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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington,
D.C. 20549



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FORM 10-K



|(Mark One) |  |                                                     
|---------- |  | ----------------------------------------------------
|x          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF    
|           |  | THE SECURITIES EXCHANGE ACT OF 1934                 
|           |  | FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002         
|          
|           |  | or                                                  
|          
| ̈          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
|           |  | THE SECURITIES EXCHANGE ACT OF 1934                 
|           |  | For The Transition Period From To                   



Commission file number 0-27074



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SECURE COMPUTING CORPORATION

(Exact name of registrant as specified in its charter)





|Delaware                                                       |  | 52-1637226                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                              
|4810 Harwood Road, San Jose, California                        |  | 95124                               
|(Address of principal executive offices)                       |  | (Zip code)                          
|                                                              
|Registrants telephone number, including area
code:            |  | (408) 979-6100                      



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Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock, par value $.01 per share



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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 ̈



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Act).    Yes ̈No  x



The aggregate market value of the Common Stock
held by non-affiliates of the Registrant as of March 24, 2003 was $115,877,492 based on the closing sale price for the Companys Common Stock on that date. For purposes of determining this number, all officers and directors of the Registrant
are considered to be affiliates of the Registrant, as well as individual stockholders holding more than 10% of the Registrants outstanding Common Stock. This number is provided only for the purpose of this report on Form 10-K and does not
represent an admission by either the Registrant or any such person as to the status of such person.



As of March 24, 2003, the Registrant had 29,786,280 shares of Common Stock issued and outstanding.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of the Registrants Proxy Statement for its
Annual Meeting of Stockholders to be held May 14, 2003 for the year ended December 31, 2002 are incorporated by reference in Part III hereof.





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TABLE OF CONTENTS



|        
|--------
|PART I  
|        
|ITEM 1. 
|        
|ITEM 2. 
|        
|ITEM 3. 
|        
|ITEM 4. 
|        
|PART II 
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|ITEM 5. 
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|ITEM 6. 
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|ITEM 7. 
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|ITEM 7A.
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|ITEM 8. 
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|ITEM 9. 
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|PART III
|        
|ITEM 10.
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|ITEM 11.
|        
|ITEM 12.
|        
|ITEM 13.
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|ITEM 14.
|        
|PART IV 
|        
|ITEM 15.



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Part
I



Forward-looking statements made in
this Annual Report on Form 10-K or in the documents incorporated by reference herein that are not statements of historical fact are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. A number of risks and uncertainties, including those discussed under the caption Certain Factors That May Affect Future Results in this Form 10-K and the documents incorporated by
reference herein, could affect such forward-looking statements and could cause actual results to differ materially from the statements made. We do not undertake any obligation to update or correct any forward-looking statements.



In this Annual Report on Form 10-K, Secure
Computing, we, us, our, and Registrant refer to Secure Computing Corporation.



Item 1.     Business



With broad expertise in security technology, we develop network security products that help our customers create trusted network environments both inside and outside of their organizations. Our customers operate some of the
worlds largest and most sophisticated electronic business operations and include prominent organizations in banking, financial services, healthcare, telecommunications, manufacturing, public utilities, federal and local governments. We work
closely with them to deliver secure access control and innovative new features.



Our technologies enable our customers to balance security and accessibility by controlling, managing, and personalizing access for millions of customers, employees, and partners connecting to their
businesses. The challenge for organizations conducting business over public networks is to provide application and network solutions that let growing numbers of trusted users into business systems, easily, safely, and privately. Our objective is to
solve the most difficult network security challenges our customers face.



We partner with a number of companies in several different capacities. These partnerships include members of our Secure Alliance program, resellers, systems integrators, and companies who include our solutions in their
product offerings. These companies include, for example: Alternative Technologies, Blue Coat Systems, Cisco, Computer Associates, CSC, Dell, EDS, F5 Networks, Hewlett-Packard, Network Appliance, NetOne Systems, Northrop Grumman, Ositis, Phoenix
Technologies, Radware, Rainbow Technologies, Sun PS, Vertex Link, Wavecrest Computing, Westcon, and 3Com.



Industry Background



Enterprise computing has evolved over the past 25 years from data centers with isolated mainframe computers supporting a number of terminals in a closed environment to open networks of interconnected
servers and personal computers which are accessible by outsiders. The rapid adoption of the Internet as a worldwide networking standard has accelerated the distribution and sharing of data and applications, enabling enterprises to adopt new ways of
doing business electronically. The rise of e-business has created new challenges for securing IT systems and elevated information security to a critical business issue.



Conducting Business Over Public Networks



Internet-based systems have emerged as the platform for todays electronic commerce. These systems are a
combination of traditional mainframe and client/server computing systems with Web technologies and the Internet. They extend internal systems to the external business environment in order to perform activities such as electronic trading of goods and
services, online delivery of digital content, electronic funds transfers and share trading, electronic bills of lading, commercial auctions, collaborative design and engineering, online sourcing, public procurement, direct consumer marketing, and
after-sales service.



The key reason
organizations are moving rapidly to an e-business model is the direct interaction between the e-business system and its suppliers, customers, and partners. This direct interaction lowers costs of doing business and expedites commerce. A
well-designed e-business infrastructure may give any organization a competitive advantage.



Public Network Security Issues



The move to Internet-based business processes brings speed and efficiency, but it also exposes organizations and their partners to increased security risks of theft, downtime, espionage, embarrassment,
and infiltration. As e-business evolves, the need for secure, trusted remote access for employees and partners is more important than ever.



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A 2002
FBI/Computer Security Institute study found that 90% of information security professionals surveyed had experienced computer security breaches during the previous year, including theft of proprietary information, outsider penetration of security
perimeters, and denial of service attacks. Eighty percent of respondents acknowledged financial losses due to those security incidents.



Concern about network security has become an issue at the forefront of electronic business infrastructure. While outsider attacks receive
the most publicity, insider threats are a growing concern. Remote employees, partners, customers, and others who are already inside a companys security perimeters pose a big risk. Any information sitting on the network must be protected and
access rights need to be established to ensure safe business practices.



To mitigate these risks, organizations conducting business over networks must have solid and scalable security architecture, and appropriate security policy. They need exceptional security products that can control the
interactive communication they provide to their networks, whether its remote access to internal networks, customer and partner access to their online business resources, or employee access to the Internet from inside their organizations.



Market Need and Strategy



Organizations must establish secure, dynamic business
relationships with an ever-increasing number of internal and external users. The traditional Internet security perimeter, the hallmark of which was the firewall, is being augmented or replaced with more pervasive solutions that manage access to any
size organization.



Corporations realize now more
than ever they have to take responsibility to protect their confidential information and their customers confidential information. Not only are enterprises realizing and acting on this need but customers and business partners have become
knowledgeable about security as well. Customers want to know if their data residing on a given network is secure and demand the assurance that parameters are in place for managing access to their proprietary information.



Our strategy is to provide organizations with the strong
security options that are capable of enforcing even the most complex security policies and to continue providing world class support and leading expertise in our related technology. Our goal is to help organizations be confident in the security of
their network operations. All of our products are designed to provide the strongest network protection available, comprehensive manageability, and greater scalability and interoperability than other competitive solutions available, along with the
flexibility necessary to implement and enforce customized security policies.



Secure Computing Solutions



Our products provide complete solutions separately and they also work well together for a more comprehensive solution, depending upon the goals and needs of our customers. Our solutions are comprised of products and applications that
are easy to use, administer, and manage across different systems as they grow. Our products ability to scale as an infrastructure increases or as the number of users grows has always been, and continues to be, one of our hallmarks. Our
architecture allows security functions to be easily embedded into other platforms. Our solutions run on a variety of platforms and integrate well with other enterprise solutions, making our products a safe and economical choice for corporations
world wide.



| |  |  | SafeWord®PremierAccess
| | - |  | -----------------------



Remote access to network resources is a requirement for many businesses, but verifying the identity of your remote users is vital for
security. Organizations are increasingly realizing the many vulnerabilities of passwords, and they need strong authentication systems that are easy to install and deploy, simple to manage, and able to grow with their needs.



SafeWord PremierAccess meets these needs. It positively
identifies users through strong authentication, controls access to protected resources using role-based authorization, and offers unparalleled scalability and ease of use.



SafeWord PremierAccess integrates well with Web, VPN, wireless, Citrix®, Windows, remote dial-up, UNIX, SSH, Oracle, Novell, and other network applications. SafeWord tokens provide one-time passwords that eliminate the
vulnerabilities of the fixed passwords used by many systems and applications. SafeWord PremierAccess also supports a wide range of other authenticators including software tokens, smart cards, digital certificates, USB tokens, biometrics, and
MobilePass, which sends one-time passwords to your cell phone, pager, or wireless PDA.



SafeWord PremierAcess systems protect thousands of companies
and millions of end users because they are highly secure, easy to manage, and practical to deploy. With a single management system, SafeWord PremierAccess lets organizations secure all their remote access points without the expense and complexity of
integrating multiple point products. SafeWord PremierAccess



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includes powerful capabilities
such as the Universal Web Agent, user self-enrollment, and brokered authentication to external systems, which makes it a complete and flexible strong authentication solution.



| |  |  | Sidewinder®G2Firewall
| | - |  | ----------------------



In early 2002 we released the Sidewinder Appliance, a hardware appliance firewall utilizing Dells
custom factory integration services to manufacture and ship the rack-mounted Dell hardware platforms pre-imaged with Sidewinder Appliance software. Also, in early 2002 we acquired the Gauntlet VPN firewall business from Network Associates. We are
now delivering a next generation firewall which has been built as a combination of the key features from both Sidewinder and Gauntlet.



In January 2003 we released our new next generation firewall branded Sidewinder G2Firewall. Sidewinder G2provides enterprise strongprotection for the worlds most important networks. With a simple
Power-It-Ondeployment and SecureOSUNIX operating system, the G2Firewall and VPN gateway improves manageability and reduces emergency security patches without sacrificing performance. Sidewinder G2s hybrid, tunable architecture encompasses the entire range of firewall security mechanisms including stateful inspection, circuit level proxies, application filtering, secured servers, and
real-time Strikeback®intrusion detection and automated response in one package. Our uncompromised SecureOSwith patented Type Enforcementtechnology puts Sidewinder G2in a class by itself. A single-site or enterprise-wide deployment of Sidewinder G2firewalls can be
centrally managed from any Windows®platform.



Also in January 2003 we released the Sidewinder G2Enterprise Manager, a new security appliance that delivers both single-point policy management and a central audit-log and configuration back-up repository for
hundreds of distributed Sidewinder G2Firewalls. This appliance based enterprise manager resides on our SecureOS
ensuring the same protection they receive from our Sidewinder G2Firewall.



| |  |  | SmartFilter®
| | - |  | ------------



SmartFilter enables organizations
to build and enforce sophisticated Web-usage policies. From informing users real-time on policies, to denying access to specific sites, SmarFilter creates a positive, productive Web culture in any organization. SmartFilters Control List,
updated continuously, accurately categorizes millions of Web sites into content-specific groups. Management-ready reports detail Web-surfing activity. SmartFilters On-BoxTMarchitecture provides outstanding performance with industry-leading filtering speeds.



SmartFilter has become the market leading de-facto standard for Web filtering on edge or caching devices
through original equipment manufacturer (OEM) relationships. SmartFilters simple software plug-in architecture provides OEMs a way to integrate a high demand, revenue-generating, capability  Web filtering  directly into their
solutions, quickly and easily. We are the only company with OEM relationships for On-Box filtering with all three of the top caching appliance vendors  Blue Coat, Cisco, and Network Appliance, as well as several other vendors.



In 2002, we significantly enhanced the enterprise capabilities
of SmartFilter by adding a Java-based software console for centralized remote management. This is a key differentiator in the Web filtering space. In addition, there were considerable enhancements to our global Web filtering coverage in 2002.
Currently, SmartFilter has over 4 million entries in the SmartFilter Control List and Web site database entries in 66 unique languages, providing industry leading international coverage.



| |  |  | Embedded Firewall
| | - |  | -----------------



Our Embedded Firewall technology is commercially available through 3Com. By embedding access control technology inside the network
interface cards, independent of the host operating system, the embedded firewall offers a scalable, tamper-resistant, and non-by-passable security solution to manage access control inside the corporate perimeter firewall. The 3Com Embedded
Firewall provides the next generation of secure e-business connectivity, allowing employees, partners, and suppliers to access only the information they require. The security technology resident in the embedded firewall, provides for centrally
managed packet filtering, auditing, and IP Security Option (IPSec) hardware acceleration.



The embedded firewall uses a centrally managed architecture. The user-friendly graphical user interface (GUI) is designed to allow administrators to quickly and easily define access control policies on
the Embedded FirewallPolicy Server. The policy server is a fully replicated system that provides fail-over capabilities for up to 3000 embedded firewall NICs. This flexible, scalable solution allows administrators to securely allow
access to resources required by employees, partners, and suppliers, without sacrificing the integrity and confidentiality of the corporate networks. The product is available for desktop, laptop, and server environments.



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Security and Support
Services



Our services are designed to
ensure that our customers make optimal use of our products when controlling access to their e-business systems. We provide a life cycle of support and services: Solution Planning, Solution Implementation, and Solution Support. These services are
described below.



| |  |  | Solution Planning
| | - |  | -----------------



Our Security Services offerings include a variety of options for rapid assessment of a companys current network architecture and
evaluation of the current status of network security. We then compare this information to the companys business needs, both current and future, to help them plan a scalable, secure e-commerce solution. In addition, we offer security policy
services that help customers prepare a policy and plan that transfers their security policy from paper to practice. We provide the following services: network architecture security assessment; security policy assessment and development; and AAA
system security assessment.



| |  |  | Solution Implementation
| | - |  | -----------------------



Our Network Services team offers a full range of rapid-deployment integration services and training to assist our customers through
implementation and integration of our products. Both the configuration process of a security system and the security products themselves, by their nature, may have an impact on several areas within a customers network. Accordingly, we offer a
complete package of product integration assistance to ensure our customers maximize network uptime and maintain productivity during the process. We provide the following services: product implementation; product audit and configuration; and product
training.



As part of our Network Services
training program, we provide extensive product and network training on-line with our Web-based/tutor assisted training at our training facilities, and on-site worldwide for customers and partners. These services help our customers understand basic
and advanced administration rules and tools that enable partners to configure, integrate, and maintain our products as part of a comprehensive e-business solution.



| |  |  | Solution SupportSecureSupport
| | - |  | -------------------------------



We offer
industry leading live answer support services. SecureSupport has a team of technical support engineers that provide customer support around the clock via e-mail, the Web, or telephone. Service options are tailored for each of our network security
products. Customers can select the SecureSupport option that best meets their needs. Our support center call statistics are published and posted to our corporate website at www.securecomputing.com.



We designed SecureSupport Online, a tool to assist our
customers and channel partners with any problem they may experience with any of our products. Through this process, technical expertise is offered online through a searchable knowledge base, viewable support history, and our customer support
newsletters. Product patches and release notes can also be downloaded.



We offer our customers the option to purchase software support and upgrade service for an annual fee. We provide software updates and technical support through this program.



Advanced Technology Contracts



We have traditionally engaged in research and development of
information security technology and products through contracts with departments and agencies of the United States government, including the Defense Advanced Research Projects Agency (DARPA), the National Security Agency, and the Department of
Energy. Our Advanced Technology Divisions mission is to develop new technologies and drive our solutions into operational environments to meet the ever-changing needs of homeland security. Our strategy is to focus on development contracts that
leverage our core products, drive leading edge technology, and provide state-of-the-market, real world solutions for organizations of all types and sizes.



The majority of our contracts require that we perform specified services, for which we are paid a fee and reimbursed for actual costs.
Under these cost-reimbursement contracts, we have the ability to recoup all legitimate costs associated with the performance of the contract. Generally, these contracts are also subject to termination at the convenience of the applicable government
agency. If a contract is terminated, we typically are reimbursed for our costs to the date of termination plus the cost of an orderly termination and are paid a portion of the fee. Our United States government contracts are subject to audit by the
Defense Contract Audit Agency (DCAA). The DCAA has periodically audited our contracts without any cost disallowances. In addition,



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we are seeing an increase in
commercially funded, fixed price contracts under which we would be completing specified services, for a specified price.



