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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-Q



(Mark One)



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

For the Quarterly Period Ended June 30, 2003



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





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, CA                                |  | 95124                               
|(Address of principal executive offices)                       |  | (Zip code)                          



(800) 379-4944

Registrants telephone number, including area code



Not Applicable

(Former name, former address and former fiscal year, if changed since last report)





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



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



Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practical date: Common Stock, $.01 par
value  32,135,963 issued and outstanding as of July 31, 2003.



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SECURE COMPUTING CORPORATION



INDEX



|PART I  |  | FINANCIAL INFORMATION                                                                                                 |  | Page No.
|------- |  | --------------------------------------------------------------------------------------------------------------------- |  | --------
|        |  |                                                                                                                      
|Item 1. |  | Condensed Consolidated Financial Statements:                                                                          |  |         
|        |  |                                                                                                                      
|        |  | Condensed Consolidated Balance Sheets as of June 30, 2003 (Unaudited) and December 31, 2002                           |  | 3       
|        |  |                                                                                                                      
|        |  | Condensed Consolidated Statements of Operations (Unaudited) for the three and six months ended June 30, 2003 and 2002 |  | 4       
|        |  |                                                                                                                      
|        |  | Condensed Consolidated Statements of Cash Flows (Unaudited) for the six months ended June 30, 2003 and 2002           |  | 5       
|        |  |                                                                                                                      
|        |  | Notes to the Condensed Consolidated Financial Statements (Unaudited)                                                  |  | 6 - 9   
|        |  |                                                                                                                      
|        |  |                                                                                                                       |  |         
|        |  |                                                                                                                      
|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                 |  | 10 - 14 
|        |  |                                                                                                                      
|Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                                                            |  | 14      
|        |  |                                                                                                                      
|Item 4. |  | Controls and Procedures                                                                                               |  | 14      
|        |  |                                                                                                                      
|PART II |  | OTHER INFORMATION                                                                                                     |  |         
|        |  |                                                                                                                      
|Item 1. |  | Legal Proceedings                                                                                                     |  | 15      
|        |  |                                                                                                                      
|Item 2. |  | Changes in Securities                                                                                                 |  | 15      
|        |  |                                                                                                                      
|Item 3. |  | Defaults upon Senior Securities                                                                                       |  | 15      
|        |  |                                                                                                                      
|Item 4. |  | Submission of Matters to a Vote of Security Holders                                                                   |  | 15      
|        |  |                                                                                                                      
|Item 5. |  | Other Information                                                                                                     |  | 15      
|        |  |                                                                                                                      
|Item 6. |  | Exhibits and Reports on Form 8-K                                                                                      |  | 16      
|        |  |                                                                                                                      
|        |  | Signatures                                                                                                            |  | 17      



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PART 1. Financial Information



SECURE COMPUTING CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS



(In thousands, except share amounts)



