peer applications.

Internet access at work is fast, convenient and
essentially free to employees. According to a 2000 survey by
Nielsen// NetRatings, less than seven percent of U.S. residents
have high-speed Internet access at home. Therefore, in general,
employees enjoy quicker and relatively unrestricted Internet
access from their desktop computers. As a result, many employees
use their employers Internet connections for recreational
surfing or personal matters during business hours.
However, non-business use of company Internet access by
employees can result in lost employee productivity, increased
network bandwidth consumption and storage costs, and potential
legal liability. These factors in turn contribute to higher
costs for companies that use the Internet.

Recent research and news reports widely document
the hidden costs of open Internet access in the workplace.
According to research firm IDC, 30 to 40 percent of all
Internet use at work is non-business-related. This non-business
use of the Internet can consume large portions of expensive
network bandwidth and decrease employee productivity. According
to a recent study we commissioned with Luth Research, more than
60 percent of mid- to large-sized companies surveyed had
disciplined employees for Internet misuse, and more than 50
percent of those companies had terminated employees for
inappropriate Internet activity.

Businesses are increasingly recognizing the
problem of personal Internet use in the workplace, and
traditionally have attempted to manage or modify employee
behavior through written policies. These policies are easily
ignored and difficult to enforce. In order to monitor compliance
with policy, managers may require their information technology
professionals to review the log files of Web pages visited
generated by company servers. This method of employee Internet
management is generally cumbersome and time consuming, and often
does not provide the company with useful information regarding
the actual content or category of Web sites visited. Because
this method does not proactively curtail undesirable Internet
activity, employers are forced to discipline employee violations
after the fact. Such disciplinary actions can be expensive. For
instance, the Saratoga Institute estimates that the average cost
of replacing fired employees is $77,000 per person.

To address the problems associated with improper
Internet use in the workplace, many businesses have sought
products that enable them to proactively manage their
employees Internet access. Early Internet filtering
software for the enterprise was largely derived from products
that were originally developed to help parents prevent their
children from accessing adult content at home, and used keyword
matching and dynamic page review to block content. These, and
other more recent products, lack the ability to meet the needs
of growing organizations, cannot operate on multiple network
platforms, do not provide the flexibility required by management
and can be labor-intensive to deploy, consuming valuable
information technology resources. In addition, these
applications generally do not operate in conjunction with a
comprehensive database that is

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consistently refreshed. Moreover, many of these
products databases have typically focused on only a few
categories such as sex, violence and inappropriate language,
ignoring the emergence of new Web content and the subtleties
within categories, such as commercial versus residential real
estate, for example.


Workplace management of non-business-related
Internet access is an increasingly important priority because of
its impact on employee productivity, network bandwidth
consumption and potential legal liability. Given the necessity
of corporate Internet access and consumers continuing
adoption of the Web as a mass entertainment, information and
commerce medium, we believe there is a significant opportunity
for an employee Internet management product that effectively
addresses the needs of businesses.

Our Employee Internet Management
Products

We provide employee Internet management products
that enable businesses to manage how their employees use the
Internet. Our primary product is Websense Enterprise, a software
and database package that gives business managers the ability to
implement customized Internet access policies for different
users and groups within the business, and supports an
organizations efforts to improve employee productivity,
conserve network bandwidth and storage space, and mitigate
potential legal liability. The software component of Websense
Enterprise allows managers the flexibility to select the types
of Internet content they wish to allow, block or defer access to
based on the database categories we have defined. Our software
enforces these managerial selections by comparing Web site
requests with the addresses we have categorized in our database.
Websense Enterprise is sold on a subscription basis. The
principal benefits of our products include:

Increased Employee
Productivity.Websense Enterprise
gives businesses the ability to more effectively manage employee
Internet access, thereby reducing non-productive Internet use.
Our software enables organizations to identify the pattern and
scope of Internet use and to manage access to non-business
related content or particular categories of Internet content
chosen by an organization. In addition, our software allows
managers to permit or deny Internet access based on the
employee, type of user, time of day, amount of personal surfing
time, and type of content being accessed. Websense Enterprise
may also be configured to defer access until after work hours or
set time-based quotas for each employee, allowing for limited
personal surfing during the workday, limiting workplace
distractions but allowing appropriate use of the
organizations high-speed Internet connection.

Reduced Bandwidth Consumption and Network
Storage Space.We believe Websense
Enterprise allows organizations to reduce bandwidth consumption
by managing personal Internet use and access to Web sites, in
particular those which may contain bandwidth-intensive content,
such as streaming audio and video, MP3 music files, multi-player
games and other new media. Reducing the bandwidth consumed by
non-business-related Internet traffic allows an organization to
use its network more efficiently and effectively in performing
important business tasks. In addition, by limiting access to
these types of sites, organizations are able to save valuable
network storage space from being cluttered with MP3s, images and
other files. This avoids costs arising from the need to buy
additional networking equipment and storage servers.

Reduced Exposure to Potential Legal
Liabilities.Websense Enterprise
supports organizations efforts to reduce exposure to legal
liability resulting from the improper use of the Internet in the
workplace. By implementing our products in conjunction with an
overall corporate Internet usage policy, organizations can
proactively curtail access to objectionable Internet content
such as adult entertainment, illegal activities, hate and racism.

In addition to the benefits above, our products
provide these key features:

Access to a Comprehensive
Database.We provide access to a
proprietary database of more than 3.1 million Web sites,
representing approximately 600 million unique Web pages.
Our database is cataloged into 79 different categories to enable
organizations to determine the types of Internet content that
are appropriate for their workplace culture. We add
approximately 5,000 newly categorized Web sites each business
day to our database and make these updates available to our
customers for daily incremental downloads. This database is
updated daily and refreshed every seven hours to remove dead
links and irrelevant content and to identify changing content
and newly emerging sites.

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Ability to Customize Employee Internet
Access.Websense Enterprise allows
organizations to configure specific Internet access policies for
various groups, user types or individuals. Through our
easy-to-use browser interface, we enable managers to implement
Internet access policies with limited impact on information
technology resources and personnel. Organizations may choose
Internet access options which include blocking Web sites,
setting time periods for access, allowing access but generating
an exception report, allowing users a specified amount of
personal surfing, or deferring access until after work hours.

Ability to Adapt to a Customers
Particular Employee Surfing Patterns.We utilize our relationship with our customers to help our
software adapt to any companys particular employee surfing
patterns. We accomplish this with WebCatcher, a feature by which
customers anonymously send uncategorized Web sites visited by
their employees to us daily for review and categorization into
the Websense Master Database.

Premium Group Database Additions for Emerging
Web Content.Websense has developed
Premium Group database additions that encompass emerging Web
content. Premium Group I focuses on productivity management
by allowing administrators to manage message boards and clubs,
advertisements, freeware/ shareware, instant messaging, online
brokerage and trading, and pay-to-surf sites. Premium
Group II focuses on bandwidth management and features sites
relating to Internet radio and TV, peer-to-peer file sharing,
personal network storage/backup, Internet telephony and
streaming media.

Ability to Scale and Operate on a Variety of
Network Platforms.Our software is
designed to have minimal impact on network performance. Websense
Enterprise is available on a broad range of network platforms,
and existing implementations currently support up to 50,000
users on a single server. Our software works with popular proxy
servers, firewalls and cache engines offered by Internet
infrastructure providers such as Cisco, CacheFlow, Check Point,
Inktomi, Microsoft Corp., Netscreen, Network Appliance, and
SonicWALL.

Products and Services

We develop and market a software and database
application for managing employee access to the Internet. Our
products consist of customizable software that reference our
proprietary database. Our database of Web page addresses is
organized into 79 categories, which are regularly updated and
available for incremental daily downloads. In addition to our
current offerings, we plan to introduce and market new products
and services that will provide enterprises with additional
flexibility in managing employee Internet access.

Websense Enterprise.Websense Enterprise is the foundation of our software offerings.
Websense Enterprise integrates with an organizations
network server, proxy server or firewall and is designed to work
in networks of virtually any size and configuration. The table
below describes the platforms for which we currently offer our
Websense Enterprise product.

|                                                                         |  |                                                                                                                         |  |                                                                                                                                                                                                                                                                             
|------------------------------------------------------------------------ |  | ----------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Proxy Servers                                                            |  | Firewalls                                                                                                               |  | Cache Software and Appliances                                                                                                                                                                                                                                               
|                                                                         |  |                                                                                                                         |  |                                                                                                                                                                                                                                                                             
| Microsoft Proxy Server
	 Microsoft ISA Server
	 iPlanet Proxy Server |  |  Check Point FireWall-1
	 Cisco PIX
	 NetScreen
	 CyberGuard
	 SLMsoft SecurIT
	 Lightspeed IP Magic
	 SonicWALL |  |  Cisco Content Engine
	 Network Appliance NetCache
	 CacheFlow
	 Inktomi Traffic Server and Appliances including:
	Compaq TaskSmart, Hewlett-Packard Web Cache, Dell
	PowerApp.cache, and F5 EDGE-FX
	 Volera Excelerator
	 InfoLibria DynaCache
	 IMimic DataReactor

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We sell Websense Enterprise as a subscription
based on the number of Internet users to be managed. Additional
users, additional features and enhanced technical support are
priced separately. Revenues from sales of subscriptions to
Websense Enterprise accounted for 99% of total revenues in 2001,
96% of total revenues in 2000 and 83% of total revenues in 1999.

Content Management.Websense Enterprise enables employers
to proactively manage employee Internet access based on the
content of the requested Web site. Our software application
gives managers the ability to customize, implement and modify
Internet access policies for various groups, user types and
individuals. An easy-to-use graphical interface enables business
managers to define the categories of Web sites to which access
will be managed. The filtering software examines each Internet
access request, determines the category of the requested Web
site and applies the policies that have been defined by the
company. Some examples of management options include:



| |   |                                                                                                                                                                                                                                                                                                 
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Allow.The request
	is allowed to proceed, because the organization has chosen not
	to restrict access to the category applicable to the Web site or
	because the requested Web site does not fall into any of our
	categories.                                                                  
|
| |  | Block.The requested
	Web site is in a category that is not allowed to be accessed
	according to the policy in effect.                                                                                                                                                                           
|
| |  | Quota.Users are
	allowed a specified amount of personal surfing time within
	categories that are determined by the administrator. Once the
	user reaches his or her quota time, he or she is no longer able
	to access sites in those categories.                                               
|
| |  | Defer and Save.The
	user can bookmark the requested Web site to a personalized
	AfterWork.com Web page for access at a later time when the
	organizations access policy is less restrictive. This Web
	page can also be accessed from alternative locations, such as
	from the employees home.
|
| |  | Continue with Exception
	Report.The user is reminded about the
	organizations Internet usage policy, but can choose to
	access the requested Web site. Alternatively, the user can save
	the Web site as described above.                                                                      

The Websense Master
Database.We offer an extensive and
regularly updated database of Web sites. Our database currently
catalogs more than 3 million Web sites representing
approximately 600 million Web page addresses cataloged into
79 categories. Through proprietary techniques 
such as Websense Fingerprint and Websense WebMap  as
well as customer features such as WebCatcher, we add
approximately 5,000 newly categorized Web sites,
representing approximately 500,000 Web page addresses, per
business day to our database and make these updates available
for incremental daily downloads. In addition, our database is
refreshed every seven hours to remove dead links and irrelevant
content and to identify changing content and newly emerging
sites.

The breadth and specificity of Web site
categories we have defined, provide the enterprise flexibility
in selecting which types of material should be allowed, blocked,
deferred or reported. We define the categories, based on input
we have received from our customers, to identify the types of
materials that we believe

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employers would deem to be unacceptable,
inappropriate or undesirable in a work environment. Categories
in our database include the following:


|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| Abortion
	Advocacy   Pro-Choice   Pro-Life
	 Adult Material   Adult
	Content   Lingerie &
	Swimsuit   Nudity   Sex   Sex
	Education
	 Advocacy Groups
	 Business &
	Economy   Financial Data &
	Services
	 Drugs   Abused
	Drugs   Marijuana   Prescribed
	Medications   Supplements/ Unregulated
	Compounds
	 Education   Cultural
	Institutions   Educational
	Institutions   Educational Materials
	 Entertainment   MP3
	 Gambling
	 Games
	 Government   Military   Political
	Groups
	 Health
	 Illegal/ Questionable
	 Information
	Technology   Hacking   Proxy
	Avoidance Systems   Search Engines
	& Portals   URL Translation
	Sites   Web Hosting
	 Internet
	Communication   Web
	Chat   Web-based Email |  |  Job Search
	 Militancy/ Extremist
	 News &
	Media   Alternative Journals
	 Premium Group
	I   Advertisements   Freeware/
	Software Download   Instant
	Messaging   Message Boards &
	Clubs   Online Brokerage &
	Trading   Pay-to-Surf
	 Premium Group II   Internet
	Radio & TV   Internet
	Telephony   Peer-to-Peer File
	Sharing   Personal Network Storage/
	Backup   Streaming Media
	 Racism/ Hate
	 Religion   Non-Traditional
	Religions   Traditional Religions
	 Shopping   Internet
	Auctions   Real Estate
	 Society &
	Lifestyles   Alcohol/
	Tobacco   Gay & Lesbian
	Issues   Hobbies   Personal
	Web Sites   Personal/
	Dating   Restaurants & Dining
	 Special Events
	 Sports   Sport Hunting/ Gun
	Clubs
	 Tasteless
	 Travel
	 User-Defined
	 Vehicles
	 Violence
	 Weapons

Reporter.Websense
Reporter is a software application that is offered with Websense
Enterprise. This application assists managers in analyzing
Internet use within their organizations. Websense Reporter
generates more than 50 tabular and graphical reports based on an
organizations Internet use. It analyzes information from
Internet monitoring logs and builds visual charts in a variety
of formats for easy distribution to and interpretation by
managers. Websense Reporter enables managers to identify useful
information, including summaries of categories of Web sites
visited, requests to all destinations and details regarding
individual destination requests.

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Customers

Our customers range from Fortune 500
companies to government and educational organizations covering
more than 16,500 subscriptions and a total of more than
11.2 million seats. No customer accounted for more than 10%
of our total revenues in 2001, 2000 or 1999.

Sales, Marketing and Distribution

Sales.We sell our
products and services through both indirect and direct channels.
For 2001, indirect channel sales comprised more than 80% of
total revenues, while direct sales to customers accounted for
the remainder of our revenues. Our indirect channels include:

Value-Added
Resellers.We currently have more than
835 domestic value-added resellers that sell our products in the
United States.

Distributors.Internationally, we sell our products through a network of more
than 145 distributors and resellers in more than
80 countries.

Our channel sales efforts are coordinated
worldwide through a sales team of approximately 55 individuals.
Typical customers that buy direct from us are large
organizations that prefer a direct relationship.

In 2001, we generated approximately 35% of our
total revenue from customers outside of the United States.
Revenue generated in the United Kingdom represented
approximately 10% of our total revenues and revenue generated in
Japan represented approximately 7% of our total revenues. We
expect international markets to provide increased opportunities
for our products in the future. Our current international
efforts are focused on expanding our indirect sales channels in
Asia/ Pacific, Europe, Latin America and Australia. Our
increasing reliance on sales in international markets exposes us
to risks attendant to foreign sales. See Item 7.
Risks and Uncertainties  Sales to customers outside
the United States have accounted for a significant portion of
our revenue, and we expect this trend to continue, which exposes
us to risks inherent in international sales.

Marketing.Our
marketing strategy is to generate qualified sales leads, build
our brand and raise corporate awareness of Websense as a
provider of Employee Internet Management products.

Our marketing efforts are targeted toward
operational executives and decision makers within businesses,
including information technology professionals, chief
executives, upper level management and human resource personnel.
We actively manage our public relations, communicating directly
with technology professionals and the media, in an effort to
promote greater awareness of the growing problem caused by
employee misuse of the Internet at work. Our additional
marketing initiatives include:



| |   |                                                                                                                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | advertising in high-technology trade magazines,
	management journals and other business oriented periodicals;                                                                                                             
|
| |  | participation in and sponsorship of trade shows
	and industry events;                                                                                                                                                     
|
| |  | cooperative marketing efforts with our Internet
	infrastructure partners including Web link exchanges, joint
	press announcements, joint trade show activities, channel
	marketing campaigns, road shows and seminars; and
|
| |  | use of our Web site to communicate with our
	indirect sales channels, allow free trials and purchases of our
	products and provide product and company information to
	interested parties.                                

Customer Service, Training and
Support

We believe that superior customer support is
critical to retaining and expanding our customer base. Our
technical support group provides dependable and timely
resolution of customer technical inquiries and is available to
customers by telephone, e-mail and over the Web. Our training
services group delivers education, training and pre-sales
support to our customers. We also offer online training to our
customers and resellers to provide them with the knowledge and
skills to successfully deploy, use and maintain our products. Our

7



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customer service team is responsible for handling
general customer inquiries, answering questions about the
ordering process, investigating the status of orders and
payments, as well as processing customer orders. In addition,
our customer service team uses our e-mail system to proactively
update customers on a variety of topics, including release dates
of new products and updates to existing products.


Research and Development

We have invested significant time and resources
in creating a structured process for undertaking product and
database development projects. The research and development
department is divided into several groups, which include
database production, software development, quality assurance and
documentation. Individuals are grouped along product lines and
work as part of cross-disciplined teams designed to provide a
framework for defining and addressing the activities required to
bring product concepts and development projects to market
successfully. Research and development expenses totaled
$7.6 million in 2001, $6.3 million in 2000 and
$3.9 million in 1999.

Technology

Software
Architecture.Websense Enterprise is a
server-based system designed to function in networks of
virtually any size and configuration. Websense Enterprise is
composed of an integrated system of monitoring, reporting and
management applications. It is designed to accommodate network
growth without impairing performance or requiring major
overhauls and can scale to support networks of up to 50,000
users on a single server. Websense Enterprise integrates with
major firewalls, proxy servers and caching engines. We have
designed our products to run on multiple network platforms and
in multiple locations.

Database Content Analysis and
Updating.We use a process of
automated content assessment and classification with manual
verification to gather and classify new Web sites for our
database. Our automated search technology uses Java-based tools
and proprietary pattern recognition systems to automatically
search the Internet to identify and catalog Web sites into one
of our 79 database categories.

