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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



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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 SEPTEMBER 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 0-24544



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CYBERGUARD CORPORATION

(Exact name of Registrant as Specified in Its Charter)



|Florida                                                        |  | 65-0510339                          
|-------------------------------------------------------------- |  | ------------------------------------
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)



|2000 West Commercial Blvd., Suite 200, Fort Lauderdale, Florida |  | 33309     
|--------------------------------------------------------------- |  | ----------
|(Address of Principal Executive Offices)                        |  | (Zip Code)



Registrants
Telephone Number, Including Area Code 954-958-3900



Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report



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



As of November 13, 2003, 21,790,146 shares of the Registrants $0.01 par
value Common Stock were outstanding.



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##### Table of Contents

TABLE OF CONTENTS



|PART I. FINANCIAL INFORMATION |  |                                                                                              
|----------------------------- |  | ---------------------------------------------------------------------------------------------
|                              |  |                                                                                              
|                              |  | Item 1.
Financial Statements                                                                 
|                              |  |                                                                                              
|                              |  | Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations
|                              |  |                                                                                              
|                              |  | Item 3.
Quantitative and Qualitative Disclosures about Market Risk                           
|                              |  |                                                                                              
|                              |  | Item 4.
Controls and Procedures                                                              
|                              | 
|PART II. OTHER INFORMATION    |  |                                                                                              
|                              |  |                                                                                              
|                              |  | Item 1.
Legal Proceedings                                                                    
|                              |  |                                                                                              
|                              |  | Item 2.
Changes in Securities and Use of Proceeds                                            
|                              |  |                                                                                              
|                              |  | Item 3.
Defaults Upon Senior Securities                                                      
|                              |  |                                                                                              
|                              |  | Item 4.
Submission of Matters to a Vote of Security Holders                                  
|                              |  |                                                                                              
|                              |  | Item 5.
Other Information                                                                    
|                              |  |                                                                                              
|                              |  | Item 6.
Exhibits and Reports on Form 8-K                                                     
|                              | 
|SIGNATURES                    |  |                                                                                              
|                              | 
|EXHIBITS                      |  |                                                                                              



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

(Unaudited)



PART 1: FINANCIAL INFORMATION



|Item 1. |  | Financial Statements
|------- |  | --------------------



CYBERGUARD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Amounts in thousands)



|                                                                                                                                  |  | Sept. 30, 2003 |         |   | June 30, 2003 |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | -------------- | ------- | - | ------------- | -
|ASSETS                                                                                                                           
|Cash and cash equivalents                                                                                                         |  | $              | 15,469  |   |               | $
|Restricted cash                                                                                                                   |  |                | 340     |   |               |  
|Accounts receivable, less allowance for uncollectible accounts of $663 at Sep 30, 2003 and $707 at June 30, 2003                  |  |                | 7,472   |   |               |  
|Inventories, net                                                                                                                  |  |                | 342     |   |               |  
|Other current assets                                                                                                              |  |                | 894     |   |               |  
|Receivable from insurance company                                                                                                 |  |                |        |   |               |  
|                                                                                                                                  |  |                |         |   |               |  
|Total current assets                                                                                                              |  |                | 24,517  |   |               |  
|Property and equipment at cost, less accumulated depreciation of $3,676 at Sep 30, 2003 and $3,373 at June 30,
2003               |  |                | 1,604   |   |               |  
|Capitalized software, less accumulated amortization of $2,032 at Sep 30, 2003 and $1,988 at June 30, 2003                         |  |                | 189     |   |               |  
|Intangibles, less accumulated amortization of $488 at Sep 30, 2003 and $304 at June 30, 2003                                      |  |                | 615     |   |               |  
|Other assets                                                                                                                      |  |                | 130     |   |               |  
|Deferred tax asset, net                                                                                                           |  |                | 4,517   |   |               |  
|                                                                                                                                  |  |                |         |   |               |  
|Total assets                                                                                                                      |  | $              | 31,572  |   |               | $
|                                                                                                                                  |  |                |         |   |               |  
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                             
|Accounts payable                                                                                                                  |  |                | 1,153   |   |               |  
|Deferred revenue                                                                                                                  |  |                | 6,244   |   |               |  
|Litigation payable                                                                                                                |  |                | 3,000   |   |               |  
|Accrued expenses and other liabilities                                                                                            |  |                | 3,159   |   |               |  
|                                                                                                                                  |  |                |         |   |               |  
|Total liabilities                                                                                                                 |  | $              | 13,556  |   |               | $
|                                                                                                                                  |  |                |         |   |               |  
|Commitments and Contingencies                                                                                                     |  |                |        |   |               |  
|Shareholders equity                                                                                                              |  |                |         |   |               |  
|Preferred stock par value $0.01; authorized 5,000 shares; none issued                                                             |  |                |        |   |               |  
|                                                                                                                                  |  |                |         |   |               |  
|Common stock par value $0.01; authorized 50,000 shares; issued and outstanding 21,760 at Sep 30, 2003 and 20,953 at June 30,
2003 |  |                | 218     |   |               |  
|Additional paid-in capital                                                                                                        |  |                | 97,113  |   |               |  
|Accumulated deficit                                                                                                               |  |                | (79,382 | ) |               |  
|Accumulated other comprehensive income                                                                                            |  |                | 67      |   |               |  
|                                                                                                                                  |  |                |         |   |               |  
|Total shareholders equity                                                                                                        |  |                | 18,016  |   |               |  
|                                                                                                                                  |  |                |         |   |               |  
|Total liabilities and shareholders equity                                                                                        |  | $              | 31,572  |   |               | $
|                                                                                                                                  |  |                |         |   |               |  



See accompanying notes
to consolidated financial statements



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##### Table of Contents

CYBERGUARD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands, except
per share data)



|                                                     |  | Three Months Ended |       
|---------------------------------------------------- |  | ------------------ | ------
|                                                     |  | Sept.30, 2003      |       
|Revenues:                                            |  |                    |       
|Products                                             |  | $                  | 6,172 
|Services                                             |  |                    | 2,848 
|                                                     |  |                    |       
|Total revenues                                       |  |                    | 9,020 
|Cost of revenues:                                    |  |                    |       
|Products                                             |  |                    | 1,619 
|Services                                             |  |                    | 837   
|                                                     |  |                    |       
|Total cost of revenues                               |  |                    | 2,456 
|                                                     |  |                    |       
|Gross profit                                         |  |                    | 6,564 
|                                                     |  |                    |       
|Operating expenses:                                  |  |                    |       
|Research and development                             |  |                    | 1,832 
|Selling, general and administrative                  |  |                    | 3,898 
|                                                     |  |                    |       
|Total operating expenses                             |  |                    | 5,730 
|                                                     |  |                    |       
|Operating income                                     |  |                    | 834   
|                                                     |  |                    |       
|Other income (expense)                               |  |                    |       
|Interest income                                      |  |                    | 33    
|Loss on sale of assets                               |  |                    | 0     
|Other income (expense)                               |  |                    | 25    
|                                                     |  |                    |       
|Total other income (expense)                         |  |                    | 58    
|                                                     |  |                    |       
|Net income before income tax benefit                 |  |                    | 892   
|                                                     |  |                    |       
|Income tax benefit                                   |  |                    | 268   
|                                                     |  |                    |       
|Net income                                           |  | $                  | 1,160 
|                                                     |  |                    |       
|Basic earnings per common share                      |  | $                  | 0.05  
|                                                     |  |                    |       
|Weighted average number of common shares outstanding |  |                    | 21,312
|                                                     |  |                    |       
|Diluted earnings per common share                    |  | $                  | 0.04  
|                                                     |  |                    |       
|Weighted average number of common shares outstanding |  |                    | 26,928