|                                                                                                                                                |  | June 30,2003(Unaudited) |          |   | December 31,2002(See Note) |  
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | -------- | - | -------------------------- | -
|ASSETS                                                                                                                                          |  |                         |          |   |                            |  
|Current assets                                                                                                                                  |  |                         |          |   |                            |  
|Cash and cash equivalents                                                                                                                       |  | $                       | 20,919   |   |                            | $
|Investments                                                                                                                                     |  |                         | 1,306    |   |                            |  
|Accounts receivable, net                                                                                                                        |  |                         | 12,843   |   |                            |  
|Inventories                                                                                                                                     |  |                         | 1,053    |   |                            |  
|Other current assets                                                                                                                            |  |                         | 4,267    |   |                            |  
|                                                                                                                                                |  |                         |          |   |                            |  
|Total current assets                                                                                                                            |  |                         | 40,388   |   |                            |  
|                                                                                                                                                |  |                        
|Property and equipment, net                                                                                                                     |  |                         | 5,231    |   |                            |  
|Goodwill                                                                                                                                        |  |                         | 14,226   |   |                            |  
|Other assets                                                                                                                                    |  |                         | 2,564    |   |                            |  
|                                                                                                                                                |  |                         |          |   |                            |  
|                                                                                                                                                |  | $                       | 62,409   |   |                            | $
|                                                                                                                                                |  |                         |          |   |                            |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                            |  |                         |          |   |                            |  
|Current liabilities                                                                                                                             |  |                         |          |   |                            |  
|Accounts payable                                                                                                                                |  | $                       | 2,615    |   |                            | $
|Accrued payroll                                                                                                                                 |  |                         | 3,062    |   |                            |  
|Other accrued expenses                                                                                                                          |  |                         | 1,476    |   |                            |  
|Litigation settlement accrual                                                                                                                   |  |                         |         |   |                            |  
|Deferred revenue                                                                                                                                |  |                         | 14,449   |   |                            |  
|                                                                                                                                                |  |                         |          |   |                            |  
|Total current liabilities                                                                                                                       |  |                         | 21,602   |   |                            |  
|                                                                                                                                                |  |                        
|Stockholders equity                                                                                                                            |  |                         |          |   |                            |  
|Common stock, par value $.01; 50,000,000 shares authorized;issued and outstanding  June 30, 2003  32,120,548
andDecember 31, 2002 29,684,459 |  |                         | 300      |   |                            |  
|Additional paid-in capital                                                                                                                      |  |                         | 165,756  |   |                            |  
|Foreign currency translation                                                                                                                    |  |                         | (666     | ) |                            |  
|Accumulated deficit                                                                                                                             |  |                         | (124,583 | ) |                            |  
|                                                                                                                                                |  |                         |          |   |                            |  
|Total stockholders equity                                                                                                                      |  |                         | 40,807   |   |                            |  
|                                                                                                                                                |  |                         |          |   |                            |  
|                                                                                                                                                |  | $                       | 62,409   |   |                            | $
|                                                                                                                                                |  |                         |          |   |                            |  



Note: The balance sheet at December
31, 2002 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.



See accompanying notes to condensed consolidated financial statements.



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SECURE COMPUTING CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS



(Unaudited, in thousands, except per share amounts)



|                                                             |  | Three Months EndedJune 30, |        |      | Six Months EndedJune 30, |       
|------------------------------------------------------------ |  | -------------------------- | ------ | ---- | ------------------------ | ------
|                                                             |  | 2003                       |        | 2002 |                          |       
|Products and Services revenue                                |  | $                          | 17,630 |      | $                        | 15,578
|Advanced Technology contracts revenue                        |  |                            | 547    |      |                          | 1,033 
|                                                             |  |                            |        |      |                          |       
|                                                             |  |                            | 18,177 |      |                          | 16,611
|                                                             |  |                            |        |     
|Cost of revenue                                              |  |                            | 2,316  |      |                          | 1,650 
|                                                             |  |                            |        |      |                          |       
|Gross profit                                                 |  |                            | 15,861 |      |                          | 14,961
|                                                             |  |                            |        |     
|Operating expenses:                                          |  |                            |        |      |                          |       
|Selling and marketing                                        |  |                            | 9,927  |      |                          | 9,828 
|Research and development                                     |  |                            | 3,737  |      |                          | 3,693 
|General and administrative                                   |  |                            | 1,234  |      |                          | 1,332 
|                                                             |  |                            |        |      |                          |       
|                                                             |  |                            | 14,898 |      |                          | 14,853
|                                                             |  |                            |        |      |                          |       
|Operating income (loss)                                      |  |                            | 963    |      |                          | 108   
|                                                             |  |                            |        |     
|Other non-recurring expense                                  |  |                            |       |      |                          | (7,258
|Interest and other income                                    |  |                            | 46     |      |                          | 71    
|                                                             |  |                            |        |      |                          |       
|Net income (loss)                                            |  | $                          | 1,009  |      | $                        | (7,079
|                                                             |  |                            |        |      |                          |       
|                                                             |  |                            |        |     
|Net income (loss) per share  basic                          |  | $                          | 0.03   |      | $                        | (0.24 
|                                                             |  |                            |        |      |                          |       
|                                                             |  |                            |        |     
|Shares used in computing net income (loss) per share  basic |  |                            | 31,716 |      |                          | 29,306
|                                                             |  |                            |        |      |                          |       
|                                                             |  |                            |        |     
|Net income (loss) per share  diluted                        |  | $                          | 0.03   |      | $                        | (0.24 
|                                                             |  |                            |        |      |                          |       
|                                                             |  |                            |        |     
|Shares used in computing net loss per share  diluted        |  |                            | 32,756 |      |                          | 29,306
|                                                             |  |                            |        |      |                          |       



See accompanying notes
to condensed consolidated financial statements.



