##### Table of Contents



SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

|    |  |                                                    
|--- |  | ---------------------------------------------------
|[X] |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934


FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2002

OR

|     |  |                                                  
|---- |  | -------------------------------------------------
|[  ] |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934


COMMISSION FILE NUMBER 0-26825

N2H2, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)


WASHINGTON
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION)

91-1686754
(I.R.S. EMPLOYER IDENTIFICATION NO.)

900 FOURTH AVENUE, SUITE 3600, SEATTLE, WA 98164
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES, INCLUDING ZIP CODE)

REGISTRANTS TELEPHONE NUMBER, INCLUDING AREA CODE: (206) 336-1501

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

As of February 6, 2003, the registrant had outstanding 22,104,776 shares
of common stock, no par value.





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TABLE OF CONTENTS



|                             |                                                                                                |                                                      |  |  |  |  |  | 
|---------------------------- | ---------------------------------------------------------------------------------------------- | ---------------------------------------------------- |  |  |  |  |  | 
|PART IFINANCIAL INFORMATION
|                             | ITEM 1. FINANCIAL STATEMENTS                                                                  
|                             |                                                                                                | CONDENSED CONSOLIDATED BALANCE SHEETS               
|                             |                                                                                                | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS     
|                             |                                                                                                | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS     
|                             |                                                                                                | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
|                             | ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
|                             | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                            
|                             | ITEM 4. CONTROLS AND PROCEDURES                                                               
|PART IIOTHER INFORMATION   
|                             | ITEM 1. LEGAL PROCEEDINGS                                                                     
|                             | ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                             
|                             | ITEM 3. DEFAULTS UPON SENIOR SECURITIES                                                       
|                             | ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                   
|                             | ITEM 5. OTHER INFORMATION                                                                     
|                             | ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K                                                      
|SIGNATURES                  
|CERTIFICATIONS              
|EXHIBIT 99.1                



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##### Table of Contents



N2H2, INC.

TABLE OF CONTENTS

|                             |                                                                                               |                                                                        |    |    |   | 
|---------------------------- | --------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------- | -- | -- | - | 
|PART IFINANCIAL INFORMATION |                                                                                               |                                                                        | 3  |   
|                             | Item 1. Financial Statements                                                                  |                                                                        |    | 3  |  
|                             |                                                                                               | CONDENSED CONSOLIDATED BALANCE SHEETS                                  |    |    | 3 | 
|                             |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS |    |    | 4 | 
|                             |                                                                                               | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                        |    |    | 5 | 
|                             |                                                                                               | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                   |    |    | 6 | 
|                             | Item 2. Managements Discussion And Analysis Of Financial Condition And Results Of Operations |                                                                        |    | 8  |  
|                             | Item 3. Quantitative And Qualitative Disclosures About Market Risk                            |                                                                        |    | 19 |  
|                             | Item 4. Controls and Procedures                                                               |                                                                        |    | 19 |  
|PART IIOTHER INFORMATION    |                                                                                               |                                                                        | 20 |   
|                             | Item 1. Legal Proceedings                                                                     |                                                                        |    | 20 |  
|                             | Item 2. Changes In Securities And Use Of Proceeds                                             |                                                                        |    | 20 |  
|                             | Item 3. Defaults Upon Senior Securities                                                       |                                                                        |    | 20 |  
|                             | Item 4. Submission Of Matters To A Vote Of Security Holders                                   |                                                                        |    | 20 |  
|                             | Item 5. Other Information                                                                     |                                                                        |    | 20 |  
|                             | Item 6. Exhibits And Reports On Form 8-K                                                      |                                                                        |    | 20 |  
|SIGNATURES                   |                                                                                               |                                                                        | 21 |   
|CERTIFICATIONS               |                                                                                               |                                                                        | 22 |   

2



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##### Table of Contents






PART IFINANCIAL INFORMATION




ITEM 1. FINANCIAL STATEMENTS

N2H2, INC.




CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands)

|                                      |                                                                                             |                                      |                                            |         |              |       |               |         |        |       | 
|------------------------------------- | ------------------------------------------------------------------------------------------- | ------------------------------------ | ------------------------------------------ | ------- | ------------ | ----- | ------------- | ------- | ------ | ----- | 
|                                      |                                                                                             |                                      |                                            |         | DECEMBER 31, |       | SEPTEMBER 30,
|                                      |                                                                                             |                                      |                                            |         | 2002         |       | 2002         
|                                      |                                                                                             |                                      |                                            |         |              |       |              
|ASSETS:                               |                                                                                             |                                      |                                            |         |              |       |               |        
|Current assets:                       |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      | Cash and cash equivalents                                                                   |                                      | $                                          | 4,042   |              |       | $             | 4,009   |       
|                                      | Restricted cash and cash equivalents                                                        |                                      |                                            | 675     |              |       |               | 675     |       
|                                      | Accounts receivable, net of allowances                                                      |                                      |                                            | 1,288   |              |       |               | 1,825   |       
|                                      | Prepaid expenses and other current assets                                                   |                                      |                                            | 494     |              |       |               | 737     |       
|                                      |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      |                                                                                             | Total current assets                 |                                            |         | 6,499        |       |               |         | 7,246  |      
|Property and equipment, net           |                                                                                             |                                      | 971                                        |         |              |       | 1,249         |        
|Other assets, net                     |                                                                                             |                                      | 140                                        |         |              |       | 140           |        
|                                      |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      |                                                                                             |                                      | Total assets                               |         | $            | 7,610 |               |         | $      | 8,635 | 
|                                      |                                                                                             |                                      |                                            |         |              |       |               |         |       
|LIABILITIES AND SHAREHOLDERS EQUITY: |                                                                                             |                                      |                                            |         |              |       |               |        
|Current liabilities:                  |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      | Accounts payable                                                                            |                                      | $                                          | 320     |              |       | $             | 262     |       
|                                      | Accrued payroll & benefits                                                                  |                                      |                                            | 308     |              |       |               | 452     |       
|                                      | Other accrued liabilities                                                                   |                                      |                                            | 381     |              |       |               | 467     |       
|                                      | Deferred revenue                                                                            |                                      |                                            | 7,463   |              |       |               | 8,179   |       
|                                      | Note payable                                                                                |                                      |                                            | 33      |              |       |               | 58      |       
|                                      | Current portion of capital lease obligations                                                |                                      |                                            |        |              |       |               | 21      |       
|                                      |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      |                                                                                             | Total current liabilities            |                                            |         | 8,505        |       |               |         | 9,439  |      
|Deferred revenue                      |                                                                                             |                                      | 927                                        |         |              |       | 863           |        
|Other non-current                     |                                                                                             |                                      | 94                                         |         |              |       | 105           |        
|                                      |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      |                                                                                             | Total liabilities                    |                                            |         | 9,526        |       |               |         | 10,407 |      
|                                      |                                                                                             |                                      |                                            |         |              |       |               |        
|Shareholders equity (deficit):       |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      | Preferred stock, no par value; 50,000 shares
authorized, no shares issued and outstanding   |                                      |                                            |        |              |       |               |        |       
|                                      | Common stock, no par value; 250,000 shares
authorized, 22,105 shares issued and outstanding |                                      |                                            | 92,176  |              |       |               | 92,176  |       
|                                      | Notes receivable from shareholders, net of allowances                                       |                                      |                                            | (38     | )            |       |               | (41     | )     
|                                      | Deferred stock compensation                                                                 |                                      |                                            | (168    | )            |       |               | (415    | )     
|                                      | Accumulated other comprehensive loss                                                        |                                      |                                            | (67     | )            |       |               | (102    | )     
|                                      | Accumulated deficit                                                                         |                                      |                                            | (93,819 | )            |       |               | (93,390 | )     
|                                      |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      |                                                                                             | Total shareholders equity (deficit) |                                            |         | (1,916       | )     |               |         | (1,772 | )    
|                                      |                                                                                             |                                      |                                            |         |              |       |               |        
|                                      |                                                                                             |                                      | Total liabilities and shareholders equity |         | $            | 7,610 |               |         | $      | 8,635 | 
|                                      |                                                                                             |                                      |                                            |         |              |       |               |         |       

The accompanying notes are an integral part of these condensed
consolidated financial statements.

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N2H2, INC.




CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands except per share amounts)

|                                                      |                                                  |                          |        |                    |       |      |        |       |       | 
|----------------------------------------------------- | ------------------------------------------------ | ------------------------ | ------ | ------------------ | ----- | ---- | ------ | ----- | ----- | 
|                                                      |                                                  |                          |        | THREE MONTHS ENDED
|                                                      |                                                  |                          |        | DECEMBER 31,      
|                                                      |                                                  |                          |        |                   
|                                                      |                                                  |                          |        | 2002               |       | 2001
|                                                      |                                                  |                          |        |                    |       |     
|Revenues:                                             |                                                  | $                        | 3,027  |                    |       | $    | 2,893  |      
|Operating expenses:                                   |                                                  |                          |        |                    |       |      |        |      
|                                                      | Internet filtering services and customer support |                          |        | 598                |       |      |        | 846   |      
|                                                      | Sales and marketing                              |                          |        | 1,411              |       |      |        | 1,800 |      
|                                                      | General and administrative                       |                          |        | 830                |       |      |        | 985   |      
|                                                      | Research and development                         |                          |        | 348                |       |      |        | 437   |      
|                                                      | Depreciation and amortization                    |                          |        | 276                |       |      |        | 533   |      
|                                                      |                                                  |                          |        |                    |       |      |        |      
|                                                      |                                                  | Total operating expenses |        |                    | 3,463 |      |        |       | 4,601 | 
|Loss from operations                                  |                                                  |                          | (436   | )                  |       |      | (1,708 | )    
|Interest income, net of interest expense              |                                                  |                          | 19     |                    |       |      | 43     |      
|Loss on disposal of property and equipment            |                                                  |                          | (12    | )                  |       |      |       |      
|                                                      |                                                  |                          |        |                    |       |      |        |      
|                                                      |                                                  |                          |        |                    |       |      |        |      
|Net loss                                              |                                                  | $                        | (429   | )                  |       | $    | (1,665 | )    
|                                                      |                                                  |                          |        |                    |       |      |        |      
|Foreign currency translation gain                     |                                                  |                          | 35     |                    |       |      | 24     |      
|                                                      |                                                  |                          |        |                    |       |      |        |      
|Comprehensive loss                                    |                                                  | $                        | (394   | )                  |       | $    | (1,641 | )    
|                                                      |                                                  |                          |        |                    |       |      |        |      
|Basic and diluted net loss per share                  |                                                  | $                        | (0.02  | )                  |       | $    | (0.08  | )    
|                                                      |                                                  |                          |        |                    |       |      |        |      
|Basic and diluted weighted average shares outstanding |                                                  |                          | 21,934 |                    |       |      | 21,725 |      
|                                                      |                                                  |                          |        |                    |       |      |        |      

The accompanying notes are an integral part of these condensed
consolidated financial statements.

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N2H2, INC.




CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)

|                                                                                          |                                              |   |                    |      |      |   |        |       |  
|----------------------------------------------------------------------------------------- | -------------------------------------------- | - | ------------------ | ---- | ---- | - | ------ | ----- | -
|                                                                                          |                                              |   | THREE MONTHS      
|                                                                                          |                                              |   | ENDED DECEMBER 31,
|                                                                                          |                                              |   |                   
|                                                                                          |                                              |   | 2002               |      | 2001
|                                                                                          |                                              |   |                    |      |     
|Cash flows from operating activities:                                                     |                                              |   |                    |      |      |   |        |      
|Net loss                                                                                  |                                              | $ | (429               | )    |      | $ | (1,665 | )    
|Adjustments
to reconcile net loss to net cash provided by (used by) operating activities: |                                              |   |                    |      |      |   |        |      
|                                                                                          | Depreciation and amortization                |   |                    | 275  |      |   |        | 533   |  
|                                                                                          | Amortization of deferred stock compensation  |   |                    | 247  |      |   |        | 622   |  
|                                                                                          | Change in accounting policy                  |   |                    | (95  | )    |   |        | (345  | )
|                                                                                          | Loss on disposal of property and equipment   |   |                    | 12   |      |   |        |      |  
|                                                                                          | Interest on shareholder loans                |   |                    | (5   | )    |   |        | (7    | )
|Changes in operating assets and liabilities:                                              |                                              |   |                    |      |      |   |        |      
|                                                                                          | Accounts receivable                          |   |                    | 537  |      |   |        | 1,117 |  
|                                                                                          | Prepaid expenses and other current assets    |   |                    | 243  |      |   |        | 208   |  
|                                                                                          | Other assets                                 |   |                    | (6   | )    |   |        |      |  
|                                                                                          | Accounts payable                             |   |                    | 58   |      |   |        | (113  | )
|                                                                                          | Accrued liabilities                          |   |                    | (230 | )    |   |        | (299  | )
|                                                                                          | Deferred revenue                             |   |                    | (557 | )    |   |        | (550  | )
|                                                                                          | Other non-current liabilities                |   |                    | (11  | )    |   |        |      |  
|                                                                                          |                                              |   |                    |      |      |   |        |      
|Net cash provided by (used by) operating activities:                                      |                                              |   | 39                 |      |      |   | (499   | )    
|                                                                                          |                                              |   |                    |      |      |   |        |      
|Cash flows from investing activities:                                                     |                                              |   |                    |      |      |   |        |      
|                                                                                          | Notes receivable from shareholders           |   |                    | 7    |      |   |        |      |  
|                                                                                          | Additions to property and equipment          |   |                    | (4   | )    |   |        | (116  | )
|                                                                                          | Proceeds from sale of property and equipment |   |                    | 1    |      |   |        | 9     |  
|                                                                                          |                                              |   |                    |      |      |   |        |      
|Net cash provided by (used by) investing activities                                       |                                              |   | 4                  |      |      |   | (107   | )    
|                                                                                          |                                              |   |                    |      |      |   |        |      
|Cash flows from financing activities:                                                     |                                              |   |                    |      |      |   |        |      
|                                                                                          | Exercise of stock options                    |   |                    |     |      |   |        | 1     |  
|                                                                                          | Payments under capital lease obligations     |   |                    | (21  | )    |   |        | (56   | )
|                                                                                          | Repayments of notes payable                  |   |                    | (24  | )    |   |        | (17   | )
|                                                                                          |                                              |   |                    |      |      |   |        |      
|Net cash used by financing activities                                                     |                                              |   | (45                | )    |      |   | (72    | )    
|                                                                                          |                                              |   |                    |      |      |   |        |      
|                                                                                          | Effects of exchange rate changes             |   |                    | 35   |      |   |        | 24    |  
|                                                                                          |                                              |   |                    |      |      |   |        |      
|Net decrease in cash                                                                      |                                              |   | 33                 |      |      |   | (654   | )    
|Cash, beginning of period                                                                 |                                              |   | 4,009              |      |      |   | 5,979  |      
|                                                                                          |                                              |   |                    |      |      |   |        |      
|Cash, end of period                                                                       |                                              | $ | 4,042              |      |      | $ | 5,325  |      
|                                                                                          |                                              |   |                    |      |      |   |        |      
|SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION                                          |                                              |   |                    |      |      |   |        |      
|Cash paid for interest                                                                    |                                              | $ | 1                  |      |      | $ | 5      |      
|                                                                                          |                                              |   |                    |      |      |   |        |      

The accompanying notes are an integral part of these condensed
consolidated financial statements.

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N2H2, INC.




NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

1. BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

The accompanying condensed consolidated financial statements of N2H2, Inc.
and subsidiaries (the Company) are unaudited. In the opinion of management, the
financial statements include all adjustments, consisting only of normal
recurring adjustments necessary for their fair presentation in conformity with
accounting principles generally accepted in the United States of America.
Preparing financial statements requires management to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenue,
and expenses and the disclosure of contingent assets and liabilities. Actual
results may differ from these estimates. Operating results for the three-month
period ended December 31, 2002 are not necessarily indicative of results to be
expected for a full year. The information included in this Form 10-Q should be
read in conjunction with Managements Discussion and Analysis of Financial
Condition and Results of Operations herein, as well as with the financial
statements and notes thereto included in the Companys annual report on Form
10-K for the year ended September 30, 2002 as filed with the Securities and
Exchange Commission on December 19, 2002.

The Company has experienced significant net operating losses from
inception and has an accumulated shareholders deficit. In fiscal 2002, the
Company incurred operating losses of $6.6 million and used $1.8 million of cash
in its operating activities. For the three-months ended December 31, 2002, the
Company incurred operating losses of $429,000 and generated cash of $39,000
from its operating activities. The Company anticipates that operating losses
will continue at least through a portion of fiscal 2003 as the Company
continues to develop its distribution channels and customer base. If cash
generated from operations is insufficient to satisfy the Companys longer-term
liquidity requirements, the Company may seek to further reduce expenses, sell
additional equity or debt securities, or obtain a credit facility to continue
operations beyond twelve months from the date of this filing. Alternatively,
management may seek to sell the Company. The incurring of indebtedness would
result in increased fixed obligations and could result in covenants that would
restrict the Companys operations. The Company has not made arrangements to
obtain additional financing and there can be no assurance that financing will
be available in amounts or on acceptable terms, if at all.

