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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



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FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS
PURSUANT TO SECTIONS 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

|   |  |                                                                                         
|-- |  | ----------------------------------------------------------------------------------------
|x  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|   |  | For the fiscal year ended June 30, 2002                                                 
|  
|OR
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number 0-24544
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 Boulevard, Suite 200,Fort Lauderdale, Florida |  | 33309                               
|(Address of Principal Executive Offices)                           |  | (Zip Code)                          

Registrants telephone number, including area code: (954) 958-3900

Securities Registered Pursuant to Section 12(b) of the Act: None

Securities Registered Pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share

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

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

The aggregate market value of voting stock held by non-affiliates of the
Registrant was approximately $35,375,373 (Calculated by excluding all shares
that may be deemed to be beneficially owned by executive officers, directors
and greater than 10% shareholders of the Registrant, without conceding that all
such persons are affiliates of the registrant for purpose of the federal
securities laws), and computed by reference to the last sales price of
Registrants Common stock on September 26, 2002).

As of September 26,
2002, 19,251,660 shares of the Registrants
Common Stock, par value $.01 per share were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Definitive Proxy Statement to be issued in connection with
the Registrants 2002 Annual Meeting of Shareholders (incorporated in Part III
to the extent provided in Items 10,11, 12 and 13 hereof).

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CyberGuard Corporation
Form 10-K
For the Fiscal Year Ended June 30, 2002
Table of Contents

|                           |                                                                                               |  |  |    | 
|-------------------------- | --------------------------------------------------------------------------------------------- |  |  | -- | 
|Forward-Looking Statements |                                                                                               |  |  |   
|Part I:                    |                                                                                               |  |  |   
|                           | Item 1: Business                                                                              |  |  | 4  | 
|                           | Item 2: Properties                                                                            |  |  | 16 | 
|                           | Item 3: Legal Proceedings                                                                     |  |  | 17 | 
|                           | Item 4: Submission of Matters to a Vote of Security Holders                                   |  |  | 18 | 
|Part II:                   |                                                                                               |  |  |   
|                           | Item 5: Market for Registrants Common Equity and Related Stockholder Matters                 |  |  | 19 | 
|                           | Item 6: Selected Financial Data                                                               |  |  | 20 | 
|                           | Item 7: Managements Discussion and Analysis of Financial Condition and Results of Operations |  |  | 22 | 
|                           | Item 7A: Quantitative and Qualitative Disclosure about Market Risk                            |  |  | 34 | 
|                           | Item 8: Financial Statements and Supplementary Data                                           |  |  | 35 | 
|                           | Item 9: Changes In and Disagreements with Accountants on Accounting and Financial Disclosures |  |  |    | 
|Part III:                  |                                                                                               |  |  |   
|                           | Item 10: Directors and Executive Officers of the Registrant                                   |  |  | 35 | 
|                           | Item 11: Executive Compensation                                                               |  |  | 35 | 
|                           | Item 12: Security Ownership of Certain Beneficial Owners and Management                       |  |  | 35 | 
|                           | Item 13: Certain Relationships and Related Transactions                                       |  |  | 35 | 
|Part IV:                   |                                                                                               |  |  |   
|                           | Item 14: Exhibits, Financial Statement Schedules and Reports on Form 8-K                      |  |  | 36 | 
|                           | Signatures                                                                                    |  |  | 39 | 

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FORWARD-LOOKING STATEMENTS

Statements regarding future products, future prospects, future
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-K that are not purely historical are forward-looking
statements.

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 upon
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; the slowing U.S.
economy; changes in customer needs resulting from economic conditions;
dependence on information systems; 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; the events of September 11, 2001, and its repercussions. In
addition, certain other factors may 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 within the Company; the
assembly of a new management team for CyberGuard; and the outcome of a class
action lawsuit against the Company and former executive officers and directors
of 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 its products
current. The Company believes that its ability to generate adequate cash flow
from operations will be critical to its future.

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PART I

ITEM 1. BUSINESS

Overview

CyberGuard Corporation (CyberGuard or the Company) is a leading
provider of network security solutions designed to protect enterprises that use
the Internet for electronic commerce and secure communication (customers
include Fortune 1000 companies, major financial institutions, and government
agencies worldwide). The Companys CyberGuard® appliance, which includes
firewall and VPN (Virtual Private Network), provides a level of security,
features and availability that the Company believes is not matched in the
industry. Through a combination of proprietary and third-party technology, the
Company provides a full suite of products and services that are designed to
protect the integrity of electronic data and customer applications from
unauthorized individuals and digital thieves.