See accompanying notes
to consolidated financial statements



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CYBERGUARD CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in thousands)



|                                                                                                                                                                                                                               |  | Three MonthsEnded |       
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------ |  | ----------------- | ------
|                                                                                                                                                                                                                               |  | Sept. 30, 2003    |       
|Cash flows from operating activities:                                                                                                                                                                                          |  |                   |       
|Net income                                                                                                                                                                                                                     |  | $                 | 1,160 
|Adjustments to reconcile net income to net cash provided by operating activities:                                                                                                                                              |  |                   |       
|Depreciation                                                                                                                                                                                                                   |  |                   | 302   
|Amortization                                                                                                                                                                                                                   |  |                   | 228   
|Loss on disposal of property & equipment                                                                                                                                                                                       |  |                   |      
|Deferred tax benefit                                                                                                                                                                                                           |  |                   | (268  
|Provision for uncollectible accounts receivable                                                                                                                                                                                |  |                   | (44   
|Provision for inventory reserve                                                                                                                                                                                                |  |                   |      
|Compensation expense related to stock options                                                                                                                                                                                  |  |                   | 5     
|Non cash expense for company 401(k) match                                                                                                                                                                                      |  |                   | 112   
|Translation adjustment                                                                                                                                                                                                         |  |                   | (11   
|Changes in assets and liabilities:                                                                                                                                                                                             |  |                   |       
|Decrease in restricted cash                                                                                                                                                                                                    |  |                   | 39    
|Decrease/(Increase) in accounts receivable                                                                                                                                                                                     |  |                   | 179   
|Decrease/(Increase) in other current assets                                                                                                                                                                                    |  |                   | 73    
|(Increase) in inventories                                                                                                                                                                                                      |  |                   | (12   
|Decrease in other, net                                                                                                                                                                                                         |  |                   | 154   
|(Decrease)/Increase in accounts payable                                                                                                                                                                                        |  |                   | (62   
|(Decrease)/Increase in accrued expenses and other liabilities                                                                                                                                                                  |  |                   | (18   
|Increase/(Decrease) in deferred revenue                                                                                                                                                                                        |  |                   | 547   
|Decrease in litigation receivable                                                                                                                                                                                              |  |                   | 6,500 
|(Decrease) in litigation payable                                                                                                                                                                                               |  |                   | (7,400
|                                                                                                                                                                                                                               |  |                   |       
|Net cash provided by operating activities                                                                                                                                                                                      |  |                   | 1,484 
|                                                                                                                                                                                                                               |  |                   |       
|Cash flows used in investing activities                                                                                                                                                                                        |  |                   |       
|Capitalized software costs                                                                                                                                                                                                     |  |                   | (75   
|Purchase of property & equipment                                                                                                                                                                                               |  |                   | (116  
|                                                                                                                                                                                                                               |  |                   |       
|Net cash used in investing activities                                                                                                                                                                                          |  |                   | (191  
|                                                                                                                                                                                                                               |  |                   |       
|Cash flows provided by financing activities:                                                                                                                                                                                   |  |                   |       
|Repayment of notes payable                                                                                                                                                                                                     |  |                   |      
|Proceeds from stock options exercised                                                                                                                                                                                          |  |                   | 2,017 
|Proceeds from sale of common stock in stock purchase plan                                                                                                                                                                      |  |                   | 64    
|                                                                                                                                                                                                                               |  |                   |       
|Net cash provided by financing activities                                                                                                                                                                                      |  |                   | 2,081 
|                                                                                                                                                                                                                               |  |                   |       
|Net increase in cash                                                                                                                                                                                                           |  |                   | 3,374 
|Cash and cash equivalents at beginning of period                                                                                                                                                                               |  |                   | 12,095
|                                                                                                                                                                                                                               |  |                   |       
|Cash and cash equivalents at end of period                                                                                                                                                                                     |  | $                 | 15,469
|                                                                                                                                                                                                                               |  |                   |       
|Supplemental disclosure of cash flow information                                                                                                                                                                               |  |                   |       
|Cash paid for interest                                                                                                                                                                                                         |  | $                 |      
|                                                                                                                                                                                                                               |  |                   |       
|Cash paid for income taxes                                                                                                                                                                                                     |  | $                 |      
|                                                                                                                                                                                                                               |  |                   |       
|                                                                                                                                                                                                                               |  |                   |       
|Supplemental disclosure of non-cash information During fiscal year 2002, the Company's CEO, Scott Hammack, participated in a special option program which required the Company to record compensation expense of $45 .         |  |                   |       
|                                                                                                                                                                                                                               |  |                  
|Approximately 310 options to purchase shares of the Companys common stock were issued at a below market price, which
required the Company to record approximately $5 in compensation expense during fiscal year 2003 and 2002 |  |                   |       



See accompanying notes
to consolidated financial statements



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

Amounts in thousands, except per share data

(Unaudited)



1. Basis of Presentation



CyberGuard Corporation (the Company) has prepared the condensed
consolidated financial statements included herein, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission with respect to Form 10-Q. Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures made are adequate so as to make the information
contained not misleading. These interim financial statements and the notes should be read in conjunction with the financial statements and the notes included in the Companys 10-K for the year ended June 30, 2003 and the risk factors set forth
in the Companys annual report on Form 10-K, including, without limitation, risk related to the factors listed below. In the Companys opinion, all adjustments (consisting only of normal recurring adjustments) necessary for fair
presentation of the information shown, have been included. 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 consolidated financial statements and accompanying notes. On an on-going basis, we evaluate significant estimates used in preparing our financial statements, including revenue recognition, bad debt, software development cost, inventory
valuation, and reserve for deferred taxes. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the
carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The results of operations for the three months ended September 30,
2003 are not necessarily indicative of the results of operations that may be expected for the year ending June 30, 2004.



2. Summary of Significant Accounting Policies



Software Development CostsThe Company capitalizes costs related to the development of certain software products on a product by product basis
in accordance with Statement of Financial Accounting Standards No. 86, Accounting For the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed (SFAS No. 86) which requires capitalization to begin when
technological feasibility has been established and ends when the product is available for general release to customers. Software development costs incurred prior to technological feasibility, defined by implementation of a beta project, are
considered research and development costs and are expensed as incurred. Capitalized costs are amortized on a straight-line method over two years, which reflects the rapid changes in security software and is the greater of the two amounts calculated
using the methods noted in SFAS 86. Amortization starts when the product is available for general release to customers. Unamortized capitalized software cost is evaluated at each balance sheet date and compared to the net realizable value. Any
excess capitalized cost above net realizable value will be written off. No such impairment existed at September 30, 2003. The Company capitalized $75 in software development costs for the three months ended September 30, 2003.