Customers



Our customers operate some of the largest and most sensitive networks in the world. Our partners and customers include the majority of the
Dow Jones Global 50 Titans and organizations in banking, financial services, healthcare, telecommunications, manufacturing, public utilities, and federal and local governments. Secure Computing has close relationships with the largest agencies of
the United States government, including contracts for advanced security research. Our customer list also includes numerous international organizations and foreign governments. Overseas, our customers are concentrated primarily in Europe, Japan,
China, and the Pacific Rim



No customer accounted
for more than 10% of our total revenue in 2002, 2001 or 2000.



Sales



We sell our
products and services through both indirect and direct channels, using a worldwide sales organization. For 2002, sales to major end users comprised 47% of total product sales, while indirect channel sales comprised the remaining 53%. Indirect
channels include sales made to domestic and international distributors, value-added resellers, major integrators, and OEMs.



Our sales strategy is a hybrid, high-touch model designed to reduce possible channel conflict and allow the customer to decide how best to
acquire our products. In this model, our direct sales teams work closely with our channel and OEM partners to ensure that the customer is satisfied. Whether the customer buys our product and services from our salesperson or from a channel or OEM
partner, both salespeople are compensated for the transaction. As an enterprise software vendor, our goal is to ensure that our applications are successfully implemented and supported. This model allows the customer to choose their preferred partner
for purchase, implementation and support, all of which are endorsed by Secure Computing and our sales force.



We have a United States federal government sales team and maintain a General Services Administration (GSA) schedule for our products to
facilitate government orders. The United States government is the worlds largest buyer of security products, and this continues to be a strong market for us.



International sales accounted for 26% of total revenue during 2002. Major foreign markets for our products
include Europe, Japan, China, the Pacific Rim and Latin America. In each country, we have independent channel partners that are responsible for marketing, selling, and supporting our products to resellers and end users within their defined
territories. Independent market analyst reports indicate that international markets will continue to provide increased opportunities for e-business security products. The following table summarizes information about our international and domestic
sales and operations:



|                                          |  | Year ended December 31,
|----------------------------------------- |  | -----------------------
|(In thousands)                            |  | 2002                   
|Revenues:                                 |  |                        
|United States Products and Services sales |  | $                      
|International Products and Services sales |  |                        
|Advanced Technology contracts             |  |                        
|                                          |  |                        
|                                          |  | $                      
|                                          |  |                        



Our
Advanced Technology contract revenue strategy remains focused only on development contracts that add value to our Products and Services offerings.



Marketing



We market our products to prospects worldwide using a variety of programs. Dedicated marketing personnel are based primarily in our
corporate headquarters in San Jose, California. They create and implement marketing programs in each of our major functional market areas  corporate marketing for company and brand awareness, product marketing, and partner marketing.



We use comprehensive targeted marketing programs
to generate sales leads and brand awareness. Programs include: direct marketing, web marketing, advertising, seminars, webinars, trade shows, and ongoing customer, channel, and partner events.



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An active
public relations program ensures that we receive appropriate press coverage for our various programs and announcements as well as obtain product reviews and speaking engagements. In addition to the marketing programs, we stimulate interest and
demand about our e-business solutions through our Web site, partner Web sites and other industry specific Web sites, providing white papers, newsletters, and technical notes. Several of our senior technical staff contribute articles to industry
periodicals as well as abstracts for presentations they provide to industry specific summits and events, further extending our ability to educate the industry about e-business and extranet security.



Through our partnering programs, we enter strategic marketing
and selling relationships with various vendors of communications, security, and network management products or managed services. These partners recommend our products along with theirs in helping customers build a security solution.



Competition and Market Consolidation



The principal competitors for our existing solutions include:



| |  |  | Check Point Software Technologies Ltd.;
| | - |  | ---------------------------------------



| |  |  | RSA Security, Inc.;
| | - |  | -------------------



| |  |  | SurfControl, plc;
| | - |  | -----------------



| |  |  | NetScreen Technologies Inc.;
| | - |  | ----------------------------



| |  |  | Symantec Corporation; and
| | - |  | -------------------------



| |  |  | Websense, Inc.
| | - |  | --------------



Backlog



Our backlog for commercial products at any point in time is not significant since products are shipped upon receipt of order. We do not believe that our commercial backlog at any particular point in time is indicative of future sales
levels. The timing and volume of customer orders are difficult to forecast because our customers typically require prompt delivery of products and a majority of our sales are booked and shipped in the same quarter. In addition, sales are generally
made pursuant to standard purchase orders that can be rescheduled, reduced, or canceled prior to shipment with little or no penalty.



Our backlog relating to Advanced Technology contracts as of February 28, 2003 was approximately $1.1 million compared to $900,000 as of
February 28, 2002. Backlog historically has represented firm government orders for research and development services. Funded backlog represents that portion of backlog for which our government customers have actually committed to compensate us. As
of February 28, 2003, $590,000 of our government contract backlog was funded, compared to none as of February 28, 2002.



Manufacturing



Our manufacturing operations consist primarily of light assembly and packaging associated with our software products. We use
subcontractors to duplicate our software media and print our user documentation and product packaging. We then assemble the final software products at our facilities in St. Paul, Minnesota. We also perform some limited hardware manufacturing
operations that consist of purchasing hardware components, final assembly, and testing. Hardware components include commercially available servers, computers, memory, and third-party peripherals.



The majority of the materials used in our manufacturing
operations are industry-standard parts that are widely available. Typical materials required are media and media duplication services, user documentation and other printed materials, product packaging, and computer systems (personal computers,
computer peripherals, memory disk drives, and storage devices).



Our SafeWord product line includes a small token, available in various designs, which is used for user authentication. We source these tokens through ReachOut Ltd., an electronics assembly manufacturer located in China. We are also
in the process of developing a second source for the current versions of our tokens with Northgate Innovations, Inc. In addition, we utilize specialized robotic equipment for certain automated deployment services for some of our SafeWord token
customers.



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Research and Development



Our internal engineering staff performs
internal development of new products and features. Of our 101 engineering employees at March 24, 2003, 19 held postgraduate degrees.



We intend to keep our products broadly compatible with a variety of host computer configurations, other information security products and
other applications. In addition, we will introduce new products as market demand develops for such products. We design our products so that they support emerging security standards, such as the Content Vectoring Protocol (CVP), the Public Key
Cryptography Standard (PKCS), the IPSec, and the Lightweight Directory Access Protocol (LDAP).



We will continue to seek government research and development contracts to maintain our high-technology base, as well as deploy our existing product solutions into operational environments. We currently
have contracts with government agencies, including the DARPA, the United States Navy, and the United States Army. These contracts address the information security requirements that allow for secure and trusted communications between collaboration
partners. We will continue to pursue, with these and other government organizations, contracts that advance our products and technologies into these operational environments.



Patents and Proprietary Technology



We rely on patent, trademark, copyright, and trade secret laws, employee and third-party nondisclosure
agreements, and other methods to protect our proprietary rights. We currently hold a number of United States and foreign patents relating to computer security software and hardware products. We believe that our patents are broad and fundamental to
information security computer products.



Our
success depends, in part, upon our proprietary software and security technology. We also rely on trade secrets and proprietary expertise that we seek to protect, in part, through confidentiality agreements with employees, consultants, and other
parties.



We have used, registered, and/or
applied to register certain trademarks and service marks to distinguish genuine Secure Computing products, technologies and services from those of our competitors in the United States and in foreign countries and jurisdictions. We enforce our
trademark, service mark and trade name rights in the United States and abroad.



Employees



As of March
24, 2003, Secure Computing had approximately 362 employees. Of these employees, 108 were involved in sales and marketing, 66 in customer support and services, 121 in research and development, 21 in production, 21 in information technology and 25 in
administrative, human resources and finance. No employee of Secure Computing is represented by a labor union or is subject to a collective bargaining agreement. We believe that we maintain good relations with our employees.



Executive Officers



Our executive officers and their ages as of March 24, 2003
are as follows:



|EXECUTIVE OFFICERS   |  | AGE |  | POSITION WITH SECURE COMPUTING CORPORATION       
|-------------------- |  | --- |  | -------------------------------------------------
|John E. McNulty      |  | 56  |  | Chief Executive Officer and Chairman of the Board
|Timothy P. McGurran  |  | 40  |  | President and Chief Operating Officer            
|Timothy J. Steinkopf |  | 41  |  | Senior Vice President and Chief Financial Officer
|Vincent M. Schiavo   |  | 45  |  | Senior Vice President of Worldwide Sales         



JOHN E.
MCNULTY is our Chairman and Chief Executive Officer. Mr. McNulty first joined us as President and Chief Operating Officer in May 1999 and assumed the positions of Chairman of the Board and Chief Executive Officer in July 1999. From 1997 until
joining us, he served as Senior Vice President of Sales, Services, and Business Development at Genesys Telecommunications Laboratories, a leading independent software company in the computer telephony integration environment. Mr. McNulty was
also previously with Intel Corporation, the worlds leading semiconductor manufacturer, where he held a number of positions, including Director of Marketing and Business Development for the Enterprise Server Group, which he launched.
Mr. McNulty currently serves on the board of directors of Auspex Systems, Inc., a network storage company.



TIMOTHY P. MCGURRAN has been a director of Secure Computing since January 2002. Mr. McGurran is our President and Chief Operating Officer
and is a member of the Board of Directors. Mr. McGurran first joined us as Senior Vice



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President of Operations and
Chief Financial Officer in May 1996 and assumed the positions of President and Chief Operating Officer in March 2002. From 1984 until joining us, he was at Ernst & Young LLP, where his last position was Senior Manager.



TIMOTHY J. STEINKOPF is our Senior Vice President and Chief
Financial Officer. Mr. Steinkopf first joined us as Treasurer and Director of Investor Relations in September 2000 and assumed the positions of Vice President and Chief Financial Officer in March 2001. Mr. Steinkopf was appointed to Senior Vice
President in January 2002. From 1999 until joining us, he served as Chief Financial Officer and Vice President of Finance at Silicon Entertainment, Inc. He was the Vice President of Finance, Secretary and Treasurer at Watt/Peterson Inc. from 1991 to
1999, and prior to that he was at Ernst & Young LLP.



VINCENT M. SCHIAVO is our Senior Vice President of Worldwide Sales. Mr. Schiavo joined us in April 2001. From 1998 until joining us, he served as President of PolyServe, Inc. Prior to that he served as Vice President of Worldwide
Sales at Sonic Solutions and in various other sales management roles at Radius, Apple Computer and Data General Corporation.



None of the executive officers are related to each other or to any other director of Secure Computing.



Certain Factors That May Affect Future Results



The following important factors, among others, could cause
actual results to differ materially from those indicated by forward-looking statements made in this Annual Report on Form 10-K and presented elsewhere by us from time to time.



We have experienced operating losses in the past and may experience operating losses in the future.In
2002 we had operating profit. However, we have incurred losses in the past. For example, for the quarter ended March 31, 2002, we had an operating loss of $1.5 million, but for the full year 2002 we had operating income of $361,000. We expect to
incur a small operating loss in the first quarter of 2003, and we could incur losses after that. If we are unable to attain operating profits in the second, third and fourth quarters, and for the year, our stock price may decline, which could cause
you to lose part or all of your investment.



In 2002 we were cash flow positive, however, we have experienced negative cash flow in the past and may experience negative cash flow in the future. If sources of financing are not available, we may not have sufficient cash to
satisfy working capital requirements. We believe that our current cash balances are sufficient to satisfy our working capital requirements for at least the next twelve months. We may need to obtain additional financing at that time or sooner if
our plans change or if we expend cash sooner than anticipated. We currently do not have any commitments from third parties to provide additional capital. The risk to us is that at the time we will need cash, financing from other sources may not be
available on satisfactory terms or at all. Our failure to obtain financing could result in our insolvency and the loss to investors of their entire investment in our common stock.



The potential increase in revenue from our relationships with various vendors of communications, security,
and network management products or managed services may be reduced by requirements to provide volume price discounts and other allowances and significant costs incurred in customizing our products. Although we do not intend that such
relationships be exclusive, we may be required to enter into an exclusive relationship or forego a significant sales opportunity. To the extent we become dependent on actions by such parties, we could be adversely affected if the parties fail to
perform as expected. To minimize our risk, we often set minimum quotas with our customers as a condition of exclusivity.



Competition from companies producing enterprise network and data security products could reduce our sales and market share.The
market for network security products is intensely competitive and characterized by rapid technological change. We believe that competition in this market is likely to persist and to intensify as a result of increasing demand for security products.
Each of our individual products competes with a different group of competitors and products. Because the market for our products is highly competitive, it may be difficult to significantly increase our market share or our share may actually decline.



Our customers purchase decisions are based
heavily upon the quality of the security our products provide, the ease of installation and management, the ability to increase the numbers of individuals using our software simultaneously, and the flexibility of our software. If a competitor can
offer our customers a better solution in these areas or others and we are unable to rapidly offer a competitive product, we may lose customers. Competitors with greater resources could offer new solutions rapidly and at relatively low costs which
could lead to increased price pressure, reduced margins, and a loss of market share.



Many of our competitors and potential competitors have significantly greater financial, marketing, technical, and other competitive resources than we have. Our larger actual and potential competitors
may be able to leverage an installed customer base and/or other existing or future enterprise-wide products, adapt more quickly to new or emerging technologies and changes in customer requirements, or devote greater resources to the promotion and
sale of their products than we can. Additionally, we may lose product sales to these competitors because of their greater name recognition and reputation among potential customers.



9



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Our future
potential competitors could include developers of operating systems or hardware suppliers not currently offering competitive enterprise-wide security products, including Microsoft Corporation, Sun Microsystems, Inc., IBM, Computer Associates, and
Hewlett Packard. If any of those potential competitors begins to offer enterprise-wide security systems as a component of its hardware, demand for our software could decrease. Ultimately, approaches other than ours may dominate the market for
enterprise network and data security products.



In the future, we may also face competition from our competitors and other parties that develop or acquire network security products based upon approaches similar to or different from those we employ. There are no guarantees that our
approach will dominate the market for network security products. While we believe that we do not compete against manufacturers of other classes of security products, such as encryption, due to the complementary functions performed by such other
classes, our customers may perceive such other companies as our competitors.



Consolidation among competitors may erode our market share. Current and potential competitors have established, or may in the future establish, cooperative relationships among themselves or with
third parties to increase the ability of their products to address the needs of our prospective customers. Accordingly, it is possible that new competitors or alliances may emerge and rapidly acquire significant market share. If this were to occur,
it could materially and adversely affect the financial condition or results of our operations.



The trend toward multi-function security solutions may result in a consolidation of the market around a smaller number of vendors that are able to provide the necessary breadth of products and
services. In the event that we are unable to internally develop all of the products needed for a complete, secure e-business solution, we may need to acquire such technology or be acquired by a larger entity. However, there is no assurance that, in
the event that we are not able to internally develop all of the products needed for an enterprise-wide security solution, we will be able to acquire or merge with other entities on terms favorable to us and our stockholders.



The pricing policies of our competitors may impact the
overall demand for our product and our profitability. Some of our competitors are capable of operating at significant losses for extended periods of time, increasing pressure on our products. If we do not maintain competitive pricing, the demand
for our products, as well as our market share, may decline, having an adverse effect on our business. From time to time, in responding to competitive pressures we lower the price of our products. When this happens, if we are unable to reduce our
component costs or improve operating efficiencies, our revenues and margins will be adversely affected.



Other vendors may include products similar to ours in their hardware or software and render our products obsolete.In the future,
vendors of hardware and of operating system or other software may continue to enhance their products or bundle separate products to include functions that are currently provided primarily by network security software. If network security functions
become standard features of computer hardware or of operating system software or other software, our products may become obsolete and unmarketable, particularly if the quality of these network security features is comparable to that of our products.
Furthermore, even if the network security and/or management functions provided as standard features by hardware providers or operating systems or other software is more limited than that of our products, our customers might accept this limited
functionality in lieu of purchasing additional software. Sales of our products would suffer materially if we were then unable to develop new network security and management products to further enhance operating systems or other software and to
replace any obsolete products.