CyberGuard delivers appliance solutions that, we believe, are high
performance, easy to install and cost effective. The appliance is sold to end
users directly and indirectly by direct sales and resellers worldwide in over
thirty countries.

The Company was incorporated in 1994 in connection with a spin-off from
Harris Corporation. The Company produced computers for the real-time computing
market as well as the CyberGuard firewall for the secure computing market. The
Company changed its name from Harris Computer Systems Corporation in June 1996
following a sale of the Companys real-time computer business. The Company has
two subsidiaries, CyberGuard Europe Ltd. and CYBG Consultants, Inc.

Industry Background

Network security has historically been a requisite for government and
businesses in security-sensitive industries such as healthcare, financial
services, insurance, and telecommunications. Businesses in these industries
historically maintained a secure network environment by isolating their
networks from others and allowing only authorized users to connect to their
privately managed networks.

With the increased growth and reliability of the Internet, businesses are
now able to use the Internet as a more cost-effective alternative to their
existing private network. These businesses are also shifting corporate data
dissemination, which traditionally occurred via call centers, facsimile, and/or
postal mail, to the Internet. These systems can provide a more customized
interface to their customers, business partners, or employees. As this
migration continues, more business sensitive data and systems are exposed to a
potentially hostile environment, hence the growing need for network security.

As worldwide Internet usage continues to escalate, so do information
security breaches. According to www.cert.org, an Internet site that tracks
security breaches, more system and network vulnerabilities were discovered in
2001 than in the entire four preceding years. Attrition.org, another
organization that tracks security breaches, reported the number of Web site
hacks grew from 245 in 1998 to 22,379 during 2001.

Following the events of September 11, 2001, much greater attention has
been paid to the possibility of a cyber attack as the next wave of terrorism.
As a result, the U.S. federal government has begun encouraging both government
and private sectors to take information assurance more seriously. In February
2002, Richard A. Clarke, special advisor to the President for cyberspace
security, said, The vulnerabilities are too great for someone not to exploit
them and make the Nimda and Code Red attacks look like small problems.
Information security has been seen as a way of saving money, and it is, but not
as much money as we have been saving by shortchanging security.

NSTISSP 11, the National Information Assurance Acquisition Policy, is a
means for the U.S. Government to standardize information assurance purchasing
by government agencies. According to the policy, by 1 July 2002, the
acquisition of all information assurance IT products to be used on systems
entering, processing, storing, displaying, or transmitting national security
information ... shall be limited only to those which have been evaluated and
validated in accordance with the criteria, schemes, or programs specified.
Listed first is the International Common Criteria for Information Security
Technology Evaluation Mutual Recognition Arrangement. CyberGuards line of
appliances holds Common Criteria Augmented Evaluation Assurance

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Level 4 Certification (EAL4+). In the interest of national cyber security,
Richard Clarke has suggested that the requirement to purchase evaluated and
validated information security products be extended to apply to commercial
sector information assurance purchases.

The following elements are principal means for protecting organizations from
digital mischief. These elements require substantial integration and
interoperability to smoothly implement an organizations security policy.

Security Policy. Security products are not effective unless they follow a
well-thought-out enterprise security policy. Creating a policy requires
cooperation between information technology staffers, business unit managers and
senior executives. Generally, a policy should follow one of two philosophies.
The first is, That which is not expressly prohibited is permitted. The second
is, That which is not expressly permitted is prohibited. The former is less
intrusive but will not provide maximum protection. The latter requires
discussion and support from management because it affects the workflow of the
entire organizationall the way down to rules for locking offices and filing
cabinets and discarding waste paper. The use of such security technology as a
firewall generally is associated with the second philosophy.

LAN Security. Popular local-area network (LAN) operating system software
provides various security optionsmany of which are seldom used. Network
managers can immediately improve protection by implementing security features
such as login restrictions on specific workstations, days of the week and hours
of the day. More stringent password policies also create extra barriers, such
as increasing the minimum password length, requiring that passwords include a
combination of numbers and letters, and forcing regular password changes.
Rigorous application of LAN security features can bolster protection from
internal breaches.