Principles of Consolidation

The consolidated financial statements include the accounts of N2H2, Inc.
and its wholly owned subsidiaries, N2H2, Ltd. and N2H2 Pty Limited. All
inter-company accounts and transactions have been eliminated in consolidation.

Use of Estimates

The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.

Revenue Recognition

The Companys revenues are derived primarily from sales of Internet
filtering subscriptions. A smaller portion of its revenue also comes from
installation and maintenance fees. The Company recognizes revenue in accordance
with Statement of Position No. 97-2, Software Revenue Recognition (SOP 97-2).
Accordingly, revenue is recognized when persuasive evidence of an arrangement
exists, the product or service has been delivered, the fee is fixed and
determinable, and collection is reasonably assured.

Subscription revenues represent the fees associated with the right to use
the Companys software and/or hardware, and to access the Companys filtering
updates. Maintenance revenues represent fees associated with technical support
services provided to customers. Subscription and maintenance agreements are
generally 12, 24 or 36 months in duration. Subscription and maintenance
revenues are recognized on a straight-line basis over the life of the
agreement. Amounts billed in advance of services provided are recorded as
deferred revenue. The Companys revenue growth is significantly influenced by
subscription renewals, and a decrease in renewals could negatively impact the
Companys revenue.

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Installation revenues represent one-time fees associated with the customization
and installation of the Companys software on customer servers. Installation
services are billed upon completion and are recognized over the expected life
of the customer relationship in accordance with Staff Accounting Bulletin No.
101, Revenue Recognition in Financial Statements. The Company estimates the
expected life of its customer relationships based on a number of factors,
including customer type and customer history. Estimates of expected customer
lives are assessed on an ongoing basis. A material change in the estimated
customer life could significantly impact the rate at which the Company
recognizes these revenues.

2. NET LOSS PER SHARE

Basic net loss per share is computed on the basis of the weighted average
number of common shares outstanding. Diluted net loss per share includes common
equivalent shares during the period, if dilutive. As the Company had a net loss
attributable to common shareholders in each of the periods presented, basic and
diluted net loss per share are the same.

The components of basic and diluted loss per share were as follows:

|             |                                                              |                                      |   |                        |       |      |   |        |       |  
|------------ | ------------------------------------------------------------ | ------------------------------------ | - | ---------------------- | ----- | ---- | - | ------ | ----- | -
|             |                                                              |                                      |   | THREE MONTHS          
|             |                                                              |                                      |   | ENDED
DECEMBER 31,    
|             |                                                              |                                      |   |                       
|             |                                                              |                                      |   | 2002                   |       | 2001
|             |                                                              |                                      |   |                        |       |     
|             |                                                              |                                      |   | (in thousands,        
|             |                                                              |                                      |   | except per share data)
|Numerator:   |                                                              |                                      |   |                        |       |      |   |       
|             | Net loss                                                     |                                      | $ | (429                   | )     |      | $ | (1,665 | )    
|Denominator: |                                                              |                                      |   |                        |       |      |   |       
|             | Basic and diluted weighted average
common shares outstanding |                                      |   | 21,934                 |       |      |   | 21,725 |      
|             |                                                              |                                      |   |                        |       |      |   |       
|             |                                                              | Basic and diluted net loss per share |   | $                      | (0.02 | )    |   | $      | (0.08 | )
|             |                                                              |                                      |   |                        |       |      |   |        |      

Warrants for 539,280 shares, options for 4,799,598 shares, and 170,596
restricted shares have been excluded from the calculation of diluted loss per
share at December 31, 2002 because they are anti-dilutive. Warrants for 539,280
shares, options for 3,066,333 shares, and 341,192 restricted shares have been
excluded from the calculation of diluted loss per share at December 31, 2001
because they are anti-dilutive.

3. CHANGE IN ACCOUNTING POLICY

In December 1999, the Securities and Exchange Commission issued Staff
Accounting Bulletin No. 101, Revenue Recognition in Financial Statements (SAB
101). SAB 101 requires that up-front installation fees be deferred and
recognized over the term of the customer relationship. In fiscal 2000 and
previous years, the Company recognized installation revenue upon completion of
the installation. Effective at the beginning of fiscal 2001, in accordance
with the provisions of SAB 101, the Company began deferring installation
revenue over the expected life of the customer relationship. The adoption of
SAB 101 resulted in a one-time, non-cash charge of $3.6 million on October 1,
2000 for the cumulative effect of the change in accounting policy. The
cumulative effect was recorded as deferred revenue and is being recognized as
revenue over the remaining expected life of the customer relationship. The
amount of related deferred revenue, which was recognized as revenue during the
three-month periods ended December 31, 2002 and 2001 was $95,000 and $345,000,
respectively. The remaining related deferred revenue of $134,000 will be
recognized in fiscal 2003.

4. RESTRICTED CASH AND CASH EQUIVALENTS

The Company has $675,000 of restricted cash pledged as collateral for a
letter of credit related to the Companys leased office space in the amount of
$665,000, expiring on July 31, 2005, and a $10,000 deposit held by Comerica for
the issuance of corporate credit cards. The restriction will remain in effect
through the term of these commitments. Alternatively, the Company may seek to
obtain a line of credit to underwrite these obligations.

5. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, Accounting for Stock-Based Compensation  Transition and
Disclosure. SFAS 148 amends SFAS 123, Accounting for Stock-Based Compensation,
to provide alternative methods of transition for an entity that voluntarily
changes to the fair value based method of accounting for stock-based
compensation. It also amends the disclosure provisions of that statement. The
disclosure provisions of SFAS 148 are effective for

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financial statements issued for fiscal periods beginning after December
15, 2002 and will become effective for the Company commencing with the second
quarter of the 2003 fiscal year. The Company does not currently have plans to
change to the fair value method of accounting for its stock-based compensation.




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

FORWARD LOOKING INFORMATION

Our disclosure and analysis in this report contain forward-looking
statements, which provide our current expectations or forecasts of future
events. Forward-looking statements in this report include, without limitation:



| |  |  | statements about our future capital requirements, our future cash
flows and the sufficiency of our existing cash, cash equivalents,
investments and available bank borrowings to meet these requirements;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | information concerning possible or assumed future results of
operations, trends in financial results and business plans, including
those relating to earnings growth and revenue growth;                 
|
| |  |  | statements about the level of our costs and operating expenses
relative to our revenues;                                                                                                                 
|
| |  |  | other statements about our plans, objectives, expectations and
intentions; and                                                                                                                           
|
| |  |  | other statements that are not historical facts.                                                                                                                                                          

Words such as believes, anticipates and intends may identify
forward-looking statements, but the absence of these words does not necessarily
mean that a statement is not forward-looking. Forward-looking statements are
subject to known and unknown risks and uncertainties and are based on
potentially inaccurate assumptions that could cause actual results to differ
materially from those expected or implied by the forward-looking statements.
Our actual results could differ materially from those anticipated in the
forward-looking statements for many reasons, including the factors described in
the section entitled Important Factors That May Affect Our Business, Our
Results of Operations and Our Stock Price in this report. Other factors
besides those described in this report could also affect actual results. You
should carefully consider the factors described in the section entitled
Important Factors That May Affect Our Business, Our Results of Operations and
Our Stock Price in evaluating our forward-looking statements.

You should not unduly rely on these forward-looking statements, which
speak only as of the date of this report. We undertake no obligation to
publicly revise any forward-looking statement to reflect circumstances or
events after the date of this report, or to reflect the occurrence of
unanticipated events. You should, however, review the factors and risks we
describe in the reports we file from time to time with the Securities and
Exchange Commission, or SEC.

OVERVIEW

N2H2 is an international Internet monitoring and filtering company. Our
solutions help customers control, manage and understand their Internet use by
filtering Web content, monitoring Internet access and delivering concise
reports on user activity. These safeguards are designed to enable
organizations of any size to mitigate potential legal liability, increase user
productivity and optimize network bandwidth.

Our Bess® and Sentian filtering solutions are powered by our
premium-quality filtering database  a list recognized by independent and
respected third-parties as the most effective in the industry. N2H2 is based in
Seattle, Washington and serves millions of users worldwide. Our software
solutions are Cisco Verified, Microsoft Gold Certified and Check Point OPSEC
compliant and are available for major platforms and devices.

As a leading provider of Internet content filtering to schools, we are
attempting to leverage our expertise in filtering large-scale networks within
sensitive environments via additional channel presence and expansion plans for
ISPs, corporations, governments, and other organizations. We have customers in
several countries including Australia, Canada, Chile, the Dominican Republic,
Japan, Mexico, the United Kingdom and the United States. To cover these
markets, we use a combination of our own sales force and various resellers,
both domestic and international.