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SECURE COMPUTING CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited, in thousands)



|                                                                                     |  | Six Months EndedJune 30, |       
|------------------------------------------------------------------------------------ |  | ------------------------ | ------
|                                                                                     |  | 2003                     |       
|Operating activities                                                                 |  |                          |       
|Net income (loss)                                                                    |  | $                        | 1,580 
|Adjustments to reconcile net income (loss) to net cash used in operating activities: |  |                          |       
|Depreciation                                                                         |  |                          | 1,440 
|Amortization                                                                         |  |                          | 122   
|Loss on disposals of property and equipment                                          |  |                          | 6     
|Deferred income taxes, net                                                           |  |                          | (256  
|Changes in operating assets and liabilities:                                         |  |                          |       
|Accounts receivable                                                                  |  |                          | (1,422
|Inventories                                                                          |  |                          | (168  
|Other current assets                                                                 |  |                          | (201  
|Accounts payable                                                                     |  |                          | 770   
|Payroll related accruals                                                             |  |                          | (201  
|Accrued liabilities and reserves                                                     |  |                          | (518  
|Litigation settlement accrual                                                        |  |                          |      
|Deferred revenue                                                                     |  |                          | (360  
|                                                                                     |  |                          |       
|Net cash provided by (used in) operating activities                                  |  |                          | 793   
|                                                                                     |  |                         
|Investing activities                                                                 |  |                          |       
|Net proceeds from sales of investments                                               |  |                          | 2,036 
|Purchase of property and equipment, net                                              |  |                          | (969  
|Increase in intangibles and other assets                                             |  |                          | (153  
|                                                                                     |  |                          |       
|Net cash provided by investing activities                                            |  |                          | 914   
|                                                                                     |  |                         
|Financing activities                                                                 |  |                          |       
|Proceeds from issuance of common stock                                               |  |                          | 1,225 
|                                                                                     |  |                          |       
|Net cash provided by financing activities                                            |  |                          | 1,225 
|                                                                                     |  |                          |       
|                                                                                     |  |                         
|Effect of exchange rate changes                                                      |  |                          | (63   
|                                                                                     |  |                          |       
|                                                                                     |  |                         
|Net increase (decrease) in cash and cash equivalents                                 |  |                          | 2,869 
|Cash and cash equivalents, beginning of period                                       |  |                          | 18,050
|Cash and cash equivalents, end of period                                             |  | $                        | 20,919
|                                                                                     |  |                          |       



See accompanying notes
to condensed consolidated financial statements.



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SECURE COMPUTING CORPORATION

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except share and per share amounts)

(Unaudited)



|1. |  | 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.



|2. |  | Condensed Consolidated Financial Statements
|-- |  | -------------------------------------------



The accompanying condensed consolidated financial statements have been prepared by us without audit and reflect all adjustments (consisting only of normal
and recurring adjustments and accruals) which are, in our opinion, necessary to present a fair statement of the results for the interim periods presented. The consolidated financial statements include our accounts and those of our subsidiaries. All
intercompany balances and transactions have been eliminated in consolidation. The statements have been prepared in accordance with the regulations of the Securities and Exchange Commission, but omit certain information and footnote disclosures
necessary to present the statements in accordance with generally accepted accounting principles. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full fiscal year. The
December 31, 2002 Condensed Balance Sheet is derived from our audited Condensed Balance Sheet as of December 31, 2002. These condensed financial statements should be read in conjunction with the Consolidated Financial Statements and footnotes
thereto included in our Annual 10-K Report for the year ended December 31, 2002, as filed with the Securities and Exchange Commission.



|3. |  | Significant Accounting Policies
|-- |  | -------------------------------



Stock Options



We account for our two stock option based plans under the recognition and measurement provisions of Accounting Principles Bulletin (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 income (loss) and net income (loss) per share if we had applied the fair value recognition provisions of Statement of
Financial Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation:



|                                                                                                                                            |  | For the three monthsended June 30, |        |   | For the six monthsended June 30, |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------------------- | ------ | - | -------------------------------- | -
|                                                                                                                                            |  | 2003                               |        |   | 2002                             |  
|Net income (loss), as reported                                                                                                              |  | $                                  | 1,009  |   |                                  | $
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related
tax effects |  |                                    | (2,396 | ) |                                  |  
|                                                                                                                                            |  |                                    |        |   |                                  |  
|Pro forma net loss                                                                                                                          |  | $                                  | (1,387 | ) |                                  | $
|                                                                                                                                            |  |                                    |        |   |                                  |  
|Net income (loss) per share:                                                                                                                |  |                                    |        |   |                                  |  
|Basic and Diluted  as reported                                                                                                             |  | $                                  | 0.03   |   |                                  | $
|Basic and Diluted  pro forma                                                                                                               |  | $                                  | (0.04  | ) |                                  | $