If an OEM
customer reduces or delays purchases, our revenue may decline and/or our business could be adversely affected.We currently have formed relationships with several OEMs including Cisco, Blue Coat, 3Com, and Network Appliance. If we fail to sell
to such OEMs in the quantities expected, or if any OEM terminates our relationship, this could adversely affect our reputation, the perception of our products and technology in the marketplace or the growth of our business, and your investment in
our common stock may decline in value.



Technology in the network security market is changing rapidly, and if we fail to develop new products that are well accepted, our market share will erode. To compete successfully, we must enhance our existing products and
develop and introduce new products in a timely manner. Our net sales and operating results could be materially affected if we fail to introduce new products on a timely basis. The rate of new network security product introductions is substantial,
and security products have relatively short product life cycles. Our customer requirements and preferences change rapidly. Our net sales and operating results will be materially affected if the market adopts as industry standards, solutions other
than those we employ. In addition, portions of our basic research efforts are funded by government contracts. If those contracts are terminated for any reason, it could reduce our new product stream, which could materially reduce our net sales and
operating results.



Denial of our patent
applications or invalidation or circumvention of our patents may weaken our ability to compete in the network security market. While we believe that our pending applications relate to patentable devices or concepts, there are no guarantees that
any pending or future patent applications will be granted. There is also the risk that a current or future patent,



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regardless of whether we are an owner or a licensee of such patent, may be challenged, invalidated, or
circumvented. In addition, there are no guarantees that the rights granted under a patent or under licensing agreements will provide competitive advantages to us.



If another party alleges that we infringe its patents or proprietary rights, we may incur substantial
litigation costs. We are not aware of any third-party claims that we or our products have infringed a patent or other proprietary rights. However, the computer technology market is characterized by frequent and substantial intellectual property
litigation. Intellectual property litigation is complex and expensive, and the outcome of such litigation is difficult to predict. In the event that a third party were to make a claim of infringement against us, we could be required to devote
substantial resources and management time to the defense of such claim, which could have a material adverse effect on our business and results of operations.



Disclosure of our trade secrets or proprietary information may undermine our competitive advantages. There are no guarantees that
the confidentiality agreements protecting our trade secrets and proprietary expertise will not be breached, that we will have adequate remedies for any breach, or that our trade secrets will not otherwise become known to or independently developed
by competitors. In addition, under their contracts with us, United States government agencies have the right to disclose certain technology developed with government funding to our competitors as part of the establishment by the government of
second-source manufacturing arrangements or competitive bidding.



If the use of public switched networks such as the Internet does not continue to grow, our market and ability to sell our products and services may be limited. Our sales also depend upon a robust industry and infrastructure
for providing access to public switched networks, such as the Internet. If the infrastructure or complementary products necessary to take these networks into viable commercial marketplaces are not developed or, if developed, these networks do not
become and continue to be viable commercial marketplaces, our net sales and operating results could suffer.



Our product lines are not diversified beyond providing network security solutions to our customers, and any drop in the demand for
network security products would materially harm our business. Substantially all of our revenue comes from sales of enterprise network security products and related services. We expect this will continue for the foreseeable future. As a result,
if for any reason our sales of these products and services are impeded, our net sales and operating results will be significantly reduced.



Our stock price is highly volatile, which may cause our investors to lose money and may impair our ability to raise money, if
necessary. The price of our common stock, like that of many technology companies, has fluctuated widely. During 2002, our stock price ranged from a per share high of $24.50 to a low of $2.26. Fluctuation in our stock price may cause our
investors to lose money and impair our ability to raise additional capital, if necessary. Factors that may affect stock price volatility include:



| |  |  | Unexpected fluctuations in operating results;
| | - |  | ---------------------------------------------



| |  |  | Secure Computing or its competitors announcing technological innovations or new products;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | General economic conditions and weaknesses in geographic regions of the world;
| | - |  | ------------------------------------------------------------------------------



| |  |  | Threat of terrorist attacks or acts of war in the United States or abroad;
| | - |  | --------------------------------------------------------------------------



| |  |  | Developments with respect to our patents or other proprietary rights or those of our competitors;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | Our ability to successfully execute our business plan and compete in the network security industry;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | Relatively low trading volume;
| | - |  | ------------------------------



| |  |  | Product failures; and
| | - |  | ---------------------



| |  |  | Analyst reports and media stories.
| | - |  | ----------------------------------



Quarterly revenues and operating results depend on the volume and timing of orders received, which may be affected by large individual
transactions and which sometimes are difficult to predict. Our quarterly operating results may vary significantly depending on a number of other factors, including:



| |  |  | The timing of the introduction or enhancement of products by us or our competitors;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | The size, timing, and shipment of individual orders;
| | - |  | ----------------------------------------------------



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| |  |  | Market acceptance of new products;
| | - |  | ----------------------------------



| |  |  | Changes in our operating expenses;
| | - |  | ----------------------------------



| |  |  | Personnel departures and new hires and the rate at which new personnel become productive;
| | - |  | -----------------------------------------------------------------------------------------



| |  |  | Mix of products sold;
| | - |  | ---------------------



| |  |  | Changes in product pricing;
| | - |  | ---------------------------



| |  |  | Development of our direct and indirect distribution channels;
| | - |  | -------------------------------------------------------------



| |  |  | Costs incurred when anticipated sales do not occur; and
| | - |  | -------------------------------------------------------



| |  |  | General economic conditions.
| | - |  | ----------------------------



Sales of our products generally involve a significant commitment of capital by customers, with the attendant delays frequently associated
with large capital expenditures. For these and other reasons, the sales cycle for our products is typically lengthy and subject to a number of significant risks over which we have little or no control. We are often required to ship products shortly
after we receive orders, and consequently, order backlog, if any, at the beginning of any period has in the past represented only a small portion, if any, of that periods expected revenue. As a result, our product revenue in any period
substantially depends on orders booked and shipped in that period. We typically plan our production and inventory levels based on internal forecasts of customer demand, which are highly unpredictable and can fluctuate substantially.



If customer demand falls below anticipated levels, it could
seriously harm our operating results. In addition, our operating expenses are based on anticipated revenue levels, and a high percentage of our expenses are generally fixed in the short term. Based on these factors, a small fluctuation in the timing
of sales can cause operating results to vary significantly from period to period.



If our products fail to function properly or are not properly designed, our reputation may be harmed, and consumers may make product liability and warranty claims against us. Our customers rely
on our information security products to prevent unauthorized access to their networks and data transmissions. These customers include major financial institutions, defense-related government agencies protecting national security information, and
other large organizations. These customers use our products to protect confidential business information with commercial value far in excess of our net worth. Therefore, if our products malfunction or are not properly designed, we could face
warranty and other legal claims, which may exceed our ability to pay. We seek to reduce the risk of these losses by attempting to negotiate warranty disclaimers and liability limitation clauses in our sales agreements and by maintaining product
liability insurance. However, these measures may ultimately prove ineffective in limiting our liability for damages.



In addition to any monetary liability for the failure of our products, an actual or perceived breach of network or data security at one of
our customers could harm the markets perception of our products and our business. The harm could occur regardless of whether that breach is attributable to our products.



We also face the more general risk of bugs and other errors in our software. Software products often contain
undetected errors or bugs when first introduced or as new versions are released, and software products or media may contain undetected viruses. Errors or bugs may also be present in software that we license from third parties and incorporate into
our products. Errors, bugs, or viruses in our products may result in loss of or delay in market acceptance, recalls of hardware products incorporating the software, or loss of data. Our net sales and operating results could be materially reduced if
we experience delays or difficulties with new product introductions or product enhancements.



If we lose a significant customer, we will incur smaller profits.We derive a significant portion of our revenues from a limited number of customers. For example, our top five customers in
products and services made up 18% of our Products and Services revenue in 2002. If we lose any of these customers and fail to replace the customer or fail to increase revenues from other customers, we will incur greater losses. Additionally, if our
revenues from any of these customers are reduced, without an increase in revenues from other customers, we will incur greater losses.



If we fail to collect amounts due from our customers on a timely basis, our cash flow and operating results may suffer. Because the
timing of our revenues is difficult to predict and our expenses are often difficult to reduce in the short run, management of our cash flow is very important to us. Like most companies, we anticipate that a portion of the amounts owed to us will
never be paid. However, if our actual collection of amounts owed to us is less than we have estimated, we will have less cash to fund our operations than we anticipated, and our financial condition and operating results could be adversely affected.



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In addition,
collection of amounts due us from sales to resellers, distributors, and international customers generally takes longer than for other sales. Therefore, if our sales to resellers and distributors increase as a percentage of our total revenue, the
average number of days it takes for us to collect amounts due from our customers may increase. If there is an increase in the time required for us to collect amounts due us, we will have less cash to fund our operations than we anticipated. This in
turn could adversely affect our financial condition and operating results.



We have taken and may from time to time take various forms of action to manage the amounts due us from customers and granting customer discounts in exchange for earlier payment.



The Internet may become subject to increased regulation by
government agencies. Due to the increasing popularity and use of the Internet, it is possible that a number of laws and regulations may be adopted with respect to the Internet, covering issues such as user privacy, pricing and characteristics,
and quality of products and services. In addition, the adoption of laws or regulations may slow the growth of the Internet, which could in turn decrease the demand for our products and increase our cost of doing business or otherwise have an adverse
effect on our business, operating results or financial condition.



Anti-takeover provisions in our charter documents, share right agreement, and Delaware law could discourage a takeover or future financing. The terms of our certificate of incorporation and share right agreement
permit our Board of Directors to issue up to 2,000,000 shares of preferred stock and determine the price, rights, preferences, privileges, and restrictions, including voting rights, of those shares without any further vote or action by our
stockholders.



The Board may authorize the
issuance of preferred stock with voting or conversion rights that could materially weaken the voting power or other rights of the holders of our common stock. The issuance of preferred stock, while providing desirable flexibility in connection with
possible acquisitions and other corporate purposes, could make it more difficult for a third party to acquire a majority of our outstanding voting stock. Further, provisions of Delaware law, our certificate of incorporation and our bylaws, such as a
classified board and limitations on the ability of stockholders to call special meetings, and provisions of our share rights agreement could delay or make more difficult a merger, tender offer, proxy contest, or other takeover attempts.



Unanticipated costs and disallowance of costs
under our government contracts may harm our business.Under our government contracts, we bear the risk that increased or unexpected costs of providing our services may reduce our profit margin. Any material unanticipated costs could therefore
harm our business. In addition, recoverable expenses previously billed by us are subject to review and audit, once every three years, by the DCAA. If the DCAA disallows any of the costs we claim under our contracts, it could adversely affect our
operating results.



The ability to attract and
retain highly qualified personnel to develop our products and manage our business is extremely important, and our failure to do so could harm our business. We believe our success depends significantly upon a number of key technical and
management employees. We may be unable to achieve our revenue and operating performance objectives unless we can attract and retain technically qualified and highly skilled engineers and sales, consulting, technical, financial, operations,
marketing, and management personnel. These personnel are particularly important to our research and development efforts and to our growing professional service business, where we employ a large number of technical personnel holding advanced degrees
and special professional certification. Competition for qualified personnel is intense, and we expect it to remain so for the foreseeable future. We may not be successful in retaining our existing key personnel and in attracting and retaining the
personnel we require. Our operating results and our ability to successfully execute our business plan will be adversely affected if we fail to retain and increase our key employee population.



Our international operations subject us to risks related to
doing business in foreign countries. International sales are a substantial portion of our business. Although almost all of our sales are payable in U.S. dollars, several factors could make it difficult for customers from foreign countries to
purchase our products and services or pay us for obligations already incurred. Such factors include:



| |  |  | Severe economic decline in one of our major foreign markets; and
| | - |  | ----------------------------------------------------------------



| |  |  | Substantial decline in the exchange rate for foreign currencies with respect to the U.S. dollar.
| | - |  | ------------------------------------------------------------------------------------------------



A decline in our international sales or collections of amounts
due us from customers could materially affect our operations and financial conditions. For fiscal year 2002, 26% of our total sales came from international sales compared to 25% in 2001. A very large drop in our sales or collections of amounts due
us in these specific countries as a result of recession or other economic or political disturbances would likely harm our net sales and operating results.



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In addition,
we face a number of general risks inherent in doing business in international markets including, among others:



| |  |  | Unexpected changes in regulatory requirements;
| | - |  | ----------------------------------------------



| |  |  | Tariffs and other trade barriers;
| | - |  | ---------------------------------



| |  |  | Legal uncertainty regarding liability;
| | - |  | --------------------------------------



| |  |  | Threat of terrorist attacks or acts of war in the United States or abroad;
| | - |  | --------------------------------------------------------------------------



| |  |  | Political instability;
| | - |  | ----------------------



| |  |  | Potentially greater difficulty in collecting amounts due us;
| | - |  | ------------------------------------------------------------



| |  |  | Longer periods of time to collect amounts due us; and
| | - |  | -----------------------------------------------------



| |  |  | A higher rate of piracy of our products in countries with a high incidence of software piracy.
| | - |  | ----------------------------------------------------------------------------------------------



Other



Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments
to those reports are available, without charge, on our website, www.securecomputing.com, as soon as reasonably practicable after they are filed with the SEC.



Item 2.     Properties



We are currently headquartered in approximately 11,000 square feet of office space in San Jose, California. We have three separate facilities with a combined square footage of approximately 84,000
square feet in St. Paul, Minnesota, that are occupied by production, research and development, and administration. We have a research facility located in Concord, California, that occupies approximately 17,000 square feet and another research
facility located in Gaithersburg, Maryland, that occupies approximately 6,800 square feet. In support of our United States field sales organization, we also lease 5,200 square feet of office space in Reston, Virginia. We occupy these premises under
leases expiring at various times through the year 2008. We also have foreign offices in London, England; Sydney, Australia; Munich, Germany; Paris, France; Singapore; Japan; China; and Hong Kong. We believe that our facilities are adequate for our
current needs.



Item 3.     Legal Proceedings



In April 1999, purported securities class action complaints were filed in the United States District Court for the Northern District of California against us and certain of our officers and directors.
Each complaint alleges that defendants made false and misleading statements about our business condition and prospects during a purported class period of November 10, 1998 through March 31, 1999, and asserts claims for violations of Sections 10(b)
and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. In July 2002, we reached a settlement of the class action complaint. In November 2002, the Court granted final approval of the settlement for $10.1 million. $2.8 million in cash
will be covered by our insurance. The $7.3 million balance of the settlement, reflected on the consolidated statement of operations as other non-recurring expense, will be contributed by us in common stock or in a combination of common stock and
cash at the date of distribution. The final allocation of the contribution will be determined by us at our sole option. Distribution of the settlement is anticipated sometime in mid-2003.



On February 11, 2002, Herbert Silverberg filed a shareholder
derivative action captioned Silverberg v. McGurran, et al., Case No. CV 805193 in California Superior Court in Santa Clara County against certain of our current and former officers and directors. We are named as nominal defendant. Plaintiff alleges
that defendants breached their fiduciary duties by making false and misleading statements about our business condition and prospects during the period of November 10, 1998 through March 31, 1999. On April 29, 2002, the Court dismissed the complaint
with leave to amend. The parties subsequently negotiated a settlement of $300,000 by which plaintiff will dismiss the action with prejudice. On March 11, 2003 the Court granted final approval of the settlement.



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



No matters were submitted to a vote of the stockholders during the three months ended December 31, 2002.



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Part II



Item 5.
    Market for Registrants Common Equity and Related Stockholder Matters



Market Information



Our common stock is listed on the NASDAQ national market under ticker symbol: SCUR. As of March 24, 2003, there were approximately 631 registered holders. The number of registered holders represents
the number of shareholders of record plus the number of individual participants in security position listings. We believe, however, that many beneficial holders of our common stock have registered their shares in nominee or street name and that
there are approximately 8,500 beneficial owners. The low and high price of our common stock during the last eight quarters are as follows:



|                                 |  | Low Price |  | High Price
|-------------------------------- |  | --------- |  | ----------
|2001                             |  |           |  |           
|Quarter ended March 31, 2001     |  | $  7.00   |  | $14.95    
|Quarter ended June 30, 2001      |  | $  7.91   |  | $19.21    
|Quarter ended September 30, 2001 |  | $  7.90   |  | $17.20    
|Quarter ended December 31, 2001  |  | $  8.00   |  | $24.92    
|                                
|2002                             |  |           |  |           
|Quarter ended March 31, 2002     |  | $13.10    |  | $24.50    
|Quarter ended June 30, 2002      |  | $  6.86   |  | $18.88    
|Quarter ended September 30, 2002 |  | $  2.26   |  | $  8.00   
|Quarter ended December 31, 2002  |  | $  2.68   |  | $  8.74   



We have
not paid any dividends on our common stock during the periods set forth above. It is presently the policy of the Board of Directors to retain earnings for use in expanding and developing our business. Accordingly, we do not anticipate paying
dividends on the common stock in the foreseeable future.