Revenue RecognitionOur revenue is derived from two primary
sources:



(1) Product revenue which includes revenue from the
sale of our firewall/VPN appliance, and



(2) Service revenue
which is primarily maintenance which provides for customer support.



Revenues from product sales are recognized only when a contract or agreement has been executed, delivery of the product has occurred, the fee is fixed and determinable and we believe collection is



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

Amounts in thousands, except per share data

(Unaudited)



probable. Product revenue is generally recognized on product shipment;
this includes the transfer of both title and risk of loss, provided that no significant obligations remain. There is no product right of return available to the customer. We defer revenues on product sales for new value added resellers where we are
unable to determine the ability of the reseller to honor a commitment to make fixed or determinable payment. Revenue will be deferred until the resellers demonstrate consistency of payment within terms and there are no instances where we have to
take back the product because of non-payment for a three-month period. For the quarter ended September 30, 2003, one reseller was reclassified from cash basis to accrual and for the quarter ended September 30, 2002, fourteen (14) resellers were
changed from cash basis to accrual based on a reasonable assurance of collectibility from evaluating their payment history and no product returns. The impact of the reclassification did not have a material effect on revenue for the quarter ended
September 30, 2003. For the quarter ended September 30, 2002, the reclassification increased revenues by approximately $252.



Service revenues consist primarily of the annual fee for maintenance (post-contract customer support) and maintenance renewals from our existing customers
and are recognized ratably on a monthly basis over the service contract term. The post contract customer support provides our customers access to our worldwide support organization for technical support, unspecified product updates/enhancements on a
when and if available basis, and general security information. The updates are considered minor enhancements to the software that are not separately marketable or considered a competitive feature or major upgrade. All products and services are
separately priced.



The Company also provides other
professional support services, such as training and consulting, which are available under service agreements and charged for separately. These services are generally provided under time and materials contracts and revenue is recognized as the
service is provided.



Reclassifications.Certain prior
period amounts have been reclassified to conform to the current year presentation.



Net Income Per ShareBasic income per share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted earnings
per share data is computed on the basis of the weighted average number of common shares outstanding plus the effect of outstanding stock options and warrants using the treasury method. When the effects of the outstanding stock options, warrants
and/or convertible securities are anti-dilutive, they are not included in the calculation of diluted earnings per share.



The table below illustrates the components of earnings per share:



|                                                     |  | Three Months EndedSeptember 30, 2003 |        | Three Months EndedSeptember 30, 2002
|---------------------------------------------------- |  | ------------------------------------ | ------ | ------------------------------------
|Net Income                                           |  | $                                    | 1,160  |                                     
|Weighted average number of common shares outstanding |  |                                      | 21,312 |                                     
|Dilutive effect of:                                  |  |                                      |        |                                     
|Employee stock options                               |  |                                      | 3,755  |                                     
|Warrants                                             |  |                                      | 1,861  |                                     
|Weighted average number of common shares outstanding |  |                                      | 26,928 |                                     
|Earnings per share                                   |  |                                      |        |                                     
|Basic                                                |  |                                      | 0.05   |                                     
|Diluted                                              |  |                                      | 0.04   |                                     



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

Amounts in thousands, except per share data

(Unaudited)



Stock-Based Compensation. The Company has adopted
the disclosure provisions of SFAS No. 148, Accounting for Stock Based CompensationTransition and Disclosure, which amends SFAS No. 123, Accounting for Stock-Based Compensation. SFAS No. 148 allows for continued use of
recognition and measurement principles of Accounting Principles Board (APB) Opinion No. 25 and related interpretations in accounting for stock based compensation. The Company applies the recognition and measurement principles of APB
Opinion No. 25, and related interpretations in accounting for stock based compensation. For the three months ended September 30, 2003 and 2002, there was approximately $5 and $50 of stock based compensation reflected in net income. Stock based
compensation was the result of stock issued at prices below market value at the date of the grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions to
stock-based employee compensation. Such disclosure is not necessarily indicative of the fair value of stock options that could be granted by the Company in future periods or of the value of all options currently outstanding.



|                                                                                                                |  | Three months ended September 30, |      
|--------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | -----
|                                                                                                                |  | 2003                             |      
|Net income as reported                                                                                          |  | $                                | 1,160
|Add: Stock-based employee compensation expense included in net income, net of related tax effect                |  | $                                | 5    
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards |  | $                                | 432  
|Pro forma net income/ (loss)                                                                                    |  | $                                | 733  
|Earnings / (loss) per share:                                                                                    |  |                                  |      
|Basicas reported                                                                                               |  | $                                | 0.05 
|Basicpro forma                                                                                                 |  | $                                | 0.03 
|Dilutedas reported                                                                                             |  | $                                | 0.04 
|Dilutedpro forma                                                                                               |  | $                                | 0.03 



The fair value method
for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for the three month periods ended September 30, 2003 and September 30, 2002: the risk-free interest
rate was 2.16% and 3.12%; the expected dividend yield was 0% and 0%; the volatility factor of the expected market price of the Companys common stock was 94% and 94%; and a grant life of the option of 3 years in both periods.



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

Amounts in thousands, except per share data

(Unaudited)



The Companys operating results and financial
condition may be impacted by a number of factors including, but not limited to, the following, any of which could cause actual results to vary materially from current and historical results or the Companys anticipated future results. A portion
of the Companys revenue is derived from its international operations and sources. As a result, the Companys operations and financial results could be affected by international factors such as; changes in foreign currency exchange rates,
weak economic conditions in the international markets in which the Company distributes its products, conflict in the Middle East, and recent health warnings in the Asia / Pacific region. The network security industry is highly competitive and
competition is expected to intensify. There are numerous companies competing in segments of the market in which the Company does business. Competitors include organizations significantly larger and with more development, marketing and financial
resources than the Company. In addition, the Company is subject to risks and uncertainties which include, but are not limited to, the timely development of and acceptance of new products, impact of competitive products, competition for and retention
of key management and technology employees, possible attacks on our networks causing changes to the publics perception of the Company, the ability to secure additional financing, government regulation, inventory obsolescence, the ultimate
outcome of certain litigation matters, and cash balances in excess of federally insured limits. For a more complete discussion of these factors affecting the Companys business and prospects and forward-looking statements, please refer
to Part II, Item 7 of Form 10K for the fiscal year ended June 30, 2003.



3.
Recent Accounting Pronouncements



In January 2003, the
FASB issued FASB Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have
sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (variable
interest entities). Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a
majority of the entitys expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise
obtains an interest after that date. It applies in the first fiscal year or interim period beginning after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. At
September 30, 2003 we were not a party to transactions contemplated under FIN 46.



In November 2002, the Emerging Issues Task Force reached a consensus opinion on EITF 00-21, Revenue Arrangements with Multiple Deliverables. The consensus provides that revenue arrangements with multiple
deliverables should be divided into separate units of accounting if certain criteria are met. The consideration for the arrangement should be allocated to the separate units of accounting based on their relative fair values, with different
provisions if the fair value of all deliverables is not known or if the fair value is contingent on delivery of specified items or performance conditions. Applicable revenue recognition criteria should be considered separately for each separate unit
of accounting. EITF 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. Entities may elect to report the change as a cumulative effect adjustment in accordance with APB Opinion 20, Accounting
Changes. The Company believes EITF 00-21 will not have any impact on the Company at this time.