Competition

The market for Internet-filtering software and
related services is fragmented, highly and increasingly
competitive, quickly evolving and subject to rapid technological
change. Increased competition may result in reduced market
acceptance of our products, price reductions and reduced gross
margins, any of which could seriously harm our business.
Competitors vary in size and in the scope and breadth of the
products and services they offer. Our current principal
competitors include:



| |   |                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | companies offering network filtering products,
	such as SurfControl plc, Secure Computing, Symantec Corporation,
	N2H2 Incorporated, and 8e6 Technologies; and
|
| |  | companies offering network reporting products,
	such as the WebTrends business acquired by NetIQ in 2001 and
	Wavecrest Computing.                            

We also face current and potential competition
from vendors of Internet servers, operating systems and
networking hardware, many of which now, or may in the future,
develop and/or bundle employee Internet management products with
their offerings. We also compete against and expect increased
competition from traditional network management software
developers and Web management service providers. Many of our
current and potential competitors have longer operating
histories and significantly greater financial, technical,
marketing or other resources than we do. They may have
significantly greater name recognition, established marketing
relationships and access to a larger installed base of
customers. In addition, current and potential competitors have
established or may establish cooperative relationships among
themselves or with third parties to increase the functionality
of their products to address customer needs. Accordingly, new
competitors or alliances among competitors may emerge and
rapidly acquire significant market share.

8



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We believe that the principal competitive factors
in the market for our products include:



| |   |                                                                                
| | - | -------------------------------------------------------------------------------
| |  | a products ability to scale and support the
	requirements of complex networks;
|
| |  | use of a large and professionally maintained
	category database;               
|
| |  | breadth of product line, giving customers a
	number of implementation choices; 
|
| |  | depth of monitoring, reporting and analysis
	capabilities;                     
|
| |  | capacity to integrate with key network providers;                              
|
| |  | quality of customer support; and                                               
|
| |  | price and payment methods.                                                     

Intellectual Property Rights

Our intellectual property rights are important to
our business. We rely on a combination of trademark, copyright
and trade secret laws in the United States and other
jurisdictions as well as confidentiality procedures and
contractual provisions to protect our proprietary technology and
Websense brand. We have registered our Websense trademark in the
United States, Japan and the European Union. In addition, we
have trademark registrations pending in several other countries.
Effective trademark protection may not be available in every
country where our products are available.

We currently have four patent applications
pending in the United States and four pending international
patent applications that seek to protect our proprietary
database and filtering technologies. We do not have any issued
patents and our pending patent applications may not result in
issued patents.

Our policy is to enter into confidentiality and
invention assignment agreements with all employees and
consultants, and nondisclosure agreements with all other parties
to whom we disclose confidential information. These protections,
however, may not be adequate to protect our intellectual
property rights.

Employees

As of February 28, 2002, we had 255
employees. None of our employees is represented by a labor
union, and we have never experienced a work stoppage. We believe
that our relations with our employees are good.

Executive Officers

Our executive officers and their ages as of
February 28, 2002 are as follows:

|                    |  |     |    |             |  |                                                              
|------------------- |  | --- | -- | ----------- |  | -------------------------------------------------------------
|Name                |  | Age |    | Position(s)
|                    |  |     |    |            
|John B. Carrington  |  |     | 57 |             |  | Chairman of the Board, President and Chief
	Executive Officer
|Douglas C. Wride    |  |     | 48 |             |  | Chief Financial Officer                                      
|Harold M. Kester    |  |     | 55 |             |  | Chief Technology Officer                                     
|Curtis H. Staker    |  |     | 42 |             |  | Executive Vice President of Worldwide Sales                  
|William M. Goldbach |  |     | 47 |             |  | Vice President of North America Sales                        
|Karen V. Goodrum    |  |     | 44 |             |  | Vice President of Finance and Administration                 
|Geoff Haggart       |  |     | 46 |             |  | Vice President of Europe, Middle East and Africa
	Sales      
|Ronald B. Hegli     |  |     | 41 |             |  | Vice President of Engineering                                
|Andrew Meyer        |  |     | 44 |             |  | Vice President of Marketing                                  
|Kian Saneii         |  |     | 37 |             |  | Vice President of Business Development                       

John B. Carrington has served as our President
and Chief Executive Officer since May 1999 and has served as our
Chairman since June 1999. Prior to joining Websense,
Mr. Carrington was Chairman, President and Chief Executive
Officer of Artios, Inc., a provider of hardware and software
design solutions to companies in the packaging industry, from
August 1996 until it was acquired by BARCO n.a. in December
1998. From

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September 1991 to October 1995,
Mr. Carrington was President and Chief Executive Officer of
Digitalk, Inc., a software development tools company, which has
since merged to form ParcPlace-Digitalk, Inc. He received his
B.S. in Business Administration from the University of Texas.


Douglas C. Wride has served as our Chief
Financial Officer since June 1999. From March 1997 to December
1998, Mr. Wride served as Chief Financial Officer of
Artios, Inc. Mr. Wride also served as Chief Operating
Officer of Artios from July 1997 to December 1998. From April
1996 to March 1997, Mr. Wride served as Chief Operating
Officer and Chief Financial Officer of NetCount, LLC, a provider
of Internet measurement and research services. From February
1992 to January 1996, Mr. Wride was Chief Financial Officer
at Digitalk, Inc. Mr. Wride has also held senior-level
positions with SSD Management, Inc., a developer of network
communications software for wide area networks and Accountants
Overload Group, an accounting, finance and data processing job
placement company, and spent 11 years in the
entrepreneurial technology group at Price Waterhouse & Co.
Mr. Wride is a C.P.A and received his B.S. in Business/
Accounting from the University of Southern California.

Harold M. Kester has served as our Chief
Technology Officer since June 1999. Prior to joining us, from
August 1993 to June 1999, Mr. Kester served as Vice
President of Encyclopedia Britannica, a provider of general
reference materials on a multitude of subjects, and General
Manager and Chief Scientist of its La Jolla Research
Laboratory. Prior to his employment with Encyclopedia
Britannica, Mr. Kester founded The Del Mar Group, a
provider of information retrieval software products.
Mr. Kester received his B.A. in Mathematics from California
State University, Long Beach.

Curtis H. Staker has served as our Executive
Vice President of Worldwide Sales since February 2001. Prior to
that, he was with Structural Dynamics Research
Corporation (SDRC) from July 1989 to February 2001 serving
in a variety of management positions, including Vice President
and General Manager of Americas Operations (North and South
America regions) and Vice President and General Manager of
Asia-Pacific Operations. SDRC, a provider of e-business
collaboration solutions, is now owned by Electronic Data Systems
(EDS). Mr. Staker began his career as an engineer for
Caterpillar Tractor Co. after receiving his B.S. in Mechanical
Engineering from Bradley University.

William M. Goldbach has served as our Vice
President of North America Sales since November 2001. From March
1993 to September 2001, he was Director, North America Sales for
MRO Software Inc. (formerly PSDI), an Enterprise Asset
Management (EAM) solution provider, and for its MRO.COM
e-commerce subsidiary. Mr. Goldbach graduated with honors
from Boston College, where he received his B.S. in Accounting.

Karen V. Goodrum has served as our Vice
President of Finance and Administration since August 2000. From
January 1997 to February 2000, Ms. Goodrum served as Chief
Financial Officer for COMPS.Com, Inc., a provider of commercial
real estate information services. Ms. Goodrum previously
served as Vice President of Finance and Administration for
COMPS.Com, Inc. from September 1993 to January 1997.
Ms. Goodrum received her B.A. in Education from the
University of Maryland, College Park, and her M.B.A. from
San Diego State University.

Geoff Haggart has served as our Vice President of
Europe, Middle East and Africa Sales since February 2000. From
February 1997 to February 2000, Mr. Haggart served as Vice
President of European/ International Operations for Continuus
Software, a manufacturer and distributor of software change
management solutions. Mr. Haggart previously served as
Managing Director  UK for Continuus Software from
September 1995 to February 1997. Mr. Haggart has also held
management and technical positions for a number of companies in
Europe and the Middle East, including Legent, Cincom Systems and
Bahrain Petroleum Company.

Ronald B. Hegli has served as our Vice
President of Engineering since March 1999. Prior to joining us,
from August 1998 to March 1999, Mr. Hegli served as
Director of Product Development for Nuera Communications, an
Internet protocol telephony vendor. From March 1994 to April
1998, Mr. Hegli served as Vice President of Engineering
with TriTeal Corp., a graphical user interface software
developer. TriTeal Corp. filed a bankruptcy petition in April
1999. Mr. Hegli received his B.S. in Nuclear Engineering
from Oregon State University and an M.S. in Mechanical
Engineering from the University of California, Berkeley.

10



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##### Table of Contents



Andrew Meyer has served as our Vice President of
Marketing since August 1999. From November 1997 to August 1999,
Mr. Meyer served as Vice President of Marketing for Epicor
Software (formerly Platinum Software), a provider of enterprise
resource planning software. From September 1993 to November
1997, Mr. Meyer was Director of Marketing for
Scientific-Atlanta, a cable television and telecommunications
manufacturer. Mr. Meyer received his bachelors degree
in Mechanical Engineering from Georgia Tech and an M.B.A. from
the University of New Orleans.

Kian Saneii has served as our Vice President of
Business Development since August 2001. From August 1999 to
February 2001, he was Senior Vice President of Worldwide
Marketing and Business Development at IPNet Solutions, Inc., a
provider of business-to-business integration and supply-chain
collaboration solutions. From July 1997 to July 1999, he served
as Senior Vice President of Worldwide Marketing for
IMA Corporation, a supplier of customer relationship
management solutions. From December 1995 to July 1997, he held
key positions in marketing management with FileNET Corporation,
a developer of software for e-process management.
Mr. Saneii received his B.S. in Computer Science from
New York University, and an M.S. in Computer Science from
Rutgers University.




Item 2.     Properties

Our corporate headquarters and principal offices
are located in San Diego, California, where we lease
approximately 58,000 square feet. The lease for the
significant majority of the space expires in August 2002, with
an option to extend the lease for an additional three years. We
believe that our current space is adequate for our current and
identified future needs. We lease space for our European
headquarters in an executive suite arrangement on an annual
basis. We also lease space for our Japan operations in an
executive suite arrangement on an annual basis.




Item 3.     Legal
Proceedings

We are not a party to any material legal
proceedings.




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

None.

11



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##### Table of Contents



PART II






|        |                                                                      
|------- | ---------------------------------------------------------------------
|Item 5. | Market for Registrants Common Stock
	and Related Stockholder Matters

Our Common Stock is traded on the Nasdaq National
Market under the symbol WBSN. The Common Stock was
initially offered to the public on March 28, 2000 at $18.00
per share. The following table sets forth the range of high and
low closing prices on the Nasdaq National Market of our Common
Stock for the periods indicated, as reported by Nasdaq. Such
quotations represent inter-dealer prices without retail markup,
markdown or commission and may not necessarily represent actual
transactions.

|                                       |  |      |       |     |  |   |       | 
|-------------------------------------- |  | ---- | ----- | --- |  | - | ----- | 
|                                       |  | High |       | Low
|                                       |  |      |       |    
|Year Ended December 31, 2001           |  |      |       |     |  |   |       | 
|First Quarter                          |  | $    | 16.42 |     |  | $ | 7.69  | 
|Second Quarter                         |  |      | 20.00 |     |  |   | 9.09  | 
|Third Quarter                          |  |      | 19.19 |     |  |   | 9.99  | 
|Fourth Quarter                         |  |      | 33.60 |     |  |   | 10.54 | 
|Year Ended December 31, 2000           |  |      |       |     |  |   |       | 
|First Quarter (subsequent to March 28) |  |      | 48.06 |     |  |   | 39.63 | 
|Second Quarter                         |  |      | 41.25 |     |  |   | 15.38 | 
|Third Quarter                          |  |      | 29.00 |     |  |   | 12.75 | 
|Fourth Quarter                         |  |      | 23.38 |     |  |   | 10.38 | 

To date, we have neither declared nor paid any
dividends on the Common Stock. We currently intend to retain all
future earnings, if any, for use in the operation and
development of our business and, therefore, do not expect to
declare or pay any cash dividends on the Common Stock in the
foreseeable future. As of February 28, 2002, there were
5,541 holders of record of the Common Stock.

Use of Proceeds

On March 31, 2000, we closed the sale of
4,000,000 shares of our Common Stock, $0.01 par value, in
our initial public offering (the Offering). The
shares of Common Stock sold in the Offering were
registered under the Securities Act of 1933, as amended, on
a Registration Statement on Form S-1
(Reg. No. 333-95619) that was declared effective by
the SEC on March 27, 2000. After deducting the underwriting
discounts and commissions and various Offering expenses, we
received net proceeds from the Offering of approximately
$65.7 million. A portion of the proceeds from the Offering
was used to repay the $1.5 million balance of our fixed
term loan agreements with a financial institution. We currently
have approximately $64.2 million in proceeds remaining from
the Offering. We intend to use these proceeds for general
corporate purposes, including working capital. We may also use a
portion of the net proceeds for acquisitions of businesses,
products and technologies, or the establishment of new business
opportunities that are complementary to our current and future
business.

12



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##### Table of Contents






Item 6.     Selected
Financial Data

You should read the following selected financial
data in conjunction with our financial statements and related
notes and Managements Discussion and Analysis of
Financial Condition and Results of Operations appearing
elsewhere in this annual report. We derived the statement of
operations data for the years ended December 31, 2001, 2000
and 1999 and the balance sheet data as of December 31, 2001
and 2000 from our financial statements audited by Ernst &
Young LLP, which appear elsewhere in this report. We derived the
statement of operations data for the years ended
December 31, 1998 and 1997 and the balance sheet data as of
December 31, 1999, 1998 and 1997 from our financial
statements audited by Ernst & Young LLP, which are not
included in this annual report. Our historical results are not
necessarily indicative of operating results to be expected in
the future.

|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |       |       | 
|------------------------------------- | ---------------------------------------- | ----------------------------------------- | ------ | ------ | ------ | ---- | ------ | ------ | ------ | ---- | ------ | ----- | ------ | - | ------ | ----- | ----- | - | ------ | ----- | ----- | 
|                                      |                                          |                                          
|                                      |                                          | Years Ended December 31,                 
|                                      |                                          |                                          
|                                      |                                          | 2001                                      |        | 2000   |        | 1999 |        | 1998   |        | 1997
|                                      |                                          |                                           |        |        |        |      |        |        |        |     
|                                      |                                          |                                          
|                                      |                                          | (In thousands, except for per share data)
|Statement of Operations Data:         |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Revenues:                             |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|                                      | Subscriptions                            |                                           | $      | 35,530 |        |      | $      | 16,680 |        |      | $      | 7,141 |        |   | $      | 2,503 |       |   | $      | 637   |      
|                                      | Other products and services              |                                           |        | 363    |        |      |        | 761    |        |      |        | 1,506 |        |   |        | 4,416 |       |   |        | 4,383 |      
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|                                      |                                          | Total revenues                            |        |        | 35,893 |      |        |        | 17,441 |      |        |       | 8,647  |   |        |       | 6,919 |   |        |       | 5,020 | 
|Cost of revenues:                     |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|                                      | Subscriptions                            |                                           |        | 3,397  |        |      |        | 1,989  |        |      |        | 1,084 |        |   |        | 736   |       |   |        | 218   |      
|                                      | Other products and services              |                                           |        | 205    |        |      |        | 718    |        |      |        | 1,191 |        |   |        | 3,724 |       |   |        | 3,214 |      
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|                                      |                                          | Total cost of revenues                    |        |        | 3,602  |      |        |        | 2,707  |      |        |       | 2,275  |   |        |       | 4,460 |   |        |       | 3,432 | 
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Gross margin                          |                                          |                                           | 32,291 |        |        |      | 14,734 |        |        |      | 6,372  |       |        |   | 2,459  |       |       |   | 1,588  |      
|Operating expenses:                   |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|                                      | Selling and marketing                    |                                           |        | 19,707 |        |      |        | 12,726 |        |      |        | 6,311 |        |   |        | 4,597 |       |   |        | 1,720 |      
|                                      | Research and development                 |                                           |        | 7,642  |        |      |        | 6,287  |        |      |        | 3,913 |        |   |        | 1,789 |       |   |        | 528   |      
|                                      | General and administrative               |                                           |        | 5,220  |        |      |        | 3,491  |        |      |        | 3,805 |        |   |        | 1,715 |       |   |        | 767   |      
|                                      | Amortization of stock-based compensation |                                           |        | 860    |        |      |        | 1,938  |        |      |        | 1,822 |        |   |        |      |       |   |        |      |      
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|                                      |                                          | Total operating expenses                  |        |        | 33,429 |      |        |        | 24,442 |      |        |       | 15,851 |   |        |       | 8,101 |   |        |       | 3,015 | 
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Income (loss) from operations         |                                          |                                           | (1,138 | )      |        |      | (9,708 | )      |        |      | (9,479 | )     |        |   | (5,642 | )     |       |   | (1,427 | )    
|Interest income (expense), net        |                                          |                                           | 4,362  |        |        |      | 3,761  |        |        |      | 225    |       |        |   | 33     |       |       |   | (35    | )    
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Net income (loss) before income taxes |                                          |                                           | 3,224  |        |        |      | (5,947 | )      |        |      | (9,254 | )     |        |   | (5,609 | )     |       |   | (1,462 | )    
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Provision for income taxes            |                                          |                                           | 108    |        |        |      |       |        |        |      |       |       |        |   |       |       |       |   |       |      
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Net income (loss)                     |                                          | $                                         | 3,116  |        |        | $    | (5,947 | )      |        | $    | (9,254 | )     |        | $ | (5,609 | )     |       | $ | (1,462 | )    
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Net income (loss) per share:          |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Basic                                 |                                          | $                                         | 0.16   |        |        | $    | (0.35  | )      |        | $    | (1.25  | )     |        | $ | (0.80  | )     |       | $ | (0.21  | )    
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Diluted                               |                                          | $                                         | 0.14   |        |        | $    | (0.35  | )      |        | $    | (1.25  | )     |        | $ | (0.80  | )     |       | $ | (0.21  | )    
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Weighted average shares  basic       |                                          |                                           | 20,082 |        |        |      | 16,882 |        |        |      | 7,403  |       |        |   | 7,000  |       |       |   | 7,000  |      
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      
|Weighted average shares  diluted     |                                          |                                           | 22,780 |        |        |      | 16,882 |        |        |      | 7,403  |       |        |   | 7,000  |       |       |   | 7,000  |      
|                                      |                                          |                                           |        |        |        |      |        |        |        |      |        |       |        |   |        |       |       |   |        |      

|                                     |  |                    |         |      |  |      |        |      |  |      |        |  |  |   |        |   |  |   |        |  
|------------------------------------ |  | ------------------ | ------- | ---- |  | ---- | ------ | ---- |  | ---- | ------ |  |  | - | ------ | - |  | - | ------ | -
|                                     |  |                   
|                                     |  | As of December 31,
|                                     |  |                   
|                                     |  | 2001               |         | 2000 |  | 1999 |        | 1998 |  | 1997
|                                     |  |                    |         |      |  |      |        |      |  |     
|                                     |  |                   
|                                     |  | (In thousands)    
|Balance Sheet Data:                  |  |                    |         |      |  |      |        |      |  |      |        |  |  |   |        |   |  |   |        |  
|Cash and cash equivalents            |  | $                  | 23,715  |      |  | $    | 13,106 |      |  | $    | 10,735 |  |  | $ | 1,753  |   |  | $ | 123    |  
|Investments in marketable securities |  |                    | 79,393  |      |  |      | 68,153 |      |  |      |       |  |  |   |       |   |  |   |       |  
|Working capital (deficit)            |  |                    | 79,846  |      |  |      | 69,019 |      |  |      | 5,222  |  |  |   | (377   | ) |  |   | (1,350 | )
|Total assets                         |  |                    | 119,812 |      |  |      | 92,454 |      |  |      | 16,756 |  |  |   | 4,355  |   |  |   | 1,625  |  
|Deferred revenue                     |  |                    | 43,478  |      |  |      | 24,487 |      |  |      | 11,593 |  |  |   | 4,236  |   |  |   | 1,132  |  
|Debt                                 |  |                    |        |      |  |      |       |      |  |      | 1,497  |  |  |   | 496    |   |  |   |       |  
|Total stockholders equity (deficit) |  |                    | 70,680  |      |  |      | 64,064 |      |  |      | 1,642  |  |  |   | (1,217 | ) |  |   | (1,340 | )

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Item 7.     Managements
Discussion and Analysis of Financial Condition and Results of
Operations

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

Forward Looking Statements

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



| |   |                                                             
| | - | ------------------------------------------------------------
| |  | anticipated trends in revenue;                              
|
| |  | growth opportunities in domestic and
	international markets;
|
| |  | expected trends in operating
	expenses;                     
|
| |  | anticipated cash and capital requirements;
	and             
|
| |  | intentions regarding investment of excess
	cash.            