Equity Compensation Plan Information



The following table sets forth information regarding securities authorized for issuance under equity compensation plans:



|Plan category                                              |  | Number of securities to be issued upon exercise of outstanding
options, warrants, and rights |  | Weighted-average exercise price of outstanding options,
warrants and rights |       | Number of securities remaining available for future
issuance
|---------------------------------------------------------- |  | -------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------- | ----- | ------------------------------------------------------------
|Equity compensation plans approved by shareholders (1)     |  | 7,224,865                                                                                    |  | $                                                                           | 10.40 |                                                             
|Equity compensation plans not approved by shareholders (2) |  | 494,150                                                                                      |  | $                                                                           | 3.13  |                                                             
|                                                           |  |                                                                                              |  |                                                                             |       |                                                             
|Total                                                      |  | 7,719,015                                                                                    |  | $                                                                           | 9.93  |                                                             
|                                                           |  |                                                                                              |  |                                                                             |       |                                                             

---

|(1) |  | In September 1995, our Board of Directors and stockholders approved our 1995 Omnibus Stock Plan. Under the terms of the 1995 Omnibus Stock Plan, key employees and
nonemployees may be granted options to purchase up to 11,494,131 shares of our Common Stock. The majority of options granted under this plan have 10-year terms and vest either annually over three years, or fully vest at the end of three years.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | In July 2002, our Board of Directors and compensation committee approved our 2002 Stock Option Plan. Under the terms of the 2002 Option Stock Plan, key employees and
non-employees may be granted options to purchase up to 1,000,000 shares of our Common Stock. The options granted in 2002 have 10-year terms and vest either annually over three years, or fully vest at the end of three years. Directors and executive
officers are not included in this plan.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Beginning in 2003, all new stock option grants under both plans vest 25% after the first year and then monthly over the following three years.



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Item 6.     Selected Financial Data



The consolidated statement of operations data set forth below for the fiscal years ended December 31, 2002, 2001, and 2000, and the consolidated balance sheet data at December 31, 2002 and 2001, are
derived from the audited consolidated financial statements included elsewhere in this Form 10-K. The consolidated statement of operations data set forth below for the fiscal years ended December 31, 1999 and 1998, and the consolidated balance sheet
data at December 31, 2000, 1999, and 1998, are derived from audited consolidated financial statements which are not included in this Form 10-K. You should read the data set forth below in conjunction with the financial statements and notes thereto
and Managements Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K.



|                              |  | Year ended December 31,                  |  
|----------------------------- |  | ---------------------------------------- | -
|                              |  | (In thousands, except per share amounts) |  
|                              |  | 2002(1)                                  |  
|STATEMENT OF OPERATIONS DATA: |  |                                          |  
|Revenue:                      |  |                                          |  
|Products and Services         |  | $61,960                                  |  
|Advanced Technology contracts |  | 3,877                                    |  
|                              |  |                                          |  
|Total revenue                 |  | 65,837                                   |  
|Gross profit                  |  | 58,257                                   |  
|Operating income (loss)       |  | 361                                      |  
|Net loss                      |  | (6,476                                   | )
|Net loss per share:           |  |                                          |  
|Basic and diluted             |  | (0.22                                    | )
|                             
|BALANCE SHEET DATA:           |  |                                          |  
|Working capital               |  | $6,185                                   |  
|Total assets                  |  | 60,943                                   |  
|Stockholders equity          |  | 29,663                                   |  

---

|(1) |  | 2002 balance sheet data includes $15,195 of goodwill related to the acquisition of the GauntletTMfirewall and VPN business completed in early 2002 and a litigation settlement accrual of $7,258.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | 1999 statement of operations data includes $11,729 in significant charges. In 1999, we commenced and substantially completed, activities related to rationalizing our
product line, refocusing on e-commerce products, and streamlining our executive management structure. As a result, a portion of our product portfolio was discontinued, including several firewall products and a URL filtering option that we no longer
considered strategic. We recorded costs of $11.7 million associated with these activities during 1999. These costs consisted primarily of $10.2 million in assets which were written off related to discontinued products and the associated costs which
no longer fit our business model. In addition, $1.5 million of costs related to payments for severance and related benefits, legal and audit costs, and contract cancellation fees. As of December 31, 2001, there were no remaining accruals or unpaid
costs related to these activities.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



Information Regarding Forward-Looking Statements



The following discussion contains forward-looking statements, including statements regarding our expectations, beliefs, intentions, or
strategies regarding the future. These statements are not guarantees of future performance and are subject to risks, uncertainties, and other factors, some of which are beyond our control and difficult to predict and could cause actual results to
differ materially from those expressed or forecasted in the forward-looking statements. The risks and uncertainties are summarized in Item 1 above and in the other documents we file with the SEC. These forward-looking statements reflect our view
only as of the date of this report. We cannot guarantee future results, levels of activity, performance, or achievement. We do not undertake any obligation to update or correct any forward-looking statements.



Results of Operations



The following table sets forth, for the periods indicated,
certain items from the statements of operations of our company expressed as a percentage of revenue:



|                                                    |  | Year ended December 31, |   
|--------------------------------------------------- |  | ----------------------- | --
|                                                    |  | 2002                    |   
|Revenue:                                            |  |                         |   
|Products and Services                               |  | 94.1                    | % 
|Advanced Technology contracts                       |  | 5.9                     |   
|                                                    |  |                         |   
|Total revenue                                       |  | 100.0                   |   
|Cost of revenue                                     |  | 11.5                    |   
|                                                    |  |                         |   
|Gross profit                                        |  | 88.5                    |   
|                                                   
|Operating expenses:                                 |  |                         |   
|Selling and marketing                               |  | 56.5                    |   
|Research and development                            |  | 22.8                    |   
|General and administrative                          |  | 7.8                     |   
|Separation costs                                    |  | .8                      |   
|                                                    |  |                         |   
|Total operating expenses                            |  | 87.9                    |   
|                                                    |  |                         |   
|Operating income (loss) Other non-recurring expense |  | .6 (11.0                | ) 
|Interest and other income                           |  | .6                      |   
|                                                    |  |                         |   
|Loss before income taxes                            |  | (9.8                    | ) 
|Income tax benefit (expense)                        |  |                        |   
|                                                    |  |                         |   
|Net loss                                            |  | (9.8                    | )%
|                                                    |  |                         |   



Comparison of Years Ended December 31, 2002 and 2001.



Revenue. Our revenue increased 25.5% to $65.8 million in 2002, up from $52.5 million in 2001. Products and Services revenue was $62.0 million, an increase of 28.1% over the $48.4 million
reported in 2001. The growth in Products and Services revenue in 2002 was driven by sustained demand for high assurance solutions and increased traction with our OEM relationships. We expect 2003 revenue from Products and Services to grow 18% over
2002 for the same reasons noted above. Advanced Technology contract revenue was $3.9 million in 2002, a decrease of 5.8% from the $4.1 million reported in 2001, in keeping with our strategy of focusing only on development contracts that add value to
our Products and Services offerings. We expect 2003 revenue from Advanced Technology contracts to remain at levels comparable to 2002.



Gross Profit. Gross profit as a percentage of revenue increased from 83.6% in 2001 to 88.5% in 2002. This improvement was driven by
increased sales volume on software products, which have higher profit margins. Aggregate gross margins in 2003 are expected to be consistent with the 89.0% that was achieved in the fourth quarter of 2002.



Selling and Marketing. Selling and marketing expenses
consist primarily of salaries, commissions, and benefits related to personnel engaged in selling, marketing and customer support functions, along with costs related to advertising, promotions, public relations, travel and allocations of information
technology, facilities and human resources expenses. Selling and marketing expenses increased 5.4% to $37.2 million in 2002, up from $35.3 million in 2001. This increase was driven primarily by an



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increase in payroll and
related costs and an increase in commission expense due to expanding revenues. As a percentage of revenue, selling and marketing expenses were 56.5% for the year compared to 67.3% in 2001. This improvement was driven by increased revenue in 2002
while a significant portion of the selling and marketing expenses are fixed in nature. We expect selling and marketing expenses to increase on an actual dollar basis but to continue to decline as a percent of revenue for the full year 2003 when
compared to 2002. We expect the increase in selling and marketing expenses in 2003 to be driven by an increase in commission expense due to expanding revenue, an increase in marketing and advertising activities, and inflationary increases in payroll
and benefit costs.



Research and
Development. Research and development expenses consist primarily of salaries and benefits for our product development personnel and allocations of information technology, facilities and human resources expenses. Research and development expenses
increased 5.7% to $15.0 million in 2002, up from $14.2 million in 2001. This increase was driven primarily by an increase in payroll and related costs. As a percentage of revenue, research and development expenses were 22.8% for the year compared to
27.1% in 2001. This improvement was driven by increased revenue in 2002 while a significant portion of the research and development expenses are fixed in nature. We expect research and development expenses to increase on an actual dollar basis but
to continue to decline as a percent of revenue for the full year 2003 when compared to 2002. We expect the increase in research and development expenses in 2003 to be driven primarily by inflationary increases in payroll and benefit costs.



General and Administrative. General and
administrative expenses consist primarily of salaries, benefits and related expenses for our executive, finance and legal personnel along with allocated information technology, facilities and human resources expenses. General and administrative
expenses increased 21.4% to $5.1 million in 2002, up from $4.2 million in 2001. This increase was driven primarily by an increase in directors and officers insurance premiums, legal fees, and to a lesser extent, inflationary increases in payroll and
benefits. The executive management team was given payroll increases in 2002. As a percentage of revenue, general and administrative expenses were 7.8% for the year compared to 8.1% in 2001. We expect general and administration expenses to increase
on an actual dollar basis and as a percent of revenue for the full year 2003 when compared to 2002. We expect the increase in general and administrative expenses in 2003 to be driven primarily by increases in directors and officers insurance
premiums, legal fees, and inflationary increases in payroll and benefit costs.



Separation Costs.In addition to normal operating expenses, we incurred $568,000 of expenses in 2002 related to a 6% reduction in headcount in July 2002.



Non-recurring Expense.Non-recurring expense of $7.3
million in 2002 pertains to a one-time charge for a litigation settlement. In July 2002, we reached a settlement of the class action securities lawsuit that was brought in United States District Court for the Northern District of California on
behalf of persons who acquired our common stock between November 10, 1998 and March 31, 1999.



The class action case settled for $10.1 million. $2.8 million in cash will be covered by our insurance. The $7.3 million balance of the settlement will be contributed by us in common stock or in a
combination of common stock and cash at the date of distribution. The final allocation of the distribution will be determined by us at our sole option. Distribution of the settlement is anticipated sometime in mid-2003.



Interest and Other Income.Net interest and other
income was $421,000 in 2002, a decrease from $870,000 in 2001. The decrease reflects lower average cash and investment balances as well as lower interest rates in 2002 as compared to 2001.



Income Taxes. We recognized no income tax expense or tax benefit for either 2002 or 2001. We believe
it is more likely than not that deferred tax assets of $2.7 million at December 31, 2002 will be realized. The computations of our deferred tax assets and valuation allowance are based on taxable income we expect to earn on government contracts,
commercial products, and projected interest income over the next three years. Future taxable income of $6.8 million is required to realize the $2.7 million deferred tax asset at December 31, 2002. We had total net operating loss carryforwards of
approximately $134.9 million at December 31, 2002. Of these carryforwards, $31.3 million relates to stock option exercises. These deductions currently have a full valuation allowance, and when realized for financial statement purposes, they will not
result in a reduction in income tax expense. Rather, the benefit will be recorded as an increase to additional paid-in capital. Of the remaining benefit associated with the carryforwards, approximately $96.8 million have yet to be recognized as a
benefit in the consolidated statement of operations. However, there are no assurances that these carryforwards will be available to offset future income tax expense when taxable income is realized.



Comparison of Years Ended December 31, 2001 and 2000.



Revenue. Our revenue increased 34.1%
to $52.5 million in 2001, up from $39.1 million in 2000. Products and Services revenue was $48.4 million, an increase of 39.6% over 2000. The growth in Products and Services revenue in 2001 was driven by the addition of 25 direct sales people and
over 70 value added resellers, and price increases implemented across all product lines in



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the first half of 2001.
Advanced Technology contract revenue was $4.1 million in 2001, a decrease of 8.0% from 2000, in keeping with our strategy of focusing only on development contracts that add value to our Products and Services offerings.



Gross Profit. Gross profit as a percentage of revenue
increased from 69.6% in 2000 to 83.6% in 2001. This improvement was driven by increased sales volume on software products, which have higher profit margins.



Selling and Marketing. Selling and marketing expenses consist primarily of salaries, commissions, and benefits related to personnel
engaged in selling, marketing and customer support functions, along with costs related to advertising, promotions, public relations, travel and allocations of information technology, facilities and human resources expenses. Selling and marketing
expenses increased 13.2% to $35.3 million in 2001, up from $31.2 million in 2000. This increase was driven primarily by an increase in payroll and related costs due to significant growth in selling headcount and increased Products and Services
revenue. As a percentage of revenue, selling and marketing expenses were 67.3% for the year compared to 79.7% in 2000. This improvement was driven by increased revenue in 2001 while a significant portion of the selling and marketing expenses are
fixed in nature.



Research and
Development. Research and development expenses consist primarily of salaries and benefits for our product development personnel and allocations of information technology, facilities and human resources expenses. Research and development expenses
increased 9.1% to $14.2 million in 2001, up from $13.0 million in 2000. This increase was driven primarily by an increase in payroll and related costs. As a percentage of revenue, research and development expenses were 27.1% for the year compared to
33.3% in 2000. This improvement was driven by increased revenue in 2001 while a significant portion of the research and development expenses are fixed in nature.



General and Administrative. General and administrative expenses consist primarily of salaries,
benefits and related expenses for our executive, finance and legal personnel along with allocated information technology, facilities and human resources expenses. General and administrative expenses decreased 6.1% to $4.2 million in 2001, down from
$4.5 million in 2000. As a percentage of revenue, general and administrative expenses were 8.0% for the year compared to 11.5% in 2000. This improvement was driven by increased revenue in 2001 while a significant portion of the general and
administrative expenses are fixed in nature.



Interest and Other Income.Net interest and other income was $870,000 in 2001, a decrease from $2.3 million in 2000. The decrease reflects higher average cash and investment balances in 2001 as compared to 2000 offset by the
$1.6 million gain on the sale of the Professional Services group included in 2000.



Income Taxes. We recognized no income tax expense or tax benefit for either 2001 or 2000. We believe it is more likely than not that deferred tax assets of $2.7 million at December 31, 2001 will
be realized. The computations of our deferred tax assets and valuation allowance are based on taxable income we expect to earn on government contracts, commercial products, and projected interest income over the next three years. Future taxable
income of $6.8 million is required to realize the $2.7 million deferred tax asset at December 31, 2001. We had total net operating loss carryforwards of approximately $128.6 million at December 31, 2001. Of these carryforwards, $29.7 million relates
to stock option exercises. These deductions currently have a full valuation allowance, and when realized for financial statement purposes, they will not result in a reduction in income tax expense. Rather, the benefit will be recorded as an increase
to additional paid-in capital. Of the remaining benefit associated with the carryforwards, approximately $92.2 million have yet to be recognized as a benefit in the statement of operations. However, there are no assurances that these carryforwards
will be available to offset future income tax expense when taxable income is realized.



Liquidity and Capital Resources



Our cash, cash equivalents and short term investments increased by $351,000 from December 31, 2001 to December 31, 2002. The increase is primarily due to cash received from the exercise of stock options and sales of common stock
through our employee stock purchase plan, offset by cash used in operating activities and capital additions. We expect to generate cash for the full year 2003 as we expect revenue to continue to grow at a faster rate than operating expenses.