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Our prospects are subject to the risks, expenses, and difficulties
encountered by companies in the rapidly evolving Internet market. We have
incurred significant net losses since inception and, as of December 31, 2002,
had incurred aggregate operating losses of approximately $93.8 million from
inception. These losses have been funded primarily through the issuance of
common stock. We intend to continue to seek opportunities to improve
efficiencies in our operations to reduce operating
losses.

RESULTS OF OPERATIONS  THREE MONTHS ENDED DECEMBER 31, 2002

Revenue

We generate our revenue primarily from subscriptions to our Internet
filtering, monitoring, and reporting services. A smaller portion of our revenue
also comes from installation and maintenance fees.

Revenue increased by 5% to $3.0 million for the quarter, compared to $2.9
million for the comparable period in the prior fiscal year. Revenue increased
due to the addition of new customers in the corporate and education markets. Our
new Bess and Sentian filtering solutions now make up the majority of our sales,
with these subscriptions accounting for 63% of our sales during the quarter.
The increase in revenue was partially offset by a decline in revenue recognized
in conjunction with the adoption of SAB 101. The amount of related SAB 101
revenue recognized during the quarter was $95,000, down from $345,000 in the
same quarter of the prior year. Excluding these amounts, revenue from
customers increased 15% over the same quarter of the prior year.

Internet filtering services and customer support costs

Internet filtering services and customer support costs consist of the
costs of Website review, technical installation and support, costs associated
with building and maintaining our database, collocation, bandwidth, and an
allocation of corporate facilities costs.

Internet filtering services and customer support costs decreased by 29% to
$598,000 for the quarter, compared to $846,000 for the comparable period in the
prior fiscal year. The decrease is primarily due to reductions in employee
count that took place in the fourth quarter of fiscal 2002, and Internet
connectivity and collocation cost savings realized by changing vendors and
negotiating more favorable terms in fiscal 2002. We anticipate that Internet
filtering services and customer support costs will remain materially consistent
with first quarter levels through the remainder of the fiscal year.

Sales and marketing

Sales and marketing expenses consist primarily of salaries, commissions
and stock compensation expense for personnel engaged in selling and marketing
functions, and various marketing programs, such as public relations,
advertising, and lead generation. Sales and marketing also includes an
allocation of corporate facilities costs.

Sales and marketing expenses decreased by 22% to $1.4 million for the
quarter, from $1.8 million for the comparable period in the prior fiscal year.
The decrease is primarily due to reduced deferred stock compensation expense.
Deferred stock compensation is being amortized using an accelerated method,
which resulted in higher expense in fiscal 2002 as compared to 2003. The
decrease is also due in part to reductions in the employee count that took
place in the fourth quarter of fiscal 2002. The decrease in sales and
marketing expense was partially offset by increased spending on various
marketing programs, as we continue to build, train and support our distribution
channels. We may further increase our spending on marketing programs in future
quarters.

General and administrative

General and administrative expenses consist primarily of salaries,
benefits and related costs for executive, finance, human resources and
administrative personnel, third party professional service fees, insurance
costs, and an allocation of corporate facilities costs.

General and administrative expenses decreased by 16% to $830,000 for the
quarter, from $985,000 for the comparable period in the prior fiscal year. This
decrease is due in part to reductions in administrative staffing that took
place in the fourth quarter of fiscal 2002. We also incurred less bad debt
expense, as the improved financial stability of our customer base resulted in
an improved collection rate. We anticipate that general and administrative
expenses will remain materially consistent with first quarter levels through
the remainder of the fiscal year.

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Research and development

Research and development costs consist primarily of salaries and benefits
for software developers, consulting fees and an allocation of corporate
facilities costs. Research and development activities consist primarily of
developing new filtering products and enhancing existing products. Product
costs related to internal research and development have been expensed as
incurred.

Research and development expenses decreased by 20% to $348,000 for the
quarter, from $437,000 for the comparable period in the prior fiscal year.
This decrease is due in part to reductions in employee count that took place in
the fourth quarter of fiscal 2002, and our reduced usage of contractors and
third party service providers in the development of our products. Research and
development costs are expected to remain materially consistent with first
quarter levels through the remainder of the fiscal year.

Depreciation and amortization

Depreciation and amortization expenses decreased by 48% to $276,000 for
the quarter, from $533,000 for the comparable period in the prior fiscal year.
This decrease is due to the declining net book value of our fixed assets and
leasehold improvements.

Interest income and expense

Interest income consists primarily of interest earned on our cash
equivalents and short-term investments, if any. Interest expense consists of
interest paid on our note payable and capital lease obligations. Net interest
income decreased by 56% to $19,000, from $43,000 for the comparable period in
the prior fiscal year. The decrease is due to our reduced cash and cash
equivalent balance.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents were $4.72 million (including restricted cash of
$675,000) or 62% of total assets at December 31, 2002, compared to $4.68
million (including restricted cash of $675,000) or 54% of total assets at
September 30, 2002. The increase in cash and cash equivalents is due to cash
provided by operations, offset by minor purchases of computer equipment and
payments under capital lease and note payable obligations. Operating
activities provided $39,000 for the quarter, while operating activities
consumed $499,000 for the comparable period in the prior fiscal year.

Net cash provided by investing activities was $4,000 for the quarter,
compared to net cash used in investing activities of $107,000 for the
comparable period of the prior fiscal year. Investing activities consist of
amounts collected on notes receivable and proceeds from sales of property and
equipment, partially offset by capital expenditures. The additions to property
and equipment during the period consist of computers purchased to support
internal operations. We anticipate a small increase in equipment purchases in
future quarters to support our internal operations and our growing customer
base.

Financing activities consumed $45,000 for the quarter, compared to $72,000
for the comparable period of the prior fiscal year. Financing activities
consist of payments under capital lease and note payable obligations.
Restricted cash of $675,000 is pledged as collateral for a letter of credit
related to our leased office space in the amount of $665,000, expiring on July
31, 2005, and a $10,000 deposit held by Comerica for the issuance of corporate
credit cards. The restriction will remain in effect through the term of these
commitments. Alternatively, we may seek to obtain a line of credit to
underwrite these obligations.

We have experienced significant net operating losses from inception. In
fiscal 2002, we incurred operating losses of $6.6 million. We incurred
operating losses of $429,000 for the three-months ended December 31, 2002. We
anticipate that operating losses will continue at least through a portion of
fiscal 2003 as we continue to develop our distribution channels and customer
base. Given our reduced level of employees and operating expenses, and our
customer renewal rates, we believe that our cash on hand, together with cash
generated from operations, will be sufficient to meet our anticipated cash
needs for at least the next twelve months. If cash generated from operations
is insufficient to satisfy our longer-term liquidity requirements, we may seek
to further reduce expenses, sell additional equity or debt securities, obtain a
credit facility, or sell N2H2. The incurring of indebtedness would result in
increased fixed obligations and could result in covenants that would restrict
our operations. We have not made arrangements to obtain additional financing
and we cannot assure you that financing will be available in amounts or on
terms acceptable to us, if at all. If revenues generated from operations are
insufficient to satisfy our long-term liquidity requirements and we are not
successful in further reducing expenses, raising additional funds, or finding a
buyer for N2H2 on acceptable terms when needed, our business would not succeed.

Following is a summary of our significant unconditional contractual
obligations and commercial commitments:

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|                         |                 |  |                        |           |        |  |           |           |           |  |         |           |  |  |  |   |       |  |  |   | 
|------------------------ | --------------- |  | ---------------------- | --------- | ------ |  | --------- | --------- | --------- |  | ------- | --------- |  |  |  | - | ----- |  |  | - | 
|                         |                 |  | Payments Due by Period
|                         |                 |  |                       
|                         |                 |  |                        |           |        |  | Less than |           |           |  |         |           |  |  |  |   | After
|                         |                 |  |                        |           |        |  |           |           |           |  |         |           |  |  |  |   |      
|                         |                 |  | Total                  |           | 1 year |  | 1-3 years |           | 4-5 years |  | 5 years
|                         |                 |  |                        |           |        |  |           |           |           |  |        
|Contractual Obligations: |                 |  |                        |           |        |  |           |           |           |  |         |           |  |  |  |   |       |  |  |  
|                         | Operating Lease |  | $                      | 3,400,000 |        |  | $         | 1,238,000 |           |  | $       | 2,162,000 |  |  |  |  |       |  |  |  | 

IMPORTANT FACTORS THAT MAY AFFECT OUR BUSINESS, OUR RESULTS OF OPERATIONS AND
OUR STOCK PRICE

If we are unable to achieve profitability as planned, we may need additional
funding to continue operations. We may be unable to obtain additional funding
and any funding we do obtain could dilute our shareholders ownership interest
in N2H2.