Firewalls. Firewalls provide access control. They usually are aimed at
preventing external security breaches but can also provide additional internal
security for corporate intranets. Firewalls are a combination of software and
hardware, usually consisting of a fast workstation located outside the LAN but
inside the router link to the Internet. To be effective, all network traffic
must pass through the firewall, whether going to the outside world or entering
the LAN. The firewall permits only authorized traffic to pass either way and
must be impervious to unauthorized penetration.

Premium firewalls run on special versions of the UNIX® operating system
although Windows NT®-based versions are also popular for less-rigorous security
environments. Some firewalls also support ancillary special features such as
Web URL filtering or virus scanning. Firewall features and the underlying
operating system of the firewall generally determine the level of security that
a firewall provides. Presented below is the security spectrum of firewall
products available today.

[CHART]

Generally, these technologies build on each other so that the most secure
technologies can also perform the functions of the less secure ones and,
depending on price and other factors, can serve markets for such products.
CyberGuard has developed its products to emphasize stringent security and thus
falls to the far right of this diagram.

Traditionally, when businesses have selected a firewall solution, they
have had to choose between high security and high performance. CyberGuards
approach to appliance technology is to offer extremely high

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security as well as high-speed throughput and substantial numbers of
simultaneous connections. CyberGuards line of appliances allows purchasers
to choose based on the level of performance they require for their particular
business environment.

Encryption. Encryption is a data-scrambling technique that prevents
information from being read by unauthorized people. It is used to protect data
packets during transmission from one point to another. Encryption can be
implemented in two ways: from the PC that originates the data or from the
server or Internet connection device that passes the data outside the LAN.
Protected data is decrypted by a reciprocating destination LAN server or PC.
Digital key technology is a common means of implementing encryption. A digital
key bearing a secret value is used to encrypt data. Decryption can occur only
by someone who possesses the appropriate decryption key. Systems using the same
key for encryption and decryption are referred to as symmetric key encryption
systems, whereas those that use a different key for decryption than encryption
are referred to as asymmetric or public-key encryption systems. Encryption is
a common security technique used to protect virtual private networks (VPN)
and standard intranets.

Anti-Virus. A computer virus modifies programs and data, sometimes in an
innocuous manner and sometimes with malicious intent. Some viruses can erase
applications and data from systems or merely act as electronic graffiti. Any
form of computer virus, regardless of its intent, increases costs and decreases
productivity. Anti-virus software can be run from individual workstations or
from a network server or firewall. This software scans incoming files and
attachments to E-mail messages to protect servers, PCs and LANs from infection.

Identification and Authentication. On the Internet, no one can truly see
who is using the system. Digital identification technology is used to identify
who you are before you start using an information system. Authentication is the
means for proving to the system that you actually are the person you claim to
be. This is similar to the process of signing a check, then showing a drivers
license and a major credit card to a store clerk. Digital identification and
authentication employ passwords, keys, physical tokens, badges and smart
cardseven fingerprints, retinal scans or voiceprints (biometric
identification) in advanced systems. Digital identification and authentication
are particularly important for securing electronic commerce, which mostly
operates outside the protection of a corporate intranets security
infrastructure.

The CyberGuard Solution

The Company produces a family of appliances that all utilize a UNIX
operating system obtained from Caldera International, Inc. CyberGuard has
modified the Caldera SCO® UnixWare® operating system to remove penetration
vulnerabilities that are common in UNIX platforms.

The Companys secure operating system and secure networking software
technologies allow CyberGuard to position its product suite to address the
broad range of customer requirements in the commercial network security market.
Generically speaking, a firewall consists of the hardware, a firewall
application, an operating system and networking software, each playing an
important role in the receipt and processing of data through the firewall. In
competitive network security products, only the firewall application has been
designed to resist penetration by an attacker, leaving the operating system and
network software unsecured. Therefore, an attacker can penetrate a competitive
firewall through the unsecured operating system or networking software.
CyberGuards appliance uses a secure operating system and secure networking
software to prevent network penetration by requiring network communication to
pass through the firewall application.

The graphic presentation below depicts the three major components of a
firewall system and demonstrates the fundamental security deficiency of an
application-only solution as compared to the CyberGuard appliance.

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[CHART]

CyberGuards secure operating system and secure networking software are
based on multilevel security (MLS); that is, they restrict access to
information based on the sensitivity of the information and the access
authorization of system users. In an MLS system, a user cannot read data that
has been labeled at a level more sensitive than the security level that person
has been given and cannot create or modify data having a different security
label. The operating system and programs reside at a protected level that
cannot be read or modified by network users.