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

Overview

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

In 1999, we changed our name to Websense, Inc.
and completed our change in business strategy. In the same year,
we expanded our senior management team, raised approximately
$9.8 million in a private round of financing and further
strengthened indirect sales channels and business relationships.
In December 1999, we released version 4.0, a redesigned version
of Websense Enterprise; our most recent version was released in
June 2001. We currently derive nearly all of our revenues from
subscriptions to this solution and expect this trend to continue
in the future.

We also derive revenues from professional
services for the implementation of our products. We recognize
revenues for these services upon their completion or delivery.
These revenues have declined significantly over the past three
years due to our shift in business strategy. We expect these
revenues to constitute an insignificant percentage of our total
revenues in future periods.

In 2001, we derived 35% of revenues from
international sales compared to 32% in 2000. We believe
international markets represent a significant growth opportunity
and are continuing to expand our international operations,
particularly in selected countries in the European and
Asia/Pacific markets.

We currently sell Websense Enterprise through
indirect (more than 80 percent of our revenue) and direct
channels; however, our strategy is to continue to rely on
indirect sales channels for the majority of our sales.
Domestically, we sell solutions through more than 835 Value
Added Resellers, or VARs, and through our direct sales force.
Internationally, we distribute Websense Enterprise through more
than 145 distributors and resellers in more than 80 countries
who resell our solution through VARs and their resellers. In
addition, we

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leverage the sales and marketing capabilities of
the original equipment manufacturers, or OEMs, and other key
providers of complementary hardware and software products.


As described above, we recognize revenues from
subscriptions to Websense Enterprise on a straight-line basis
over the term of the subscription. However, we recognize
operating expenses as they are incurred. These expenses include
commissions relating to the sale of new subscriptions, which are
based on the total amount of the subscription contract and are
fully expensed in the current period. Operating expenses have
continued to increase as compared to prior periods due to
expanded selling and marketing efforts and investments in
administrative infrastructure to support subscription sales that
we will recognize as revenue in subsequent periods.

Critical Accounting Policies

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

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

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

Deferred Tax Assets.We record a valuation allowance to
reduce our deferred tax assets to the amount that is more likely
than not to be realized. While we have considered future taxable
income and ongoing prudent and feasible tax planning strategies
in assessing the need for the valuation allowance, in the event
we were to determine that we would be able to realize our
deferred tax assets in the future in excess of their net
recorded amounts, an adjustment to the deferred tax assets would
increase our income in the period such determination was made.
Likewise, should we determine that we would not be able to
realize all or part of our net deferred tax assets in the
future, an adjustment to the deferred tax assets would be
charged against income in the period such determination was
made. As of December 31, 2001, we had $14.3 million in
gross deferred tax assets, which were fully offset by a
valuation allowance.

15



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##### Table of Contents



Results of Operations

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

|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |    |     |  
|------------------------------------- | ---------------------------------------- | ------------------------ | -- | ---- | --- | ---- | --- | -- | --- | - | ---- | -- | --- | -
|                                      |                                          |                         
|                                      |                                          | Years Ended December 31,
|                                      |                                          |                         
|                                      |                                          | 2001                     |    | 2000 |     | 1999
|                                      |                                          |                          |    |      |     |     
|Revenues:                             |                                          |                          |    |      |     |      |     |    |     |   |      |   
|                                      | Subscriptions                            |                          |    | 99   | %   |      |     | 96 | %   |   |      | 83 | %  
|                                      | Other products and services              |                          |    | 1    | %   |      |     | 4  | %   |   |      | 17 | %  
|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |   
|                                      |                                          | Total revenues           |    |      | 100 | %    |     |    | 100 | % |      |    | 100 | %
|Cost of revenues:                     |                                          |                          |    |      |     |      |     |    |     |   |      |   
|                                      | Subscriptions                            |                          |    | 9    | %   |      |     | 12 | %   |   |      | 13 | %  
|                                      | Other products and services              |                          |    | 1    | %   |      |     | 4  | %   |   |      | 14 | %  
|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |   
|                                      |                                          | Total cost of revenues   |    |      | 10  | %    |     |    | 16  | % |      |    | 27  | %
|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |   
|Gross margin                          |                                          |                          | 90 | %    |     |      | 84  | %  |     |   | 73   | % 
|Operating expenses:                   |                                          |                          |    |      |     |      |     |    |     |   |      |   
|                                      | Selling and marketing                    |                          |    | 55   | %   |      |     | 73 | %   |   |      | 73 | %  
|                                      | Research and development                 |                          |    | 21   | %   |      |     | 36 | %   |   |      | 45 | %  
|                                      | General and administrative               |                          |    | 15   | %   |      |     | 20 | %   |   |      | 44 | %  
|                                      | Amortization of stock-based compensation |                          |    | 2    | %   |      |     | 11 | %   |   |      | 21 | %  
|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |   
|                                      |                                          | Total operating expenses |    |      | 93  | %    |     |    | 140 | % |      |    | 183 | %
|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |   
|Loss from operations                  |                                          |                          | (3 | )%   |     |      | (56 | )% |     |   | (110 | )%
|Interest income, net                  |                                          |                          | 12 | %    |     |      | 22  | %  |     |   | 3    | % 
|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |   
|Net income (loss) before income taxes |                                          |                          | 9  | %    |     |      | (34 | )% |     |   | (107 | )%
|Provision for income taxes            |                                          |                          | 0  | %    |     |      | 0   | %  |     |   | 0    | % 
|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |   
|Net income (loss)                     |                                          |                          | 9  | %    |     |      | (34 | )% |     |   | (107 | )%
|                                      |                                          |                          |    |      |     |      |     |    |     |   |      |   

Years Ended
December 31, 2001 and 2000



| |         
| | --------
| | Revenues

Subscriptions.Subscription revenue increased from
$16.7 million in 2000 to $35.5 million in 2001. This
increase was primarily a result of the addition of new
customers. Approximately 66% of subscription revenue recognized
in 2001 was derived from sales to first-time customers, who
initially purchased one-, two-, or three-year subscriptions to
Websense Enterprise in 2001 or prior years. The remaining 34% of
subscription revenues was generated from renewal business with
existing customers. Subscription revenue accounted for 99% of
total revenues in 2001 compared to 96% in 2000. The increase as
a percentage of sales is due to our focus on selling Websense
Enterprise as well as our Premium Group (PG) I and PG II
offerings.

Other products and services.Other products and services revenue,
which include revenues from professional services and the resale
of hardware and software, decreased from $761,000 in 2000 to
$363,000 in 2001. Other products and services revenue accounted
for 1% of revenues in 2001 compared to 4% in 2000. Due to our
focus on selling Websense Enterprise, we expect other products
and services revenue will continue to represent an insignificant
percentage of our total revenues in future periods.



| |                 
| | ----------------
| | Cost of Revenues

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

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$2.0 million in 2000 to $3.4 million in
2001. This increase was primarily due to the costs associated
with additional personnel in our database and technical support
groups. Cost of subscriptions as a percentage of subscription
revenue decreased to 9% in 2001 from 12% in 2000. The decrease
in the percentage of subscription revenue was due to the
increase in revenue and economies of scale achieved relative to
the associated costs.


Cost of other products and
services.Cost of other products and
services consists primarily of the cost of resale software and
related hardware. Cost of other products and services decreased
from $718,000 in 2000 to $205,000 in 2001. The costs decreased
as a result of the shift in focus away from reselling hardware
and software. Cost of other products and services as a
percentage of total revenue decreased to 1% in 2001 compared to
4% in 2000.



| |             
| | ------------
| | Gross Margin

Gross margin increased from $14.7 million in
2000 to $32.3 million in 2001. The increase was due to a
higher percentage mix of subscription revenues, which generate a
higher margin as compared to other products and services, as
well as increased subscription revenues.



| |                   
| | ------------------
| | Operating Expenses

Selling and
marketing.Selling and marketing
expenses consist primarily of salaries, commissions and benefits
related to personnel engaged in selling, marketing and customer
support functions, along with costs related to public relations,
advertising, promotions and travel. Selling and marketing
expenses increased from $12.7 million in 2000 to
$19.7 million in 2001. The increase in selling and
marketing expenses in 2001 of $7.0 million was primarily
due to $3.9 million of increased headcount costs,
$1.9 million of increased commission expenses resulting
from increased sales of pre-paid subscriptions (also referred to
as billings), and increased advertising and promotional
activities in North America, Europe and Asia Pacific resulting
in increased costs of $1.2 million. We expect selling and
marketing expenses to increase in the future as more personnel
are added to support our globally expanding selling and
marketing efforts.

Research and
development.Research and development
expenses consist primarily of salaries and benefits for software
developers, contract programmers, facilities costs and equipment
depreciation. Research and development expenses increased from
$6.3 million in 2000 to $7.6 million in 2001. The
increase of $1.3 million in research and development
expenses was primarily a result of personnel added in 2001 to
support our expanding list of technology partners as well as the
growing feature set of Websense Enterprise.

General and
administrative.General and
administrative expenses consist primarily of salaries, benefits
and related expenses for our executive, finance, human resources
and administrative personnel, third party professional service
fees and allocated facilities and depreciation expenses. General
and administrative expenses increased from $3.5 million in
2000 to $5.2 million in 2001. The $1.7 million
increase in general and administrative expenses in 2001 is
primarily due to increased professional service fees of
approximately $390,000, increased personnel and facility costs
related to our wholly-owned subsidiary in the United Kingdom of
approximately $310,000, increased third-party administrative and
accounting costs related to our wholly-owned international
subsidiaries of approximately $270,000, and also includes
increased compensation costs for our executive officers,
increased insurance premiums, increased bad debt expense and
other increased costs associated with being a public company. We
expect general and administrative expenses to increase in future
periods, reflecting growth in operations and increased expenses
associated with being a public company.

Amortization of stock-based
compensation.Amortization of
stock-based compensation decreased from $1.9 million in
2000 to $860,000 in 2001. The decrease in the amortization
expense in 2001 is primarily due to the accelerated method of
amortization used that resulted in higher expense in 2000 as
compared to 2001. We expect amortization of stock-based
compensation to decrease in future periods as a result of using
the accelerated method of amortization.

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Interest
Income, Net

Net interest income increased from
$3.8 million in 2000 to $4.4 million in 2001. The
increase is due primarily to larger invested balances resulting
from the interest earned on the net proceeds from our initial
public offering, which closed in March 2000 (net proceeds were
invested for 12 months in 2001 as compared to 9 months
in 2000), as well as continuing investment of our positive
operating cash flow. Operating cash flow for 2001 was
$20.8 million as compared to $7.7 million in 2000. We
expect net interest income to increase during 2002 as a result
of larger invested balances.

Provision
for Income Taxes

In 2000, there was no provision for income taxes.
During 2001, we incurred estimated income taxes of $108,000
related to our wholly-owned subsidiary in the United Kingdom. We
did not incur income taxes related to our operations in the
United States (US) due to the utilization of our deferred
tax assets that we recorded in prior periods. We expect our
effective US tax rate to be less than both the federal and state
statutory rates in 2002 due to the continued utilization of our
deferred tax assets, however, we expect our provision for income
taxes to increase in 2002 as compared to 2001. Subsequent to
2002, we expect the provision for income taxes to continue to
increase, reflecting continued growth in our business, both
domestically and internationally, and the depletion of our
deferred tax assets.

Years Ended
December 31, 2000 and 1999



| |         
| | --------
| | Revenues

Subscriptions.Subscription revenue increased from
$7.1 million in 1999 to $16.7 million in 2000. This
increase of $9.6 million was primarily a result of the
addition of new customers (approximately $6.2 million)
during 2000 as well as renewals by existing customers
(approximately $3.4 million). Subscription revenue
accounted for 96% of total revenues in 2000 compared to 83% in
1999. The increase as a percentage of sales is due to our focus
on selling Websense Enterprise.

Other products and services.Other products and services revenue
decreased from $1.5 million in 1999 to $761,000 in 2000.
Other products and services revenue accounted for 4% of revenues
in 2000 compared to 17% in 1999. The decrease as a percentage of
sales in 2000 is consistent with the strategy that transformed
Websense from a network security service organization and
reseller of third party security software to a provider of
subscription-based employee Internet management products.



| |                 
| | ----------------
| | Cost of Revenues

Cost of
subscriptions.Cost of subscriptions
increased from $1.1 million in 1999 to $2.0 million in
2000. This increase was primarily due to additional technical
support personnel and the development of automation tools by our
database group, as well as increased allocated facilities and
human resource costs in 2000. Cost of subscriptions as a
percentage of subscription revenue decreased to 12% in 2000 from
15% in 1999. This decrease in costs of subscription revenue as a
percentage of subscription revenue was due to increased revenue
and the relative fixed nature of these costs.

Cost of other products and
services.Cost of other products and
services decreased from $1.2 million in 1999 to $718,000 in
2000. The costs have decreased as a result of the shift in focus
away from reselling hardware and software. Cost of other
products and services as a percentage of other products and
services revenue increased to 94% in 2000 compared to 79% in
1999 primarily due to lower volume discounts on the firewall
software and computers that we resold.



| |             
| | ------------
| | Gross Margin

Gross margin increased from $6.4 million in
1999 to $14.7 million in 2000. The increase was due to a
higher percentage mix of subscription revenues, which generate a
higher margin as compared to other products and services, as
well as increased subscription revenues.

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Operating
Expenses

Selling and
marketing.Selling and marketing
expenses increased from $6.3 million in 1999 to
$12.7 million in 2000. The $6.4 million increase in
selling and marketing expenses in 2000 was primarily due to
increased costs of $2.6 million due to increased headcount,
increases in advertising and promotional costs of
$1.3 million, increased travel costs of $328,000 and
increased allocations of information technology, facilities and
human resource costs of $2.2 million.

Research and
development.Research and development
expenses increased from $3.9 million in 1999 to
$6.3 million in 2000. The increase of $2.4 million in
research and development expenses was primarily a result of
increased headcount of $1.0 million and increased
allocations of information technology, facilities and human
resource costs of $1.4 million.

General and
administrative.General and
administrative expenses decreased from $3.8 million in 1999
to $3.5 million in 2000. The $300,000 decrease in general
and administrative expenses in 2000 is primarily due to the
expanded allocation of information technology, facilities and
human resource costs to other departments of $600,000 and to
non-recurring charges in the first quarter of 1999 which
consisted of an additional allowance for doubtful accounts of
$100,000 partially offset by increased costs related to being a
public company of $400,000.

Amortization of stock-based
compensation.Amortization of
stock-based compensation increased from $1.8 million in
1999 to $1.9 million in 2000. There was no amortization of
stock-based compensation in periods prior to 1999. The increase
in the amortization expense in 2000 was primarily due to the
large number of option grants that occurred after March 1999 for
which deferred compensation was recorded as well as deferred
compensation recorded for options issued in the first quarter of
2000.

Interest
Income, Net

Net interest income increased from $225,000 in
1999 to $3.8 million in 2000. This increase reflected an
increase in interest income generated from higher average cash
balances and investments in marketable securities in 2000, which
included the proceeds from our initial public offering completed
in March 2000.

Liquidity and Capital Resources

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

As of December 31, 2001, we had cash and
cash equivalents of $23.7 million and investments in
marketable securities of $79.4 million and an accumulated
deficit of $17.7 million.

Net cash provided by operating activities was
$20.8 million in 2001 and $7.7 million in 2000 compared to
net cash used in operating activities of $421,000 in 1999. In
2001 and 2000, cash provided by operating activities is
primarily due to an increase in our subscriptions (which are
initially recorded as deferred revenue) and interest earnings on
our invested cash. In 1999, cash used in operations was
primarily the result of our net loss partially offset by an
increase in deferred revenue. Our operating cash flow and
revenue are significantly influenced by subscription renewals,
and a decrease in subscription renewals would negatively impact
our operating cash flow and revenue.