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

Amounts in thousands, except per share data

(Unaudited)



In April 2003, the FASB issued SFAS No. 149, Amendment
of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. In general, the SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The
adoption of SFAS No. 149 did not have a material impact on our financial condition or results of operations.



On May 15, 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.
SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). SFAS No. 150 affects the issuers accounting for three types of freestanding financial instruments:



| |  | mandatory redeemable shares, which the issuing company is obligated to buy back in exchange for cash or other assets;
| | - | ---------------------------------------------------------------------------------------------------------------------



| |  | instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets; includes put options and forward purchase contracts; and
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the
value of the issuers shares.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



SFAS No. 150
does not apply to features embedded in a financial instrument that is not a derivative in its entirety. Most of the guidance in SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS No. 150 did not have a material impact on our financial condition or results of operations.



4. Litigation



On August 24, 1998, the Company announced, among other things, that due to a review of its revenue recognition practices
relating to distributors and resellers, it would restate prior financial results. After the August 24, 1998 announcement, twenty-five purported class action lawsuits were filed by alleged shareholders against the Company and certain former officers
and directors. Pursuant to an order issued by the Court, these actions have been consolidated into one action, styled Stephen Cheney, et al. v. CyberGuard Corporation, et al., Case No. 98-6879-CIV-Gold, in the United States District Court,
Southern District of Florida. On August 23, 1999, the plaintiffs filed a Consolidated and Amended Class Action Complaint. This action seeks damages purportedly on behalf of all persons who purchased or otherwise acquired the Companys common
stock during various periods from November 7, 1996 through August 24, 1998. The complaint alleges, among other things, that as a result of accounting irregularities relating to the Companys revenue recognition policies, the Companys
previously issued financial statements were materially false and misleading and that the defendants knowingly or recklessly published these financial statements which caused the Companys common stock prices to rise artificially. The action
alleges violations of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and SEC Rule 10b-5 promulgated thereunder and Section 20(a) of the Exchange Act.



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

Amounts in thousands, except per share data

(Unaudited)



Subsequently, the defendants, including the Company, filed their
respective motions to dismiss the Consolidated and Amended Class Action Complaint. On July 31, 2000, the Court issued a ruling denying the Companys and Robert L. Carberrys (the Companys CEO from June 1996 through August 1998)
motions to dismiss. The court granted the motions to dismiss with prejudice for defendants William D. Murray (the Companys CFO from November 1997 through August 1998), Patrick O. Wheeler (the Companys CFO from April 1996 through October
1997), C. Shelton James (the Companys former Audit Committee Chairman), and KPMG Peat Marwick LLP (KPMG). On August 14, 2000, the plaintiffs filed a motion for reconsideration of that order. The Company filed an answer to the
plaintiffs Consolidated and Amended Class Action Complaint on August 24, 2000. On March 20, 2001, the Court ruled on the plaintiffs motion for reconsideration that the previously dismissed defendants William D. Murray, Patrick O. Wheeler
and C. Shelton James should not have been dismissed from the action and shall be defendants in this action under the control person liability claims under Section 20(a) of the Exchange Act, and that the plaintiffs may amend the Consolidated and
Amended Class Action Complaint to bring claims against C. Shelton James under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. On April 5, 2001, the plaintiffs filed their Second Consolidated and Amended Class Action
Complaint to include amended claims against C. Shelton James. On May 10, 2001, the Company filed an answer and affirmative defenses to plaintiffs Second Consolidated and Amended Class Action Complaint. On August 14, 2002, the Court granted the
plaintiffs Motion for Class Certification and certified the class to include all investors who acquired the Companys common stock between November 7, 1996 and August 24, 1998 and were damaged by the purchase of such stock. The trial is
scheduled for March 2004.



In July 2003, the Company entered
into a Memorandum of Understanding to settle this lawsuit. The settlement amount of $10 million required the Company to incur a one-time charge of $3.9 million in the fourth quarter of its fiscal year ending June 30, 2003 for the amount in excess of
the insurance coverage and related costs. The Company paid in full its portion of the settlement amount in October. On October 9, 2003, the Company and all other parties signed a Stipulation and Agreement of Settlement and filed a Joint Motion for
Preliminary Approval of Settlement of the lawsuit. On November 6, 2003, a hearing was held on the joint motion. The Company expects that a final hearing will be held in March of 2004. The terms of the settlement are subject to final approval by the
court, and there can be no assurance that the court will approve this proposed settlement of the lawsuit.



If the court does not approve the settlement, there can be no assurance that the Company will ultimately be successful in defending the lawsuit, or that
if the Company is unsuccessful, that there will be sufficient insurance coverage to cover any expense of the lawsuit and/or any judgment rendered against the Company. The Companys obligation to indemnify its officers and directors under the
aforementioned lawsuit is insured to the extent of the limits of the applicable insurance policies. The Company has initially notified its insurance carrier of the existence of the lawsuit, and the carrier has sent the Company a reservation of
rights letter. If the settlement is not approved by the court, the Company intends to vigorously defend this action, and believes that in the event that it is unsuccessful, insurance coverage will be available to defray a portion, or substantially
all, of the expense of defending and settling the lawsuit or paying a judgment. However, the Company is unable to predict the ultimate outcome of the litigation. There can be no assurance that the Company will be successful in defending the lawsuit
or, if unsuccessful, that insurance will be available to pay all or any portion of the expense of the lawsuit. If the Company is unsuccessful in defending the lawsuit and the insurance coverage is unavailable or insufficient, the resolution of the
lawsuit could have a material adverse effect on the Companys consolidated financial position, results of operations, and cash flows.



On November 14, 2002, the Company filed a lawsuit against Data Return Corporation in the United States District Court of the Northern District of Texas,
alleging breach of contract, and seeking, among



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

Amounts in thousands, except per share data

(Unaudited)



other remedies, damages of approximately $4 million. On December 9, 2002,
Data Return Corporation filed an answer and affirmative defenses, and also counterclaims against the Company, alleging breach of contract, breach of warranty, fraud, negligent misrepresentation and deceptive trade practices, and seeking unspecified
damages. On December 30, 2002, CyberGuard filed its answer and affirmative defenses to the counterclaim and a motion to dismiss the fraud, negligent misrepresentation and deceptive trade practices counterclaims. In February 2003, the Company has
learned that Data Return Corporation filed for bankruptcy protection under Chapter 11 in the United States Bankruptcy Court, District of Massachusetts. At this time, it is impossible to determine whether the Company will be able to recover any
amounts from Data Return Corporation even if the Company is successful in pursuing its claims.



The Company is involved from time to time, in the ordinary course of its business, in various litigation relating to the conduct of its business. The Company believes that these other litigation matters will not have
a material adverse effect on its consolidated financial position, results of operations or cash flows.