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SECURE COMPUTING CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(In
thousands, except share and per share amounts)

(Unaudited)



|3. |  | Significant Accounting Policies (continued)
|-- |  | -------------------------------------------



Foreign Currency Translation



Results of operations are translated using the average exchange rates throughout the period. Translation gains or losses, net of applicable deferred
taxes, are accumulated as a separate component of stockholders equity and included in comprehensive income. During the second quarter of 2003, total comprehensive income amounted to $988 compared to total comprehensive loss of $7,097 for
second quarter of 2002. During the first six months of 2003, total comprehensive income amounted to $1,517 compared to total comprehensive loss of $8,407 for second quarter of 2002.



|4. |  | Distribution of Class Action Lawsuit 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.



In November 2002, the Court granted final approval of the settlement for $10,100. $2,800 in cash was covered by our insurance. The $7,300 balance of the
settlement was contributed by us in common stock on April 16, 2003, the date of distribution. Total shares distributed were 1,951,807.



|5. |  | Segment Information
|-- |  | -------------------



We have two reportable segments consisting of Products and Services and Advanced Technology. Our Products and Services segment sells computer software
products and services designed to provide secure access control for users engaging in business over public networks. 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, general and administrative expenses, and stock option compensation costs 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 included in our Annual 10-K Report for the year ended December 31, 2002. Revenue is
recognized when earnings process is complete and/or when performance of services are complete 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.



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.



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SECURE COMPUTING CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(In
thousands, except share and per share amounts)

(Unaudited)



|5. |  | Segment Information (continued)
|-- |  | -------------------------------



Significant components of our segments are as follows:



|Six Months Ended June 30, 2003     |  | Products andServicesSegment |        | AdvancedTechnologySegment |   |       | Corporate |  |   | Total 
|---------------------------------- |  | --------------------------- | ------ | ------------------------- | - | ----- | --------- |  | - | ------
|Revenues from external customers   |  | $                           | 33,809 |                           | $ | 1,377 |           |  | $ |      
|Depreciation expense               |  |                             | 1,421  |                           |   | 6     |           |  |   | 13    
|Segment gross profit               |  |                             | 30,571 |                           |   | 254   |           |  |   |      
|Segment operating income (loss)    |  |                             | 4,172  |                           |   | (228  | )         |  |   | (2,463
|Interest and other income          |  |                             |       |                           |   |      |           |  |   | 99    
|Segment assets                     |  |                             | 21,775 |                           |   | 1,160 |           |  |   | 39,474
|Expenditures for long lived assets |  |                             | 1,171  |                           |   |      |           |  |   | 12    
|                                   |  |                             |        |                           |   |       |           |  |   |       



|Six Months Ended June 30, 2002     |  | Products andServicesSegment |        | AdvancedTechnologySegment |   |       | Corporate |  |   | Total  |  
|---------------------------------- |  | --------------------------- | ------ | ------------------------- | - | ----- | --------- |  | - | ------ | -
|Revenues from external customers   |  | $                           | 28,042 |                           | $ | 2,024 |           |  | $ |       |  
|Depreciation expense               |  |                             | 1,320  |                           |   | 8     |           |  |   | 14     |  
|Segment gross profit               |  |                             | 25,906 |                           |   | 609   |           |  |   |       |  
|Segment operating income (loss)    |  |                             | 1,756  |                           |   | (712  | )         |  |   | (2,425 | )
|Interest and other income          |  |                             |       |                           |   |      |           |  |   | 287    |  
|Segment assets                     |  |                             | 19,062 |                           |   | 1,007 |           |  |   | 36,941 |  
|Expenditures for long lived assets |  |                             | 16,160 |                           |   |      |           |  |   | 29     |  
|                                   |  |                             |        |                           |   |       |           |  |   |        |  