Net cash used in investing activities was
$12.8 million in 2001 compared to $70.3 million in
2000 and $1.7 million in 1999. The relative decrease in
cash used in investing activities in 2001 is primarily due to
purchases of marketable securities mainly using positive
operating cash flow whereas we utilized the proceeds of our
initial public offering in March 2000 as well as positive
operating cash flow to purchase marketable securities during
2000. The relative increase in cash used in investing activities
in 2000 is primarily due to purchases of marketable securities
using proceeds of our initial public offering in March 2000. In
1999, cash

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used in investing activities consisted primarily
of capital expenditures related to our investments in computer
equipment and facilities, which were required to support our
business expansion.


Net cash provided by financing activities was
$2.6 million in 2001 compared to $64.9 million in 2000
and $11.1 million in 1999. Cash provided by financing
activities in 2001 was primarily due to proceeds received from
the exercise of stock options and warrants as well as the
issuance of common stock pursuant to our employee stock purchase
plan. Cash provided by financing activities in 2000 was
primarily due to net proceeds of $65.7 million from the
completion in March 2000 of our initial public offering, reduced
by the $1.5 million repayment of our outstanding equipment
financing notes payable in the second quarter of 2000. In 1999,
cash provided by financing activities consisted primarily of
$9.8 million received from the sale of Series B
Convertible Preferred Stock and $1.3 million in proceeds
from borrowings.

In June 2000, we entered into a loan and security
agreement with a bank for a credit facility of
$1.5 million. At December 31, 2001, we had
$1.0 million available for drawing under this facility and
$500,000 set aside for existing or future letters of credit. We
have operating lease commitments of $1.0 million expiring in
2002 and $139,000 expiring in 2003.

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

Summarized Quarterly Data
(Unaudited)

The following tables present unaudited quarterly
financial information for the eight quarters ended
December 31, 2001. We believe this information reflects all
adjustments (consisting only of normal recurring adjustments)
that we consider necessary for a fair presentation of such
information in accordance with generally accepted accounting
principles. The results for any quarter are not necessarily
indicative of results for any future period.

|                                    |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|----------------------------------- |  | ------------------------------------- | ------ | ----------- |  | ----------- | ------ | ----------- |  | - | ------ | - |  | - | ------ | -
|                                    |  | 1st Quarter                           |        | 2nd Quarter |  | 3rd Quarter |        | 4th Quarter
|                                    |  |                                       |        |             |  |             |        |            
|                                    |  |                                      
|                                    |  | (In thousands, except per share data)
|2001                                |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Net revenue                         |  | $                                     | 6,861  |             |  | $           | 8,203  |             |  | $ | 9,549  |   |  | $ | 11,280 |  
|Gross margin                        |  |                                       | 6,044  |             |  |             | 7,366  |             |  |   | 8,638  |   |  |   | 10,243 |  
|Income (loss) from operations       |  |                                       | (1,447 | )           |  |             | (1,183 | )           |  |   | 874    |   |  |   | 618    |  
|                                    |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Net income (loss)                   |  | $                                     | (387   | )           |  | $           | (13    | )           |  | $ | 1,873  |   |  | $ | 1,643  |  
|                                    |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Basic income (loss) per share(1)    |  | $                                     | (0.02  | )           |  | $           | (0.00  | )           |  | $ | 0.09   |   |  | $ | 0.08   |  
|                                    |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Diluted income (loss) per share(1)  |  | $                                     | (0.02  | )           |  | $           | (0.00  | )           |  | $ | 0.08   |   |  | $ | 0.07   |  
|                                    |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|2000                                |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Net revenue                         |  | $                                     | 3,125  |             |  | $           | 3,794  |             |  | $ | 4,743  |   |  | $ | 5,779  |  
|Gross margin                        |  |                                       | 2,506  |             |  |             | 3,130  |             |  |   | 4,063  |   |  |   | 5,035  |  
|Loss from operations                |  |                                       | (2,913 | )           |  |             | (2,801 | )           |  |   | (1,946 | ) |  |   | (2,048 | )
|                                    |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Net loss                            |  | $                                     | (2,809 | )           |  | $           | (1,583 | )           |  | $ | (789   | ) |  | $ | (766   | )
|                                    |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  
|Basic and diluted loss per share(1) |  | $                                     | (0.32  | )           |  | $           | (0.08  | )           |  | $ | (0.04  | ) |  | $ | (0.04  | )
|                                    |  |                                       |        |             |  |             |        |             |  |   |        |   |  |   |        |  

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---



|    |                                                                                                                                                                                                                                                                                                                                 
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Basic and diluted net income (loss) per
	share computations for each quarter are independent and may not
	add up to the net loss per share computation for the respective
	year. See Note 1 of Notes to the Consolidated Financial
	Statements for an explanation of the determination of basic and
	diluted net loss per share.

Risks and Uncertainties

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



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

In 2001 we achieved profitability for the first
time since 1996. Prior to the third quarter of 2001, we had
experienced net losses in each of our previous 21 fiscal
quarters, and as of December 31, 2001, we had an
accumulated deficit of $17.7 million. We incurred net
losses of $5.9 million and $9.3 million for the years
ended December 31, 2000 and 1999, respectively. We may be
unable to maintain profitability unless our revenues continue to
increase at a greater rate than our operating expenses. We
currently expect our operating expenses to increase
substantially, as we, among other things:



| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | expand our domestic and international selling and
	marketing activities;                                                   
|
| |  | expand our Websense product offerings;                                                                                     
|
| |  | increase our research and development efforts to
	upgrade our existing products and develop new products and
	technologies;
|
| |  | develop and expand our proprietary database and
	systems;                                                                  
|
| |  | upgrade our operational and financial systems,
	procedures and controls; and                                               
|
| |  | hire additional personnel, including sales and
	marketing personnel, engineers and other technical staff.                  

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



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

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

21



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or delay in diversifying our existing offerings
could harm our business, results of operations and financial
condition.




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

Based on our experience with potential customers,
we believe that many corporations are unaware of the existence
or scope of problems caused by employee misuse of the Internet.
In addition, there may be a time-limited opportunity to achieve
and maintain a significant share of the market for employee
Internet management products due in part to the emerging nature
of this market and the substantial resources available to our
existing and potential competitors. If employers do not
recognize or acknowledge these problems, then the market for
Websense Enterprise may develop more slowly than we expect,
which could adversely affect our operating results. Developing
and maintaining awareness of our Websense brand is critical to
achieving widespread acceptance of our existing and future
employee Internet management products. Furthermore, we believe
that the importance of brand recognition will increase as
competition in our market develops. Successful promotion of our
Websense brand will depend largely on the effectiveness of our
marketing efforts and on our ability to develop reliable and
useful products at competitive prices. If we fail to
successfully promote our Websense brand, or if our expenses to
promote and maintain our Websense brand are greater than
anticipated, our results of operations and financial condition
could suffer.



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

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



| |   |                                                                                                                                                               
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | companies offering network filtering products,
	such as SurfControl plc, Secure Computing, Symantec Corporation,
	N2H2 Incorporated, and 8e6 Technologies; and
|
| |  | companies offering network reporting products,
	such as the WebTrends business acquired by NetIQ in 2001 and
	Wavecrest Computing.                            

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



| |   |                                                                              
| | - | -----------------------------------------------------------------------------
| |  | greater name recognition and larger marketing
	budgets and resources;        
|
| |  | established marketing relationships and access to
	larger customer bases; and
|
| |  | substantially greater financial, technical and
	other resources.             

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



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

Our future success depends on achieving
substantial revenue from customer renewals for subscriptions to
Websense Enterprise. Subscriptions for Websense Enterprise
typically have durations of 12, 24 or 36 months.

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Our customers have no obligation to renew their
subscriptions upon expiration. We may be unable to generate
significant revenue from renewals. In order to maintain our
revenues we must be successful in selling renewal subscriptions.


Our future success also depends on our ability to
sell further subscriptions to existing customers in order to
obtain additional seats within their respective organizations.
As a result, to increase our revenues we must sell our existing
customers additional subscriptions for Websense Enterprise to
get greater coverage of their workforces. This may require
increasingly sophisticated and costly sales efforts targeting
senior management and other management personnel associated with
our customers Internet infrastructure.



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

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



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

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



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

We currently sell the significant majority of our
products indirectly. We intend to rely on our indirect sales
channels for increasing levels of revenue. We depend on our
indirect sales channels, including value-added resellers,
distributors, and providers of managed Internet services, to
offer Websense Enterprise to a larger customer base than can be
reached through a direct sales effort. We will need to expand
our existing relationships and enter into new relationships to
increase our current and future market share and revenue. We may
be unable to maintain and expand our existing relationships or
enter into new relationships on commercially reasonable terms or
at all. If we are unable to maintain and expand our existing
relationships or enter into new relationships, we would lose
customer introductions and co-marketing benefits and our
operating results could suffer.



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

Our indirect sales channels accounted for more
than 80% of our revenues in 2001. We anticipate that sales from
our various indirect sales channels, including value-added
resellers, distributors, providers of managed Internet services,
and others, will continue to account for a large percentage of
our total revenues in

23



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future periods. None of these parties is
obligated to continue selling our products or to make any
purchases from us. Our ability to generate increased revenue
depends significantly upon the ability and willingness of our
indirect sales channels to market and sell our products to
organizations worldwide. If they are unsuccessful in their
efforts, our operating results will suffer. We cannot control
the level of effort these parties expend or the extent to which
any of them will be successful in marketing and selling our
products. Some of our indirect sales channels also market and
sell products that compete with Websense Enterprise or may
decide to do so in the future. We may not be able to prevent
these parties from devoting greater resources to support our
competitors products and/or eliminating their efforts to
sell Websense Enterprise.




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

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



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

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



| |                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Negative economic conditions in the United
	States and in the other countries and geographic areas in which
	we offer our products may negatively impact our ability to
	maintain profitability.

During 2001, the United States and other
international markets in which we offer our products experienced
a significant economic downturn. In addition, the United States
and other countries suffered significant acts of hostility and
terror. Such acts may increase or prolong such negative economic
conditions. The economic downturn may impact our ability to
sustain profitability by:



| |   |                                                                                            
| | - | -------------------------------------------------------------------------------------------
| |  | negatively affecting growth in demand for our
	products and services;                      
|
| |  | causing some of our customers to be unable to pay
	for subscriptions they have ordered; and
|
| |  | decreasing the renewal rate of subscriptions by
	our existing customers.                   

In addition, the economic downturn may force
companies to prioritize expenditures, and these companies may
decide that subscriptions to our products are unnecessary
expenditures in a slowing economy. There can be no certainty as
to the degree or severity of the duration of this downturn. We
also cannot predict the extent

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and timing of the impact of the economic downturn
in the United States and in other countries and geographic
regions in which we conduct our business.




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

We market and sell our products outside the
United States through value-added resellers, distributors and
other resellers. International sales represented approximately
35% of our total revenues in 2001. As a key component of our
business strategy, we intend to expand our international sales.
In addition to the risks associated with our domestic sales, our
international sales are subject to the following risks:



| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | dependence on foreign distributors and their
	sales channels;                                                              
|
| |  | the ability of our Websense Enterprise products
	to properly categorize and filter Web sites containing foreign
	languages;
|
| |  | laws and business practices favoring foreign
	competitors;                                                                 
|
| |  | compliance with multiple, conflicting and
	changing governmental laws and regulations, including tax laws
	and regulations;
|
| |  | foreign currency fluctuations;                                                                                             
|
| |  | longer accounts receivable payment cycles and
	other collection difficulties; and                                          
|
| |  | regional economic and political conditions.                                                                                

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



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

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



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

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

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

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



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

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



| |   |                                                                                                                    
| | - | -------------------------------------------------------------------------------------------------------------------
| |  | concentration of marketing expenses for
	activities such as trade shows and advertising campaigns;                 
|
| |  | concentration of general and administrative
	expenses, such as recruiting expenses and professional services
	fees;
|
| |  | concentration of research and development costs;
	and                                                              
|
| |  | concentration of expenses associated with
	commissions paid on sales of subscriptions to Websense
	Enterprise.     

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



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

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



| |   |                                                                                            
| | - | -------------------------------------------------------------------------------------------
| |  | announcements of technological innovations or new
	products or services by our competitors;
|
| |  | demand for Websense Enterprise, including
	fluctuations in subscription renewals;          
|
| |  | fluctuations in revenues from our indirect sales
	channels;                                
|
| |  | changes in the pricing policies of our
	competitors; and                                   
|
| |  | changes in government regulations.                                                         

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



| |   |                                                                                                     
| | - | ----------------------------------------------------------------------------------------------------
| |  | announcements of technological innovations or new
	products or services by us;                      
|
| |  | changes in our pricing policies;                                                                    
|
| |  | quarterly variations in our operating expenses;
	and                                                
|
| |  | our technological capabilities to accommodate the
	future growth in our operations or our customers.

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

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

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



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

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



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

The success of Websense Enterprise depends on the
breadth and accuracy of our database. Although our database
currently catalogs more than 3 million Web sites, it
contains only a fraction of the material available on the
Internet. In addition, the total number of Web sites is growing
rapidly, and we expect this rapid growth rate to continue in the
future. Our database and database technologies may not be able
to keep pace with the growth in the number of Web sites,
especially the growing number of Web sites containing foreign
languages. Further, the ongoing evolution of the Internet will
require us to continually improve the functionality, features
and reliability of our database. Because Websense Enterprise can
only manage access to Web sites included in our database, if our
database does not contain a meaningful portion of relevant Web
sites, the effectiveness of Websense Enterprise will be
significantly diminished. Any failure of our database to keep
pace with the rapid growth and technological change of the
Internet will impair the market acceptance of Websense
Enterprise, which in turn will harm our business, results of
operations and financial condition.



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

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

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

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



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

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

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

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



| |                                                              
| | -------------------------------------------------------------
| | Evolving regulation of the Internet may
	affect us adversely.

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



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

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

28



---



##### Table of Contents





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

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



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

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



| |                                                                                                                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our growth could strain our personnel and
	infrastructure resources, and if we are unable to implement
	appropriate controls and procedures to manage our growth, we may
	not be able to successfully implement our business
	plan.

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



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

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



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

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

29



---



##### Table of Contents



Acquisitions and investments involve numerous
risks, including:



| |   |                                                                                      
| | - | -------------------------------------------------------------------------------------
| |  | difficulties in integrating operations,
	technologies, services and personnel;       
|
| |  | diversion of financial and management resources
	from existing operations;           
|
| |  | risk of entering new markets;                                                        
|
| |  | potential loss of key employees; and                                                 
|
| |  | inability to generate sufficient revenues to
	offset acquisition or investment costs.

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



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

Some provisions of our certificate of
incorporation and bylaws, as well as some provisions of Delaware
law, may discourage, delay or prevent third parties from
acquiring us, even if doing so would be beneficial to our
stockholders. For example, our certificate of incorporation
provides for a classified board, with each board member serving
a staggered three-year term. It also provides that stockholders
may not fill board vacancies, call stockholder meetings or act
by written consent. Our bylaws further provide that advance
written notice is required prior to stockholder proposals. Each
of these provisions makes it more difficult for stockholders to
obtain control of our board or initiate actions that are opposed
by the then current board. Additionally, we have authorized
preferred stock that is undesignated, making it possible for the
board to issue preferred stock with voting or other rights and
preferences that could impede the success of any attempted
change of control. Delaware law also could make it more
difficult for a third party to acquire us. Section 203 of
the Delaware General Corporation Law may have an anti-takeover
effect with respect to transactions not approved in advance by
our board, including discouraging attempts that might result in
a premium over the market price of the shares of common stock
held by our stockholders.



| |                                    
| | -----------------------------------
| | We do not intend to pay
	dividends.

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




Item 7A.     Quantitative
and Qualitative Disclosures About Market Risk

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

We are exposed to changes in interest rates
primarily from our short-term available-for-sale investments.
Under our current policies, we do not use interest rate
derivative instruments to manage exposure to interest rate
changes. A hypothetical 100 basis point adverse move in
interest rates along the entire interest rate yield curve would
not materially affect the fair value of our interest sensitive
financial instruments at December 31, 2001. Declines in
interest rates over time will, however, reduce our interest
income.

In addition, we have a $1.5 million loan and
security agreement with a financial institution. Interest on
this credit facility is 5.00% at December 31, 2001. At
December 31, 2001, we had no advances outstanding under
this credit facility. If we were to draw advances under this
facility changes in interest rates would affect the interest
expense we would pay and could, therefore, impact our cash flows
and results of operations.

30



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##### Table of Contents






Item 8.     Financial
Statements and Supplementary Data

See Index to Consolidated Financial Statements on
page F-1 below for a list of the financial statements being
filed herein.




Item 9.     Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure

None




PART III




Item 10.     Directors
and Executive Officers of the Registrant

(a) Identification of Directors. Information
concerning our directors is incorporated by reference from the
section captioned Proposal 1: Election of
Directors contained in our Proxy Statement related to the
Annual Meeting of Stockholders to be held on June 12, 2002.

(b) Identification of Executive Officers.
Information concerning our executive officers is set forth under
the section captioned Executive Officers in
Part I of this report.

(c) Compliance with Section 16(a) of
the Exchange Act. Information concerning compliance with
Section 16(a) of the Exchange Act is incorporated by
reference from the section captioned Section 16(a)
Beneficial Ownership Reporting Compliance contained in our
Proxy Statement related to the Annual Meeting of Stockholders to
be held on June 12, 2002.




Item 11.     Executive
Compensation

The information required by item 11 of
Form 10-K is incorporated by reference from the information
contained in the section captioned Executive Compensation
and Other Information in our Proxy Statement related to
the Annual Meeting of Stockholders to be held on June 12,
2002.






|         |                                                                                                 
|-------- | ------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
	Owners and Management and Related Stockholder
	Matters

The information required by item 12 is
incorporated by reference from the information contained in the
section captioned Ownership of Securities in our
Proxy Statement related to the Annual Meeting of Stockholders to
be held on June 12, 2002.




Item 13.     Certain
Relationships and Related Transactions

The information required by item 13 is
incorporated by reference from the information contained in the
section captioned Certain Relationships and Related
Transactions in our Proxy Statement related to the Annual
Meeting of Stockholders to be held on June 12, 2002.