Net cash used in operating activities of
$236,000 for the twelve months ended December 31, 2002, net of the effects of the Gauntlet firewall business, was comprised of net loss of $6.5 million, offset by net non-cash related expenses of $3.1 million, a $612,000 increase in current assets,
and a $3.7 million increase in liabilities.



Net
cash used in investing activities of $116,000 for the twelve months ended December 31, 2002, net of the effects of the acquisition of the Gauntlet firewall business, consisted primarily of net proceeds from sale of investments of $1.7 million offset
by $2.1 million of cash used for capital additions, which were made up of computer equipment, technology upgrades, and leasehold improvements.



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Net cash
provided by financing activities of $2.6 million for the twelve months ended December 31, 2002 consisted primarily of proceeds received from the exercise of stock options and sales of common stock through our employee stock purchase plan.



As of December 31, 2002 we had working capital
of $6.2 million. We anticipate using available cash to fund growth in operations, invest in capital equipment, acquire businesses and to license technology or products related to our line of business.



We believe that we have sufficient financial resources
available to fund our current working capital and capital expenditure requirements for at least the next twelve months. We intend to continue to invest our cash in excess of current operating requirements in interest bearing, short term investments.



Critical Accounting Policies and Estimates



Our discussion of the financial condition and results
of operations are based upon the consolidated financial statements, which have been prepared in conformity with generally accepted accounting principles in the United States. The preparation of our financial statements requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosure of any contingent assets and liabilities at the date of the financial statements. Management regularly reviews its
estimates and assumptions, which are based on historical factors and other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions, estimates, or conditions.



Critical accounting policies are defined as
those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. See Note 1 to the consolidated financial statements for additional discussion of
the application of these and other accounting policies.



Revenue Recognition.Our revenue is derived from two primary sources: (1) product and services revenue which includes revenue for software licenses, hardware, royalties, and maintenance for providing product
upgrades and customer support, and (2) Advanced Technology contract revenue. We recognize revenue in accordance with Statement of Position (SOP) 97-2, Software Revenue Recognition, as modified by SOP 98-9.



Revenue from products is recognized when persuasive evidence
of an arrangement exists, delivery has occurred, the fee is fixed and determinable, and collection is probable. Subscription revenue is deferred and recognized ratably over the subscription period. Maintenance revenue for providing product upgrades
and customer support is deferred and recognized ratably over the service period.



For arrangements with multiple elements we allocate revenue to the various elements based on the fair value of each element sold. We determine the fair value of each element based on its selling price
when sold separately. Evidence of fair value includes the approved price list and discount schedule and the actual prices charged for comparable arrangements. These price lists and discount schedules may change from time to time in response to
factors including market conditions, value of services and product provided and competitive positioning. Historically, we have not offered significant discounts off of our list prices.



Further, it is our policy that our distributors and resellers are not allowed to hold inventory.



Advanced Technology contract revenues for
cost-plus-fixed-fee contracts are recognized on the basis of costs incurred during the period plus the fee earned. Award fees are recognized based upon the percentage of completion and forecasted profit in accordance with SOP 81-1 Accounting
for Performance of Construction-Type and Certain Production-Type Contracts. A provision is made for the estimated loss, if any, on the contracts in the period the loss becomes probable. Historically, we have not experienced losses on Advanced
Technology contracts.



Allowance for
Doubtful Accounts.We make estimates regarding the collectibility of our accounts receivables. When we evaluate the adequacy of our allowance for doubtful accounts, we closely analyze specific accounts receivable balances, customer
creditworthiness, changes in our customer payment cycles, and current economic trends. If the financial condition of our customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be
required.



Deferred Tax Assets.The
computations of our deferred tax asset and valuation allowance are based on taxable income we expect to earn on government contracts, commercial products, and projected interest income over the next three years. We believe this is a conservative
approach in determining the deferred tax asset that may be realized. The risk factors noted above in Certain Factors That May Affect Future Results, could adversely affect our ability to generate future taxable income, thereby also
adversely impacting our ability to realize the deferred tax asset.



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Inflation



To date, we have not been significantly affected by
inflation.



Item 7a.     Quantitative and Qualitative Disclosures About Market Risk



We do not have any material exposure to quantitative and qualitative market risks because we do not own any risk-sensitive financial
instruments. We invest our cash in a variety of financial instruments, including bank time deposits and commercial paper. Investments in fixed rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have
their fair market value adversely impacted due to a rise in interest rates. Due in part to these factors, our future investment income may fall short of expectations due to changes in interest rates or we may suffer losses in principal if forced to
sell securities which have seen a decline in market value due to changes in interest rates. Our investment securities are held for purposes other than trading.



Item 8.     Financial Statements and Supplementary Data



See Part IV, Item 15 of this Form 10-K.



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



Not applicable.



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Part III



Item 10.    Directors and Executive Officers of the Registrant



Incorporated herein by reference is the information under the heading Election of Directors and Section 16(a) Beneficial
Ownership Reporting Compliance, in the Registrants Proxy Statement to be filed on or about April 10, 2003. See also Part I, Item 1, Executive Officers of this Form 10-K.



Item 11.    Executive Compensation



Incorporated herein by reference is the information appearing in the Registrants Proxy Statement which the Registrant anticipates filing on or about April 10, 2003, under the headings
Election of Directors, Report of the Compensation Committee, Executive Officer Compensation Program, Summary Compensation Table, Option Grants in Last Fiscal Year, Aggregated Option
Exercises in Last Fiscal Year and Fiscal Year-End Option Values, Employment Contracts, Termination of Employment and Change-in-Control Arrangements, and Performance Evaluation.



Item 12.    Security Ownership of Certain Beneficial Owners and Management



Incorporated herein by reference is the information appearing under the heading Security Ownership of Principal Stockholders and
Management in the Registrants Proxy Statement that the Registrant anticipates filing on or about April 10, 2003.



Item 13.    Certain Relationships and Related Transactions



Incorporated herein by reference is the information appearing under the heading Certain Transactions in the Registrants
Proxy Statement that the Registrant anticipates filing on or about April 10, 2003.



Item 14.    Controls and Procedures



Our Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation within 90 days of the filing date of this report, that our disclosure controls and procedures are
effective for gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Securities Exchange Act of 1934. There have been no significant changes in our internal controls or in other factors that
could significantly affect these controls subsequent to the date of their evaluation.



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Part IV



Item 15.    Exhibits, Financial Statement Schedules, and Reports on Form 8-K



|(a) |  | Documents filed as part of this report:
|--- |  | ---------------------------------------



| | 1. |  | Consolidated Financial Statements:
| | -- |  | ----------------------------------



Consolidated Balance Sheets as of December 31, 2002 and 2001

Consolidated Statements of Operations for the years ended

December 31, 2002, 2001, and 2000

Consolidated Statement of Stockholders Equity for the years

ended December 31, 2002, 2001, and 2000

Consolidated Statements of Cash Flows for the years ended

December 31, 2002, 2001, and 2000

Notes to Consolidated Financial Statements

Report of Independent Auditors



| | 2. |  | Consolidated Financial Statement Schedules:
| | -- |  | -------------------------------------------



| | Schedule |  | IIValuation and Qualifying Accounts. Such schedule should be read in conjunction with the consolidated financial statements. All other supplemental schedules
are omitted because of the absence of conditions under which they are required.
| | -------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



A Form 8-K was not filed during the quarter ended December 31, 2002.



|(c) |  | Exhibits:
|--- |  | ---------



The following exhibits are filed as part of this Annual Report on Form 10-K for the fiscal year ended December 31, 2002:



|Exhibit |  | Description                                                                                                                                                                                                                                                                                                                                                                                         
|------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1     |  | Restated Certificate of Incorporation, effective March 6, 1996, as amended by the Certificate of Amendment of
Certificate of Incorporation effective December 11, 1988, the Certificate of Designations of Series E 4% Cumulative Preferred Stock effective January 26, 2000; and the Certificate of Designations of Series F 4% Cumulative Convertible Preferred Stock
effective June 30, 2000. (1)
|3.2     |  | By-Laws of the Registrant. (2)                                                                                                                                                                                                                                                                                                                                                                      
|4.1     |  | Specimen of common stock certificate. (3)                                                                                                                                                                                                                                                                                                                                                           
|4.2     |  | Amended and Restated 1995 Omnibus Stock Plan. (4)                                                                                                                                                                                                                                                                                                                                                   
|4.3     |  | 2002 Stock Option Plan. (5)                                                                                                                                                                                                                                                                                                                                                                         
|23.1    |  | Consent of Ernst & Young LLP.                                                                                                                                                                                                                                                                                                                                                                       
|24.1    |  | Power of Attorney. (see page 41)                                                                                                                                                                                                                                                                                                                                                                    
|99.1    |  | Certification of Disclosure in Annual Report by Chief Executive Officer.                                                                                                                                                                                                                                                                                                                            
|99.2    |  | Certification of Disclosure in Annual Report by President and Chief Operating Officer.                                                                                                                                                                                                                                                                                                              
|99.3    |  | Certification of Disclosure in Annual Report by Senior Vice President and Chief Financial
Officer.                                                                                                                                                                                                                                                                                                  
|99.4    |  | Secure Computing Code of Ethics for Finance.                                                                                                                                                                                                                                                                                                                                                        

---

|(1) |  | Incorporated herein by reference to Exhibit 3.1 to Secure Computings Amended Quarterly Report on Form 10-Q filed on September 6, 2000.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Incorporated herein by reference to Exhibit 3.3 to Secure Computings Registration Statement on Form S-1 (Registration Number 33-97838).
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------



|(3) |  | Incorporated herein by reference to the same numbered Exhibit to Amendment No. 2 to Secure Computings Registration Statement on Form S-1 (Registration Number
33-97838).
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) |  | Incorporated herein by reference to the Exhibit 10.1 to Secure Computings Current Report on Form 8-K filed on October 8, 1999.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------



|(5) |  | Incorporated herein by reference to Exhibit 99.3 to Secure Computings Registration Statement on Form S-8 (Registration Number 333-103595) filed on March 4,
2003.
|--- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



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SECURE COMPUTING CORPORATION

CONSOLIDATED BALANCE SHEETS

(in thousands,
except share and per share amounts)



|ASSETS                                                                                                                            |  | December 31, 2002 |          |   | December 31, 2001 |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ----------------- | -
|                                                                                                                                 
|Current assets                                                                                                                    |  |                   |          |   |                   |  
|Cash and cash equivalents                                                                                                         |  | $                 | 18,050   |   |                   | $
|Investments                                                                                                                       |  |                   | 3,342    |   |                   |  
|Accounts receivable (net of reserves of 2002$514;
2001$1,404)                                                                   |  |                   | 11,421   |   |                   |  
|Inventories                                                                                                                       |  |                   | 885      |   |                   |  
|Deferred income taxes                                                                                                             |  |                   | 2,000    |   |                   |  
|Other current assets                                                                                                              |  |                   | 1,767    |   |                   |  
|                                                                                                                                  |  |                   |          |   |                   |  
|Total current assets                                                                                                              |  |                   | 37,465   |   |                   |  
|                                                                                                                                 
|Property and equipment                                                                                                            |  |                   |          |   |                   |  
|Equipment                                                                                                                         |  |                   | 15,148   |   |                   |  
|Furniture and fixtures                                                                                                            |  |                   | 2,285    |   |                   |  
|Leasehold improvements                                                                                                            |  |                   | 1,972    |   |                   |  
|                                                                                                                                  |  |                   |          |   |                   |  
|                                                                                                                                  |  |                   | 19,405   |   |                   |  
|Accumulated depreciation                                                                                                          |  |                   | (13,697  | ) |                   |  
|                                                                                                                                  |  |                   |          |   |                   |  
|                                                                                                                                  |  |                   | 5,708    |   |                   |  
|                                                                                                                                 
|Goodwill                                                                                                                          |  |                   | 15,195   |   |                   |  
|Intangible assets(net of accumulated amortization of 2002$393;
2001$1,160)                                                      |  |                   | 1,239    |   |                   |  
|Deferred income taxes                                                                                                             |  |                   | 700      |   |                   |  
|Other assets                                                                                                                      |  |                   | 636      |   |                   |  
|                                                                                                                                  |  |                   |          |   |                   |  
|Total assets                                                                                                                      |  | $                 | 60,943   |   |                   | $
|                                                                                                                                  |  |                   |          |   |                   |  
|                                                                                                                                 
|LIABILITIES AND STOCKHOLDERS
EQUITY                                                                                              |  |                   |          |   |                   |  
|Current liabilities                                                                                                               |  |                   |          |   |                   |  
|Accounts payable                                                                                                                  |  | $                 | 1,845    |   |                   | $
|Accrued payroll                                                                                                                   |  |                   | 3,263    |   |                   |  
|Other accrued expenses                                                                                                            |  |                   | 4,105    |   |                   |  
|Litigation settlement accrual                                                                                                     |  |                   | 7,258    |   |                   |  
|Deferred revenue                                                                                                                  |  |                   | 14,809   |   |                   |  
|                                                                                                                                  |  |                   |          |   |                   |  
|Total current liabilities                                                                                                         |  |                   | 31,280   |   |                   |  
|                                                                                                                                 
|Stockholders equity                                                                                                              |  |                   |          |   |                   |  
|Common stock, par value $.01 per share:                                                                                           |  |                   |          |   |                   |  
|Authorized  50,000,000 shares; issued and outstanding shares  December 31, 2002 
29,684,459 and December 31, 2001  28,830,992 |  |                   | 297      |   |                   |  
|Additional paid-in capital                                                                                                        |  |                   | 156,132  |   |                   |  
|Accumulated deficit                                                                                                               |  |                   | (126,163 | ) |                   |  
|Foreign currency translation                                                                                                      |  |                   | (603     | ) |                   |  
|                                                                                                                                  |  |                   |          |   |                   |  
|Total stockholders' equity                                                                                                        |  |                   | 29,663   |   |                   |  
|                                                                                                                                  |  |                   |          |   |                   |  
|Total liabilities and stockholders' equity                                                                                        |  | $                 | 60,943   |   |                   | $
|                                                                                                                                  |  |                   |          |   |                   |  



See
accompanying notes.



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SECURE COMPUTING CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(in
thousands, except per share amounts)



|                                                        |  | Year ended December 31, |       
|------------------------------------------------------- |  | ----------------------- | ------
|                                                        |  | 2002                    |       
|Revenue                                                 |  |                         |       
|Products and Services                                   |  | $                       | 61,960
|Advanced Technology contracts                           |  |                         | 3,877 
|                                                        |  |                         |       
|                                                        |  |                         | 65,837
|Cost of revenue                                         |  |                         | 7,580 
|                                                        |  |                         |       
|Gross profit                                            |  |                         | 58,257
|                                                       
|Operating expenses                                      |  |                         |       
|Selling and marketing                                   |  |                         | 37,203
|Research and development                                |  |                         | 15,012
|General and administrative                              |  |                         | 5,113 
|Separation costs                                        |  |                         | 568   
|                                                        |  |                         |       
|                                                        |  |                         | 57,896
|                                                        |  |                         |       
|Operating income (loss)                                 |  |                         | 361   
|Other non-recurring expense                             |  |                         | (7,258
|Interest and other income                               |  |                         | 421   
|                                                        |  |                         |       
|Net loss                                                |  | $                       | (6,476
|                                                        |  |                         |       
|                                                       
|Net loss per share  basic and diluted                  |  | $                       | (0.22 
|                                                       
|Weighted average shares outstanding  Basic and diluted |  |                         | 29,307

See accompanying notes.