International sales
accounted for 33 percent and 30 percent of total revenue for the six months ended June 30, 2003 and 2002 respectively. Major foreign markets for our products include Europe, Japan, the Pacific Rim, and Latin America. In each market, we have
independent channel partners who 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:



|                    |  | Six Months EndedJune 30,
|------------------- |  | ------------------------
|                    |  | 2003                    
|Revenues:          
|United States sales |  | $                       
|International sales |  |                         
|                    |  |                         
|                    |  | $                       
|                    |  |                         





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SECURE COMPUTING CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)

(In
thousands, except share and per share amounts)

(Unaudited)



|6. |  | Subsequent Event  Acquisition of N2H2
|-- |  | --------------------------------------



On July 29, 2003, we announced that we had signed a definitive merger agreement to acquire all of the outstanding stock of N2H2, Inc. (N2H2).
Under the merger agreement, we will issue .0841 shares of our common stock for each outstanding share of N2H2 common stock, or approximately 1.861 million shares, which will represent approximately 5% of the outstanding stock of Secure Computing
Corporation after the closing of the merger. Based on the closing price of our stock on July 28, 2003, the market value of the transaction is approximately $19,900.



N2H2 provides Internet filtering and monitoring solutions that are designed to allow Internet users to monitor and filter
content categories thereby increasing productivity, reducing bandwidth consumption, and limiting potential legal liability. They have 2 product lines: SentianTMfor corporate and government customers and Bess®for schools, libraries, and non-profit organizations. N2H2 is headquartered in Seattle, Washington.





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SECURE COMPUTING CORPORATION

Managements Discussion and Analysis of

Financial Condition and Results of Operations



INFORMATION REGARDING FORWARD-LOOKING STATEMENTS



The following discussion contains forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, 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. Forward-looking statements reflect our view only as of the date of this report. We cannot guarantee future results, levels of activity, performance, or achievements.



In addition, the following information should be read in conjunction with the
financial statements and notes thereto included in Item 1 of this Quarterly Report, the risk factors detailed in our Annual Report on Form 10-K for the year ended December 31, 2002, as well as the factors identified in Forward Looking Statements
below.



RESULTS OF OPERATIONS



Comparison of Three Months Ended June 30, 2003 and 2002.



Revenue. Our revenue increased 10 percent to $18.2 million for the
second quarter of 2003 up from $16.6 million in the same period of 2002. Products and Services revenue was $17.6 million for the quarter, an increase of 13 percent over 2002. The year over year Products and Services revenue growth was driven
primarily by an increase in SafeWord®hardware token shipments, an increase in the direct
Sidewinder®G2TMappliance sales, and increased traction with our OEM relationships. For the third and fourth quarters of 2003, we expect year over year Products and Services
revenue growth of 14 percent and 21 percent, respectively. Advanced Technology contract revenue was $0.5 million for the quarter compared to $1.0 million in the same period of 2002 and consistent with our strategy of focusing only on funded
development contracts that add value to our commercial product offerings.Advanced Technology revenue is projected to be between $0.5 and $0.8 million in each of the remaining quarters of 2003.



Gross Profit. Gross profit as a percentage of revenue was 87 percent
in the second quarter of 2003 compared to 90 percent in 2002. This decrease in the gross margin rate was driven by an increase in SafeWord®token shipments and related hardware costs. Aggregate gross margins throughout the remainder of 2003 are expected to be approximately 88 percent.



Operating Expenses. Operating expenses consist of selling and
marketing, research and development, and general and administrative expenses. Total operating expenses remained flat at $14.9 million in the second quarter of 2003 compared to the same period of 2002. As a percentage of revenue, total operating
expense was 82 percent for the quarter compared to 89 percent in the same period of 2002. As a percentage of total revenues, including Advanced Technology revenue, operating expenses are expected to be 78 percent and 72 percent for the third and
fourth quarters of 2003, respectively.



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 expense increased 1 percent to $9.9 million in the second quarter of 2003, an increase from $9.8 million in the same period
of 2002. The increase resulted primarily from normal inflationary increases in payroll and related costs and an increase in commission expense due to expanding revenues, mostly offset by a reduction in headcount due to productivity gains. As a
percentage of revenue, selling and marketing expense was 55 percent for the quarter compared to 59 percent in the same period of 2002.