31



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##### Table of Contents






PART IV




Item 14.     Exhibits,
Financial Statement Schedules and Reports on
Form 8-K

(a) The following documents are filed as
part of this report:



| |                                                                                                                                                                                                          
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 1.     Consolidated
	Financial Statements.The following consolidated financial
	statements of Websense, Inc. are included in a separate section
	of this report commencing on the pages referenced below.

|                                                                                                      |  |        |     | 
|----------------------------------------------------------------------------------------------------- |  | ------ | --- | 
|                                                                                                      |  | Page  
|                                                                                                      |  | Number
|                                                                                                      |  |       
|Report of Ernst & Young LLP, Independent
	Auditors                                                    |  |        | F-2 | 
|Consolidated Balance Sheets as of
	December 31, 2001 and 2000                                         |  |        | F-3 | 
|Consolidated Statements of Operations for the
	years ended December 31, 2001, 2000 and 1999           |  |        | F-4 | 
|Consolidated Statements of Stockholders
	Equity for the years ended December 31, 2001, 2000 and 1999 |  |        | F-5 | 
|Consolidated Statements of Cash Flows for the
	years ended December 31, 2001, 2000 and 1999           |  |        | F-6 | 
|Notes to Consolidated Financial Statements                                                            |  |        | F-7 | 



| |                                       
| | --------------------------------------
| | 2.     Financial
	Statement Schedules.

|                                              |  |  |      | 
|--------------------------------------------- |  |  | ---- | 
|Schedule II Valuation and Qualifying Accounts |  |  | II-1 | 



| |                                                                                                                                                                                                                          
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Schedules not listed above have been omitted
	because they are not applicable, not required, or the
	information required to be set forth therein is included in the
	consolidated financial statements or notes thereto.

|        |          |                         |  |                                                                                                                                          
|------- | -------- | ----------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |          |                        
|Number  |          | Description of Document
|        |          |                        
|        | 3.1(1)   |                         |  | Amended and Restated Certificate of Incorporation                                                                                        
|        | 3.2(1)   |                         |  | Restated Bylaws                                                                                                                          
|        | 4.1(1)   |                         |  | Specimen Stock Certificate of Websense, Inc.                                                                                             
|        | 10.1(1)  |                         |  | Amended and Restated Registration Rights
	Agreement dated June 9, 1999                                                                   
|        | 10.2(1)  |                         |  | Form of Subscription Agreement regarding
	Series B Preferred Stock                                                                       
|        | 10.3(1)  |                         |  | Warrant to Purchase Common Stock between
	Websense, Inc. and Alps System Integration Co., Ltd., dated
	April 15, 1999                    
|        | 10.4(1)  |                         |  | Form of Warrant to Purchase Common Stock between
	Websense, Inc. and entities listed on Schedule A attached
	thereto, dated July 30, 1999
|        | 10.5(1)* |                         |  | Employment Agreement by and between Websense,
	Inc. and John B. Carrington, dated May 10, 1999                                           
|        | 10.6(1)* |                         |  | Employment Agreement by and between Websense,
	Inc. and Douglas C. Wride, dated June 11, 1999                                            
|        | 10.7(1)  |                         |  | Lease Agreement between Websense, Inc. and
	Legacy-RECP Sorrento OPCO, LLC, dated June 21, 1999, as
	amended                             
|        | 10.8(1)  |                         |  | 1998 Equity Incentive Plan                                                                                                               
|        | 10.9(1)* |                         |  | Standard Terms and Conditions Relating to
	Incentive Stock Option Under the 1998 Equity Incentive Plan                                   
|        | 10.10(1) | *                       |  | 2000 Stock Incentive Plan                                                                                                                
|        | 10.11(1) | *                       |  | 2000 Stock Incentive Plan, Notice of Grant of
	Stock Option                                                                              
|        | 10.12(1) | *                       |  | 2000 Stock Incentive Plan, Form of Incentive
	Stock Option Agreement                                                                     
|        | 10.13(1) | *                       |  | 2000 Employee Stock Purchase Plan                                                                                                        
|        | 10.14(1) |                         |  | Form of Indemnification Agreement between
	Websense, Inc. and its directors                                                              

32



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##### Table of Contents



|        |          |                         |  |                                                                                                                   
|------- | -------- | ----------------------- |  | ------------------------------------------------------------------------------------------------------------------
|Exhibit |          |                        
|Number  |          | Description of Document
|        |          |                        
|        | 10.15(1) |                         |  | Form of Indemnification Agreement between
	Websense, Inc. and its officers                                        
|        | 10.16(2) |                         |  | Lease Agreement between Websense, Inc. and
	Legacy-RECP Sorrento OPCO, LLC, dated February 12, 2000               
|        | 10.17(2) |                         |  | First Amendment to Lease Agreement between
	Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated
	June 2, 2000
|        | 21.1     |                         |  | Subsidiaries of the Registrant                                                                                    
|        | 23.1     |                         |  | Consent of Ernst & Young LLP, Independent
	Auditors                                                               



---



|  |                                                                    
|- | -------------------------------------------------------------------
|* | Indicates management contract or compensatory
	plan or arrangement.



|    |                                                                                                                                                             
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Previously filed as an exhibit to our
	Registration Statement on Form S-1 (Registration
	No. 333-95619) and incorporated herein by reference.               
|   
|(2) | Previously filed as an exhibit to our
	Form 10-K for the period ended December 31, 2000
	(Registration No. 000-30093) and incorporated herein by
	reference.

(b) Reports on Form 8-K.

We did not file any reports on Form 8-K
during the quarter ended December 31, 2001.

Supplemental Information

No Annual Report to stockholders or proxy
materials have been sent to stockholders as of the date of this
report. The Annual Report to stockholders and proxy material
will be furnished to our stockholders subsequent to the filing
of this report and we will furnish such material to the SEC at
that time.

33



---



##### Table of Contents






SIGNATURES

Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant
has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.



| |               
| | --------------
| | WEBSENSE, INC.



| |     |                     
| | --- | --------------------
| | By: | /s/ DOUGLAS C. WRIDE

| |                        
| | -----------------------
| |                        
| | Douglas C. Wride       
| | Chief Financial Officer



Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|                                         |  |                                                                       |  |               
|---------------------------------------- |  | --------------------------------------------------------------------- |  | --------------
|Signature                                |  | Title                                                                 |  | Date          
|                                         |  |                                                                       |  |               
|/s/ JOHN B. CARRINGTONJohn B. Carrington |  | Chairman of the Board, President and Chief
	Executive Officer         |  | March 29, 2002
|/s/ DOUGLAS WRIDEDouglas Wride           |  | Chief Financial Officer (principal financial and
	accounting officer) |  | March 29, 2002
|/s/ ROBERT J. LOARIERobert J. Loarie     |  | Director                                                              |  | March 29, 2002
|/s/ BRUCE T. COLEMANBruce T. Coleman     |  | Director                                                              |  | March 29, 2002
|/s/ JOHN SCHAEFERJohn Schaefer           |  | Director                                                              |  | March 29, 2002
|/s/ GARY E. SUTTONGary E. Sutton         |  | Director                                                              |  | March 29, 2002
|/s/ PETER WALLERPeter Waller             |  | Director                                                              |  | March 29, 2002

34



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##### Table of Contents



WEBSENSE, INC.

INDEX TO CONSOLIDATED FINANCIAL
STATEMENTS

|                                                                                                      |  |      |     | 
|----------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                      |  | Page
|                                                                                                      |  |     
|Index to Consolidated Financial Statements                                                            |  |      | F-1 | 
|Report of Ernst & Young LLP, Independent
	Auditors                                                    |  |      | F-2 | 
|Consolidated Balance Sheets as of
	December 31, 2001 and 2000                                         |  |      | F-3 | 
|Consolidated Statements of Operations for the
	years ended December 31, 2001, 2000 and 1999           |  |      | F-4 | 
|Consolidated Statements of Stockholders
	Equity for the years ended December 31, 2001, 2000 and 1999 |  |      | F-5 | 
|Consolidated Statements of Cash Flows for the
	years ended December 31, 2001, 2000 and 1999           |  |      | F-6 | 
|Notes to Consolidated Financial Statements                                                            |  |      | F-7 | 

F-1



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##### Table of Contents



REPORT OF ERNST & YOUNG LLP, INDEPENDENT
AUDITORS

The Board of Directors and Stockholders

Websense, Inc.


We have audited the accompanying consolidated
balance sheets of Websense, Inc. as of December 31, 2001
and 2000 and the related consolidated statements of operations,
stockholders equity, and cash flows for each of the three
years in the period ended December 31, 2001. Our audits
also included the financial statement schedule listed in the
Index at Item 14(a). These financial statements and
schedule are the responsibility of the Companys
management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.

We conducted our audits in accordance with
auditing standards generally accepted in the United States.
Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits
provide a reasonable basis for our opinion.

In our opinion, the financial statements referred
to above present fairly, in all material respects, the
consolidated financial position of Websense, Inc. at
December 31, 2001 and 2000, and the consolidated results of
their operations and their cash flows for each of the three
years in the period ended December 31, 2001, in conformity
with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material
respects the information set forth therein.



| |                      
| | ---------------------
| | /S/ ERNST & YOUNG LLP

San Diego, California

January 18, 2002


F-2



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##### Table of Contents



WEBSENSE, INC.

CONSOLIDATED BALANCE SHEETS

|                                       |                                                                                                                                            |                            |                      |         |        |         |       |         |        |        | 
|-------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------ | -------------------------- | -------------------- | ------- | ------ | ------- | ----- | ------- | ------ | ------ | 
|                                       |                                                                                                                                            |                           
|                                       |                                                                                                                                            | December 31,              
|                                       |                                                                                                                                            |                           
|                                       |                                                                                                                                            | 2001                       |                      | 2000   
|                                       |                                                                                                                                            |                            |                      |        
|                                       |                                                                                                                                            |                           
|                                       |                                                                                                                                            | (In thousands, except per 
|                                       |                                                                                                                                            | share amounts)            
|ASSETS                                
|Current assets:                        |                                                                                                                                            |                            |                      |         |        |         |       |        
|                                       | Cash and cash equivalents                                                                                                                  |                            | $                    | 23,715  |        |         | $     | 13,106  |       
|                                       | Investments in marketable securities                                                                                                       |                            |                      | 79,393  |        |         |       | 68,153  |       
|                                       | Accounts receivable, net of allowance for
	doubtful accounts of $334 and $125 at December 31, 2001 and
	2000                               |                            |                      | 12,001  |        |         |       | 7,073   |       
|                                       | Accounts receivable from a related party                                                                                                   |                            |                      | 525     |        |         |       | 525     |       
|                                       | Other current assets                                                                                                                       |                            |                      | 1,084   |        |         |       | 616     |       
|                                       |                                                                                                                                            |                            |                      |         |        |         |       |        
|                                       |                                                                                                                                            |                            | Total current assets |         |        | 116,718 |       |         |        | 89,473 | 
|                                       | Property and equipment, net                                                                                                                |                            |                      | 2,710   |        |         |       | 2,793   |       
|                                       | Deposits and other assets                                                                                                                  |                            |                      | 384     |        |         |       | 188     |       
|                                       |                                                                                                                                            |                            |                      |         |        |         |       |        
|                                       | Total assets                                                                                                                               |                            | $                    | 119,812 |        |         | $     | 92,454  |       
|                                       |                                                                                                                                            |                            |                      |         |        |         |       |        
|LIABILITIES AND STOCKHOLDERS
	EQUITY 
|Current liabilities:                   |                                                                                                                                            |                            |                      |         |        |         |       |        
|                                       | Accounts payable                                                                                                                           |                            | $                    | 640     |        |         | $     | 815     |       
|                                       | Accrued payroll and related benefits                                                                                                       |                            |                      | 2,750   |        |         |       | 1,764   |       
|                                       | Other accrued expenses                                                                                                                     |                            |                      | 2,264   |        |         |       | 1,324   |       
|                                       | Current portion of deferred revenue                                                                                                        |                            |                      | 31,218  |        |         |       | 16,551  |       
|                                       |                                                                                                                                            |                            |                      |         |        |         |       |        
|                                       |                                                                                                                                            | Total current liabilities  |                      |         | 36,872 |         |       |         | 20,454 |       
|Deferred revenue, less current portion |                                                                                                                                            |                            | 12,260               |         |        |         | 7,936 |        
|Stockholders equity:                  |                                                                                                                                            |                            |                      |         |        |         |       |        
|                                       | Common stock  $0.01 par value; 100,000
	shares authorized; 20,596 and 19,705 shares issued and
	outstanding at December 31, 2001 and 2000 |                            |                      | 206     |        |         |       | 197     |       
|                                       | Additional paid-in capital                                                                                                                 |                            |                      | 88,639  |        |         |       | 86,111  |       
|                                       | Deferred compensation                                                                                                                      |                            |                      | (531    | )      |         |       | (1,459  | )     
|                                       | Accumulated deficit                                                                                                                        |                            |                      | (17,694 | )      |         |       | (20,810 | )     
|                                       | Accumulated other comprehensive income                                                                                                     |                            |                      | 60      |        |         |       | 25      |       
|                                       |                                                                                                                                            |                            |                      |         |        |         |       |        
|                                       |                                                                                                                                            | Total stockholders equity |                      |         | 70,680 |         |       |         | 64,064 |       
|                                       |                                                                                                                                            |                            |                      |         |        |         |       |        
|                                       | Total liabilities and stockholders equity                                                                                                 |                            | $                    | 119,812 |        |         | $     | 92,454  |       
|                                       |                                                                                                                                            |                            |                      |         |        |         |       |        

See accompanying notes.

F-3



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##### Table of Contents



WEBSENSE, INC.

CONSOLIDATED STATEMENTS OF
OPERATIONS

|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |       |        | 
|------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------ | ------ | ------ | ------ | ---- | ------ | ------ | ------ | - | ------ | ----- | ------ | 
|                                      |                                                                                                                                                                                                   |                         
|                                      |                                                                                                                                                                                                   | Years Ended December 31,
|                                      |                                                                                                                                                                                                   |                         
|                                      |                                                                                                                                                                                                   | 2001                     |        | 2000   |        | 1999
|                                      |                                                                                                                                                                                                   |                          |        |        |        |     
|                                      |                                                                                                                                                                                                   |                         
|                                      |                                                                                                                                                                                                   | (In thousands, except   
|                                      |                                                                                                                                                                                                   | per share amounts)      
|Revenues:                             |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      | Subscriptions                                                                                                                                                                                     |                          | $      | 35,530 |        |      | $      | 16,680 |        |   | $      | 7,141 |       
|                                      | Other products and services                                                                                                                                                                       |                          |        | 363    |        |      |        | 761    |        |   |        | 1,506 |       
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      |                                                                                                                                                                                                   | Total revenues           |        |        | 35,893 |      |        |        | 17,441 |   |        |       | 8,647  | 
|Cost of revenues:                     |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      | Subscriptions                                                                                                                                                                                     |                          |        | 3,397  |        |      |        | 1,989  |        |   |        | 1,084 |       
|                                      | Other products and services                                                                                                                                                                       |                          |        | 205    |        |      |        | 718    |        |   |        | 1,191 |       
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      |                                                                                                                                                                                                   | Total cost of revenues   |        |        | 3,602  |      |        |        | 2,707  |   |        |       | 2,275  | 
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|Gross margin                          |                                                                                                                                                                                                   |                          | 32,291 |        |        |      | 14,734 |        |        |   | 6,372  |      
|Operating expenses:                   |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      | Selling and marketing (exclusive of $192, $589
	and $230 for the years ended December 31, 2001, 2000 and
	1999, respectively, reported below as amortization of
	stock-based compensation)        |                          |        | 19,707 |        |      |        | 12,726 |        |   |        | 6,311 |       
|                                      | Research and development (exclusive of $139, $359
	and $256 for the years ended December 31, 2001, 2000 and
	1999, respectively, reported below as amortization of
	stock-based compensation)     |                          |        | 7,642  |        |      |        | 6,287  |        |   |        | 3,913 |       
|                                      | General and administrative (exclusive of $529,
	$990 and $1,336 for the years ended December 31, 2001, 2000
	and 1999, respectively, reported below as amortization of
	stock-based compensation) |                          |        | 5,220  |        |      |        | 3,491  |        |   |        | 3,805 |       
|                                      | Amortization of stock-based compensation                                                                                                                                                          |                          |        | 860    |        |      |        | 1,938  |        |   |        | 1,822 |       
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      |                                                                                                                                                                                                   | Total operating expenses |        |        | 33,429 |      |        |        | 24,442 |   |        |       | 15,851 | 
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|Loss from operations                  |                                                                                                                                                                                                   |                          | (1,138 | )      |        |      | (9,708 | )      |        |   | (9,479 | )    
|Interest income, net                  |                                                                                                                                                                                                   |                          | 4,362  |        |        |      | 3,761  |        |        |   | 225    |      
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|Net income (loss) before income taxes |                                                                                                                                                                                                   |                          | 3,224  |        |        |      | (5,947 | )      |        |   | (9,254 | )    
|Provision for income taxes            |                                                                                                                                                                                                   |                          | 108    |        |        |      |       |        |        |   |       |      
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|Net income (loss)                     |                                                                                                                                                                                                   | $                        | 3,116  |        |        | $    | (5,947 | )      |        | $ | (9,254 | )    
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|Net income (loss) per share:          |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      | Basic net income (loss) per share                                                                                                                                                                 |                          | $      | 0.16   |        |      | $      | (0.35  | )      |   | $      | (1.25 | )     
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      | Diluted net income (loss) per share                                                                                                                                                               |                          | $      | 0.14   |        |      | $      | (0.35  | )      |   | $      | (1.25 | )     
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      | Weighted average shares  basic                                                                                                                                                                   |                          |        | 20,082 |        |      |        | 16,882 |        |   |        | 7,403 |       
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      
|                                      | Weighted average shares  diluted                                                                                                                                                                 |                          |        | 22,780 |        |      |        | 16,882 |        |   |        | 7,403 |       
|                                      |                                                                                                                                                                                                   |                          |        |        |        |      |        |        |        |   |        |      

See accompanying notes.