Our future revenues may be insufficient to support the expenses of our
operations and the expansion of our business. We may therefore need to raise
additional capital to finance our operations. If we are unable to raise
additional capital on acceptable terms, we may seek to further reduce expenses,
obtain a credit facility, or sell N2H2. The incurring of indebtedness would
result in increased fixed obligations and could result in covenants that would
restrict our operations. If revenues generated from operations are insufficient
to satisfy our long-term liquidity requirements and we are not successful in
further reducing expenses, raising additional funds, or finding a buyer for
N2H2 on acceptable terms when needed, our business would not succeed.

We believe that our existing cash and cash equivalents will be sufficient
to meet our capital requirements for at least the next 12 months. However, we
may seek additional funds before that time through public or private equity
financing or from other sources to fund our operations and pursue our business
strategy. We have no commitment for additional financing, and we may
experience difficulty in obtaining additional financing on favorable terms, if
at all. The delisting of our common stock from the Nasdaq National Market, and
commencement of trading on the OTC-BB may also make it even more difficult for
us to obtain financing. Further, if we issue additional equity securities,
shareholders may experience significant dilution, and the new equity securities
may have rights, preferences or privileges senior to those of existing holders
of our common stock.

We have a history of losses and may not achieve profitability, which could
force us to reduce or cease operations.

We have incurred net losses in each quarter since we incorporated in 1995.
We incurred net losses of $881,000 for 1997, $2.6 million for 1998, $7.7
million for 1999, $39.3 million for 2000, $35.5 million for 2001, $6.6 million
for 2002 and $429,000 for the three-months ended December 31, 2002. If we fail
to achieve and maintain profitability, our stock price will decline, our future
capital raising efforts will be impaired and we may be forced to reduce or
cease operations.

Our recent restructuring initiatives have reduced our costs and operating
expenses. However, despite these initiatives, our operating expenses will
continue to consume a significant amount of our cash resources in the near
term. In addition, the restructuring may adversely affect our business and
operating results. As a result, we will need to significantly increase our
revenues in order to achieve profitability. Although our revenues have grown
in recent quarters, we may not be able to continue this growth to achieve or
maintain profitability. Our continued losses and financial condition may cause
some of our potential customers to question our viability, which may hamper our
ability to sell our products.

Our common stock is traded on the Over-the-Counter Bulletin Board and, as a
result, it may be less liquid and subject to greater price fluctuations.

On March 20, 2002, we received notification from the Nasdaq National
Market that N2H2 had failed to meet Nasdaq listing requirements as set forth in
Marketplace Rule 4450(a)(3). Our common stock was delisted from Nasdaq
effective after the close of trading on March 20, 2002. Effective with the
opening of business on March 21, 2002, our common stock began trading on the
Over-The-Counter Bulletin Board, or OTC-BB, under the symbol NTWO. The
OTC-BB is not an exchange, and trading in stocks on the OTC-BB is often more
sporadic and lower in volume than that in shares on the national exchanges. We
cannot guarantee that our shares will ever be listed on the Nasdaq National
Market, or any other national stock exchange, in the future. As a result, it
may be more difficult to dispose of, or to obtain adequate quotations, as to
the price of our common stock.

You may be unable to resell your shares at or above the price at which you
purchased them, and our stock price may be volatile.

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Stocks trading on the OTC-BB are often subject to price fluctuations that
are unrelated, or disproportional, to the operating performance of the
companies. The price of our common stock has historically been volatile, even
before it was delisted from Nasdaq, since our initial public offering in August
1999. Our common stock reached a high of $33.13 per share on December 14, 1999
and traded as low as $0.12 per share on March 21, 2002 and November 12, 2002.
As a result of fluctuations in the price of our common stock, you may be unable
to sell your shares at or above the price at which you purchased them. The
trading price of our common stock could be subject to fluctuations for a number
of reasons, including



| |  |  | actual or anticipated quarterly variations in operating results;                                
| | - |  | ------------------------------------------------------------------------------------------------
|
| |  |  | announcements of technological innovations or new services or products by us or our competitors;
|
| |  |  | changes in analysts earning projections or recommendations;                                    
|
| |  |  | our failure to meet or exceed analyst estimates;                                                
|
| |  |  | announcements of technological innovations;                                                     
|
| |  |  | the introduction of new products;                                                               
|
| |  |  | proprietary rights litigation or other litigation; and                                          
|
| |  |  | other events or factors, many of which are beyond our control.                                  

In addition, stock prices for many technology companies fluctuate widely
for reasons that may be unrelated to operating results of these companies.
These fluctuations, as well as general economic, market and political
conditions, such as national or international currency and stock market
volatility, recessions or military conflicts, may materially and adversely
affect the market price of our common stock, regardless of our operating
performance and may expose us to class action securities litigation which, even
if unsuccessful, would be costly to defend and distracting to management.

We may be subject to third-party claims resulting from termination of our
advertising contracts.

During 2001, we terminated the advertising-based revenue model that we had
previously offered to schools. In connection with the termination of our
advertising based-revenue model, we have unilaterally terminated certain
advertising contracts. These advertising contracts may not allow unilateral
termination by us. As a result, we may be subject to liabilities associated
with breach of contract claims, although we have not received notice of any
such claims. Even if none of these claims is successful, the litigation could
result in substantial costs to the company and divert managements time and
attention away from business operations.

Economic conditions could adversely affect our revenue growth and ability to
forecast revenue.

Our revenue growth and potential for profitability depend on the overall
demand for filtering and monitoring products, which is impacted by general
economic and business conditions. A softening of demand for computer software
caused by the weakened economy, both domestic and international, has affected
our sales and may continue to result in decreased revenues and growth rates. As
a result of the economic downturn, we may also experience difficulties in
collecting outstanding accounts receivable from our customers. In addition, the
terrorist attacks on the United States in 2001, the armed conflicts that have
followed, and the threat of additional future armed conflicts, have added or
exacerbated economic, political and other uncertainties, which could adversely
affect our sales and thus our revenue growth. The slowdown in the domestic and
international economies, as well as the effects of terrorist activity and armed
conflict, may continue to cause customers and potential customers to delay
their decisions about purchasing our filtering solutions, to reduce the amount
they purchase or to cancel their orders, which could adversely affect our
business and operating results.

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

Our quarterly operating results have fluctuated significantly in the past
and are likely continue to fluctuate in the future. If our operating results
fall below the expectations of securities analysts and investors, it could
result in a decrease in our stock price. Operating results vary from quarter to
quarter, depending on a number of factors, many of which are outside our
control, including:



| |  |  | general economic conditions, which may affect our customers investment levels in enterprise software;                                                              
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | the rate of market acceptance of new product introductions;                                                                                                         
|
| |  |  | budget and spending decisions by our customers;                                                                                                                     
|
| |  |  | subscription renewal rates of our existing customers;                                                                                                               
|
| |  |  | our ability to compete in the highly competitive Internet filtering solutions market;                                                                               
|
| |  |  | the loss of any key technical, sales, customer support or management personnel and the timing of any new hires;                                                     
|
| |  |  | our ability to develop, introduce and market new products and product versions on a timely basis;                                                                   
|
| |  |  | our ability to successfully expand our operations, and
the amount and timing of expenditures related to this expansion;                                             
|
| |  |  | the tendency of our educational customers to budget and
make purchases on the basis of a fiscal school year beginning in
the fourth fiscal quarter of each year; and
|
| |  |  | the length of our sales cycle, which varies substantially
from customer to customer.                                                                                

As a result of all these factors, we cannot predict our revenues with any
significant degree of certainty, and future product revenues may differ from
historical patterns. Even though our revenues are difficult to predict, we
base our decisions regarding our operating expenses on anticipated revenue
trends. Many of our expenses are relatively fixed, and we cannot quickly
reduce spending if our resources are lower than expected. As a result, revenue
shortfalls could result in significantly lower income or greater loss than
anticipated for any given period, which could result in a decrease in our stock
price.

If potential customers do not accept our Internet and monitoring filtering
solutions, our business will not succeed.

We currently expect the substantial majority of our future revenues to be
generated through sales of our Bess and Sentian Internet filtering solutions.
As a result, factors adversely affecting the pricing or demand for Internet
filtering solutions, such as competition or technological change, could
dramatically affect our operating results. In addition, many of our Bess and
Sentian solutions were only recently introduced in fiscal 2002. As a result,
they are relatively new and unproven and may not achieve market acceptance.
Because these solutions are relatively new, we cannot accurately predict the
rate at which customers will renew their annual subscriptions.

Our future financial performance will depend, in part, upon the successful
development, introduction, and customer acceptance of new and enhanced versions
of our Internet filtering and monitoring products and services. We cannot be
certain that we will be successful in upgrading and continuing to sell our
Internet filtering products and services, or that any new products or services
that we may develop or acquire, will achieve market acceptance. If we are
unable to upgrade our services or products or to establish market acceptance of
these products, our business will not succeed.