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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 expense remained fairly consistent in the second quarter of 2003 compared to the same period
of 2002 at $3.7 million. Expenses were able to remain consistent due to normal inflationary increases in payroll and related costs and an increase in common criteria certification costs offset by a reduction in headcount due to productivity gains.
As a percentage of revenue, research and development expense was 21 percent for the quarter compared to 22 percent in 2002.



General and Administrative. General and administrative expense consists 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 expense decreased 1 percent to $1.2 million in the second quarter of 2003 from $1.3 million in the same
period of 2002. As a percentage of revenue, general and administrative expenses were 7 percent for the second quarter of 2003 compared to 8 percent for the second quarter of 2002.



Non-recurring Expense.Non-recurring expense of $7.3 million in the second quarter of 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.



In
November 2002, the Court granted final approval of the settlement for $10.1 million. $2.8 million in cash was covered by our insurance. The $7.3 million balance of the settlement was contributed by us in common stock on April 16, 2003, the date of
distribution. Total shares distributed were 1,951,807.



Interest and Other Income.Net interest and other income was $46,000 in the second quarter of 2003, a decrease from $71,000 in the same period of 2002. The decrease reflects lower average interest rates in 2003 as compared to 2002.



Income Taxes. We recognized no income tax expense for
either of the second quarters in 2003 or 2002. Tax expense of $105,000 incurred in the second quarter of 2003 for various foreign income and domestic minimum income taxes was offset by a corresponding increase in our net deferred tax asset. We
believe it is more likely than not that deferred tax assets, which total $3.0 million at June 30, 2003, will be realized. The computations of our deferred tax assets and valuation allowance are based on taxable income we expect to earn on existing
government contracts, commercial products, and projected interest income. The amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income are reduced.



Comparison of Six Months Ended June 30, 2003 and 2002.



Revenue.Our revenue increased 17 percent to $35.2 million for the
first six months of 2003 up from $30.1 million in the same period of 2002. Products and services revenue was $33.8 million for the first six months, an increase of 21 percent over the same six months of 2002. The Products and Services revenue growth
was driven primarily by an increase in SafeWord®hardware token shipments, an increase in
the direct Sidewinder®G2TMappliance sales, and increased traction with our OEM relationships. For the third and fourth quarters of 2003, we expect year over year Products and Services
revenue growth of 14 percent and 21 percent, respectively. Advanced Technology contract revenue was $1.4 million for the first six months of 2003, a decrease of 32 percent from the first six months of 2002 as we continue our focus on development
contracts that add value to our products and services offerings. Advanced Technology revenue is projected to be between $0.5 and $0.8 million in each of the remaining quarters of 2003.



Gross Profit.Gross profit as a percentage of revenue for the first six months of 2003 was consistent with the same
period in 2002 at 88 percent. Aggregate gross margins throughout the remainder of 2003 are expected to be approximately 88 percent.



Operating Expenses. Operating expenses consist of selling and marketing, research and development, and general and administrative expenses. Total
operating expenses increased 5 percent to $29.3 million in the first six months of 2003 compared to $27.9 million in the same period of 2002. As a percentage of revenue, total operating expense was 83 percent for the quarter compared to 93 percent
in the same period



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of 2002. As a percentage of total revenues, including Advanced Technology revenue, operating expenses are expected to be
78 percent and 72 percent for the third and fourth quarters of 2003, respectively.



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 expense increased 5 percent to $19.2 million in the first of six months of 2003 up
from $18.3 million in the same period of 2002. The increase resulted primarily from normal inflationary increases in payroll and related costs and an increase in commission expense due to expanding revenues.



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 expense increased 7 percent to $7.7 million in the first six months
of 2003 from $7.2 million in the same period of 2002. The increase resulted primarily from normal inflationary increases in payroll and related costs along with an increase in common criteria certification costs.



General and Administrative. General and administrative expense
consists 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 expense increased 4
percent to $2.5 million in the first six months of 2003 up from $2.4 million in the same period of 2002. The increase resulted primarily from normal inflationary increases in payroll and related costs.



Non-recurring Expense.Non-recurring expense of $7.3 million in the
first six months of 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.



In November 2002, the Court granted final approval of the settlement for $10.1 million. $2.8 million in cash was covered by our insurance. The $7.3
million balance of the settlement was contributed by us in common stock on April 16, 2003, the date of distribution. Total shares distributed were 1,951,807.