F-4



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##### Table of Contents



WEBSENSE, INC.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS
EQUITY

|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |        |       |        |  
|---------------------------- | --------------------------------------------------------------------------------------------- | --------------------------------------------------------------- | ------------------------------------------------ | ------------ | - | ---------- | -- | -------- | - | ----------- | ------ | ----------------- | - | ------------- | --- | ------ | - | ------ | ------ | ------ | - | - | ------ | ------ | - | - | ------- | ------ | ----- | ------ | -- | - | -- | -- | ------ | ------ | ----- | ------ | -
|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |       
|                             |                                                                                               | Convertible                                                     |                                                  |              |   |            |    |          |   |             |        |                   |   |              
|                             |                                                                                               | Preferred Stock                                                 |                                                  | Common Stock |   | Additional |    |          |   |             |        | Accumulated Other |   | Total        
|                             |                                                                                               |                                                                 |                                                  |              |   | Paid-in    |    | Deferred |   | Accumulated |        | Comprehensive     |   | Stockholders
|                             |                                                                                               | Shares                                                          |                                                  | Amount       |   | Shares     |    | Amount   |   | Capital     |        | Compensation      |   | Deficit       |     | Income |   | Equity
|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |       
|                             |                                                                                               |                                                                
|                             |                                                                                               | (In thousands)                                                 
|Balance at December 31, 1998 |                                                                                               |                                                                 | 3,704                                            |              |   | $          | 37 |          |   |             | 7,000  |                   |   | $             | 70  |        |   | $      | 4,285  |        |   | $ |       |        |   | $ | (5,609  | )      |       | $      |   |   |    | $  | (1,217 | )     
|                             | Preferred stock issued for cash, net of offering
	costs of $185                               |                                                                 |                                                  | 3,333        |   |            |    | 33       |   |             |        |                  |   |               |     |       |   |        |        | 9,782  |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 9,815  |      
|                             | Issuance of common stock upon exercise of options                                             |                                                                 |                                                  |             |   |            |    |         |   |             |        | 1,090             |   |               |     | 11     |   |        |        | 349    |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 360    |      
|                             | Issuance of common stock upon exercise of warrant                                             |                                                                 |                                                  |             |   |            |    |         |   |             |        | 250               |   |               |     | 3      |   |        |        |       |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 3      |      
|                             | Issuance of warrant in connection with the
	termination of an exclusive distributor agreement |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        | 37     |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 37     |      
|                             | Issuance of common stock for services                                                         |                                                                 |                                                  |              |   |            |    |          |   |             |        | 17                |   |               |     |       |   |        |        | 28     |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        | 28     |      
|                             | Issuance of common stock options for services                                                 |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        | 48     |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 48     |      
|                             | Deferred compensation                                                                         |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        | 4,407  |   |   |        | (4,407 | ) |   |         |       |       |        |    |  |    |    |        |       |      
|                             | Amortization of deferred compensation                                                         |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        |       |   |   |        | 1,822  |   |   |         |       |       |        |    |  |    |    |        | 1,822  |      
|                             | Net loss and comprehensive net loss                                                           |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        |       |   |   |        |       |   |   |         | (9,254 | )     |        |    |  |    |    |        | (9,254 | )    
|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |       
|Balance at December 31, 1999 |                                                                                               |                                                                 | 7,037                                            |              |   |            | 70 |          |   |             | 8,357  |                   |   |               | 84  |        |   |        | 18,936 |        |   |   | (2,585 | )      |   |   | (14,863 | )      |       |        |   |   |    |    | 1,642  |       
|                             | Issuance of common stock, net of offering costs
	of $6,281                                    |                                                                 |                                                  |             |   |            |    |         |   |             |        | 4,000             |   |               |     | 40     |   |        |        | 65,680 |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 65,720 |      
|                             | Conversion of preferred stock to common stock                                                 |                                                                 |                                                  | (7,037       | ) |            |    | (70      | ) |             |        | 7,037             |   |               |     | 70     |   |        |        |       |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        |       |      
|                             | Issuance of common stock upon exercise of options                                             |                                                                 |                                                  |             |   |            |    |         |   |             |        | 219               |   |               |     | 2      |   |        |        | 101    |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 103    |      
|                             | Issuance of common stock upon exercise of warrant                                             |                                                                 |                                                  |             |   |            |    |         |   |             |        | 55                |   |               |     | 1      |   |        |        | 15     |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 16     |      
|                             | Issuance of common stock for stock purchase plan                                              |                                                                 |                                                  |             |   |            |    |         |   |             |        | 37                |   |               |     |       |   |        |        | 567    |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 567    |      
|                             | Deferred compensation (net of forfeitures)                                                    |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        | 812    |   |   |        | (812   | ) |   |         |       |       |        |    |  |    |    |        |       |      
|                             | Amortization of deferred compensation                                                         |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        |       |   |   |        | 1,938  |   |   |         |       |       |        |    |  |    |    |        | 1,938  |      
|                             | Comprehensive income (loss):                                                                  |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |        |      
|                             |                                                                                               |                                                                 | Net loss                                         |              |   |           |    |          |   |            |        |                   |   |              |     |        |   |       |        |        |   |  |        |        |   |  |         |        |       | (5,947 | )  |   |    |   |        |        |       | (5,947 | )
|                             |                                                                                               |                                                                 | Unrealized gain on securities available for sale |              |   |           |    |          |   |            |        |                   |   |              |     |        |   |       |        |        |   |  |        |        |   |  |         |        |       |       |    |   |    | 25 |        |        |       | 25     |  
|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |       
|                             |                                                                                               |                                                                 | Comprehensive net loss                           |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |        |       | (5,922 | )
|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |       
|Balance at December 31, 2000 |                                                                                               |                                                                 |                                                 |              |   |            |   |          |   |             | 19,705 |                   |   |               | 197 |        |   |        | 86,111 |        |   |   | (1,459 | )      |   |   | (20,810 | )      |       |        | 25 |   |    |    | 64,064 |       
|                             | Issuance of common stock upon exercise of options                                             |                                                                 |                                                  |             |   |            |    |         |   |             |        | 782               |   |               |     | 8      |   |        |        | 1,553  |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 1,561  |      
|                             | Issuance of common stock upon exercise of warrant                                             |                                                                 |                                                  |             |   |            |    |         |   |             |        | 23                |   |               |     |       |   |        |        | 70     |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 70     |      
|                             | Issuance of common stock for stock purchase plan                                              |                                                                 |                                                  |             |   |            |    |         |   |             |        | 86                |   |               |     | 1      |   |        |        | 973    |   |   |        |       |   |   |         |       |       |        |    |  |    |    |        | 974    |      
|                             | Deferred compensation (net of forfeitures)                                                    |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        | (68    | ) |   |        | 68     |   |   |         |       |       |        |    |  |    |    |        |       |      
|                             | Amortization of deferred compensation                                                         |                                                                 |                                                  |             |   |            |    |         |   |             |        |                  |   |               |     |       |   |        |        |       |   |   |        | 860    |   |   |         |       |       |        |    |  |    |    |        | 860    |      
|                             | Comprehensive income:                                                                         |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |        |      
|                             |                                                                                               | Net income                                                      |                                                  |              |  |            |    |          |  |             |        |                   |  |               |     |        |  |        |        |        |  |   |        |        |  |   |         |        | 3,116 |        |    |   |   |    |        |        | 3,116 |       
|                             |                                                                                               | Net change in unrealized gain on securities
	available for sale |                                                  |              |  |            |    |          |  |             |        |                   |  |               |     |        |  |        |        |        |  |   |        |        |  |   |         |        |      |        |    |   | 35 |    |        |        | 35    |       
|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |       
|                             |                                                                                               | Comprehensive net income                                        |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |        | 3,151 |       
|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |       
|Balance at December 31, 2001 |                                                                                               |                                                                 |                                                 |              |   | $          |   |          |   |             | 20,596 |                   |   | $             | 206 |        |   | $      | 88,639 |        |   | $ | (531   | )      |   | $ | (17,694 | )      |       | $      | 60 |   |    | $  | 70,680 |       
|                             |                                                                                               |                                                                 |                                                  |              |   |            |    |          |   |             |        |                   |   |               |     |        |   |        |        |        |   |   |        |        |   |   |         |        |       |        |    |   |    |    |        |       

See accompanying notes.

F-5



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##### Table of Contents



WEBSENSE, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |        |  
|---------------------------------------------------------------------------------------------------- | ----------------------------------------------------------- | ------------------------ | ------- | ------ | - | ---- | ------- | ------ | - | - | ------ | ------ | -
|                                                                                                     |                                                             |                         
|                                                                                                     |                                                             | Years Ended December 31,
|                                                                                                     |                                                             |                         
|                                                                                                     |                                                             | 2001                     |         | 2000   |   | 1999
|                                                                                                     |                                                             |                          |         |        |   |     
|                                                                                                     |                                                             |                         
|                                                                                                     |                                                             | (In thousands)          
|Operating activities:                                                                                |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Net income (loss)                                                                                    |                                                             | $                        | 3,116   |        |   | $    | (5,947  | )      |   | $ | (9,254 | )     
|Adjustments to reconcile net income
	(loss) to net cash provided by (used in) operating
	activities: |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|                                                                                                     | Depreciation                                                |                          |         | 1,700  |   |      |         | 1,280  |   |   |        | 601    |  
|                                                                                                     | Amortization of deferred compensation                       |                          |         | 860    |   |      |         | 1,938  |   |   |        | 1,822  |  
|                                                                                                     | Issuance of common stock options and warrants for
	services |                          |         |       |   |      |         |       |   |   |        | 114    |  
|                                                                                                     | Deferred revenue                                            |                          |         | 18,991 |   |      |         | 12,893 |   |   |        | 7,356  |  
|Changes in operating assets and liabilities:                                                         |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|                                                                                                     | Accounts receivable                                         |                          |         | (4,928 | ) |      |         | (4,022 | ) |   |        | (1,977 | )
|                                                                                                     | Deposits and other assets                                   |                          |         | (664   | ) |      |         | (306   | ) |   |        | (186   | )
|                                                                                                     | Accounts payable                                            |                          |         | (175   | ) |      |         | 242    |   |   |        | 236    |  
|                                                                                                     | Accrued payroll and related benefits                        |                          |         | 986    |   |      |         | 871    |   |   |        | 586    |  
|                                                                                                     | Other accrued expenses                                      |                          |         | 940    |   |      |         | 766    |   |   |        | 281    |  
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Net cash provided by (used in) operating
	activities                                                 |                                                             |                          | 20,826  |        |   |      | 7,715   |        |   |   | (421   | )     
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Investing activities:                                                                                |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Purchase of property and equipment                                                                   |                                                             |                          | (1,617  | )      |   |      | (2,126  | )      |   |   | (1,742 | )     
|Purchases of marketable securities                                                                   |                                                             |                          | (67,942 | )      |   |      | (70,213 | )      |   |   |       |       
|Maturities of marketable securities                                                                  |                                                             |                          | 56,737  |        |   |      | 2,085   |        |   |   |       |       
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Net cash used in investing activities                                                                |                                                             |                          | (12,822 | )      |   |      | (70,254 | )      |   |   | (1,742 | )     
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Financing activities:                                                                                |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Repayments on notes payable                                                                          |                                                             |                          |        |        |   |      | (1,497  | )      |   |   | (297   | )     
|Proceeds from issuance of note payable                                                               |                                                             |                          |        |        |   |      |        |        |   |   | 1,264  |       
|Proceeds from issuance of convertible preferred
	stock                                               |                                                             |                          |        |        |   |      |        |        |   |   | 9,815  |       
|Proceeds from exercise of stock options and
	warrants                                                |                                                             |                          | 1,631   |        |   |      | 120     |        |   |   | 363    |       
|Proceeds from issuance of common stock for stock
	purchase plan                                      |                                                             |                          | 974     |        |   |      | 567     |        |   |   |       |       
|Proceeds from issuance of common stock                                                               |                                                             |                          |        |        |   |      | 65,720  |        |   |   |       |       
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Net cash provided by financing activities                                                            |                                                             |                          | 2,605   |        |   |      | 64,910  |        |   |   | 11,145 |       
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Increase in cash and cash equivalents                                                                |                                                             |                          | 10,609  |        |   |      | 2,371   |        |   |   | 8,982  |       
|Cash and cash equivalents at beginning of year                                                       |                                                             |                          | 13,106  |        |   |      | 10,735  |        |   |   | 1,753  |       
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Cash and cash equivalents at end of year                                                             |                                                             | $                        | 23,715  |        |   | $    | 13,106  |        |   | $ | 10,735 |       
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Supplemental disclosures of cash flow
	information:                                                  |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Interest paid                                                                                        |                                                             | $                        |        |        |   | $    | 48      |        |   | $ | 67     |       
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       
|Income taxes paid                                                                                    |                                                             | $                        |        |        |   | $    | 1       |        |   | $ | 29     |       
|                                                                                                     |                                                             |                          |         |        |   |      |         |        |   |   |        |       

See accompanying notes.

F-6



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##### Table of Contents



WEBSENSE, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS

December 31, 2001


1.     Summary of
Significant Accounting Policies

Description
of Business

Websense, Inc. (Websense or the
Company) was founded in 1994. The Company provides
employee Internet management products that enable businesses to
monitor, report and manage how their employees use the Internet.
The Companys Websense Enterprise solution supports an
organizations efforts to improve employee productivity,
conserve network bandwidth and mitigate potential legal
liability.

Use of
Estimates

The preparation of the consolidated financial
statements in conformity with accounting principles generally
accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes. Actual results
could differ from those estimates.

Principles of
Consolidation

The consolidated financial statements include the
accounts of the Company and its wholly-owned subsidiaries in the
United Kingdom and Japan. Significant intercompany accounts and
transactions have been eliminated in consolidation. Activities
performed by the subsidiaries are a direct and integral
extension of the Companys primary business.

Reclassifications

Certain reclassifications have been made for
consistent presentation.

Revenue
Recognition

The Company has adopted American Institute of
Certified Public Accountants Statement of Position
No. 97-2, Software Revenue Recognition (SOP 97-2) as
amended by SOP 98-9. These statements provide guidance for
recognizing revenue related to sales by software vendors.

The Company sells Websense Enterprise on a
subscription basis. A subscription is generally 12, 24 or
36 months in duration and for a fixed number of users. Upon
entering into a subscription arrangement, the Company invoices
customers. Generally, payment is due for the full term of the
subscription within 30 days of invoicing. The Company
recognizes revenue on a monthly straight-line basis over the
term of the subscription agreement. The Company records amounts
billed to customers in excess of recognizable revenue as
deferred revenue in the accompanying balance sheets.

The Company also derives a small portion of
revenue from professional services and from resale of software
and hardware. The Company recognizes revenue for these services
and products upon their completion or delivery.

Cash and Cash
Equivalents

The Company considers all highly liquid
investments with a maturity of three months or less when
purchased to be cash equivalents. The Company generally invests
its excess cash in debt instruments of the U.S. Treasury,
government agencies and corporations with strong credit ratings.
Such investments are made in accordance with the Companys
investment policy, which establishes guidelines relative to
diversification and maturities designed to maintain safety and
liquidity. These guidelines are periodically reviewed and
modified if necessary to take advantage of trends in yields and
interest rates. The Company has not experienced any losses on
its cash and cash equivalents.

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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Marketable
Securities

Marketable securities at December 31, 2001
consist of high-grade commercial paper, auction rate notes,
government securities, corporate bonds and certificates of
deposit. The Company currently classifies all investment
securities as available for sale. Securities available for sale
are reported at fair value, adjusted for other than temporary
declines in value. Unrealized holding gains and losses on
securities available for sale are reported as a net amount in a
separate component of stockholders equity until realized.
Realized gains and losses are recorded based on the specific
identification method.

Disclosures
About Fair Value of Financial Instruments

The fair values of investment securities have
been determined using values supplied by independent pricing
services and are disclosed together with carrying amounts in
Note 2. The carrying value of cash and cash equivalents,
accounts receivable, accounts payable, accrued liabilities and
debt approximate their fair values.

Concentration
of Credit Risk

The Company sells its products to customers
primarily in the United States, Canada, Europe and Asia. The
Company maintains a reserve for potential credit losses and
historically such losses have been within managements
estimates.

Property and
Equipment

Property and equipment are stated at cost and are
depreciated using the straight-line method over their estimated
useful lives of three years.

Computer
Software Costs

In accordance with Statement of Financial
Accounting Standards (SFAS) No. 86, Accounting
for the Costs of Computer Software to be Sold, Leased, or
Otherwise Marketed, the Company capitalizes costs incurred, when
significant, in the development of specific computer software
products after establishment of technological feasibility and
marketability. There have been no such costs capitalized to date
as the costs incurred during the period between technological
feasibility to general release have not been significant.

Statement of Position 98-1 Accounting for
Costs of Computer Software Developed or Obtained for Internal
Use (SOP 98-1) requires companies to capitalize
qualifying computer software costs, which are incurred during
the application development stage and amortize them over the
softwares estimated useful life. The Company adopted
SOP 98-1 effective January 1, 1999 with no material
effect on the financial statements.

Advertising
Expenses

Advertising costs are expensed as incurred. Total
advertising costs for the years ended December 31, 2001,
2000 and 1999 were $2.0 million, $1.3 million and
$1.0 million, respectively.

Stock-Based
Compensation

The Company has elected to follow Accounting
Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees (APB 25), and related
interpretations in accounting for its employee stock options
because the alternative fair value accounting provided for under
SFAS No. 123, Accounting for Stock-Based Compensation,
requires the use of option valuation models for traded options
that were not developed for use in valuing employee stock
options, which have vesting restrictions and are not traded.
Under APB 25, when the exercise price of the Companys
employee stock options, is not less than the fair value for the
underlying

F-8



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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

stock on the date of grant, no compensation
expense is recognized. At the time stock options were granted,
the Company believed that the exercise price was at a price not
less than the fair value of the underlying common stock. In
conjunction with the Companys initial public offering the
Company reviewed its exercise prices and arrived at the deemed
fair value for each option grant during 1999. With respect to
the 3,220,500 options granted during 1999 and through
March 27, 2000, the Company recorded deferred compensation
of $5.4 million for the difference between the exercise
price per share and the deemed fair value per share at the grant
date. The approximate weighted-average exercise price per share
and the approximate weighted-average deemed fair value per share
for the options was $1.64 and $3.31, respectively. Deferred
stock compensation is recognized and amortized on an accelerated
basis in accordance with Financial Accounting Standards Board
Interpretation No. 28 over the vesting period of the
related options, generally four years.