The Companys secure operating system and networking software are designed
to meet the United States TCSEC/NCSC (Trusted Computer System Evaluation
Criteria/National Computer Security Center (NCSC)) criteria at a B1 level.
The NCSC assurance levels for operating systems range from D (systems with
minimal security) to A1 (systems with assured security). Certain agencies of
the United States government have incorporated the NCSC ratings into their
procurement requirements, and commercial users, while not having specific
NCSC-rating requirements, often look to an NCSC rating as an indication of the
products proven reliability. These components have also been successfully
evaluated by the Centre dElectronique de lArmement (CELAR) in France and
have been awarded an E3 evaluation level in the United Kingdom and Australia
against the United Kingdoms Information Technology Security Evaluation
Criteria (ITSEC) predefined assurance scale. On this scale, E (evaluation
level) is followed by a number ranging from 1 to 6, where 6 represents the
highest evaluation level. In December of 2000, the Company completed its
Common Criteria evaluation for its operating system and networking software and
was awarded the EAL4 evaluation level. EAL (Evaluation Assurance Level)
followed by a number ranging from 1 to 7 denotes the assurance level of the
product on the Common Criterias predefined assurance scale, where 7 represents
the highest evaluation assurance level. EAL4 represents assurance on a
methodically designed, tested, and reviewed product. In April of 2002, the
Company was awarded augmented EAL4 certification (EAL4+) for addition of the
FLR (flaw remediation) module. It also received its latest audit certificate
for Common Criteria Assurance Maintenance.

In July 2002, the Company completed FIPS 140-1 Level 1 evaluation for its
cryptographic module. Five algorithms were certified; DES Modes of Operation
and Triple DES Modes of Operation in April 2002; Advanced Encryption Standard
(AES) Algorithm in May 2002; and Secure Hash Standard (SHS) and Digital
Signature Algorithm (DSA) in July 2002. FIPS 140-1 certification is pending
approval by the National Institute of Standards and Technology of the United
States of America (NIST).

In July 2002, the Companys appliance line was recognized by ICSA Labs, a
division of TruSecure Corporation, as having achieved ICSA Labs Firewall
Certification.

The Companys CyberGuard appliance also meets the compliance standards of
the Internet Protocol Security Standard (IPSec). IPSec is a framework of open
standards for ensuring private communications over public networks like the
Internet. Based on standards developed by the Internet Engineering Task Force
(IETF) IP Security Working Group, IPSec is an industry-driven standard that
ensures confidentiality, integrity, and authenticity on an IP network. IPSec is
a key component of this standards-based, flexible solution for deploying a
network-wide security policy.

In addition to enhanced operating system and network security,
CyberGuards appliances have been built on the Companys legacy of providing
high-performance, real-time computing systems. Therefore, the

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Companys CyberGuard appliance also addresses the high performance end of
the commercial network security market because the underlying operating system
and networking software were designed for demanding security environments. The
Companys secure operating system is designed to function as a high
performance, real-time operating system able to process high levels of
throughput without time-consuming failures. This same operating system
technology underlies the Companys secure networking software and firewall
technology.

The CyberGuard appliance product is the basis for the Companys ability to
offer a complete suite of enterprise-wide security products including mobile
security applications, secure database applications, and network access control
filters.

The Companys appliance system is currently using Calderas SCO UnixWare
2.1.3. The Company is currently transitioning its firewall technology to be
multiplatform capable. This will enhance the Companys ability to take
advantage of advancements in operating system technology as well as third-party
products.

PRODUCTS AND SERVICES

Products

CyberGuard produces a line of premium appliances built on technology
developed when the Company was originally a division of Harris Corporation. The
technology is based on an operating system (OS) that was first evaluated to
meet OS security features outlined by the TCSEC/NCSC. The result was a trusted
secure operating system that uses layers of protection or multilevel security
(MLS) to provide the high level of network protection required by such
customers as the U.S. and European governments, who need to safeguard
classified, national security information.

Todays product offerings continue to earn the highest independent
security certifications and evaluations-most notablyEAL4+. CyberGuards
products are designed for high-end customers who require high levels of
security and are serious about their security needs. Potential customers could
include a governmental agency protecting sensitive classified information, a
worldwide financial institution securing customers private financial data and
transactions, an international communications corporation safeguarding its
headquarters and operations around the globe, or a Global 2000 company whose
dependence on electronic commerce continues to grow at the same time Internet
security dangers increase.