If existing customers do not renew their subscription agreements, our business
will not succeed.

Our future success depends on the rate at which our existing customers
renew their subscription contracts. Our customers have no obligation to renew
their subscriptions upon expiration. Because our Bess and Sentian solutions
are relatively new, we cannot predict with certainty the rate at which our
customers will renew their annual subscriptions. We may be unable to generate
significant

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revenue from our renewals and, as a result, our operating results could
fall below the expectations of analysts and investors, which could cause our
stock price to decline.

If our solutions fail to correctly categorize all potentially objectionable
content, public perception of our products and services could be harmed.

We will not succeed unless the marketplace is confident that our solutions
effectively filter Internet content. We rely upon a combination of automated
filtering technology and human review to categorize Web site content for use by
our filtering solutions. The total number of Web sites and partial Web sites
is growing rapidly. We cannot be sure that our filtering technologies will
successfully categorize all potentially objectionable Internet content for our
clients, thus causing over-blocking. Our categorized database also may not
contain substantially all of the material available on the Internet fitting
into any one of our content categories. In addition, our customers may not
agree with our categorization determinations. Our failure to effectively
categorize and filter Internet content according to our customers expectations
could result in lost customers and generate negative publicity that would
impair the growth of our business and our efforts to increase positive
associations with our brand.

Free speech and privacy concerns could adversely affect the demand for our
Internet filtering solutions.

There has been a public-policy debate regarding Internet filtering in
schools and libraries within the U.S. Congress. This debate has resulted in the
CIPA, a law mandating Internet filtering in schools and libraries receiving
certain federal funds, among other requirements. A United States District
Court, however, has declared this act as it applies to public libraries
unconstitutional. This decision has been appealed to the United States Supreme
Court, which has accepted the case and is expected to rule by June 2003. If
CIPA is ultimately held unconstitutional, some of our current customers may
decide to no longer provide filtering in their organizations. This in turn
would lead them to not renew contracts with us and would thereby harm an
important source of our revenues. If the Supreme Court determines that
filtering by public libraries is unconstitutional, plaintiffs and advocacy
groups may rely on this decision to challenge the constitutionality on First
Amendment grounds of mandatory filtering in public schools. Because public
school customers still represent the majority of our revenue, an ultimate
finding by the Supreme Court that mandatory filtering in public schools is
unconstitutional could have a serious adverse effect on our future revenues.

We have been named as a defendant in an action by the American Civil Liberties
Union that could weaken our intellectual property rights and result in
substantial costs to the company.

An individual represented by the American Civil Liberties Union has
recently filed a lawsuit against us in federal court. The plaintiff is
purportedly a computer researcher who allegedly seeks to conduct a quantitative
analysis of the accuracy and comprehensiveness of our Internet filtering
solutions for purposes of determining whether these solutions exclude some
speech on the Internet that is constitutionally protected. He alleges that his
activities in conducting this analysis, if he ever does so, would violate our
standard license agreement and our intellectual property rights. The plaintiff
alleges that the threat that we will enforce our license agreement and our
other rights has deterred him from this activity, which he alleges is protected
under the fair use doctrine of copyright law and other legal doctrines. He
seeks a declaration to prohibit us from enforcing the license agreement against
him based on his use of our software in his research activities. To the extent
that this claim is resolved in the plaintiffs favor, it could materially
affect our ability to enforce our license agreements and other intellectual
property rights against certain users of our software filtering products. In
addition, it could contribute to an increase in the number of people who seek
to use our software in ways that we believe violate our proprietary rights.
Even if the particular claim described above is resolved in our favor, the
litigation could result in substantial costs to the company and divert
managements time and attention away from business operations.

If we are unable to compete successfully in the Internet filtering market, our
business will not succeed.

The market for our solutions is intensely competitive and rapidly
changing. Many of our competitors are larger than we are and have
substantially greater resources than we do. Our major competitors and their
respective products are Surf Control  SuperScout and CyberPatrol, Websense 
Websense Enterprise, Elron Software  Internet Manager, Symantec
 I-Gear,
Secure Computing  SmartFilter and 8e6 Technologies  X-Stop. We also face
competition from a number of smaller competitors.

In the future, we may face increased competition from vendors of
Internet-related hardware and software that enhance their products or develop
separate products that include functions that are currently provided in our
products. If Internet filtering functions become standard features of
Internet-related hardware or software, the demand for our products will
decrease. Furthermore, even if our products offered greater functionality and
are more effective than products offered by Internet-related hardware or
software vendors, potential customers might accept this limited functionality
instead of purchasing our products.

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Some of our competitors filtering products are significantly less
expensive than ours. This lower cost, along with other factors, may lead to
greater market acceptance of our competitors products and services than for
ours. Increased competition or our failure to compete effectively could force
us to reduce our prices or the quality of our offerings. It could also reduce
our market share and impact the profitability of our business. In addition,
many of our competitors have longer operating histories, greater name
recognition, larger customer bases and significantly greater financial,
technical, marketing and other resources than we do. Furthermore, a number of
our competitors have recently been acquired by other large technology
companies, which enhances their resources. We believe that there will be
further consolidation among our competitors. As a result, they may be able to
adapt more quickly to new technologies and customer needs, devote greater
resources to promoting or selling their products and services, initiate and
withstand substantial price competition, take advantage of acquisition or other
strategic opportunities more readily or develop and expand their product and
service offerings more quickly than we can. In addition, our competitors may
form strategic relationships with each other and with other companies in
attempts to compete more successfully against us. These relationships may take
the form of strategic investments, joint marketing agreements, licenses or
other contractual arrangements, any of which may increase our competitors
ability, relative to ours, to address customer needs with their software and
service offerings and that may enable them to rapidly increase their market
share.

If we are unable to develop and maintain effective long-term relationships with
key resellers, or if our resellers fail to perform, our ability to sell our
solutions will be limited.

During 2001, we significantly reduced our direct sales staff and began to
develop our reseller channel for selling products and services to corporations
and government entities. In order to establish market share in these markets
and increase revenue, we will need to substantially increase the distribution
of our products and services through successful new relationships with
prestigious resellers. Because our relationships with our existing resellers
are relatively new and unproven, we cannot predict the degree to which these
resellers will succeed in marketing and selling our solutions. Many of our
existing and potential resellers have similar, and often more established,
relationships with our competitors. These existing and potential resellers,
many of which have significantly greater resources than we have, may in the
future market products that compete with our solutions or reduce or discontinue
their relationships with us or their support of our solution. In addition, our
sales and revenue growth opportunities will be limited if



| |  |  | we are unable to develop and maintain effective, long-term relationships with existing and potential key resellers;             
| | - |  | --------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | our existing and potential key resellers endorse products or technologies other than our solutions; or                          
|
| |  |  | our existing and potential key resellers do not have or do not
devote the resources necessary to effectively sell our solutions.

If we do not retain our key employees and management team, our ability to
execute our business strategy will be limited.

Our future performance will depend largely on the efforts of our key
technical, sales, customer support and managerial personnel and on our ability
to attract and retain them. In addition, our ability to execute our business
strategy will depend on our ability to recruit additional experienced
management personnel and to retain our existing executive officers. Our key
employees are not obligated to continue their employment with us and could
leave at any time. If we are unable to attract and retain these key employees
and executive officers, our growth could be limited due to our lack of capacity
to provide our services. We could also experience deterioration in service
levels or decreased customer satisfaction.

Competition for qualified personnel in the software and technology markets
is particularly intense. Many of the companies we compete against for
experienced personnel have greater resources than we do. In addition, due to
the recent trading prices of our common stock and our delisting from the Nasdaq
National Market, our employees may perceive our equity incentives such as stock
options as less attractive. In that case, our ability to attract or retain
employees may be adversely affected and we may be required to increase the
level of cash compensation paid to existing and new employees, which could
materially increase our operating expenses.

Our workforce reduction and financial performance may place additional strain
on our resources and may harm the morale and performance of our personnel and
our ability to hire new personnel.

During September of 2002, we reduced our employee count by about 25%. Our
restructuring plan may yield unanticipated consequences, such as attrition
beyond our planned reduction in force. Although we believe we can operate at
current staffing levels, this workforce reduction has placed significant strain
on our administrative, operational and financial resources and has resulted in

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increased responsibilities for each of our management personnel. As a result,
our ability to respond to unexpected challenges may be impaired and we may be
unable to take advantage of new opportunities. In addition, many of the
employees who were terminated possessed specific knowledge or expertise, and
that knowledge or expertise may prove to have been important to our operations.
In that case, their absence may create significant difficulties. Further, the
reduction in workforce may reduce employee morale and create concern among
potential and existing employees about job security at N2H2, which may lead to
difficulty in hiring and increased turnover in our current workforce. In
addition, this reduction to employee count may subject us to the risk of
litigation, which could result in substantial costs to N2H2 and could divert
managements time and attention away from business operations.