5. Income tax benefit



The Company recorded an income tax benefit of $268 as of September 30, 2003, as a result of the reversal of a portion of the deferred tax asset valuation allowance. The reversal of the allowance was made because we believe it is more likely
than not that the US net operating loss carryforward deferred tax asset, will be realized to the extent of the $268 tax benefit recorded. Our basis that it is more likely than not is our positive current financial results both in the US and on a
consolidated basis, and our future US projections through the end of the second quarter of fiscal year 2006. The companys current projection reflects in excess of $12 million in US taxable income from normal and recurring operations through
the end of the second quarter of fiscal year 2006. This projection is the minimum amount of future US taxable income that would have to be generated to realize the $4,517 deferred tax asset. Our current level of US pretax earnings for financial
reporting purposes would be sufficient to generate that minimum amount of US taxable income that would have to be generated through the end of the second quarter of fiscal year 2006. Our projection is based on continued growth in the business at
market growth rates and maintaining operating margins in the US of approximately 10 to 12% through the end of the second quarter of fiscal year 2006. Our projections do not include significant improvement in gross margins or cost reductions. The
Companys net operating loss carryforwards begin to expire in 2010.



The Company will continue to evaluate each quarter the amount, if any, of additional reduction of the valuation allowance that should be made. This will be based upon managements estimate and conclusions
regarding the ultimate realization of the deferred tax asset, including but not limited to, the Companys recent positive financial results as well as projected earnings. The factors which we will consider in evaluating when, and if, it would
be appropriate to reverse the entire valuation allowance would include: the sufficient passage of time in which we have achieved our projections and utilized the net tax operating loss carryforwards as planned, changes in the industry, our product
life-cycle, profitability trends, and tax law changes.



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CYBERGUARD CORPORATION

Notes to Condensed Consolidated Financial Statements

September 30, 2003

Amounts in thousands, except per share data

(Unaudited)



6. Subsequent Events



On November 12, 2003, the Company entered into an Agreement and Plan
of Merger with SnapGear, Inc. to acquire SnapGear for approximately $16 million in cash and stock. The transaction is expected to close by December 31, 2003.



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



|Item 2. |  | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- |  | -------------------------------------------------------------------------------------



This Form 10-Q contains forward-looking statements about future results, which are subject to risks, and uncertainties, including those discussed below.
These statements relate to future events or our future financial performance. In many cases you can identify forward-looking statements by terminology such as may, will, should, expects,
plans, anticipates, believes, estimates, predicts, potential, intend, or continue, or the negative of such terms and other comparable terminology.
However, the absence of these words does not mean that the statements are not forward-looking. Forward-looking statements include statements about our plans, objectives, expectations, intentions and other statements that are not historical facts.
They are subject to known and unknown risks and uncertainties and assumptions that could cause our actual results to differ materially from those expected or implied by the forward-looking statements. Our actual results could differ materially from
those anticipated in the forward-looking statements for many reasons, including, but not limited to, the risks described in Part II, Item 7, of the Companys 10-K for the year ended June 30, 2003. You should not unduly rely on these
forward-looking statements, which apply only as of the date of this quarterly report. We undertake no obligation to update any forward-looking statements to reflect new information, circumstances or events after the date of this report. These
forward-looking statements are only predictions.



The Company
provides a full suite of products and services for the network security industry. The products offered by the Company include the CyberGuard® Firewall and VPN, proprietary and third party technology and consulting and support services.



Results of Operations



The quarter ended September 30, 2003 compared to the quarter ended September 30, 2002



Total Revenues



Total revenues, consist of product sales and software maintenance and professional services, related to the sale of
products. For the quarter ended September 30, 2003, total revenues increased by $1,920 to $9,020 compared to $7,100 for the quarter ended September 30, 2002. The increase was comprised of an increase in product sales of $1,298 and an increase in
services of $622. International revenue represented approximately 54% of total revenues for the three months ended September 30, 2003 and 2002. The growth in revenues was driven by increased demand for our product in all geographic markets in both
governmental and commercial sectors. The increase in product and service revenue is the result of an increase in the number of units shipped and not from an increase in product prices.



Network security product revenue accounted for 68% of revenue during the quarter ended September 30, 2003 compared to 69% of
revenues during the quarter ended September 30, 2002.



Service
revenue includes maintenance contracts related to new product sales, renewal maintenance contracts for products previously deployed, training and consulting services. Support services for network security products accounted for 32% of revenues
during the quarter ended September 30, 2003 as compared to 31% of revenues during the quarter ended September 30, 2002. Revenue from maintenance contracts represented 90% of service revenue for the quarter ended September 30, 2003 and 91% of service
revenue for the quarter ended September 30, 2002. The increase in maintenance revenue accounted for 90% of the increase in service revenue. The increase in service revenue corresponds to the growth in the Companys customer base and its timing
of renewal maintenance.



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



Gross Profit



Gross profit as a percentage of revenues was 73% for the quarter ended September 30, 2003 and 74% for the quarter ended September 30, 2002.



The Companys gross margin has been, and will continue to be, affected
by a variety of factors including, competition, the mix and average selling prices of products, new product introductions and enhancements, and the fluctuations in manufacturing volumes. We must continue to manage each of these factors effectively
for our gross margins to remain at their current level.



Operating
Expenses, Other Income and Expense and Net Income



Research and development expense includes salaries, non-capitalized equipment, software, software tools, and depreciation from capital equipment. Research and development expense increased by $785 to $1,832 for the quarter ended September
30, 2003 compared to $1,047 for the quarter ended September 30, 2002. Forty-four percent of the cost increase is the result of the acquisition of NetOctave in the third quarter of fiscal year 2003. The balance is the result of the return to full
salary following the completion of the special option program discussed in Part I, Item 1, Footnote 7 of the 10Q filed with the SEC for the quarter ended December 31, 2001 as well as higher payroll costs due to additional headcount in the current
quarter, when compared to the prior year. As a percentage of total revenue, research and development expense increased to 20% for the quarter ended September 30, 2003 from 15% for the quarter ended September 30, 2002.



We expect to increase our research and development costs in total dollars to
enhance and expand our current product offerings and develop new products. We plan to continue to make the necessary investment in research and development to keep our products at a competitive advantage.



Selling, general and administrative expense includes salaries, commissions,
costs associated with the executive, human resource, finance and administrative support functions, and legal and accounting professional services. Selling, general and administrative expense increased by $643 to $3,898 for the quarter ended
September 30, 2003 from $3,255 for the quarter ended September 30, 2002.



The increase in selling, general and administrative expenses for the quarter ended September 30, 2003, of $643 is attributable to increases in professional fees associated with the NASDAQ relisting and legal fees
associated with winding up the class action settlement. Other increases included labor costs consistent with the growth in the business, facilities expenses and depreciation and amortization expense.



Total other income increased $82 for the quarter ended September 30, 2003 to
$58 compared to an expense of $24 for the quarter ended September 30, 2002.