After introducing a line of premium appliances in 2000  the KS, SL and FS
appliances, which integrate high security, high performance and manageability
to meet various customer bandwidth requirements and operating environments  in
2001, CyberGuard introduced and began shipping an integrated VPN with its
appliances.

While firewalls protect the information within a secured network, VPNs use
mathematical encryption to protect data as it moves across an unprotected
network, such as the Internet. VPNs encrypt data as it leaves one point and
then decrypt it at the receiving end.

Prior to 2001, the Company offered a third-party VPN solution to
customers. As the need for secure connections for remote access points and,
most notably, mobile workers and telecommuters has grown along with Internet
usage, demand for VPNs has grown accordingly. The Company recognized the demand
both from its existing customer base and the overall market for an integrated
VPN solution and responded to that demand with an integrated solution.

Additionally, in 2001, the Company made the deliberate decision to
transition from a direct sales model in North America to a channel sales model
to replicate the successful distribution strategy in EMEA (Europe-Middle
East-Africa) and Asia. To support that strategy, the Company decided to develop
and introduce an entry-level appliance model. The LX model was designed with a
partial complement of proxies, lesser level of performance, and a simplified
user interface so as to be suitable for a less sophisticated end user. While
the LX is an economic, compact version of the other appliances, nonetheless it
carries EAL4+certification, which makes it suitable for environments requiring
very high security.

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CyberGuards appliances include the following features and attributes in
varying combinations based on the specific products or customer requirements:



| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | PACKET FILTERING.CyberGuard uses packet-filtering technology to allow
the firewall to expressly permit or deny connections using criteria based
upon source and destination host or network and the type of network service
being requested and the time of day or day of week.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | SECURITY AUDITING AND ALARMS.CyberGuards appliance technology
incorporates built-in auditing and alarm functions designed to permit
administrators to review a chronological record of dynamic system activities
and allow the reconstruction of security sensitive activities. CyberGuards
appliance can be configured to process the security auditing information
and, in real-time, take explicit actions in response to actions deemed
security sensitive or possible attempts to attack the network or appliance.                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | APPLICATION PROXIES.CyberGuards appliance technology supports a
number of security-enhanced application proxies for many network services,
including remote login (rlogin), terminal emulation (Telnet), File
Transfer Protocol (FTP), Hypertext Transport Protocol (HTTPused with
the Internet), Secure Sockets Layer (SSL) security, Network News Transport
Protocol (NNTP), Simple Mail Transport Protocol (SMTP), X-Window System
(X11), Lightweight Directory Access Protocol (LDAP), Server Message
Block (SMB), Load Equalizer (LDE), Lotus Notes® (Notes), Port Guard
intercept (Port Guard), Post Office Protocol Version 3 (POP3), Oracle
SQL*Net for secure connection to a database host (SQL*Net), Proxy-Writer
for custom proxies (Proxy-Writer), RealAudio protocol proxy
(RealAudio), and Gopher protocol (Gopher).                                                  
|
| | SECURE REMOTE ADMINISTRATION.CyberGuards appliance supports the
ability to remotely monitor and administer an appliance from a Network
Operations Center. Using this remote administration capability, a system
administrator can manage a CyberGuard appliance from a remote site as if he
or she were physically located with the appliance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | CENTRAL MANAGEMENT.CyberGuards appliance technology provides the
ability to centrally manage and monitor multiple remote CyberGuard
appliances. Remote, or target, appliances can be administered and monitored
individually or within groups from one central station, the firewall
manager. To ensure constant availability, CyberGuard offers central
management fail-over, a mechanism that allows a back-up firewall manager to
take over management duties for the primary firewall manager when the
primary manager is not available (during system maintenance or a power
outage, for example). The back-up manager can be located anywhere in the
world remote from the primary appliance manager.                                                                                                                                                                                                                 
|
| | DYNAMIC NETWORK ADDRESS TRANSLATION.A CyberGuard appliance can be
configured to translate all internal addresses to the appliances network
address. From the Internet, the appliance appears to be the only machine
connected, reducing the risk of possible penetration attacks against the
internal network.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|
| | STATIC NETWORK ADDRESS TRANSLATION.CyberGuard appliances support the
ability to map internal private network addresses to public network
addresses. This allows machines with illegal or private network addresses to
be accessed via a public network address different from that of the
appliance.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|
| | GRAPHICAL USER INTERFACE.CyberGuards appliances provide an
OSF/Motif-based graphical user interface, or GUI, designed to facilitate
system configuration and administration. The GUI is generally considered
easier to use than the traditional command-line interface.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| | SPLIT DOMAIN NAME SERVICE.The CyberGuard appliance can function as a
Domain Name Service (DNS) server. With split DNS, the network responds to
queries differently depending on their source. For example, responses to
requests from the Internet might contain only CyberGuard appliance
information; responses from internal requests might contain a complete list
of hosts.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|
| | VIRTUAL PRIVATE NETWORKING.CyberGuard now offers an integrated IPSec
VPN solution in all of its line of appliances. The technology utilizes SSH®
VPN technology. It features a single management interface that the Company
believes makes setup and use easy. It provides support for
gateway-to-gateway and gateway-to-client VPN configurations; support for
X.509 certificates and use of certificates with IPSec and IKE (Internet Key
Exchange); capability for VPN access through Network Address Translation
(NAT) to remote private networks; access control for all traffic; central
administration, monitoring and logging capabilities; support for a wide
range of cryptographic algorithms (e.g., 3DES, DES, AES, Cast-128); and
optional cryptographic hardware acceleration support. CyberGuard offers a
SafeNet VPN client option with its appliances. A limited number is included
with the purchase of a