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SECURE COMPUTING CORPORATION

CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

(in thousands, except share amounts)



|                                                     |  | Preferred Stock |   | Common Stock |        | Additional Paid-In Capital |        |            | Foreign Currency Translation |   |     | Accumulated Deficit |   |         | Total Stockholders Equity | 
|---------------------------------------------------- |  | --------------- | - | ------------ | ------ | -------------------------- | ------ | ---------- | ---------------------------- | - | --- | ------------------- | - | ------- | -------------------------- | 
|                                                     |  | Shares          |   |              | Amount |                            | Shares |            | Amount                       |   |     |                     |  
|BALANCE, December 31, 1999                           |  | 5,706           |   |              | $      |                           |        | 23,022,884 |                              | $ | 230 |                     | $ | 106,832 |                            | 
|Comprehensive loss:                                  |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Net loss for the year                                |  |                |   |              |        |                           |        |           |                              |   |    |                     |   |        |                            | 
|Foreign currency translation adjustment              |  |                |   |              |        |                           |        |           |                              |   |    |                     |   |        |                            | 
|                                                     |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Total comprehensive loss                             |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Exercise of incentive stock options                  |  |                |   |              |        |                           |        | 469,013    |                              |   | 5   |                     |   | 2,231   |                            | 
|Employee stock purchase plan activity                |  |                |   |              |        |                           |        | 40,369     |                              |   | 1   |                     |   | 590     |                            | 
|Conversion of preferred stock                        |  | (30,756         | ) |              |        |                           |        | 2,706,477  |                              |   | 27  |                     |   | (27     | )                          | 
|Conversion of warrants                               |  |                |   |              |        |                           |        | 436,487    |                              |   | 4   |                     |   | (4      | )                          | 
|Compensation expense on options                      |  |                |   |              |        |                           |        |           |                              |   |    |                     |   | 548     |                            | 
|Preferred stock issued                               |  | 32,750          |   |              |        |                           |        |           |                              |   |    |                     |   | 31,314  |                            | 
|                                                     |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|BALANCE, December 31, 2000                           |  | 7,700           |   |              |        |                           |        | 26,675,230 |                              |   | 267 |                     |   | 141,484 |                            | 
|Comprehensive loss:                                  |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Net loss for the year                                |  |                |   |              |        |                           |        |           |                              |   |    |                     |   |        |                            | 
|Foreign currency translation adjustment              |  |                |   |              |        |                           |        |           |                              |   |    |                     |   |        |                            | 
|                                                     |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Total comprehensive loss                             |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Exercise of incentive stock options                  |  |                |   |              |        |                           |        | 779,647    |                              |   | 9   |                     |   | 3,983   |                            | 
|Employee stock purchase plan activity                |  |                |   |              |        |                           |        | 149,679    |                              |   |    |                     |   | 1,102   |                            | 
|Conversion of preferred stock                        |  | (7,700          | ) |              |        |                           |        | 1,051,972  |                              |   | 10  |                     |   | (64     | )                          | 
|Conversions of warrants                              |  |                |   |              |        |                           |        | 174,464    |                              |   | 2   |                     |   | 2,080   |                            | 
|                                                     |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|BALANCE, December 31, 2001                           |  |                |   |              |        |                           |        | 28,830,992 |                              |   | 288 |                     |   | 148,585 |                            | 
|Comprehensive loss:                                  |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Net loss for the year                                |  |                |   |              |        |                           |        |           |                              |   |    |                     |   |        |                            | 
|Foreign currency translation adjustment              |  |                |   |              |        |                           |        |           |                              |   |    |                     |   |        |                            | 
|                                                     |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Total comprehensive loss                             |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|Exercise of incentive stock options                  |  |                |   |              |        |                           |        | 191,506    |                              |   | 5   |                     |   | 1,149   |                            | 
|Employee stock purchase plan activity                |  |                |   |              |        |                           |        | 361,607    |                              |   |    |                     |   | 1,405   |                            | 
|Purchase of Gauntlet, net of stock registration fees |  |                |   |              |        |                           |        | 300,354    |                              |   | 4   |                     |   | 4,993   |                            | 
|                                                     |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 
|BALANCE, December 31, 2002                           |  |                |   |              | $      |                           |        | 29,684,459 |                              | $ | 297 |                     | $ | 156,132 |                            | 
|                                                     |  |                 |   |              |        |                            |        |            |                              |   |     |                     |   |         |                            | 



See
accompanying notes.





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##### Table of Contents

SECURE COMPUTING CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in
thousands)



|                                                                            |  | Year ended December 31, |       
|--------------------------------------------------------------------------- |  | ----------------------- | ------
|                                                                            |  | 2002                    |       
|Operating activities                                                        |  |                         |       
|Net loss                                                                    |  | $                       | (6,476
|Adjustments to reconcile net loss to net cash used in operating
activities: |  |                         |       
|Proceeds from the sale of Professional Services                             |  |                         |      
|Depreciation                                                                |  |                         | 2,772 
|Loss on disposals of property and equipment                                 |  |                         | 121   
|Loss on disposals of intangible assets                                      |  |                         |      
|Amortization                                                                |  |                         | 239   
|Changes in operating assets and liabilities:                                |  |                         |       
|Accounts receivable                                                         |  |                         | 96    
|Inventories                                                                 |  |                         | (128  
|Other current assets                                                        |  |                         | (580  
|Accounts payable                                                            |  |                         | (14   
|Accrued liabilities and reserves                                            |  |                         | (42   
|Litigation settlement accrual                                               |  |                         | 7,258 
|Deferred revenue                                                            |  |                         | (3,482
|                                                                            |  |                         |       
|Net cash used in operating activities                                       |  |                         | (236  
|                                                                           
|Investing activities                                                        |  |                         |       
|Proceeds from sales/maturities of investments                               |  |                         | 8,831 
|Purchases of investments                                                    |  |                         | (7,088
|Purchase of property and equipment, net                                     |  |                         | (2,095
|Decrease (increase) in intangibles and other assets                         |  |                         | 236   
|                                                                            |  |                         |       
|Net cash provided by (used in) investing activities                         |  |                         | (116  
|                                                                           
|Financing activities                                                        |  |                         |       
|Net proceeds from issuance of preferred stock                               |  |                         |      
|Proceeds from issuance of common stock                                      |  |                         | 2,559 
|Proceeds from the conversion of warrants                                    |  |                         |      
|                                                                            |  |                         |       
|Net cash provided by financing activities                                   |  |                         | 2,559 
|                                                                           
|Effect of foreign currency translation                                      |  |                         | (113  
|                                                                            |  |                         |       
|                                                                           
|Net increase in cash and cash equivalents                                   |  |                         | 2,094 
|Cash and cash equivalents, beginning of year                                |  |                         | 15,956
|                                                                            |  |                         |       
|Cash and cash equivalents, end of year                                      |  | $                       | 18,050
|                                                                            |  |                         |       
|Supplemental Cash Flow Disclosure:                                          |  |                         |       
|Common stock issued for purchase of Gauntlet                                |  | $                       | 5,000 



See
accompanying notes.









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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|1. |  | Summary of Significant Accounting Policies
|-- |  | ------------------------------------------



Organization



We develop and sell computer software products and services designed to provide enterprise access control solutions. We understand our
customers need to balance security and accessibility, and help them create a trusted environment both inside and outside of their organizations with our broad range of products for protecting and managing assets across the enterprise.



Basis of Presentation



The consolidated financial statements include the accounts of
Secure Computing Corporation and our wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.



Revenue Recognition



Our revenue is derived from two primary sources: (1) product and services revenue which includes revenue for software licenses, hardware,
royalties, and maintenance for providing product upgrades and customer support, and (2) Advanced Technology contract revenue.



Products and Services



Revenue from products is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and
determinable, and collection is probable. Maintenance revenue for providing product upgrades and customer support is deferred and recognized ratably over the service period. We recognize Products and Services revenue in accordance with Statement of
Position (SOP) 97-2, Software Revenue Recognition, as modified by SOP 98-9.



For arrangements with multiple elements we allocate revenue to the various elements based on the fair value of each element sold. We determine the fair value of each element based on its selling price
when sold separately. Evidence of fair value includes the approved price list and discount schedule and the actual prices charged for comparable arrangements. These price lists and discount schedules may change from time to time in response to
factors including market conditions, value of services and product provided and competitive positioning. Historically, we have not offered significant discounts off of our list prices.



Further, it is our policy that our distributors and resellers are not allowed to hold inventory.



Advanced Technology Contracts



Advanced Technology contract revenues for
cost-plus-fixed-fee contracts are recognized on the basis of costs incurred during the period plus the fee earned. Award fees are recognized based upon the percentage of completion and forecasted profit in accordance with SOP 81-1 Accounting
for Performance of Construction-Type and Certain Production-Type Contracts. A provision is made for the estimated loss, if any, on the contracts in the period the loss becomes probable.



Under our Advanced Technology contracts, we bear the risk that
increased or unexpected costs required to perform specified services may reduce our profitability. In addition, recoverable expenses we bill for government contracts are subject to review and audit by the Defense Contract Audit Agency, which could
result in amounts previously billed being renegotiated. We have had no adjustments as a result of these periodic audits. Pursuant to their terms, these contracts are also generally subject to termination at the convenience of the applicable
government agency. If a contract is terminated, we would typically be reimbursed for our costs to the date of our termination plus the cost of an orderly termination and paid a portion of the fee.



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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|1. |  | Summary of Significant Accounting Policies (continued)
|-- |  | ------------------------------------------------------



Cash Equivalents



We consider all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Cash equivalents
are carried at cost, which approximates market. We have restricted cash pledged against our letters of credit of $345 and $507 at December 31, 2002 and December 31, 2001, respectively.



Inventories



Inventories consist mainly of purchased components and prepaid licenses and are valued at the lower of cost (first-in, first-out method)
or market.



Property and Equipment



Property and equipment are carried at cost. Depreciation is
calculated using the straight-line method with estimated useful lives ranging from 3 to 8 years. Leasehold improvements are depreciated over the lesser of the useful life of the asset or the term of the lease.



Other Current Assets and Other Assets



Other current assets are carried at cost and consist
of unbilled contract receivables, interest receivable, and prepaid expenses for items such as trade shows, royalties, and foreign taxes to be either expensed or collected within 12 months. Other assets include rent deposits, employee notes
receivable, and prepaid foreign value-added tax to be collected after 12 months.



Valuation of Long-Lived Assets, Including Goodwill and Other Intangible Assets



Intangible assets consist of patents, trademarks, capitalized software costs, goodwill (excess cost over fair value of net assets
acquired) and are recorded at cost. Patents and trademarks are amortized using the straight-line method over the estimated useful lives of the assets, which range up to 17 years. See accounting policy of capitalized software costs below under
Research and Development. Goodwill is not amortized, but is tested for impairment at least annually at the reporting unit level. If impairment is indicated, a write-down is recorded as an impairment loss in income from operations.



We review all other long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to undiscounted future net cash
flows expected to be generated by the assets. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.



Foreign Currency Translation and Transactions



Foreign assets and liabilities are translated using the
year-end exchange rate. Results of operations are translated using the average exchange rates throughout the year. Translation gains or losses, net of applicable deferred taxes, are accumulated as a separate component of stockholders equity.



Selling and Marketing



Selling and marketing expenses consist primarily of
salaries, commissions, and benefits related to personnel engaged in selling, marketing and customer support functions, along with costs related to advertising, promotions, and public relations.



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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|1. |  | Summary of Significant Accounting Policies (continued)
|-- |  | ------------------------------------------------------



Research and Development



Research and development expenditures are charged to operations as incurred. Statement of Financial Accounting Standards (SFAS) No. 86,
Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed, requires capitalization of certain software development costs subsequent to the establishment of technological feasibility.



Based on our product development process, technological
feasibility is established upon completion of a working model. Costs that we incur between completion of the working model and the point at which the product is generally available for sale are capitalized and amortized over their estimated useful
life of three years.



Use of Estimates



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



Net Loss per Share



Basic earnings per share are computed using the weighted
average number of common shares outstanding. Diluted earnings per share are computed using the combination of dilutive common share equivalents and the weighted average number of common shares outstanding. Diluted earnings per share are not
presented separately, as the effect of outstanding options, warrants, and preferred stock is anti-dilutive. Potential common shares of 3,594,000, 838,000 and 235,000 related to the Companys outstanding stock options and restricted stock grants
were excluded from the computation of diluted earnings per share for 2002, 2001 and 2000, respectively, as inclusion of these shares would have been anti-dilutive.



Comprehensive Loss



Our comprehensive loss for the years ended December 31, 2002, 2001, and 2000, was $6,589, $9,052, and $19,340, respectively. The
components of our comprehensive loss are net loss and foreign currency translation adjustments.



Stock Options



At December 31, 2002, we have two stock option based compensation plans, which are described more fully in Note 8. We account for those plans under the recognition and measurement provisions of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in the consolidated statements of operations, as all options granted under those plans had an exercise price
equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net loss and net loss per share if we had applied the fair value recognition provisions of SFAS No. 123, Accounting
for Stock-Based Compensation, to stock-based employee compensation:



|                                                                                                                                            |  | Year Ended December 31, |        
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | -------
|                                                                                                                                            |  | 2002                    |        
|Net loss, as reported                                                                                                                       |  | $                       | (6,476 
|Deduct: Total stock-based employee compensation expense determined under fair value
based method for all awards, net of related tax effects |  |                         | (11,841
|                                                                                                                                            |  |                         |        
|Pro forma net loss                                                                                                                          |  |                         | (18,317
|                                                                                                                                            |  |                         |        
|Net loss per share:                                                                                                                         |  |                         |        
|Basic and Diluted  as reported                                                                                                             |  | $                       | (0.22  
|Basic and Diluted  pro forma                                                                                                               |  | $                       | (0.63  



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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|1. |  | Summary of Significant Accounting Policies (continued)
|-- |  | ------------------------------------------------------



Pro forma information regarding net loss and net loss per share is required by SFAS No. 123 and has been
determined as if we had accounted for our employee stock options under the fair value method of that statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following
weighted average assumptions:



|                        |  | 2002    |  | 2001    |  | 2000   
|----------------------- |  | ------- |  | ------- |  | -------
|Assumptions used:       |  |         |  |         |  |        
|Volatility              |  | 104%    |  | 99%     |  | 117%   
|Risk-free interest rate |  | 3.8%    |  | 4.6%    |  | 6.2%   
|Expected life           |  | 5 years |  | 5 years |  | 5 years
|Dividend-yield          |  |        |  |        |  |       



The
Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective
assumptions, including the expected stock price volatility. Because changes in the subjective input assumptions can materially affect the fair value estimate, in the opinion of management, the existing models do not necessarily provide a reliable
single value of our options and may not be representative of the future effects on reported net income (loss) or the future stock price of the Company. For purposes of pro forma disclosure, the estimated fair value of the options is amortized to
expense over the options vesting period.



Recently
Issued Accounting Standards



In July 2002,
the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities. This Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is
incurred. This Statement nullifies Emerging Issues Task Force (EITF) Issue No. 94-3 Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity, which required a liability be recognized at the
commitment date to an exit plan. We are required to adopt the provisions of this Statement effective for exit or disposal activities initiated after December 31, 2002. All restructuring activities prior to December 31, 2002 are accounted for under
EITF Issue No. 94-3.



In November 2002, the FASB
issued FASB Interpretation (FIN) No. 45, Guarantors Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. This Statement elaborates on the disclosures to be made by a
guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value
of the obligation undertaken in issuing the guarantee. The disclosure requirement of FIN No. 45 is effective for financial statements for fiscal years ending after December 15, 2002 and did not have a material effect on our consolidated financial
position or results of operation. The initial recognition and measurement provision are effective prospectively for guarantees issued or modified on or after January 1, 2003, which should not have a material effect on our consolidated financial
position or results of operation.



In December
2002, the FASB issued SFAS No. 148, Accounting for Stock-Based Compensation  Transition and Disclosure. This Statement amends SFAS No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of
transition to SFAS No. 123s fair value method of accounting for stock-based employee compensation. This statement also amends the disclosure provision of SFAS No. 123 and APB No. 28, Interim Financial Reporting, to require
disclosure in the summary of significant accounting policies of the effects of an entitys accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial
statements. The adoption of SFAS No. 148 did not have a material effect on our consolidated financial position or results of operation.