The Company recorded an income tax benefit of $268 as of September 30, 2003, as a result of the reversal of a portion of the deferred tax asset valuation allowance. The reversal of the allowance was made because we
believe it is more likely than not that the US net operating loss carryforward deferred tax asset, will be realized to the extent of the $268 tax benefit recorded. Our basis that it is more likely than not is our positive current financial results
both in the US and on a consolidated basis, and our future US projections through the end of the second quarter of fiscal year 2006. The companys current projection reflects in excess of $12 million in US taxable income from normal and
recurring operations through the end of the second quarter of fiscal year 2006. This projection is the minimum amount of future US taxable income that would have to be generated to realize the $4,517 deferred tax asset. Our current level of pretax
earnings for financial reporting purposes would be sufficient to generate that minimum amount of US taxable income that would have to be generated through the end of



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



the second quarter of fiscal year 2006. Our projection is based on continued growth in the business at market growth rates and maintaining
operating margins in the US of approximately 10 to 12% through the end of the second quarter of fiscal year 2006. Our projections do not include significant improvement in gross margins or cost reductions. The Companys net operating loss
carryforwards begin to expire in 2010.



The Company will
continue to evaluate each quarter the amount, if any, of additional reduction of the valuation allowance that should be made. This will be based upon managements estimate and conclusions regarding the ultimate realization of the deferred tax
asset, including but not limited to, the Companys recent positive financial results as well as projected earnings. The factors which we will consider in evaluating when, and if, it would be appropriate to reverse the entire valuation allowance
would include: the sufficient passage of time in which we have achieved our projections and utilized the net tax operating loss carryforwards as planned, changes in the industry, our product life-cycle, profitability trends, and tax law changes.



We believe this is a reasonable approach in determining the
deferred tax asset that may be realized. The risk factors discussed in Part II, Item 7 of Form 10K for the fiscal year ended June 30, 2003 could adversely affect our ability to generate future taxable income, thereby also adversely impacting our
ability to realize the deferred tax asset. We will continue to evaluate each quarter the amount, if any, of additional reduction of the valuation allowance that should be made. This will be based on managements estimate and conclusions
regarding the ultimate realization of the deferred tax asset, including but not limited to, the companys recent positive financial results as well as projected earnings over a two-year period. These projections are based upon products
currently being sold and markets that currently produce sales. The impact of further reductions of the valuation allowance will be to record a tax benefit which will increase net income in the period the determination is made.



Net income for the quarter ended September 30, 2003 was $1,160 compared to
net income of $931 for the quarter ended September 30, 2002.



Liquidity and
Capital Resources



At September 30, 2003, the Company had
cash and cash equivalents on hand of $15,469 representing an increase of $3,374 from $12,095 as of June 30, 2003. Net cash provided by operating activities during the three-month period ended September 30, 2003 of $1,484 was primarily attributable
to net income from operations of $1,160 combined with an increase in deferred revenue, and a decrease in litigation receivable, accounts receivable, other net and other current assets, offset by a deferred tax benefit, and a decrease in litigation
payable, accounts payable and accrued expenses. Net cash used in investing activities during the three-month period ended September 30, 2003 of $191 related to the purchase of property and equipment and the capitalization of software costs. Cash
provided by financing activities of $2,081 during the three-month period ended September 30, 2003 reflects the proceeds from stock options exercised and purchases made through the Companys Employee Stock Purchase Plan.



The Companys principal sources of liquidity at September 30, 2003,
consisted of cash and cash equivalents, accounts receivable, and vendor trade credit.



We believe our existing cash, cash equivalents and short-term investments will be sufficient to meet our cash requirements at least through the next twelve months. However, we may be required or could elect to seek
additional funding prior to that time. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending on support, product development efforts, expansion of sales and marketing,
the timing of introductions of new products and enhancement to existing products, and market acceptance of our products. Other recent and possible future events that could also materially impact the Companys ability to successfully execute on
its



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



business plans are described in Information Relating to Forward Looking Statements of this Item on Form 10-Q. We are not aware of any known
demands, commitments, events or uncertainties that will result or that are reasonably likely to result in our liquidity increasing or decreasing in a material way.



We have no other agreements or arrangements for third parties to provide us with sources of liquidity and capital resources,
including off balance sheet arrangements.



CRITICAL ACCOUNTING POLICIES



Our discussion and analysis of financial
conditions and results of operations is based on our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. 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 consolidated financial statements and accompanying notes. On an on-going basis, we evaluate significant
estimates used in preparing our financial statements, including revenue recognition, bad debt, software development cost, inventory valuation, and reserve for deferred taxes. We base our estimates on historical experience and various other
assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.



We believe the following critical accounting policies affect the more significant judgments and estimates used in preparing our consolidated financial statements:



Revenue Recognition. Revenue recognition rules for
software companies are very complex. We follow very specific and detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. The discretion involved in this process makes revenue results
difficult to predict, and any shortfall in revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter and could result in future operating losses.



Our revenue is derived from two primary sources:



| |  | Product revenue which includes revenue from the sale of our firewall/VPN appliance; and
| | - | ---------------------------------------------------------------------------------------



| |  | Service revenue, which is primarily maintenance, related to customer support.
| | - | -----------------------------------------------------------------------------



Revenue from product sales is recognized only when a contract or agreement has been executed, delivery of the product has occurred, the
fee is fixed and determinable and we believe collection is probable. Product revenue is generally recognized on product shipment; this includes the transfer of both title and risk of loss, provided that no significant obligations remain. There is no
product right of return available to the customer. We defer revenue on product sales for new value-added resellers where we are unable to determine the ability of the reseller to honor a commitment to make fixed or determinable payment. Revenue will
be deferred until the resellers demonstrate consistency of payment within the terms specified and there are no instances where we have to take back the product because of non-payment for a three-month period.



Service revenue consists primarily of the annual fee for
maintenance (post-contract customer support) and maintenance renewals from our existing customers and is recognized ratably on a monthly basis over the service contract term. The post contract customer support provides our customers access to our
worldwide support organization for technical support, unspecified product updates/enhancements on a when and if available basis and general security information. The updates are considered minor enhancements to the software that are not separately
marketable or considered a competitive feature or major upgrade. All products and services are separately contracted.



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



We also provide other professional support services, such as training and consulting, which are available
under service agreements and charged for separately. These services are generally provided under time and materials contracts and revenue is recognized as the service is provided.



Bad Debts.We maintain allowances for doubtful accounts for estimated losses resulting from the inability of
our customers to make required payments. Significant judgment is required when we assess the ultimate realization of receivables, including the probability of collection and the credit-worthiness of each customer. In estimating the allowance for
doubtful accounts, we analyze our accounts receivable aging, historical bad debts, customer credit-worthiness, current economic trends and other factors. If the financial condition of our customers were to deteriorate, resulting in an impairment of
their ability to make payments, additional allowance might be required.



Software Development Costs. We capitalize costs related to the development of certain software products in accordance with Statement of Financial Accounting Standards (SFAS) No. 86, Accounting For the Costs Of Computer Software to
be Sold, Leased, or Otherwise Marketed which requires capitalization to begin when technological feasibility has been established and ends when the product is available for general release to customers. Software development costs incurred prior
to technological feasibility, defined by implementation of a beta project, are considered research and development costs and are expensed as incurred. Capitalized costs are amortized on a straight-line method over two years and is the greater of the
two amounts calculated using the methods noted in SFAS No. 86.



Inventory Valuation. Inventories consist primarily of component parts and computer hardware and are carried at the lower of cost, determined by the First-In-First-Out method, or market. We write our inventories down to estimated
market value based on assumptions of our future demand, based on projected product releases and market conditions. Variation in market trends, customer preferences, introduction of new products (replacing existing products) or technological advances
could, however, significantly affect these estimates and result in additional inventory write-downs.