Deferred compensation for options and warrants
granted to non-employees has been determined at the grant date
in accordance with SFAS No. 123 and EITF No. 96-18,
Accounting for Equity Instruments That are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling Goods or
Services, and has been recorded at the fair value of the
consideration received or the fair value of the equity
instruments issued, whichever is more reliably measured. Such
deferred compensation is recognized over the period the related
services are rendered.



| |                     
| | --------------------
| | Comprehensive Income

The Company has adopted SFAS No. 130,
Reporting Comprehensive Income, which requires that all
components of comprehensive income, including net income, be
reported in the financial statements in the period in which they
are recognized. Comprehensive income is defined as the change in
equity during a period from transactions and other events and
circumstances from non-owner sources. Net income (loss) and
other comprehensive income, including foreign currency
translation adjustments, and unrealized gains and losses on
investments, shall be reported, net of their related tax effect,
to arrive at comprehensive income (loss). Comprehensive loss for
the year ended December 31, 1999 did not differ from the
reported net loss. Comprehensive income (loss) for the
years ended December 31, 2001 and 2000 was
$3.2 million and ($5.9 million), respectively. The
difference from reported net income (loss) is due to the
changes in unrealized gains on marketable securities for the
years ended December 31, 2001 and 2000 of $35,000 and
$25,000, respectively.

Net Income
(Loss) Per Share

Websense computes net income (loss) per share in
accordance with SFAS No. 128, Earnings Per Share
(EPS). Under the provisions of SFAS No. 128,
basic net income (loss) per share is computed by dividing the
net income (loss) for the period by the weighted average number
of common shares outstanding during the period. Diluted net
income (loss) per share is computed by dividing the net income
(loss) for the period by the weighted average number of common
and common equivalent shares outstanding during the period.

Dilutive securities include options, warrants and
preferred stock as if converted and restricted stock subject to
vesting. In 2001, the difference between the weighted average
shares used in determining basic EPS versus diluted EPS related
to dilutive stock options and warrants totaled 2,698,000.
Potentially dilutive securities totaling 335,000, 3,247,000 and
4,908,000 for the years ended December 31, 2001, 2000 and
1999, respectively, were excluded from historical basic and
diluted earnings per share because of their anti-dilutive effect.

Recently
Issued Accounting Standards

In July 2001, the Financial Accounting Standards
Board issued Statements of Financial Accounting Standards
No. 141, Business Combinations (SFAS 141)
and No. 142, Goodwill and Other Intangible Assets
(SFAS 142). SFAS 141 requires all business
combinations initiated after June 30, 2001 to be

F-9



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WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

accounted for using the purchase method. Under
SFAS 142, goodwill and intangible assets with indefinite
lives are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment.
Separable intangible assets that are not deemed to have
indefinite lives will continue to be amortized over their useful
lives (but with no maximum life). The amortization provisions of
SFAS 142 apply to goodwill and intangible assets acquired
after June 30, 2001. With respect to goodwill and
intangible assets acquired prior to July 1, 2001, the
Company is required to adopt SFAS 142 effective
January 31, 2002. The Company does not expect that the
adoption of SFAS 141 and SFAS 142 will have a material
impact on the Companys results of operations or financial
position.

In August 2001, the FASB issued SFAS
No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets (SFAS 144), which addresses
financial accounting and reporting for the impairment or
disposal of long-lived assets and supersedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, and the accounting and
reporting provisions of APB Opinion No. 30, Reporting the
Results of Operations for a disposal of a segment of a business.
SFAS 144 is effective for fiscal years beginning after
December 15, 2001, with earlier application encouraged. The
Company expects to adopt SFAS 144 as of January 1,
2002 and it does not expect that the adoption of the Statement
will have a significant impact on the Companys results of
operations or financial position.

2.     Marketable
Securities

Investments in marketable securities consisted of
the following at December 31, 2001 (in thousands):

|                        |  |                |        |            |  |            |    |                |  |   |     |   |  |   |        | 
|----------------------- |  | -------------- | ------ | ---------- |  | ---------- | -- | -------------- |  | - | --- | - |  | - | ------ | 
|                        |  |                |        | Unrealized |  | Unrealized |    | Estimated Fair
|                        |  | Amortized Cost |        | Gains      |  | (Losses)   |    | Value         
|                        |  |                |        |            |  |            |    |               
|Commercial Paper        |  | $              | 3,954  |            |  | $          |   |                |  | $ |    |   |  | $ | 3,954  | 
|Government Securities   |  |                | 58,338 |            |  |            | 65 |                |  |   |    |   |  |   | 58,403 | 
|Corporate Bonds         |  |                | 15,507 |            |  |            |   |                |  |   | (15 | ) |  |   | 15,492 | 
|Certificates of Deposit |  |                | 1,534  |            |  |            | 10 |                |  |   |    |   |  |   | 1,544  | 
|                        |  |                |        |            |  |            |    |                |  |   |     |   |  |   |        | 
|                        |  | $              | 79,333 |            |  | $          | 75 |                |  | $ | (15 | ) |  | $ | 79,393 | 
|                        |  |                |        |            |  |            |    |                |  |   |     |   |  |   |        | 

Investments in marketable securities consisted of
the following at December 31, 2000 (in thousands):

|                        |  |                |        |            |  |            |    |                |  |   |     |   |  |   |        | 
|----------------------- |  | -------------- | ------ | ---------- |  | ---------- | -- | -------------- |  | - | --- | - |  | - | ------ | 
|                        |  |                |        | Unrealized |  | Unrealized |    | Estimated Fair
|                        |  | Amortized Cost |        | Gains      |  | (Losses)   |    | Value         
|                        |  |                |        |            |  |            |    |               
|Commercial Paper        |  | $              | 36,358 |            |  | $          |   |                |  | $ | (14 | ) |  | $ | 36,344 | 
|Government Securities   |  |                | 17,493 |            |  |            | 11 |                |  |   |    |   |  |   | 17,504 | 
|Corporate Bonds         |  |                | 13,244 |            |  |            | 28 |                |  |   |    |   |  |   | 13,272 | 
|Certificates of Deposit |  |                | 1,033  |            |  |            |   |                |  |   |    |   |  |   | 1,033  | 
|                        |  |                |        |            |  |            |    |                |  |   |     |   |  |   |        | 
|                        |  | $              | 68,128 |            |  | $          | 39 |                |  | $ | (14 | ) |  | $ | 68,153 | 
|                        |  |                |        |            |  |            |    |                |  |   |     |   |  |   |        | 

The amortized cost and estimated fair value of
the securities at December 31, 2001 and 2000, by
contractual maturity, are shown below (in thousands).

|                          |  |           |        |            |  |           |        |            |  |   |        |  |  |   |        | 
|------------------------- |  | --------- | ------ | ---------- |  | --------- | ------ | ---------- |  | - | ------ |  |  | - | ------ | 
|                          |  |           |        |           
|                          |  | 2001      |        | 2000      
|                          |  |           |        |           
|                          |  | Amortized |        |            |  | Amortized |        |           
|                          |  | Cost      |        | Fair Value |  | Cost      |        | Fair Value
|                          |  |           |        |            |  |           |        |           
|Due within 1 year         |  | $         | 41,137 |            |  | $         | 41,271 |            |  | $ | 61,490 |  |  | $ | 61,509 | 
|Due between 1 and 3 years |  |           | 38,196 |            |  |           | 38,122 |            |  |   | 6,638  |  |  |   | 6,644  | 
|                          |  |           |        |            |  |           |        |            |  |   |        |  |  |   |        | 
|                          |  | $         | 79,333 |            |  | $         | 79,393 |            |  | $ | 68,128 |  |  | $ | 68,153 | 
|                          |  |           |        |            |  |           |        |            |  |   |        |  |  |   |        | 

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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Realized gains from investments in marketable
securities were $53,000 in 2001 and $0 in both 2000 and 1999.

3.     Property and
Equipment

Property and equipment consist of the following
(in thousands):

|                               |  |              |         |              |  |      |        |   |  |   |        |  
|------------------------------ |  | ------------ | ------- | ------------ |  | ---- | ------ | - |  | - | ------ | -
|                               |  |              |         |             
|                               |  |              |         | December 31,
|                               |  | Estimated    |         |             
|                               |  | Useful Lives |         | 2001         |  | 2000
|                               |  |              |         |              |  |     
|Computer hardware and software |  |              | 3 years |              |  | $    | 5,129  |   |  | $ | 3,725  |  
|Office furniture and equipment |  |              | 3 years |              |  |      | 1,387  |   |  |   | 1,175  |  
|Other equipment                |  |              | 3 years |              |  |      | 216    |   |  |   | 215    |  
|                               |  |              |         |              |  |      |        |   |  |   |        |  
|                               |  |              |         |              |  |      | 6,732  |   |  |   | 5,115  |  
|Accumulated depreciation       |  |              |         |              |  |      | (4,022 | ) |  |   | (2,322 | )
|                               |  |              |         |              |  |      |        |   |  |   |        |  
|                               |  |              |         |              |  | $    | 2,710  |   |  | $ | 2,793  |  
|                               |  |              |         |              |  |      |        |   |  |   |        |  

4.     Debt

In June 1998, the Company entered into a loan and
security agreement with Silicon Valley Bank for a $1,000,000
line of credit. In May 1999, this line was modified to provide
only for fixed asset loans. Loans outstanding under this line
were $553,000 on December 31, 1999. In October of 1999, the
Company modified the May 1999 agreement to provide an additional
$1 million for fixed assets. Loans outstanding under this
additional line were $925,000 on December 31, 1999. In
April 2000, the Company repaid the outstanding amounts due under
each of these lines of credit.

In June 2000, the Company established an amended
and restated loan and security agreement which provides a line
of credit of $1,500,000 for working capital advances
(borrowings) and stand-by letters of credit.
Advances bear interest at the banks floating prime rate
plus .25% (5.00% at December 31, 2001). In May 2001, the
Company amended the loan and security agreement to extend the
maturity date to May 2002. The Company had no advances under the
line at December 31, 2001 and open letters of credit were
$379,900.

Any borrowings under the agreements with Silicon
Valley Bank are collateralized by substantially all of the
Companys assets, and are subject to financial and
restrictive covenants.

5.     Geographic
Information

The following illustrates revenues attributed to
customers located in the Companys country of domicile (the
United States) and those attributed to foreign customers (in
thousands):

|                               |  |                          |        |      |  |      |        |  |  |   |       | 
|------------------------------ |  | ------------------------ | ------ | ---- |  | ---- | ------ |  |  | - | ----- | 
|                               |  |                         
|                               |  | Years Ended December 31,
|                               |  |                         
|                               |  | 2001                     |        | 2000 |  | 1999
|                               |  |                          |        |      |  |     
|United States                  |  | $                        | 23,377 |      |  | $    | 11,940 |  |  | $ | 6,551 | 
|Europe, Middle East and Africa |  |                          | 7,242  |      |  |      | 3,007  |  |  |   | 1,156 | 
|Asia/Pacific                   |  |                          | 3,273  |      |  |      | 1,617  |  |  |   | 494   | 
|Canada and Latin America       |  |                          | 2,001  |      |  |      | 877    |  |  |   | 446   | 
|                               |  |                          |        |      |  |      |        |  |  |   |       | 
|                               |  | $                        | 35,893 |      |  | $    | 17,441 |  |  | $ | 8,647 | 
|                               |  |                          |        |      |  |      |        |  |  |   |       | 

F-11



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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

6.     Deferred
Revenue

The Company will recognize revenues related to
subscriptions in existence as of December 31, 2001 as
follows (in thousands):

|     |  |   |        | 
|---- |  | - | ------ | 
|2002 |  | $ | 31,218 | 
|2003 |  |   | 8,651  | 
|2004 |  |   | 2,843  | 
|2005 |  |   | 628    | 
|2006 |  |   | 138    | 
|     |  |   |        | 
|     |  | $ | 43,478 | 
|     |  |   |        | 

7.     Lease
Commitments

The Company leases its facilities and certain
equipment under non-cancellable operating leases, which expire
at various dates through August 2003. The facilities leases
contain renewal options and are subject to cost increases.

Future minimum annual lease payments under
non-cancellable operating leases at December 31, 2001 are
as follows (in thousands):

|     |  |   |       | 
|---- |  | - | ----- | 
|2002 |  | $ | 1,006 | 
|2003 |  |   | 139   | 
|     |  |   |       | 
|     |  | $ | 1,145 | 
|     |  |   |       | 

Rent expense totaled $1,620,000, $882,000 and
$690,000 for the years ended December 31, 2001, 2000 and
1999, respectively.

8.     Stockholders
Equity

Convertible
Preferred Stock

All previously issued preferred stock
automatically converted into common stock concurrent with the
closing of the Companys initial public offering of common
stock on March 27, 2000. The Company issued 7,037,036
shares of common stock upon conversion of Series A and
Series B convertible preferred stock.

Warrants

The Company issued a warrant to purchase 250,000
shares of common stock at $0.01 per share in conjunction with
bridge note financing consummated in March 1998. The warrant was
exercised in June 1999.

In connection with the termination of an
exclusive distributor agreement, the Company issued a warrant to
a distributor to purchase up to 50,000 shares of common stock
for $.05 per share in March 1999. The Company recorded expense
of $38,000 related to this issuance based on the estimated fair
value of the warrant. The warrant was exercised in February
2000. This distributor accounted for $2,212,000, $1,046,000 and
$418,000 of the Companys revenues for the years ended
December 31, 2001, 2000 and 1999, respectively.

In connection with the Series B convertible
preferred stock offering, the Company issued warrants to
purchase 62,500 shares of common stock for $3.00 per share to
financial consultants. The warrants are exercisable in whole or
in part at any time and from time to time until their expiration
in June 2004. In April 2000, a warrant to purchase 4,688 shares
of common stock was exercised. In November 2001, a warrant to

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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

purchase 23,437 shares of common stock was
exercised. The Company has reserved 34,375 shares of common
stock for issuance upon exercise of the remaining warrants.

Stock Option
Plan

In May 1998, the Board of Directors elected to
replace the 1997 Stock Option/ Stock Issuance Plan with the 1998
Stock Option/ Stock Issuance Plan (the 1998 Stock
Plan) under which 4,600,000 shares of the Companys
common stock were authorized for future issuance, and reserved
for purchase upon exercise of options granted. The 1998 Stock
Plan provides for the grant of incentive and non-statutory
options and issuances of common stock to employees, directors
and consultants.

In February 2000, the Board of Directors replaced
the 1998 Stock Plan with the 2000 Stock Incentive Plan (the
2000 Plan) under which 4,500,000 shares of the
Companys common stock were initially authorized for future
issuance, and reserved for purchase upon exercise of options
granted. In addition, the 2000 Plan provides for automatic
annual increases in the number of shares reserved for issuance
thereunder (beginning in 2001) equal to the lesser of
(i) 4% of the Companys outstanding shares on the last
business day in December of the calendar year immediately
preceding or (ii) 1,500,000 shares. At December 31,
2001, 5,288,194 shares were authorized for issuance under the
2000 Plan.

The 2000 Plan provides for the grant of options
to the Companys directors, officers, employees and
consultants. The 2000 Plan provides for the grant of incentive
and nonstatutory stock options and rights to purchase stock to
employees, directors or consultants of the Company. The 2000
Plan provides that incentive stock options will be granted only
to employees and are subject to certain limitations as to fair
value during a calendar year.

The exercise price of incentive stock options
must equal at least the fair value on the date of grant and the
exercise price of non-statutory stock options and the issuance
price of common stock under the stock issuance program may be no
less than 85% of the fair value on the date of grant or
issuance. The options are exercisable for a period of up to ten
years after the date of grant and generally vest 25% one year
from date of grant and ratably each month thereafter for a
period of 36 months. Unvested common shares obtained
through early exercise of options are subject to repurchase by
the Company at the original issue price. To date only
nonstatutory options have been granted under the 2000 Plan.

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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The following table summarizes stock option
activity under the 1998 and 2000 Stock Plans and related
information through December 31, 2001:

|                             |           |           |           |            |   |   |      |       | 
|---------------------------- | --------- | --------- | --------- | ---------- | - | - | ---- | ----- | 
|                             |           |           |           | Weighted  
|                             |           |           |           | Average   
|                             |           | Number of |           | Exercise  
|                             |           | Shares    |           | Price     
|                             |           |           |           |           
|Balance at December 31, 1998 |           |           | 1,691,435 |            |   | $ | 0.20 |      
|                             | Granted   |           |           | 3,060,500  |   |   | $    | 0.91  | 
|                             | Exercised |           |           | (1,090,455 | ) |   | $    | 0.33  | 
|                             | Cancelled |           |           | (499,929   | ) |   | $    | 0.25  | 
|                             |           |           |           |            |   |   |      |      
|Balance at December 31, 1999 |           |           | 3,161,551 |            |   | $ | 0.83 |      
|                             | Granted   |           |           | 641,000    |   |   | $    | 14.57 | 
|                             | Exercised |           |           | (218,780   | ) |   | $    | 0.47  | 
|                             | Cancelled |           |           | (175,086   | ) |   | $    | 1.99  | 
|                             |           |           |           |            |   |   |      |      
|Balance at December 31, 2000 |           |           | 3,408,685 |            |   | $ | 3.38 |      
|                             | Granted   |           |           | 1,567,600  |   |   | $    | 14.85 | 
|                             | Exercised |           |           | (781,876   | ) |   | $    | 1.99  | 
|                             | Cancelled |           |           | (252,641   | ) |   | $    | 8.02  | 
|                             |           |           |           |            |   |   |      |      
|Balance at December 31, 2001 |           |           | 3,941,768 |            |   | $ | 7.92 |      
|                             |           |           |           |            |   |   |      |      