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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|2. |  | Investments
|-- |  | -----------



At December 31, 2002, and 2001, investments consisted of commercial paper with maturities of less than one year. The investments are
considered available for sale and are stated at lower of cost or market, which approximates fair market value.



|3. |  | Other Accrued Expenses
|-- |  | ----------------------



At December 31, 2002, other accrued expenses consisted of costs related to the class action litigation settlement (see Note 11),
Gauntlet acquisition costs (see Note 5), professional fees, and foreign taxes. At December 31, 2001, accrued liabilities consisted only of professional fees and foreign taxes.



|4. |  | Goodwill and Other Intangibles
|-- |  | ------------------------------



Effective January 1, 2002 we adopted SFAS No. 142, Goodwill and Other Intangible Assets, which requires goodwill and
intangible assets with indefinite lives be tested for impairment at the reporting unit level at adoption and at least annually thereafter. An impairment charge is recognized only when the calculated fair value of a reporting unit, including
goodwill, is less than its carrying amount. In accordance with SFAS No. 142, we completed the required impairment tests of goodwill and intangible assets with indefinite lives and determined the fair value to be in excess of the carrying value of
these assets.



As required by SFAS No. 142, we
continue to amortize intangibles with finite lives. Included in intangible assets are patents and trademarks and capitalized software costs. Information regarding our other intangible assets is as follows:



|                         |  | Carrying Value |       | Accumulated Amortization |   |        | Net
|------------------------ |  | -------------- | ----- | ------------------------ | - | ------ | ---
|As of December 31, 2002: |  |                |       |                          |   |        |    
|Patents and trademarks   |  | $              | 1,105 |                          | $ | (167   | )  
|Capitalized software     |  |                | 527   |                          |   | (226   | )  
|                         |  |                |       |                          |   |        |    
|Total                    |  | $              | 1,632 |                          | $ | (393   | )  
|                         |  |                |       |                          |   |        |    
|                        
|As of December 31, 2001: |  |                |       |                          |   |        |    
|Patents and trademarks   |  | $              | 959   |                          | $ | (111   | )  
|Capitalized software     |  |                | 1,367 |                          |   | (1,049 | )  
|                         |  |                |       |                          |   |        |    
|Total                    |  | $              | 2,326 |                          | $ | (1,160 | )  
|                         |  |                |       |                          |   |        |    



Total
amortization expense was $239, $433, and $490 for the years ended December 31, 2002, 2001, and 2000, respectively, none of which pertained to goodwill amortization. Estimated amortization expense for each of the five succeeding fiscal years based on
intangible assets is expected to be $201, $178, $77, $49, and $49.



5.     Acquisition of the GauntletFirewall and VPN Business



In February 2002, we completed our
acquisition of the assets of the Gauntlet firewall and VPN business from Network Associates, Inc. As a result of the acquisition, we expect to be the worldwide leader in application-layer firewalls. The purchase price, excluding stock registration
fees, was 300,354 shares of common stock valued at $5,000. The value of the common shares was determined based on the average market price of our common shares over the period including the five days before the terms of the acquisition were agreed
to and announced. The transaction was accounted for as a purchase in accordance with SFAS No. 141, Business Combinations. Accordingly, the net assets and results of operations have been included in our consolidated financial statements
from the date of acquisition. Allocation of the acquisition purchase price was based on the fair value of the assets acquired and liabilities assumed as follows: $1,043 allocated to assets acquired, consisting of net accounts receivable and computer
equipment; $11,922 allocated to liabilities assumed, consisting of support services obligations, acquisition costs, and related accruals; and $15,879 allocated to goodwill.



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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



5.     Acquisition of the GauntletFirewall and VPN Business (continued)



The following unaudited pro forma financial information was prepared in accordance with SFAS No. 141 and assumes the acquisition had
occurred at the beginning of the periods presented. The unaudited pro forma financial information is provided for informational purposes only and does not purport to be indicative of our future results. These pro forma results are based upon the
respective historical financial statements of the respective companies, and do not incorporate, nor do they assume, any benefits from cost savings or synergies of operations of the combined company.



|                                       |  | Year ended December 31, |       
|-------------------------------------- |  | ----------------------- | ------
|                                       |  | 2002                    |       
|Revenue                                |  | $                       | 67,119
|Net loss                               |  |                         | (6,772
|Net loss per share  basic and diluted |  | $                       | (0.23 



|6. |  | Leases
|-- |  | ------



We lease office space for all of our locations. Renewal options exist for our Concord, CA, Gaithersburg, MD, and Seattle, WA offices.
Future lease payments for all operating leases, excluding executory costs such as management and maintenance fees and property tax, are as follows:



|           |  | Future Lease Obligations |        | Sublease |   |      | Net Future Lease Obligations
|---------- |  | ------------------------ | ------ | -------- | - | ---- | ----------------------------
|2003       |  | $                        | 2,606  |          | $ | (98  | )                           
|2004       |  |                          | 2,562  |          |   | (104 | )                           
|2005       |  |                          | 2,510  |          |   | (107 | )                           
|2006       |  |                          | 1,710  |          |   | (88  | )                           
|2007       |  |                          | 1,394  |          |   |     |                             
|Thereafter |  |                          | 541    |          |   |     |                             
|           |  |                          |        |          |   |      |                             
|           |  | $                        | 11,323 |          | $ | (397 | )                           
|           |  |                          |        |          |   |      |                             



Rent
expense including executory costs was $3,590, $3,040, and $2,569 for the years ended December 31, 2002, 2001, and 2000, respectively. Sublease income is shown on the consolidated results of operation as a reduction of rent expense.



|7. |  | Preferred Stock
|-- |  | ---------------



In December 1999, we sold in two separate transactions, a total of 7,500 shares of Series D 4% Cumulative Convertible Preferred Stock (the
Series D Stock) to Elliott International, L.P. (Elliott International, formerly known as Westgate International, L.P.) resulting in total gross proceeds of $7,500. As of December 31, 2001, all outstanding shares of the Series
D Stock were converted into 793,205 shares of our Common Stock at an average price of $9.46 per share.



In January 2000, we entered into a Put and Call Agreement with Elliott International which provided for the sale of up to 17,500 shares of
Series E 4% Cumulative Convertible Preferred Stock (the Series E Stock) to Elliott International at $1,000 per share. In February 2000 we sold 8,750 shares of the Series E Stock to Elliott International resulting in gross proceeds of
$8,750. In June 2000 we sold the remaining 8,750 shares of the Series E Stock to Elliott resulting in gross proceeds of $8,750. All sales of securities to Elliott International were completed pursuant to the exemption provided by Regulation D under
the Securities Act of 1933. As of December 31, 2001 all outstanding shares of the Series E Stock were converted into 1,596,618 shares of our Common Stock at an average price of $11.03 per share.



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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|7. |  | Preferred Stock (continued)
|-- |  | ---------------------------



In June 2000, we entered into a Put and Call Agreement with Elliott International, which provided for the sale of up to 15,250 shares of
Series F 4% Cumulative Convertible Preferred Stock (the Series F Stock) to Elliott International at $1,000 per share. In August 2000, Elliott International assigned, and Elliott Associates, L.P. (Elliott Associates) assumed,
50% of Elliott Internationals rights and obligations under the put/call agreement. Later in August 2000, we sold to each of Elliott International and Elliott Associates 2,625 shares of the Series F Stock resulting in total gross proceeds of
$5,250. In December 2000, we sold to each of Elliott International and Elliott Associates an additional 5,000 shares of the Series F Stock resulting in total gross proceeds of $10,000. All sales of securities to Elliott International and Elliott
Associates were completed pursuant to the exemption provided by Regulation D under the Securities Act of 1933. As of December 31, 2001 all outstanding shares of the Series F Stock were converted to 1,568,559 shares of our Common Stock at an average
price of $9.74 per share.



|8. |  | Stock Plans
|-- |  | -----------



Stock Option Plans



In September 1995, our Board of Directors and stockholders approved our 1995 Omnibus Stock Plan. Under the terms of the 1995 Omnibus Stock
Plan, key employees and nonemployees may be granted options to purchase up to 11,494,131 shares of our Common Stock. The majority of options granted under this plan have 10-year terms and vest either annually over three years, or fully vest at the
end of three years.



In July 2002, our Board of
Directors approved our 2002 Stock Option Plan. Under the terms of the 2002 Stock Option Plan, key employees and non-employees may be granted options to purchase up to 1,000,000 shares of our Common Stock. The options granted in 2002 have 10-year
terms and vest either annually over three years, or fully vest at the end of three years. Directors and Executive officers are not included in this plan.



Beginning in 2003, all new stock option grants under both plans vest 25% after the first year and then monthly over the following three
years. A summary of changes in outstanding options and common shares reserved under both Stock Plans is as follows:



|                             |  | Shares Available for Grant |   |  | Options Outstanding |   |  | Weighted Average Exercise Price per Share
|---------------------------- |  | -------------------------- | - |  | ------------------- | - |  | -----------------------------------------
|Balance at December 31, 1999 |  | 469,402                    |   |  | 4,729,573           |   |  | $                                        
|Shares authorized            |  | 2,500,000                  |   |  |                    |   |  |                                          
|Granted                      |  | (2,560,986                 | ) |  | 2,560,986           |   |  |                                          
|Exercised                    |  |                           |   |  | (506,146            | ) |  |                                          
|Canceled                     |  | 976,156                    |   |  | (976,156            | ) |  |                                          
|                             |  |                            |   |  |                     |   |  |                                          
|Balance at December 31, 2000 |  | 1,384,572                  |   |  | 5,808,257           |   |  |                                          
|Shares authorized            |  | 1,250,000                  |   |  |                    |   |  |                                          
|Granted                      |  | (2,462,308                 | ) |  | 2,462,308           |   |  |                                          
|Exercised                    |  |                           |   |  | (781,300            | ) |  |                                          
|Canceled                     |  | 785,723                    |   |  | (785,723            | ) |  |                                          
|                             |  |                            |   |  |                     |   |  |                                          
|Balance at December 31, 2001 |  | 957,987                    |   |  | 6,703,542           |   |  |                                          
|Shares authorized            |  | 1,000,000                  |   |  |                    |   |  |                                          
|Granted                      |  | (1,715,944                 | ) |  | 1,715,944           |   |  |                                          
|Exercised                    |  |                           |   |  | (191,506            | ) |  |                                          
|Canceled                     |  | 508,965                    |   |  | (508,965            | ) |  |                                          
|                             |  |                            |   |  |                     |   |  |                                          
|Balance at December 31, 2002 |  | 751,008                    |   |  | 7,719,015           |   |  | $                                        
|                             |  |                            |   |  |                     |   |  |                                          



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SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|8. |  | Stock Plans (continued)
|-- |  | -----------------------



The following table summarizes information about the stock options outstanding at December 31, 2002:



|                        |  | Options Outstanding |  | Options Exercisable                        
|----------------------- |  | ------------------- |  | -------------------------------------------
|Range of Exercise Price |  | Number Outstanding  |  | Weighted Average Remaining Contractual Life
|$    .01$  3.03        |  | 601,141             |  | 8.5 years                                  
|$  3.03$  6.05         |  | 1,355,924           |  | 6.1 years                                  
|$  6.05$  9.08         |  | 893,882             |  | 6.5 years                                  
|$  9.08$12.10          |  | 2,464,613           |  | 7.4 years                                  
|$12.10$15.13           |  | 612,768             |  | 8.2 years                                  
|$15.13$18.15           |  | 1,533,487           |  | 8.5 years                                  
|$18.15$21.18           |  | 111,250             |  | 8.2 years                                  
|$21.18$24.20           |  | 132,950             |  | 7.8 years                                  
|$24.20$27.23           |  | 13,000              |  | 6.3 years                                  
|                        |  |                     |  |                                            
|$    .01$27.23         |  | 7,719,015           |  | 7.4 years                                  
|                        |  |                     |  |                                            



Options
outstanding under the Stock Plans expire at various dates from 2003 to 2012. The number of options exercisable as of December 31, 2002, 2001, and 2000, was 3,482,203, 2,268,947, and 1,761,057, at weighted average exercise prices of $8.38, $7.56, and
$6.21, respectively. The weighted average fair value of options granted and the weighted average remaining contractual life of options granted during 2002, 2001, and 2000 are $9.93, $9.86 and $7.94 and 7.4, 8.1, and 8.5 years, respectively.



We had an executive stock option program under
which options would only vest if certain price performance targets were met. Upon meeting those targets, compensation expense would be recorded. During the life of this program, 1,390,000 options were granted, while 70,000 options remain exercisable
as of December 31, 2002.



We also have an
executive stock option program under which 420,000 performance-based options were granted, while 280,000 options remain exercisable as of December 31, 2002, and are subject to accelerated vesting based on our stock price reaching certain price
performance targets prior to specified dates. These options will vest in a lump sum five years after the date of grant regardless of company stock price performance. There will be no expenses related to the granting of these options.



We recognized $548 of compensation expense for the year ended
December 31, 2000 related to the accelerated vesting of a group of options and the extended vesting of another group of options associated with the sale of the Professional Services group.



Employee Stock Purchase Plan



We have an employee stock purchase plan, which enables employees to contribute up to 10% of their
compensation toward the purchase of our common stock at the end of the participation period at a purchase price equal to 85% of the lower of the fair market value of the common stock on the first and last day of the participation period. Common
stock reserved for future employee purchases under the plan totals 495,359 shares at December 31, 2002. Common stock issued under the plan totaled approximately 362,000 in 2002, 150,000 in 2001 and 40,000 in 2000.



35



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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|9. |  | Income Taxes
|-- |  | ------------



There was no income tax expense for the years ended December 31, 2002, 2001, or 2000.



The effective tax rate differs from the statutory tax rate
primarily as a result of the following:



|                                    |  | Year ended December 31, |       
|----------------------------------- |  | ----------------------- | ------
|                                    |  | 2002                    |       
|Income taxes at statutory rate      |  | $                       | (2,173
|State taxes, net of federal benefit |  |                         | (468  
|Change in valuation allowance       |  |                         | 4,377 
|Acquisition  basis differences     |  |                         | (1,818
|Other                               |  |                         | 50    
|                                    |  |                         |       
|Income tax expense                  |  | $                       |      
|                                    |  |                         |       



Deferred
income tax assets and liabilities result from temporary differences between the carrying values of assets and liabilities for financial statement and income tax purposes. Significant components of our net deferred tax assets are as follows:



|                                                     |  | Year ended December 31, |        
|---------------------------------------------------- |  | ----------------------- | -------
|                                                     |  | 2002                    |        
|Deferred tax assets:                                 |  |                         |        
|Accrued liabilities                                  |  | $                       | 3,839  
|Liabilities                                          |  |                         | 209    
|Tax over book amortization                           |  |                         | (247   
|Book over tax depreciation                           |  |                         | 171    
|Income tax credits                                   |  |                         | 478    
|Net operating loss carryforward                      |  |                         | 53,958 
|                                                     |  |                         |        
|Total deferred tax assets before valuation allowance |  |                         | 58,408 
|Less valuation allowance                             |  |                         | (55,708
|                                                     |  |                         |        
|Net deferred tax assets                              |  | $                       | 2,700  
|                                                     |  |                         |        



SFAS No.
109, Accounting for Income Taxes, requires the consideration of a valuation allowance for deferred tax assets if it is more likely than not that benefits of deferred tax assets will not be realized. We believe it is more
likely than not that the net deferred tax assets of $2,700 at December 31, 2002 will be realized. However, the amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income are
reduced.



At December 31, 2002, we had net
operating loss (NOL) carryforwards of $134,900 that are available to offset taxable income through 2022. These carryforwards are subject to the limitations of Internal Revenue Code Section 382. This section provides limitations on the availability
of net operating losses to offset current taxable income if significant ownership changes have occurred for federal tax purposes. Included in the NOL is approximately $31,300 related to stock option exercises. These deductions currently have a full
valuation allowance, and when realized for financial statement purposes, they will not result in a reduction in income tax expense. Rather, the benefit will be recorded as an increase to additional paid-in capital.



Federal income taxes were not paid in 2002, 2001, or 2000.