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

We currently have very limited international operations. To be successful
in the long-term, we must continue to expand our international operations and
enter new international markets. If we do expand internationally, it will
require significant management attention and financial resources to develop
sales and support channels. Even if we successfully develop these channels, we
may not be able to maintain or increase international market demand for our
solution. In addition, our international operations are subject to a number of
risks inherent in international business activities, including:



| |  |  | the cost and challenges of customizing services for local markets and foreign languages;                                                                                       
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | laws and business practices favoring local competitors;                                                                                                                        
|
| |  |  | our dependence on local staff and vendors;                                                                                                                                     
|
| |  |  | compliance with multiple, conflicting and changing governmental laws and regulations, including tax laws and regulations;                                                      
|
| |  |  | longer sales cycles;                                                                                                                                                           
|
| |  |  | possible delays or greater difficulty in accounts receivable collection;                                                                                                       
|
| |  |  | import and export restrictions and tariffs;                                                                                                                                    
|
| |  |  | exposure to foreign currency exchange rate fluctuations;                                                                                                                       
|
| |  |  | reduced protection of intellectual property rights and increased liability exposure; and                                                                                       
|
| |  |  | regional, economic, cultural and political conditions, including the
direct and indirect effects of terrorist activity and armed conflict in
countries in which we do business.

If we are unable to successfully manage these risks, our international
sales growth will be limited and our results of operations will be seriously
harmed. We do not currently engage in currency hedging activities, but we may
do so in the future.

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

To succeed, we must continually change and improve our solutions in
response to rapid technological developments and changes in operating systems
and hardware, software, communication, browser and database technologies. We
may be unable to successfully and promptly develop these new solutions or
achieve and maintain market acceptance. The development of new,
technologically advanced solutions is a complex and uncertain process that
requires great innovation and the ability to anticipate technological and
market trends. Because software development is complex, it can require long
development and testing periods.

Releasing new solutions prematurely may result in quality problems, and
releasing them late may result in loss of customer confidence and market share.
Unforeseen circumstances may cause schedule delays in the introduction of new
and enhanced solutions. When we do introduce new or enhanced solutions, we may
be unable to manage the transition from the older solutions and may be forced
to continue to support the older solutions at increased cost to us. In
particular, our education customers often have older technical environments,
which require us to maintain solutions that operate on multiple platforms.

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If we delay release of our new solutions, or if they fail to achieve
market acceptance when released, it could harm our reputation and our ability
to attract and retain customers, and our revenues may decline. In addition,
customers may defer or forego purchases of our solution if we, or our
competitors introduce or announce new solutions or solution enhancements.

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

Intellectual property is critical to our success, and we rely upon
trademark, copyright and trade secret laws in the United States and other
jurisdictions to protect our proprietary technology and brands. None of our
technology is patented. We rely on United States trade secret and copyright law
to protect our proprietary search technology. We protect our proprietary rights
through the use of intellectual property agreements with employees and
consultants, which cover confidentiality, nondisclosure, and assignment of
invention matters. Some of our former employees and consultants who may have
had access to our proprietary information have not entered into these
intellectual property agreements, although we believe that all intellectual
property that is material to our business is covered by signed agreements. If
we are incorrect in this assessment, our business could be seriously harmed.

Despite our efforts to protect our proprietary rights, unauthorized
parties may copy aspects of our products and obtain and use information that we
regard as proprietary. Other parties may breach confidentiality agreements and
other protective contracts we have entered into, and we may not become aware
of, or have adequate remedies in the event of, any breach. Trademark,
copyright, and trade secret protection may not be available to us in every
country in which our services are available. In addition, 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.

Many of our products are dependent on third-party software or hardware.

Many of our products are dependent on third-party software or hardware
providers, including our products that run on Microsoft ISA, Microsoft Proxy
II, Volera Excelerator (formerly Novell ICS), Novell Border Manager, Cisco PIX
Firewall, Cisco Content Engine, and Check Point Firewall-1. We depend on these
third parties abilities to deliver and support reliable products, enhance
their current products, develop new products on a timely basis and respond to
emerging industry standards and other technological changes. If any of these
third parties cease production of these products, change the design of their
product such that it becomes incompatible with our products, delay the launch
of future products or open their proprietary interface to the public, we could
lose sales and we could incur additional costs to design around the
incompatibility.

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

In the future, we may have to resort to litigation to protect our
intellectual property rights or to determine the validity and scope of the
proprietary rights of others. In particular, we expect that as competition in
the market for Internet filtering increases and as the number of patents
relating to these products continues to increase, the potential for patent
infringement claims against us will increase. Any litigation, regardless of
its success, would likely result in significant expense to us and divert the
efforts of our management and development personnel. In the event of an
adverse result, we could be required to do one or more of the following:



| |  |  | pay substantial damages, including treble damages;                                                                                                                                                   
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | permanently cease use of any technology determined to be infringing;                                                                                                                                 
|
| |  |  | obtain a license for the technology, which may be on unfavorable terms;                                                                                                                              
|
| |  |  | attempt to redesign our filtering services to avoid the
infringement or to develop non-infringing technology, which we
might not be able to do at an acceptable price, in a timely
fashion or at all.

Our solutions may suffer from defects or errors, which could result in loss of
revenues, delayed or limited market acceptance of our products, increased costs
and damage to our reputation.

Complex software products such as ours frequently contain errors or
defects, especially when first introduced or when new versions are released.
Our customers are particularly sensitive to such defects and errors because
they rely on our services for providing a content-safe Internet environment.
Any significant defects or errors in our services or products may result in
loss of

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revenues or delay in market acceptance, diversion of development
resources, negative publicity, damage to our reputation or legal claims.
Although our agreements with customers typically contain provisions designed to
limit our exposure to potential legal liability, these limitation of liability
provisions may not be completely effective. We have not experienced any
liability claims to date, but we cannot assure you that we will not face this
type of claim in the future. We maintain errors and omissions insurance, but
we cannot assure you that this insurance coverage will adequately cover us for
any claims.

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 user requests. Such events could severely damage our
ability to service existing customers and activate new customers, and would be
very expensive to remedy and could damage our reputation, discouraging existing
and potential customers from using our services. In the past we have
experienced unsuccessful attempts at electronic break-ins but we may experience
break-ins in the future. Any such events could substantially harm our business,
financial condition, and results of operations.

We have an Internet hosting agreement with a third party hosting provider,
who houses the majority of our servers. Our network operations center is
situated at the hosting provider in a single geographic location, and not all
systems within this location are redundant. Our operations depend on their
ability to protect our systems against damage from fire, earthquake, power
loss, flood, telecommunications failures, vandalism and other malicious acts,
and similar unexpected adverse events. Any major disruption in our services
could take a substantial amount of time to remedy, and could diminish revenues,
decrease customer and user confidence in our services and limit the growth of
our business.

We may not be able to distribute our services abroad due to United States
export laws, which could cause us to lose sales.

The encryption technology contained in our services and products is
subject to United States export controls. These export controls limit our
ability to distribute certain encrypted services and products outside of the
United States. While we take precautions against unlawful exportation, such
export inadvertently may have occurred in the past or may occur from time to
time in the future, subjecting us to potential liability. Future legislation
or regulation may further limit the encryption technology that we can include
in our services and products. In addition, foreign governments have import and
domestic use laws and regulations that restrict the types of permitted
encryption software distributed in their countries. Such regulations could
alter the design, production, distribution, and use of our services and
products. Finally, some foreign competitors are subject to less stringent
controls on exporting their encryption technologies. As a result, they may be
able to compete more effectively than we can in U.S. and international markets.

If the use of the Internet in education and business does not grow, demand for
our solutions will be limited.

The success of our services and products in the education market will
depend, in large part, on the continued broad use and acceptance of the
Internet as a source of information in educational settings. Schools, teachers
and parents may cease to consider the Internet a viable research tool due to
concerns over the potential exposure of students to unsuitable material, even
with filtering services such as ours, or because of inadequate development of
telecommunications and networking systems. Similarly, we are uncertain of the
extent to which businesses will use the Internet as a means of communication
and commerce and whether the market for Internet filtering solutions will
continue to develop.

The Internet could lose its viability due to delays in the development or
adoption of new standards and protocols to handle increased levels of Internet
activity or due to increased governmental regulation. Cutbacks in technology
funding could also limit use of the Internet in schools. If the necessary
Internet infrastructure and complementary products are not developed on a
timely basis, or if school and business use of the Internet experiences a
significant decline, demand for our solutions may be limited.