Deferred Taxes. We provide a valuation allowance for that portion of deferred tax assets, which it cannot determine is more likely than not to be
recognized due to the Companys cumulative losses and the uncertainty as to future recoverability. Any reversal of the allowance is made when we believe that it is more likely than not that this portion of the deferred tax asset will be
realized. The computation of our deferred tax asset and valuation allowance is based on taxable income we expect to earn over the next two years which will include the utilization of previously accumulated net operating tax losses. We will continue
to evaluate each quarter the amount, if any, of additional reduction of the valuation allowance that should be made. This will be based on managements estimate and conclusions regarding the ultimate realization of the deferred tax asset,
including but not limited to, the companys recent positive financial results as well as projected earnings over a two-year period. The impact of further reductions of the valuation allowance will be to record a tax benefit, which will increase
net income in the period the determination is made. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we
would be able to realize the deferred tax asset, in the future, an adjustment to the deferred tax asset would increase income in the period the determination was made.



Information Relating to Forward Looking Statements



Statements regarding future products, prospects, profitability, business plans and strategies, future revenues and revenue
sources, future liquidity and capital resources, future computer network security market directions, future acceptance of the Companys products and possible growth in markets, as well as all other statements contained in this Report on Form
10-Q that are not purely historical are forward-looking statements.



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



Forward-looking statements are based upon assumptions and analyses made by the Company in light of current conditions,
future developments and other factors the Company believes are appropriate in the circumstances, or information obtained from third parties and are subject to a number of assumptions, risks and uncertainties. Readers are cautioned that
forward-looking statements are not guarantees of future performance and that the actual results might differ materially from those suggested or projected in the forward-looking statements. Accordingly, there can be no assurance that the
forward-looking statements will occur or that results will not vary significantly from those described in the forward-looking statements. Some of the factors that might cause future actual events to differ from those predicted or assumed include:
future advances in technologies and computer security; the Companys history of annual net operating losses and the financing of these losses through the sale of assets and newly issued Company securities; the Companys ability to execute
on its business plans; the Companys dependence on outside parties such as its key customers and alliance partners; competition from major computer hardware, software, and networking companies; risk and expense of government regulation and
effects on changes in regulation; the limited experience of the Company in marketing its products; uncertainties associated with product performance liability; risks associated with growth and expansion; global economic conditions, overall network
security spending, risks associated with obtaining and maintaining patent and intellectual property right protection, uncertainties in availability of expansion capital in the future and other risks associated with capital markets, including the
events of September 11, 2001 and its repercussions. In addition, certain events that have occurred also are factors that might cause future actual events to differ from those predicted or assumed, including: the impact of the restatement of
financial results for the Companys fiscal year ended June 30, 1997 and quarters ended September 30, 1997, December 31, 1997 and March 31, 1998; the completion of the numerous organizational changes and the assembly of a new management team for
CyberGuard; the outcome of a class action lawsuit against the Company relating to the restatement of financial results for the fiscal periods noted above. In addition, the forward-looking statements herein involve assumptions, risks and
uncertainties, including, but not limited to economic, competitive, operational, management, governmental, regulatory, litigation and technological factors affecting the Companys operations, liquidity, capital resources, markets, strategies,
products, prices and other factors discussed elsewhere herein and in the other documents filed by the Company with the Securities and Exchange Commission. Many of the foregoing factors are beyond the Companys control.



The Companys future success is based largely on its ability to develop
and sell increasingly technologically advanced network security solutions in sufficient volume and at sufficient prices to become profitable on a consistent basis. In addition, the network security market is characterized by extremely rapid
technological change, requiring rapid product development. The velocity of technological change has accelerated, and the Company believes that it is important to its future that it keeps pace with these changes. The Company believes that competition
will continue to intensify in the rapidly evolving markets in which the Company is involved, and that the continued development of technologically advanced products will be necessary to keep our products current. The Company believes that its
ability to generate adequate cash flow from operations will be critical to its future.



|Item 3. |  | Quantitative and Qualitative Disclosures Concerning Market Risk
|------- |  | ---------------------------------------------------------------



We have limited exposure to financial market risks, including changes in interest rates. The fair value of our investments or related income would not be
significantly impacted by a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of the major portion of our investments. A fluctuation in interest rates would not significantly affect interest expense on debt
obligations since a significant portion of the debt obligation is at a fixed rate of interest.



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



The Company uses the U.S. Dollar as its reporting currency for financial statement purposes. The Company conducts business
in numerous countries around the world through its European subsidiary that uses the local currency to denominate its transactions. Therefore, the Company is subject to certain risks associated with fluctuating foreign currencies.



Due to the long-term nature of the Companys investment in this
subsidiary, the translation adjustments resulting from these exchange rate fluctuations are excluded from the results of operations and recorded in a separate component of consolidated stockholders equity. The Company monitors its currency
exposure but does not hedge its translation exposure due to the high economic costs of such a program and the long-term nature of its investment in its European subsidiary.



|Item 4. |  | Controls and Procedures
|------- |  | -----------------------



Evaluation of Disclosure Controls and Procedures



The Company
maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the specified
time periods. As of the end of the period covered by this report, the Companys Chief Executive Officer and Chief Financial Officer evaluated, with the participation of CyberGuards management, the effectiveness of the Companys
disclosure controls and procedures. Based on the evaluation, which disclosed no significant deficiencies or material weaknesses, the Companys Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure
controls and procedures are effective. There were no changes in the Companys internal control over financial reporting that occurred during the Companys most recent fiscal quarter that have materially affected, or are reasonably likely
to materially affect, the Companys internal control over financial reporting.



Limitations on the Effectiveness of Controls



The Company
maintains a system of internal accounting controls to provide reasonable assurance that assets are safeguarded and that transactions are executed in accordance with managements authorization and recorded properly to permit the preparation of
financial statements in accordance with accounting principles generally accepted in the United States. However, the Companys management, including the CEO and CFO, does not expect that the Companys disclosure controls or internal
controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute
assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a
simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part
upon certain assumptions about the likelihood of future events, and there can be no absolute assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate
because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