The following table summarizes all options
outstanding and exercisable by price range as of
December 31, 2001:

|                         |  |                     |           |                     |  |          |     |           |  |          |       |  |  |  |           |  |  |   |       | 
|------------------------ |  | ------------------- | --------- | ------------------- |  | -------- | --- | --------- |  | -------- | ----- |  |  |  | --------- |  |  | - | ----- | 
|                         |  |                     |           |                     |  |         
|                         |  | Options Outstanding |           |                    
|                         |  |                     |           | Options Exercisable
|                         |  |                     |           | Weighted            |  |          |     |          
|                         |  |                     |           | Average             |  | Weighted |     |           |  | Weighted
|                         |  |                     |           | Remaining           |  | Average  |     |           |  | Average 
|                         |  | Number of           |           | Contractual         |  | Exercise |     | Number of |  | Exercise
|Range of Exercise Prices |  | Shares              |           | Life in Years       |  | Price    |     | Shares    |  | Price   
|                         |  |                     |           |                     |  |          |     |           |  |         
|$.20-$.50                |  |                     | 1,322,676 |                     |  |          | 7.1 |           |  | $        | 0.46  |  |  |  | 867,558   |  |  | $ | 0.44  | 
|$.75                     |  |                     | 332,944   |                     |  |          | 7.4 |           |  | $        | 0.75  |  |  |  | 141,953   |  |  | $ | 0.75  | 
|$1.50-$3.00              |  |                     | 310,911   |                     |  |          | 7.7 |           |  | $        | 2.23  |  |  |  | 114,760   |  |  | $ | 2.27  | 
|$6.00-$7.00              |  |                     | 47,553    |                     |  |          | 8.0 |           |  | $        | 6.76  |  |  |  | 11,922    |  |  | $ | 6.93  | 
|$8.30-$34.25             |  |                     | 1,927,684 |                     |  |          | 9.1 |           |  | $        | 15.22 |  |  |  | 146,794   |  |  | $ | 15.60 | 
|                         |  |                     |           |                     |  |          |     |           |  |          |       |  |  |  |           |  |  |   |       | 
|                         |  |                     | 3,941,768 |                     |  |          | 8.2 |           |  | $        | 7.92  |  |  |  | 1,282,987 |  |  | $ | 2.43  | 
|                         |  |                     |           |                     |  |          |     |           |  |          |       |  |  |  |           |  |  |   |       | 

Pro forma information regarding net income
(loss) is required by SFAS 123 and has been determined
as if the Company has accounted for its employee stock options
and stock purchase plan under the fair value method of
SFAS 123. The fair value of each option grant prior to the
Companys initial public offering in March 2000 was
estimated on the date of grant using the minimum value method
with the following weighted-average assumptions; risk-free
interest rate of 6%, dividend yield of 0% and a weighted average
expected life of 5 years. The fair value of each option
grant during 2000 subsequent to the Companys initial
public offering in March 2000 was estimated on the date of grant
using a Black-Scholes option pricing model with the following
weighted-average assumptions: risk free interest rate of 6%;
dividend yield of 0%; volatility factor of 132%; and
weighted-average expected life for the option of 5 years.
The fair value of each option grant during 2001 was estimated on
the date of grant using a Black-Scholes option pricing model
with the following weighted-average assumptions: risk free
interest rate of 5% to 6%; dividend yield of 0%; volatility
factor of 111% to 132%; and weighted-average expected life for
the option of 5 years. For purposes of pro forma
disclosures, the

F-14



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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

estimated fair value of the options is amortized
to expense over the vesting period. The Companys adjusted
pro forma information is as follows (in thousands, except per
share amounts):

|                                     |  |                          |        |      |  |      |        |   |  |   |        |  
|------------------------------------ |  | ------------------------ | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                     |  |                         
|                                     |  | Years Ended December 31,
|                                     |  |                         
|                                     |  | 2001                     |        | 2000 |  | 1999
|                                     |  |                          |        |      |  |     
|Pro forma net loss                   |  | $                        | (2,379 | )    |  | $    | (6,263 | ) |  | $ | (9,467 | )
|Pro forma basic net loss per share   |  | $                        | (0.12  | )    |  | $    | (0.37  | ) |  | $ | (1.28  | )
|Pro forma diluted net loss per share |  | $                        | (0.12  | )    |  | $    | (0.37  | ) |  | $ | (1.28  | )

The weighted average fair value of options
granted during 2001, 2000 and 1999 was $7.54, $8.85 and $1.20
per share, respectively.

The pro forma effect on net income
(loss) for 2001, 2000 and 1999 is not likely to be
representative of the pro forma effect on reported net income or
loss in future years because these amounts reflect less than
four years of vesting.

Employee Stock Purchase Plan

In February 2000, the Company adopted the 2000
Employee Stock Purchase Plan. In addition, the purchase plan
provides for automatic annual increases in the number of shares
reserved for issuance thereunder (beginning in 2001) equal to
the lesser of (i) 1% of the Companys outstanding
shares on the last business day in December of the calendar year
immediately preceding or (ii) 375,000 shares. Accordingly,
the number of shares authorized under the purchase plan were
increased to a total of 447,049. The purchase plan is intended
to qualify as an employee stock purchase plan within the meaning
of Section 423 of the Internal Revenue Code. Under the
purchase plan, the Board of Directors may authorize
participation by eligible employees, including officers, in
periodic offerings following commencement of the purchase plan.
Shares issued and available for issuance as of December 31,
2001 are as follows:

|                                                                                               |  |  |         |  
|---------------------------------------------------------------------------------------------- |  |  | ------- | -
|Shares reserved for issuance during 2000                                                       |  |  | 250,000 |  
|Shares issued during 2000                                                                      |  |  | (37,090 | )
|                                                                                               |  |  |         |  
|Shares reserved for issuance at December 31,
	2000                                             |  |  | 212,910 |  
|Shares reserved for issuance during 2001 based on
	the automatic increase in shares authorized |  |  | 197,049 |  
|Shares issued during 2001                                                                      |  |  | (85,459 | )
|                                                                                               |  |  |         |  
|Shares reserved for issuance at December 31,
	2001                                             |  |  | 324,500 |  
|                                                                                               |  |  |         |  

Unless otherwise determined by the Board,
employees are eligible to participate in the purchase plan
provided they are employed for at least 20 hours per week and
are customarily employed for at least five months per calendar
year. Employees who participate in an offering may have up to
15% of their earnings withheld pursuant to the purchase plan.
The amount withheld is then used to purchase shares of common
stock on specified dates. The price of common stock purchased
pursuant to the plan will be equal to 85% of the lower of the
fair market value of the common stock at the commencement date
of each offering period or the relevant purchase date. Employees
may end their participation in the offering at any time during
the offering period, and participation ends automatically on
termination of employment.

F-15



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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Shares Reserved for Future Issuance

The following shares of common stock are reserved
for future issuance as of December 31, 2001:

|               |                            |  |           |           | 
|-------------- | -------------------------- |  | --------- | --------- | 
|Stock options: |                            |  |           |          
|               | Granted and outstanding    |  |           | 3,941,768 | 
|               | Reserved for future grants |  |           | 409,844   | 
|               |                            |  |           |          
|               |                            |  | 4,351,612 |          
|Warrants       |                            |  | 34,375    |          
|               |                            |  |           |          
|               |                            |  | 4,385,987 |          
|               |                            |  |           |          

9.     Income
Taxes

The provision for income taxes is as follows:

|         |                    |                |     |      |  |      |   |   |  |  |   |   | 
|-------- | ------------------ | -------------- | --- | ---- |  | ---- | - | - |  |  | - | - | 
|         |                    |               
|         |                    | December 31,  
|         |                    |               
|         |                    | 2001           |     | 2000 |  | 1999
|         |                    |                |     |      |  |     
|         |                    |               
|         |                    | (In thousands)
|Current  |                    |                |     |      |  |      |   |   |  |  |   |  
|         | Federal            |                | $   |     |  |      | $ |  |  |  | $ |  | 
|         | Foreign            |                |     | 108  |  |      |   |   |  |  |   |   | 
|         | State              |                |     |     |  |      |   |  |  |  |   |  | 
|         |                    |                |     |      |  |      |   |   |  |  |   |  
|         |                    |                | 108 |      |  |      |  |   |  |  |  |  
|Deferred |                    |                |     |      |  |      |   |   |  |  |   |  
|         | Federal            |                |     |     |  |      |   |  |  |  |   |  | 
|         | State              |                |     |     |  |      |   |  |  |  |   |  | 
|         |                    |                |     |      |  |      |   |   |  |  |   |  
|         |                    |                |    |      |  |      |  |   |  |  |  |  
|         |                    |                |     |      |  |      |   |   |  |  |   |  
|         | Income Tax Expense |                | $   | 108  |  |      | $ |  |  |  | $ |  | 
|         |                    |                |     |      |  |      |   |   |  |  |   |  

The reconciliation of income tax attributable to
income before the benefit (provision) for income taxes at
the U.S. federal statutory tax rate to income tax expense is as
follows:

|                      |  |      |       |      |  |      |       |    |  |  |       |   
|--------------------- |  | ---- | ----- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                      |  | 2001 |       | 2000 |  | 1999
|                      |  |      |       |      |  |     
|Statutory Rate        |  |      | 35.0  | %    |  |      | (35.0 | )% |  |  | (35.0 | )%
|Foreign tax           |  |      | 3.3   |      |  |      |      |    |  |  |      |   
|State tax             |  |      | 5.1   |      |  |      | (3.0  | )  |  |  | (3.0  | ) 
|Credits               |  |      | (16.4 | )    |  |      | (10.8 | )  |  |  | (4.2  | ) 
|Permanent differences |  |      | (3.8  | )    |  |      | 3.0   |    |  |  | 1.3   |   
|Valuation allowance   |  |      | (20.0 | )    |  |      | 45.8  |    |  |  | 40.9  |   
|                      |  |      |       |      |  |      |       |    |  |  |       |   
|                      |  |      | 3.2   | %    |  |      |      |    |  |  |      |   
|                      |  |      |       |      |  |      |       |    |  |  |       |   

F-16



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##### Table of Contents



WEBSENSE, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Significant components of the Companys
deferred tax assets and liabilities as of December 31, 2001
and 2000 are as follows:

|                                            |                                      |                |         |        |  |   |        |       | 
|------------------------------------------- | ------------------------------------ | -------------- | ------- | ------ |  | - | ------ | ----- | 
|                                            |                                      | 2001           |         | 2000  
|                                            |                                      |                |         |       
|                                            |                                      |               
|                                            |                                      | (In thousands)
|Deferred tax assets                         |                                      |                |         |        |  |   |        |      
|                                            | Net Operating Loss Carryforwards     |                | $       | 2,472  |  |   | $      | 2,260 | 
|                                            | Tax credit carryforwards             |                |         | 1,808  |  |   |        | 1,201 | 
|                                            | Capitalized research and development |                |         | 267    |  |   |        | 432   | 
|                                            | Deferred revenue                     |                |         | 8,772  |  |   |        | 5,075 | 
|                                            | Other                                |                |         | 946    |  |   |        | 465   | 
|                                            |                                      |                |         |        |  |   |        |      
|                                            | Total deferred tax assets            |                |         | 14,265 |  |   |        | 9,433 | 
|Valuation allowance for deferred tax assets |                                      |                | (14,265 | )      |  |   | (9,433 | )    
|                                            |                                      |                |         |        |  |   |        |      
|Net deferred taxes                          |                                      | $              |        |        |  | $ |       |      
|                                            |                                      |                |         |        |  |   |        |      

At December 31, 2001, approximately
$5,200,000 of the valuation allowance for deferred tax assets
relates to stock option deductions which, when recognized, will
be allocated directly to additional paid-in-capital.

As of December 31, 2001, the Company has
federal and California research and development tax credit
carryforwards of approximately $1,177,000 and $917,000,
respectively. These credits will begin to expire in 2018 unless
previously utilized.

As of December 31, 2001, the Company had
federal and California tax net operating loss carryforwards of
approximately $6,512,000 and $3,061,000, respectively, which
will begin to expire in 2018 and 2003 respectively, unless
previously utilized.

Pursuant to Internal Revenue Code
Sections 382 and 383, use of the Companys tax loss
and credit carryforwards may be limited if a cumulative change
in ownership of more than 50% occurs within any three year
period.

10.     Employee
Retirement Plan

Effective May 1, 1997, the Company
established a 401(k) defined contribution retirement plan (the
401(k) Plan) covering substantially all employees.
The 401(k) Plan provides for voluntary employee contributions
from 1% to 20% of annual compensation, as defined, and does not
currently provide for matching contributions from the Company.

F-17



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##### Table of Contents



SCHEDULE II  VALUATION AND
QUALIFYING ACCOUNTS

WEBSENSE, INC.

|                                                       |                                 |                      |   |                  |  |                  |   |              |  |                |   |     |     |  |   |       |   |  |   |     | 
|------------------------------------------------------ | ------------------------------- | -------------------- | - | ---------------- |  | ---------------- | - | ------------ |  | -------------- | - | --- | --- |  | - | ----- | - |  | - | --- | 
|                                                       |                                 |                      |   |                  |  |                  |   |             
|A                                                      |                                 | B                    |   | C                |  | D                |   | E           
|                                                       |                                 |                      |   |                  |  |                  |   |             
|                                                       |                                 |                      |   |                  |  |                  |   |             
|                                                       |                                 |                      |   | Additions        |  |                  |   |             
|                                                       |                                 |                      |   |                  |  |                  |   |             
|                                                       |                                 |                      |   |                  |  | Charged to Other |   |              |  |               
|                                                       |                                 | Balance at Beginning |   | Charged to Costs |  | Accounts        |   | Deductions  |  | Balance at End
|Description                                            |                                 | of period            |   | and Expenses     |  | Describe         |   | Describe     |  | of Period     
|                                                       |                                 |                      |   |                  |  |                  |   |              |  |               
|                                                       |                                 |                     
|                                                       |                                 | (In thousands)      
|YEAR ENDED DECEMBER 31, 1999                           |                                 |                      |   |                  |  |                  |   |              |  |                |   |     |     |  |   |       |   |  |   |    
|Reserves and allowances deducted from asset
	accounts: |                                 |                      |   |                  |  |                  |   |              |  |                |   |     |     |  |   |       |   |  |   |    
|                                                       | Allowance for doubtful accounts |                      | $ | 27               |  |                  | $ | 236          |  |                |   |     |     |  | $ | 10(1  | ) |  | $ | 253 | 
|YEAR ENDED DECEMBER 31, 2000                           |                                 |                      |   |                  |  |                  |   |              |  |                |   |     |     |  |   |       |   |  |   |    
|Reserves and allowances deducted from asset
	accounts: |                                 |                      |   |                  |  |                  |   |              |  |                |   |     |     |  |   |       |   |  |   |    
|                                                       | Allowance for doubtful accounts |                      | $ | 253              |  |                  | $ | 128          |  |                |   |     |     |  | $ | 256(1 | ) |  | $ | 125 | 
|YEAR ENDED DECEMBER 31, 2001                           |                                 |                      |   |                  |  |                  |   |              |  |                |   |     |     |  |   |       |   |  |   |    
|Reserves and allowances deducted from asset
	accounts: |                                 |                      |   |                  |  |                  |   |              |  |                |   |     |     |  |   |       |   |  |   |    
|                                                       | Allowance for doubtful accounts |                      | $ | 125              |  |                  | $ | 226          |  |                | $ | 155 | (2) |  | $ | 172(1 | ) |  | $ | 334 | 



---



|    |                                                                                                                               
|--- | ------------------------------------------------------------------------------------------------------------------------------
|(1) | Uncollectible accounts written off, net of
	recoveries.                                                                       
|   
|(2) | Amount represents reserve recorded as a reduction
	of deferred revenue and represents customer balances deemed
	uncollectible.

II-1



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##### Table of Contents






EXHIBIT INDEX

|       |           |                         |  |                                                                                                                                          
|------ | --------- | ----------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------
|Number |           | Description of Document
|       |           |                        
|       | 3.1(1)    |                         |  | Amended and Restated Certificate of Incorporation                                                                                        
|       | 3.2(1)    |                         |  | Restated Bylaws                                                                                                                          
|       | 4.1(1)    |                         |  | Specimen Stock Certificate of Websense, Inc.                                                                                             
|       | 10.1(1)   |                         |  | Amended and Restated Registration Rights
	Agreement dated June 9, 1999                                                                   
|       | 10.2(1)   |                         |  | Form of Subscription Agreement regarding
	Series B Preferred Stock                                                                       
|       | 10.3(1)   |                         |  | Warrant to Purchase Common Stock between
	Websense, Inc. and Alps System Integration Co., Ltd., dated
	April 15, 1999                    
|       | 10.4(1)   |                         |  | Form of Warrant to Purchase Common Stock between
	Websense, Inc. and entities listed on Schedule A attached
	thereto, dated July 30, 1999
|       | 10.5(1)*  |                         |  | Employment Agreement by and between Websense,
	Inc. and John B. Carrington, dated May 10, 1999                                           
|       | 10.6(1)*  |                         |  | Employment Agreement by and between Websense,
	Inc. and Douglas C. Wride, dated June 11, 1999                                            
|       | 10.7(1)   |                         |  | Lease Agreement between Websense, Inc. and
	Legacy-RECP Sorrento OPCO, LLC, dated June 21, 1999, as
	amended                             
|       | 10.8(1)   |                         |  | 1998 Equity Incentive Plan                                                                                                               
|       | 10.9(1)*  |                         |  | Standard Terms and Conditions Relating to
	Incentive Stock Option Under the 1998 Equity Incentive Plan                                   
|       | 10.10(1)* |                         |  | 2000 Stock Incentive Plan                                                                                                                
|       | 10.11(1)* |                         |  | 2000 Stock Incentive Plan, Notice of Grant of
	Stock Option                                                                              
|       | 10.12(1)* |                         |  | 2000 Stock Incentive Plan, Form of Incentive
	Stock Option Agreement                                                                     
|       | 10.13(1)* |                         |  | 2000 Employee Stock Purchase Plan                                                                                                        
|       | 10.14(1)  |                         |  | Form of Indemnification Agreement between
	Websense, Inc. and its directors                                                              
|       | 10.15(1)  |                         |  | Form of Indemnification Agreement between
	Websense, Inc. and its officers                                                               
|       | 10.16(2)  |                         |  | Lease Agreement between Websense, Inc. and
	Legacy-RECP Sorrento OPCO, LLC, dated February 12, 2000                                      
|       | 10.17(2)  |                         |  | First Amendment to Lease Agreement between
	Websense, Inc. and Legacy-RECP Sorrento OPCO, LLC, dated
	June 2, 2000                       
|       | 21.1      |                         |  | Subsidiaries of the Registrant                                                                                                           
|       | 23.1      |                         |  | Consent of Ernst & Young LLP, Independent
	Auditors                                                                                      



---



|  |                                                                    
|- | -------------------------------------------------------------------
|* | Indicates management contract or compensatory
	plan or arrangement.



|    |                                                                                                                                                             
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Previously filed as an exhibit to our
	Registration Statement on Form S-1 (Registration
	No. 333-95619) and incorporated herein by reference.               
|   
|(2) | Previously filed as an exhibit to our
	Form 10-K for the period ended December 31, 2000
	(Registration No. 000-30093) and incorporated herein by
	reference.