The concentrated ownership of our common stock could delay or prevent a change
of control, which could cause a decline in the market price of our common
stock.

As of December 31, 2002, our directors, executive officers and their
affiliated entities beneficially owned a substantial percentage of our
outstanding common stock. As a result, these shareholders may, as a practical
matter, be able to exert significant influence over all matters requiring
shareholder approval, including the election of directors and approval of
significant corporate transactions such as acquisitions, and to block
unsolicited tender offers. This concentration of ownership may delay, deter or
prevent a third party from acquiring control over us at a premium over the
then-current market price of our common stock, which could result in a decrease
in our stock price.

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Our articles of incorporation and bylaws, our shareholder rights plan and
Washington law contain provisions that could discourage a takeover.

Some provisions of our Restated Articles of Incorporation and Amended
Bylaws, our shareholder rights plan and Washington law, could make it more
difficult for a third party to acquire us, even if doing so would be beneficial
to our shareholders. This could limit the price that certain investors might
be willing to pay in the future for shares of our common stock.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk related to changes in foreign currency
exchange rates and interest rates relating to debt and investment instruments.
We have assets and liabilities denominated in certain foreign currencies
related to our international subsidiaries. We have not hedged our translation
risk on these assets and liabilities. We do not expect that a sudden or
significant change in foreign exchange rates would have a material impact on
results of operations, financial position or cash flows. We believe the
reported amount of cash equivalents at December 31, 2002 is a reasonable
approximation of the fair value. As a result, we believe that the market risk
arising from our holdings of financial instruments is minimal.




ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures

The term disclosure controls and procedures is defined in Rules
13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934, or the Exchange
Act. These rules refer to the controls and other procedures of a company that
are designed to ensure that the information required to be disclosed by a
company in the reports that it files under the Exchange Act is recorded,
processed, summarized and reported within required time periods. Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed in our Exchange
Act reports is accumulated and communicated to management, including our chief
executive officer and chief financial officer, as appropriate to allow timely
decisions regarding required disclosure.

Our chief executive officer and our chief financial officer have evaluated
the effectiveness of our disclosure controls and procedures as of the
Evaluation Date, which is a date within 90 days before the filing of this
annual report, and they have concluded that, as of the Evaluation Date, our
disclosure controls and procedures were effective.

Changes in internal controls

There were no significant changes in our internal controls, or to our
knowledge, in other factors that could significantly affect our disclosure
controls and procedures subsequent to the Evaluation Date.

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PART IIOTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

On July 25, 2002, Benjamin Edelman filed suit against us in the U.S.
District Court for the District of Massachusetts. Mr. Edelman is purportedly a
computer researcher who seeks to conduct a quantitative analysis of the
accuracy and comprehensiveness of our Bess and Sentian Internet content
filtering products. He seeks a declaratory judgment that he cannot be held
liable for breach of certain provisions of the license agreement as a result of
his proposed activities. In addition, Mr. Edelman seeks a declaration that he
will not be prosecuted for violations of the Copyright Act of 1976, the Digital
Millennium Copyright Act, or laws protecting trade secrets if he conducts his
proposed analysis. Finally, Mr. Edelman seeks to enjoin us from initiating
litigation against him on the basis of his proposed activities. We have filed
a Motion to Dismiss this action which is set for hearing on February 27, 2003.
If granted, this action would be dismissed. If the Motion is not granted, then
the action would proceed to the discovery stage, and then possibly could even
move to trial or some other form of resolution. To the extent that this matter
is resolved in Mr. Edelmans favor, it could have a material adverse affect on
our business, future results of operations, financial position and cash flows.
Even if Mr. Edelmans claims are not successful, the litigation could result in
substantial costs to the company and divert managements time and attention
away from business operations.




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

Not Applicable.




ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not Applicable.




ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not Applicable.




ITEM 5. OTHER INFORMATION

Not Applicable.




ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K



| | a) |  | Exhibits:
| | -- |  | ---------

99.1 Certification of Principal Executive and Financial Officers pursuant
to 18 U.S.C. Section 1350



| | b) |  | Reports on Form 8-K.
| | -- |  | --------------------

There were no reports on Form 8-K filed during the quarter ended
December 31, 2002.

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SIGNATURES

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

|                         |  |            |  |                                             
|------------------------ |  | ---------- |  | --------------------------------------------
|                         |  | N2H2, INC.
|                         |  |            |  |                                             
|Dated: February 10, 2003 |  | By:        |  | /s/ Howard P. Welt                          
|                         |  |            |  |                                             
|                         |  |            |  | Howard P. Welt                              
|                         |  |            |  | President and Chief Executive Officer       
|                         |  |            |  | (principal executive officer)               
|                         |  |            |  |                                             
|Dated: February 10, 2003 |  | By:        |  | /s/ J. Paul Quinn                           
|                         |  |            |  |                                             
|                         |  |            |  | J. Paul Quinn                               
|                         |  |            |  | Vice President  Chief Financial Officer,   
|                         |  |            |  | Secretary and Treasurer                     
|                         |  |            |  | (principal financial and accounting officer)

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CERTIFICATIONS

I, Howard Philip Welt, certify that:



|1.                                                                                                                                                          |  | I have reviewed this quarterly report on Form 10-Q of N2H2, Inc. (N2H2);                                                                                                                                                                                                                                                      
|----------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                           
|2.                                                                                                                                                          |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this quarterly
report;
|                                                                                                                                                           
|3.                                                                                                                                                          |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in                                                                                                                                                                                         
|all material
respects the financial condition, results of operations and cash flows of N2H2
as of, and for, the periods presented in this quarterly report;
|                                                                                                                                                           
|4.                                                                                                                                                          |  | N2H2s other certifying officer and I are responsible for establishing and
maintaining disclosure controls and procedures (as                                                                                                                                                                                                 
|defined in Exchange Act
Rules 13a-14 and 15d-14) for N2H2 and we have:                                                                                     



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to N2H2, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of N2H2s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                              



|5.                                                                                      |  | N2H2s other certifying officer and I have disclosed, based on our most
recent evaluation, to N2H2s auditors and the audit
|--------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------
|committee of N2H2s board
of directors (or persons performing the equivalent function):



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect N2H2s ability to record, process,
summarize and report financial data and have identified for N2H2s
auditors any material weaknesses in internal controls; and
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or other
employees who have a significant role in N2H2s internal controls; and                                                                                                                              



|6.                                                                                                                                                                                                                                              |  | N2H2s other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------
|internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: February 10, 2003

/s/
HOWARD PHILIP WELT

Howard Philip Welt
President and Chief Executive Officer(Principal Executive Officer)

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I, J. Paul Quinn, certify that:



|1.                                                                                                                                                                                        |  | I have reviewed this quarterly report on Form 10-Q of N2H2, Inc. (N2H2);                                                             
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                         
|2.                                                                                                                                                                                        |  | Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material    
|fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
|                                                                                                                                                                                         
|3.                                                                                                                                                                                        |  | Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in
|all material
respects the financial condition, results of operations and cash flows of N2H2
as of, and for, the periods presented in this annual report;                                 
|                                                                                                                                                                                         
|4.                                                                                                                                                                                        |  | N2H2s other certifying officer and I are responsible for establishing and
maintaining disclosure controls and procedures (as        
|defined in Exchange Act
Rules 13a-14 and 15d-14) for N2H2 and we have:                                                                                                                   



| | a) |  | designed such disclosure controls and procedures to ensure that
material information relating to N2H2, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
| | -- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of N2H2s disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;                                                                                                              



|5.                                                                                            |  | N2H2s other certifying officer and I have disclosed, based on our most
recent evaluation, to N2H2s auditors and the audit
|--------------------------------------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------------------------
|committee of registrants
board of directors (or persons performing the equivalent function):



| | a) |  | all significant deficiencies in the design or operation of internal
controls which could adversely affect N2H2s ability to record, process,
summarize and report financial data and have identified for N2H2s
auditors any material weaknesses in internal controls; and
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that involves management or other
employees who have a significant role in N2H2s internal controls; and                                                                                                                              



|6.                                                                                                                                                                                                                                              |  | N2H2s other certifying officer and I have indicated in this quarterly
report whether or not there were significant changes in
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------
|internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: February 10, 2003

/s/ J. PAUL QUINN

J. Paul Quinn
Vice President, Chief Financial Officer, Secretary and Treasurer(Principal Financial Officer)

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EXHIBIT INDEX

|            |  |                                                                                               
|----------- |  | ----------------------------------------------------------------------------------------------
|EXHIBIT
NO. |  |                                                                                               
|            |  |                                                                                               
|99.1        |  | Certification of Principal Executive and Financial Officers pursuant to 18 U.S.C. Section 1350

24