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SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|10. |  | Employee Benefit Plan
|--- |  | ---------------------



We have a voluntary defined contribution plan under Section 401(k) of the Internal Revenue Code that covers substantially all U.S.
employees. The Plan provides a discretionary year-end employer matching contribution on employee deferral contributions made during the plan year up to 6% of the participants contributions. We also have a voluntary defined contribution profit
sharing plan that covers substantially all employees. Contributions to the latter are limited to the employers discretionary annual contribution. No employer contributions were made to the Plan during 2002, 2001, or 2000.



|11. |  | Contingencies
|--- |  | -------------



In April 1999, purported securities class action complaints were filed in the United States District Court for the Northern District of
California against us and certain of our officers and directors. Each complaint alleges that defendants made false and misleading statements about our business condition and prospects during a purported class period of November 10, 1998 through
March 31, 1999, and asserts claims for violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and SEC Rule 10b-5. In July 2002, we reached a settlement of the class action complaint. In November 2002, the Court granted final
approval of the settlement for $10,100. $2,800 in cash will be covered by our insurance. The $7,300 balance of the settlement, reflected on the consolidated statement of operations as other non-recurring expense, will be contributed by us in common
stock or in a combination of common stock and cash at the date of distribution. The final allocation of the contribution will be determined by us at our sole option. Distribution of the settlement is anticipated sometime in mid-2003.



On February 11, 2002, Herbert Silverberg filed a
shareholder derivative action captioned Silverberg v. McGurran, et al., Case No. CV 805193 in California Superior Court in Santa Clara County against certain of our current and former officers and directors. We are named as nominal defendant.
Plaintiff alleges that defendants breached their fiduciary duties by making false and misleading statements about our business condition and prospects during the period of November 10, 1998 through March 31, 1999. On April 29, 2002, the Court
dismissed the complaint with leave to amend. The parties subsequently negotiated a settlement of $300,000 by which plaintiff will dismiss the action with prejudice. On March 11, 2003 the Court granted final approval of the settlement.



We are also engaged in other certain legal proceedings and
claims arising in the ordinary course of our business. The ultimate liabilities, if any, which may result from these or other pending or threatened legal actions against us cannot be determined at this time. However, in the opinion of management,
the facts known at the present time do not indicate that such litigation will have a material effect on our consolidated financial position or results of operation.



|12. |  | Segment Information
|--- |  | -------------------



We have two reportable segments consisting of Products and Services and Advanced Technology. Our Products and Services segment markets a
range of solutions providing personalized access control over any public network. Our Advanced Technology Division is a self-funded organization whose mission is to develop new technologies and products that meet the emerging needs of the Department
of Defense (DoD) and the commercial sector. Our strategy is to focus only on development contracts that add value to our products and services offerings. As a result, we continue to innovate, providing state-of-the-market products for organizations
of all types and sizes. Cash, investments, deferred tax assets, and general and administrative expenses cannot be readily identified to the two business segments, therefore, they are presented separately in a corporate segment.



We evaluate segment performance based on gross profit.
Resources are allocated based on contractual requirements as the Advanced Technology segment is reimbursed on a cost plus basis from the various agencies of the United States government. The accounting policies of the reportable segments are the
same as those described in Note 1, Summary of Significant Accounting Policies. Revenue is recognized at time of shipment or recognized ratably over the service period for the Products and Services segment. For Advanced Technology,
contract revenue is recognized on the basis of costs incurred for the government contracts serviced by Advanced Technology and intersegment transfers are recorded at cost; there are no intercompany profits or losses recorded on intersegment
transfers.



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##### Table of Contents



SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|12. |  | Segment Information (continued)
|--- |  | -------------------------------



Our reportable segments are business units that offer distinct products and services to very different customer groups. The reportable
segments are each managed separately because they require different managerial skill sets and are focused toward different markets.



Significant components of our segments are as follows:



|Year ended December 31, 2002       |  |                               |         |   |                             |   |        |           |  |   |        |   |  |   |         |  
|---------------------------------- |  | ----------------------------- | ------- | - | --------------------------- | - | ------ | --------- |  | - | ------ | - |  | - | ------- | -
|                                   |  | Products and Services Segment |         |   | Advanced Technology Segment |   |        | Corporate |  |   | Total  |  
|Revenues from external customers   |  | $                             | 61,960  |   |                             | $ | 3,877  |           |  | $ |       |   |  | $ | 65,837  |  
|Depreciation expense               |  |                               | 2,731   |   |                             |   | 14     |           |  |   | 27     |   |  |   | 2,772   |  
|Segment gross profit               |  |                               | 57,253  |   |                             |   | 1,004  |           |  |   |       |   |  |   | 58,257  |  
|Segment operating income (loss)    |  |                               | 6,815   |   |                             |   | (1,310 | )         |  |   | (5,144 | ) |  |   | 361     |  
|Other non-recurring expense        |  |                               |        |   |                             |   |       |           |  |   | 7,258  |   |  |   | 7,258   |  
|Interest and other income          |  |                               |        |   |                             |   |       |           |  |   | 421    |   |  |   | 421     |  
|Segment assets                     |  |                               | 20,079  |   |                             |   | 819    |           |  |   | 40,045 |   |  |   | 60,943  |  
|Expenditures for long-lived assets |  |                               | 18,320  |   |                             |   |       |           |  |   | 35     |   |  |   | 18,355  |  
|                                  
|Year ended December 31, 2001       |  |                               |         |   |                             |   |        |           |  |   |        |   |  |   |         |  
|                                   |  | Products and Services Segment |         |   | Advanced Technology Segment |   |        | Corporate |  |   | Total  |  
|Revenues from external customers   |  | $                             | 48,353  |   |                             | $ | 4,114  |           |  | $ |       |   |  | $ | 52,467  |  
|Depreciation expense               |  |                               | 2,306   |   |                             |   | 97     |           |  |   | 30     |   |  |   | 2,433   |  
|Segment gross profit               |  |                               | 42,573  |   |                             |   | 1,314  |           |  |   |       |   |  |   | 43,887  |  
|Segment operating loss             |  |                               | (3,881  | ) |                             |   | (1,733 | )         |  |   | (4,226 | ) |  |   | (9,840  | )
|Interest and other income          |  |                               |        |   |                             |   |       |           |  |   | 870    |   |  |   | 870     |  
|Segment assets                     |  |                               | 20,257  |   |                             |   | 760    |           |  |   | 23,816 |   |  |   | 44,833  |  
|Expenditures for long-lived assets |  |                               | 3,358   |   |                             |   | 19     |           |  |   | 35     |   |  |   | 3,412   |  
|                                  
|Year ended December 31, 2000       |  |                               |         |   |                             |   |        |           |  |   |        |   |  |   |         |  
|                                   |  | Products and Services Segment |         |   | Advanced Technology Segment |   |        | Corporate |  |   | Total  |  
|Revenues from external customers   |  | $                             | 34,649  |   |                             | $ | 4,471  |           |  | $ |       |   |  | $ | 39,120  |  
|Depreciation expense               |  |                               | 1,826   |   |                             |   | 168    |           |  |   | 27     |   |  |   | 2,021   |  
|Segment gross profit               |  |                               | 25,793  |   |                             |   | 1,433  |           |  |   |       |   |  |   | 27,226  |  
|Segment operating loss             |  |                               | (14,776 | ) |                             |   | (2,203 | )         |  |   | (4,502 | ) |  |   | (21,481 | )
|Interest and other income          |  |                               |        |   |                             |   |       |           |  |   | 2,311  |   |  |   | 2,311   |  
|Segment assets                     |  |                               | 14,791  |   |                             |   | 1,079  |           |  |   | 29,101 |   |  |   | 44,971  |  
|Expenditures for long-lived assets |  |                               | 3,799   |   |                             |   | 12     |           |  |   | 47     |   |  |   | 3,858   |  



38



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SECURE
COMPUTING CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(in thousands, except share and per share amounts)



|12. |  | Segment Information (continued)
|--- |  | -------------------------------



International sales accounted for 26%, 25%, and 19% of total revenue for the years 2002, 2001, and 2000, respectively. Major foreign
markets for our products include Europe, Japan, China, the Pacific Rim, and Latin America. In each country, we have independent channel partners that are responsible for marketing, selling, and supporting our products to resellers and end users
within their defined territories.



The following
table summarizes information about our international and domestic sales and operations:



|                    |  | Year ended December 31,
|------------------- |  | -----------------------
|                    |  | 2002                   
|Revenues:           |  |                        
|United States sales |  | $                      
|International sales |  |                        
|                    |  |                        
|                    |  | $                      
|                    |  |                        



|13. |  | Professional Services
|--- |  | ---------------------



In March 2000, we sold our Professional Services group to Guardent, Inc. for net proceeds of $4,296. We have included the gain on this
transaction of $1,617 in other income in the accompanying consolidated statements of operations.



|14. |  | Letter of Credit
|--- |  | ----------------



We have a $345 letter of credit agreement with a bank securing rental space for our San Jose office. This letter of credit automatically
renews for a one year period each year through March 31, 2008.



|15. |  | Summarized Quarterly Financial Information (unaudited)
|--- |  | ------------------------------------------------------



|                                                |  | Quarter Ended
|----------------------------------------------- |  | -------------
|                                                |  | March 31,    
|2002                                            |  |              
|Net revenue                                     |  | $            
|Gross profit                                    |  |              
|Net income (loss)                               |  |              
|Net income (loss) per share  basic and diluted |  |              
|                                               
|2001                                            |  |              
|Net revenue                                     |  | $            
|Gross profit                                    |  |              
|Net income (loss)                               |  |              
|Net income (loss) per share  basic and diluted |  |              

---

|* |  | The quarter ended June 30, 2002, includes a $7,258 non-recurring expense, or $0.25 per share impact, related to the class action securities lawsuit settlement as
described in Note 11. Net income before the effect of the litigation settlement was $179, or $0.01 per share.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



39



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##### Table of Contents



Report of Independent
Auditors



The Board of Directors

Secure Computing Corporation



We have audited the accompanying consolidated balance sheets of Secure Computing Corporation as of December 31, 2002 and 2001, and the related
consolidated statements of operations, stockholders equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These
consolidated financial statements and schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.



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



In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Secure Computing Corporation at December 31, 2002 and 2001, and the consolidated
results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein.





/s/ Ernst & Young LLP



Minneapolis, Minnesota

January 17, 2003



40



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##### Table of Contents



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





|                     |  | SECURE COMPUTING CORPORATION
|-------------------- |  | ----------------------------
|                    
|Date: March 28, 2003 |  | By                          
|                     |  |                             
|                     |  |                             



Power of Attorney



KNOW ALL MEN BY THESE PRESENTS, that each
person whose signature appears below constitutes and appoints John McNulty and Timothy Steinkopf or either of them, his or her true and lawful attorneys-in-fact and agents, with full power of substitution and re-substitution, for him or her and in
his or her name, place and stead, in any and all capacities to sign any and all amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange
Commission, granting unto the attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as
he or she might or could do in person, hereby ratifying and confirming all that the attorneys-in-fact and agents, or either of them, or their, his or her substitutes or substitute, may lawfully do or cause to be done by virtue hereof.



Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities indicated on March 28, 2003.



|Signature                                                 |  | Title                                                                                         
|--------------------------------------------------------- |  | ----------------------------------------------------------------------------------------------
|                                                         
|/s/    JOHN E.
MCNULTYJohn E.
McNulty                     |  | Chairman and Chief Executive Officer (Principal Executive Officer)                            
|                                                         
|/s/    TIMOTHY P.
MCGURRANTimothy P.
McGurran             |  | President and Chief Operating Officer                                                         
|                                                         
|/s/    TIMOTHY J.
STEINKOPFTimothy J.
Steinkopf           |  | Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)
|                                                         
|/s/    ROBERT J.
FRANKENBERGRobert J.
Frankenberg         |  | Director                                                                                      
|                                                         
|/s/    JAMES F. JORDANJames F. Jordan                     |  | Director                                                                                      
|                                                         
|/s/    STEPHEN M.
PURICELLIStephen M.
Puricelli           |  | Director                                                                                      
|                                                         
|/s/    ERIC P. RUNDQUISTEric P. Rundquist                 |  | Director                                                                                      
|                                                         
|/s/    ALEXANDER ZAKUPOWSKY,
JR.Alexander Zakupowsky,
Jr. |  | Director                                                                                      



41



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##### Table of Contents



CERTIFICATION



Pursuant
to Sarbanes-Oxley Act Section 302



I, John E. McNulty,
certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Secure Computing Corporation;
|-- |  | --------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this annual 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 annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this annual report is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report
(the Evaluation Date); and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant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 the registrants ability to record, process, summarize
and report financial data and have identified for the registrant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 the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this annual 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.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





|                                                      
|------------------------------------------------------
|/s/    JOHN E.
MCNULTY                                
|John E. McNulty Chief Executive Officer March 28, 2003



42



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##### Table of Contents



CERTIFICATION



Pursuant
to Sarbanes-Oxley Act Section 302



I, Timothy P. McGurran,
certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Secure Computing Corporation;
|-- |  | --------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this annual 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 annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this annual report is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report
(the Evaluation Date); and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant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 the registrants ability to record, process, summarize
and report financial data and have identified for the registrant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 the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this annual 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.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





|                                                                        
|------------------------------------------------------------------------
|/s/    TIMOTHY P.
MCGURRAN                                              
|Timothy P. McGurran President and Chief Operating Officer March 28, 2003



43



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##### Table of Contents



CERTIFICATION



Pursuant
to Sarbanes-Oxley Act Section 302



I, Timothy J. Steinkopf,
certify that:



|1. |  | I have reviewed this annual report on Form 10-K of Secure Computing Corporation;
|-- |  | --------------------------------------------------------------------------------



|2. |  | Based on my knowledge, this annual 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 annual report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report;
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|4. |  | The registrants other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-14 and 15d-14) for the registrant and we have:
|-- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made
known to us by others within those entities, particularly during the period in which this annual report is being prepared;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | b) |  | evaluated the effectiveness of the registrants disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report
(the Evaluation Date); and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | c) |  | presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
| | -- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------



|5. |  | The registrants other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant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 the registrants ability to record, process, summarize
and report financial data and have identified for the registrant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 the registrants internal controls; and
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



|6. |  | The registrants other certifying officers and I have indicated in this annual 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.
|-- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





|                                                                                     
|-------------------------------------------------------------------------------------
|/s/    TIMOTHY J.
STEINKOPF                                                          
|Timothy J. Steinkopf Senior Vice President and Chief Financial Officer March 28, 2003



44



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##### Table of Contents

SCHEDULE II

VALUATION AND QUALIFYING ACCOUNTS

YEARS ENDED
DECEMBER 31, 2002, 2001, AND 2000





|Description                     |  | Balance at Beginning of Year |           | Additions Charged to Costs and Expenses |   | Less Deductions |  |   | Balance at End of Year
|------------------------------- |  | ---------------------------- | --------- | --------------------------------------- | - | --------------- |  | - | ----------------------
|Year ended December 31, 2002:   |  |                              |           |                                         |   |                 |  |   |                       
|Sales return allowance          |  | $                            | 582,000   |                                         | $ |                |  | $ | (508,000              
|Allowance for doubtful accounts |  |                              | 822,000   |                                         |   | 246,000         |  |   | (628,000              
|                                |  |                              |           |                                         |   |                 |  |   |                       
|Total                           |  | $                            | 1,404,000 |                                         | $ | 430,000         |  | $ | (801,000              
|                                |  |                              |           |                                         |   |                 |  |   |                       
|                               
|Year ended December 31, 2001:   |  |                              |           |                                         |   |                 |  |   |                       
|Sales return allowance          |  | $                            | 904,000   |                                         | $ | 31,000          |  | $ | (353,000              
|Allowance for doubtful accounts |  |                              | 871,000   |                                         |   | 399,000         |  |   | (448,000              
|                                |  |                              |           |                                         |   |                 |  |   |                       
|Total                           |  | $                            | 1,775,000 |                                         | $ | 430,000         |  | $ | (801,000              
|                                |  |                              |           |                                         |   |                 |  |   |                       
|                               
|Year ended December 31, 2000:   |  |                              |           |                                         |   |                 |  |   |                       
|Sales return allowance          |  | $                            | 710,000   |                                         | $ | 270,000         |  | $ | (76,000               
|Allowance for doubtful accounts |  |                              | 710,000   |                                         |   | 347,000         |  |   | (186,000              
|                                |  |                              |           |                                         |   |                 |  |   |                       
|Total                           |  | $                            | 1,420,000 |                                         | $ | 617,000         |  | $ | (262,000              
|                                |  |                              |           |                                         |   |                 |  |   |                       



45