PART II: OTHER INFORMATION



|Item 1. |  | Legal Proceedings
|------- |  | -----------------



Litigation



On August 24, 1998, the Company announced, among other
things, that due to a review of its revenue recognition practices relating to distributors and resellers, it would restate prior financial results. After the August 24, 1998 announcement, twenty-five purported class action lawsuits were filed by
alleged shareholders against the Company and certain former officers and directors. Pursuant to an order issued by the Court, these actions have been consolidated into one action, styled Stephen Cheney, et al. v. CyberGuard Corporation, et
al., Case No. 98-6879-CIV-Gold, in the United States District Court, Southern District of Florida. On August 23, 1999, the plaintiffs filed a Consolidated and Amended Class Action Complaint. This action seeks damages purportedly on behalf of all
persons who purchased or otherwise acquired the Companys common stock during various periods from November 7, 1996 through August 24, 1998. The complaint alleges, among other things, that as a result of accounting irregularities relating to
the Companys revenue recognition policies, the Companys previously issued financial statements were materially false and misleading and that the defendants knowingly or recklessly published these financial statements which caused the
Companys common stock prices to rise artificially. The action alleges violations of Section 10(b) of the Securities Exchange Act of 1934 (Exchange Act) and SEC Rule 10b-5 promulgated thereunder and Section 20(a) of the Exchange
Act. Subsequently, the defendants, including the Company, filed their respective motions to dismiss the Consolidated and Amended Class Action Complaint. On July 31, 2000, the Court issued a ruling denying the Companys and Robert L.
Carberrys (the Companys CEO from June 1996 through August 1998) motions to dismiss. The court granted the motions to dismiss with prejudice for defendants William D. Murray (the Companys CFO from November 1997 through August 1998),
Patrick O. Wheeler (the Companys CFO from April 1996 through October 1997), C. Shelton James (the Companys former Audit Committee Chairman), and KPMG Peat Marwick LLP (KPMG). On August 14, 2000, the plaintiffs filed a motion
for reconsideration of that order. The Company filed an answer to the plaintiffs Consolidated and Amended Class Action Complaint on August 24, 2000. On March 20, 2001, the Court ruled on the plaintiffs motion for reconsideration that the
previously dismissed defendants William D. Murray, Patrick O. Wheeler and C. Shelton James should not have been dismissed from the action and shall be defendants in this action under the control person liability claims under Section 20(a) of the
Exchange Act, and that the plaintiffs may amend the Consolidated and Amended Class Action Complaint to bring claims against C. Shelton James under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. On April 5, 2001, the
plaintiffs filed their Second Consolidated and Amended Class Action Complaint to include amended claims against C. Shelton James. On May 10, 2001, the Company filed an answer and affirmative defenses to plaintiffs Second Consolidated and
Amended Class Action Complaint. On August 14, 2002, the Court granted the plaintiffs Motion for Class Certification and certified the class to include all investors who acquired the Companys common stock between November 7, 1996 and
August 24, 1998 and were damaged by the purchase of such stock. The trial is scheduled for March 2004.



In July 2003, the Company entered into a Memorandum of Understanding to settle this lawsuit. The settlement amount of $10 million required the Company to
incur a one-time charge of $3.9 million in the fourth quarter of its fiscal year ending June 30, 2003 for the amount in excess of the insurance coverage and related costs. The Company paid in full its portion of the settlement amount in October. On
October 9, 2003, the Company and all other parties signed a Stipulation and Agreement of Settlement and filed a Joint Motion for Preliminary Approval of Settlement of the lawsuit. On November 6, 2003, a hearing was



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



held on the joint motion. The Company expects that a final hearing will be held in March of 2004. The terms of the settlement are subject to
final approval by the court, and there can be no assurance that the court will approve this proposed settlement of the lawsuit.



If the court does not approve the settlement, there can be no assurance that the Company will ultimately be successful in defending the lawsuit, or that
if the Company is unsuccessful, that there will be sufficient insurance coverage to cover any expense of the lawsuit and/or any judgment rendered against the Company. The Companys obligation to indemnify its officers and directors under the
aforementioned lawsuit is insured to the extent of the limits of the applicable insurance policies. The Company has initially notified its insurance carrier of the existence of the lawsuit, and the carrier has sent the Company a reservation of
rights letter. If the settlement is not approved by the court, the Company intends to vigorously defend this action, and believes that in the event that it is unsuccessful, insurance coverage will be available to defray a portion, or substantially
all, of the expense of defending and settling the lawsuit or paying a judgment. However, the Company is unable to predict the ultimate outcome of the litigation. There can be no assurance that the Company will be successful in defending the lawsuit
or, if unsuccessful, that insurance will be available to pay all or any portion of the expense of the lawsuit. If the Company is unsuccessful in defending the lawsuit and the insurance coverage is unavailable or insufficient, the resolution of the
lawsuit could have a material adverse effect on the Companys consolidated financial position, results of operations, and cash flows.



On November 14, 2002, the Company filed a lawsuit against Data Return Corporation in the United States District Court of the Northern District of Texas,
alleging breach of contract, and seeking, among other remedies, damages of approximately $4 million. On December 9, 2002, Data Return Corporation filed an answer and affirmative defenses, and also counterclaims against the Company, alleging breach
of contract, breach of warranty, fraud, negligent misrepresentation and deceptive trade practices, and seeking unspecified damages. On December 30, 2002, CyberGuard filed its answer and affirmative defenses to the counterclaim and a motion to
dismiss the fraud, negligent misrepresentation and deceptive trade practices counterclaims. In February 2003, the Company has learned that Data Return Corporation filed for bankruptcy protection under Chapter 11 in the United States Bankruptcy
Court, District of Massachusetts. At this time, it is impossible to determine whether the Company will be able to recover any amounts from Data Return Corporation even if the Company is successful in pursuing its claims.



The Company is involved from time to time, in the ordinary course of its business, in various
litigation relating to the conduct of its business. The Company believes that these other litigation matters will not have a material adverse effect on its consolidated financial position, results of operations or cash flows.



|Item 2. |  | Changes in Securities and Use of Proceeds
|------- |  | -----------------------------------------



None



|Item 3. |  | Defaults upon Senior Securities
|------- |  | -------------------------------



None



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



None.



|Item 5. |  | Other Information
|------- |  | -----------------



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CYBERGUARD CORPORATION

September 30, 2003

(Dollars in thousands, except per share data)



Patrick J. Clawson was appointed a member of the Board effective October 14, 2003. Scott. J. Hammack has resigned as the CEO and Chairman of
the Board, and will leave the Company in January 2004. Patrick J. Clawson will assume the position of CEO and Chairman of the Board in January 2004.



|Item 6. |  | Exhibits and Reports on Form 8-K
|------- |  | --------------------------------



(a) Exhibits:



|Exhibit No. |  | Exhibit Description
|----------- |  | -------------------
|            |  |                    
|31.01       |  |                   
|            |  |                    
|31.02       |  |                   
|            |  |                    
|32.01       |  |                   
|            |  |                    
|32.02       |  |                   



(b)
Reports filed on Form 8-K during the quarter ended September 30, 2003:



During the quarter ended September 30, 2003, the Company filed two Current Reports on Form 8-K: on July 11, 2003, Item 5 and Item 7 and on August 12, 2003, Item 7 and Item 12. The July 11, 2003 filing was in connection with the settlement
of the class action lawsuit and the August 12, 2003 filing was in connection with the results of operations for the fiscal year ended June 30, 2003.



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SIGNATURES



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



|Date: November 14, 2003 |  |  |  | CYBERGUARD CORPORATION
|----------------------- |  |  |  | ----------------------
|                        |  |  |  |                       
|                        |  |  |  |                       
|                        |  |  |  |                       
|                        |  |  |  |                       
|                        |  |  |  |                       
|                        |  |  |  |                       
|                        |  |  |  |                       
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EXHIBIT INDEX



|EXHIBIT NO. |  | DESCRIPTION
|----------- |  | -----------
|            |  |            
|31.01       |  |           
|            |  |            
|31.02       |  |           
|            |  |            
|32.01       |  |           
|            |  |            
|32.02       |  | 