Interest and Other Income.Net interest and other income was $99,000 in the first six months of 2003, a decrease from $287,000 in the same period
of 2002. The decrease reflects lower average interest rates in 2003 as compared to 2002.



Income Taxes. We recognized no income tax expense in the first six months of 2003 or 2002. Tax expense of $256,000 incurred in first six months of 2003 for various foreign income and domestic minimum income
taxes was offset by a corresponding increase in our net deferred tax asset. We believe it is more likely than not that deferred tax assets, which total $3.0 million at June 30, 2003, will be realized. The computations of our deferred tax assets and
valuation allowance are based in part on taxable income we expect to earn on existing government contracts and projected interest income. The amount of the deferred tax assets considered realizable could be reduced in the near term if estimates of
future taxable income are reduced.



LIQUIDITY AND CAPITAL RESOURCES



Our cash, cash equivalents and short term investments
increased by $833,000 from $21.4 million at December 31, 2002 to $22.2 million at June 30, 2003. This increase is due to cash provided by operating activities, the exercise of stock options and sales of common stock through our employee stock
purchase plan. We expect that our cash flow from operations on a quarterly basis for the remainder of 2003 will approximate our quarterly operating results.



Net cash provided by operating activities for the six months ended June 30, 2003 was $793,000 resulting from net income for the quarter and an increase in
accounts payable, offset by an increase in accounts receivable and a decrease in accrued liabilities and reserves. Accounts payable increased from $1.8 million at December 31, 2002 to $2.6 million at June 30, 2003 primarily due to the timing of
inventory purchases. Accounts receivable increased from $11.4 million at December 31, 2002 to $12.8 million at June



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30, 2003 due to growth in billings. Days sales outstanding increased to 64 days at June 30, 2003 compared to 57 days at
December 31, 2002 primarily due to growth in deferred revenue.



Net cash used for capital additions of $969,000 during the six months ended June 30, 2003, was made up of computer equipment, technology upgrades, and leasehold improvements. We expect to use another $1.0 million throughout the remainder of
2003 mainly for computer equipment, technology upgrades and leasehold improvements.



Net cash provided by financing activities of $1.2 million for the six months ended June 30, 2003 consisted primarily of proceeds received from the exercise of stock options and sales of common stock through our
employee stock purchase plan.



As of June 30, 2003, we had
working capital of $18.8 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.



FORWARD LOOKING STATEMENTS



Certain statements made above, which are summarized below, are
forward-looking statements that involve risks and uncertainties, and actual results may be materially different. Factors that could cause actual results to differ include those identified below:



|· |  | For the third and fourth quarters of 2003, we expect year over year Products and Services revenue growth of 14 percent and 21 percent, respectively.We may be unable
to meet this expectation for a variety of reasons, including generally soft market conditions for our products and services and other general economic uncertainties and weaknesses in geographic regions of the world, delays or difficulties in the
development and inability to obtain market acceptance of our new products, and introduction of products by competitors.
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|· |  | Advanced Technology revenue is projected to be between $0.5 and $0.8 million in each of the remaining quarters of 2003. Meeting this expectation depends upon our ability to
obtain new government contract awards and maintain the current government contracts revenue, which might not occur for a variety of reasons, including an inability to staff engineers to our current contract requirements or customer delays or
cancellations of contract awards. The continued tightened contract award funding environment is not expected to have a material adverse impact on our financial results.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|· |  | Aggregate gross margins throughout the remainder of 2003 are expected to be approximately 88 percent.Meeting this expectation depends upon our ability to maintain a higher
level of products and services revenue. We may be unable to meet this expectation for a variety of reasons, including generally soft market conditions for the Companys products and services and other general economic uncertainties and
weaknesses in geographic regions of the world, delays or difficulties in the development and inability to obtain market acceptance of our new products, and introduction of products by competitors.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|· |  | As a percent of total revenues, including Advanced Technology revenue, operating expenses are expected to be 78 percent and 72 percent for the third and fourth quarters of 2003,
respectively. This expectation depends on us maintaining the current anticipated level of spending, which may not occur due to unexpected increases in such costs or because of a need to accelerate expenditures, or decreased products and services
revenue. Additionally, meeting this expectation depends upon our ability to control costs and achieve a higher level of revenue. We may be unable to meet this expectation for a variety of reasons, including generally soft market conditions for our
products and services, development and acceptance of our new products, and introduction of products by competitors.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|· |  | We believe it is more likely than not that deferred tax assets, which total $3.0 million at June 30, 2003, will be realized. This expectation depends primarily on our
estimates of future taxable income. The
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | amount of deferred tax assets considered realizable could be reduced in the near term if estimates of future taxable income are reduced.
| |  | ----------------------------------------------------------------------------------------------------------------------------------------



|· |  | We expect that our cash flow from operations on a quarterly basis for the remainder of 2003 will approximate our quarterly operating results. Meeting this expectation depends
upon our ability to control costs and achieve a higher level of revenue. We may be unable to meet this expectation for a variety of reasons, including generally soft market conditions for our products and services, development and acceptance of our
new products, and introduction of products by competitors, unexpected increases in personnel and operating expenses, the need for additional funds to react to changes in the marketplace, and currently unplanned acquisitions.
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|· |  | 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.
Several factors may affect the availability of sufficient cash resources to fund our product development and marketing and sales plans for the next twelve months, including:
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · |  | our ability to generate revenue as currently expected;
| | - |  | ------------------------------------------------------



| | · |  | unexpected expenses, such as increases in personnel and operating expenses;
| | - |  | ---------------------------------------------------------------------------



| | · |  | the need for additional funds to react to changes in the marketplace;
| | - |  | ---------------------------------------------------------------------



| | · |  | currently unplanned acquisitions.
| | - |  | ---------------------------------



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.



CONTROLS AND PROCEDURES



Our Chief
Executive Officer, Chief Operating Officer and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by 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 has been no change in our internal control over financial reporting during our most recent fiscal quarter that has
materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



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SECURE COMPUTING CORPORATION

PART II

OTHER INFORMATION



ITEM 1. 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 alleged 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 was covered by our insurance. The $7.3 million
balance of the settlement was contributed by us in common stock on April 16, 2003, the date of distribution. Total shares distributed were 1,951,807.



ITEM 2. Changes in Securities



None



ITEM 3. Defaults upon Senior Securities



Not applicable



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



The following matters were approved at our Annual Meeting of Stockholders held on May 15, 2003:



|a) |  | The following directors were elected:
|-- |  | -------------------------------------



|                      |  | Number of CommonShares Voted
|--------------------- |  | ----------------------------
|Directors             |  | For                         
|Robert J. Frankenburg |  | 28,173,843                  
|John E. McNulty       |  | 28,553,229                  
|James F. Jordan       |  | 28,180,810                  



These directors were
elected to a three year term commencing upon their election. Directors, Timothy P. McGurran, Stephen M. Puricelli, Eric P. Rundquist, and Alexander Zakupowsky, Jr. continue in office until expiration of their respective roles.



|b) |  | The stockholders also approved the following proposal:
|-- |  | ------------------------------------------------------



|                                  |  | Number of Common Shares Voted
|--------------------------------- |  | -----------------------------
|Independent Auditors              |  | For                          
|Ratification of Ernst & Young LLP |  |                              
|As Independent Auditors           |  | 28,278,895                   



ITEM 5. Other Information



None



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ITEM 6. Exhibits and Reports on Form 8-K



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



|Exhibit 31.1 |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                               
|------------ |  | ----------------------------------------------------------------------------------------------------------------------
|             | 
|Exhibit 31.2 |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                               
|             | 
|Exhibit 31.3 |  | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                               
|             | 
|Exhibit 32.1 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.2 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
|             | 
|Exhibit 32.3 |  | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



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



A Form 8-K was filed on April 17, 2003. Pursuant to Item 12 of Form 8-K, Disclosure of Results of Operations and Financial Condition,
furnishing the press release issued April 17, 2003 relating to first quarter earnings.



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SECURE COMPUTING CORPORATION



SIGNATURES



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





SECURE COMPUTING CORPORATION



|DATE: July 31, 2003 |  | By: |  | /s/ Timothy J. Steinkopf                                                                                                        
|------------------- |  | --- |  | --------------------------------------------------------------------------------------------------------------------------------
|                    |  |     |  | Timothy J. Steinkopf Senior Vice President and Chief Financial Officer (Duly authorized officer and Principal Financial Officer)





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