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | CyberGuard firewall/VPN appliance. Additional VPN clients are available for
purchase. CyberGuards VPN solution is interoperable with a number of other
clients, including the Microsoft® Windows® XP VPN client. To optimize VPN
performance, the Company offers an optional hardware accelerator.                                                                                                                                                                                                                                                                                                                                                                                                                  
|
| | LINK AGGREGATION.CyberGuard provides a feature called link aggregation
(LAG) that will combine multiple physical network interface controller ports
into one logical network interface. This feature offers two benefits. The
first is an increase in the overall reliability of the network gained from
redundancy. In this instance, two physical ports are configured beneath one
LAG device, and one port will be active while the other will be a hot
standby. The second benefit is that link aggregation can also be used to
provide higher throughput. In this case, multiple ports are configured under
a single LAG device, and the LAG driver will optimize port utilization by
balancing the traffic load.
|
| | AUTOMATIC SYSTEM UPDATE.CyberGuards appliance includes a feature that
allows an administrator to update the appliance automatically with necessary
patches via a remote download. This feature is especially useful for very
large appliance installations because the administrator is able to implement
patches to large numbers of firewalls from a single central location.                                                                                                                                                                                                                                                                                                                                      
|
| | NETWORK TIME PROTOCOL SUPPORT.CyberGuard appliances provide a means
to update time automatically via a network. Time synchronized via a trusted
Network Time Protocol (NTP) server is required to insure that audit data can
be accurately correlated. This feature is especially important to
installations with large numbers of appliances.                                                                                                                                                                                                                                                                                                                                                                        
|
| | AUTOMATED AUDIT LOG ARCHIVING.The CyberGuard appliance offers a
feature for automatically archiving audit logs to a remote archive server.
The log files can be encrypted to insure confidentiality. This feature is
especially important with the increase in the amount of audit information
that is directly proportional to data throughput.                                                                                                                                                                                                                                                                                                                                                                      
|
| | HIGH AVAILABILITY.CyberGuards appliances support an optional high
availability configuration that combines two appliances to operate as a
single logical unit. If there is a disruption in network connectivity or if
the primary appliance fails, the secondary appliance is designed to
automatically take over to provide nearly continuous network connectivity.
All configuration changes are automatically synchronized between the
appliances in the high availability pair. For critical connections, such as
those to electronic commerce sites, this high availability configuration
minimizes the risk of lost network connectivity.                                                                      

THIRD-PARTY PRODUCTS AND SERVICES

Through strategic alliances, the Company offers other network security
products for use with CyberGuards appliances. These products include:

URL BLOCKING AND FILTERING.This software monitors and controls access
to non-business-related Web sites such as pornography, gambling, on-line
shopping, stock trading, job searching, sports, pay-to-surf sites and other
sites that an employer may wish to block. CyberGuards appliance integrates
with Websense Enterprise v4, allowing businesses to more effectively monitor,
report and manage employee activity on the Internet. As personal use of the
Internet increases in the work setting, more organizations are exploring
solutions to limit inappropriate use of the Internet. An integrated solution
enables businesses to accomplish that by establishing acceptable parameters on
personal Internet use.

TOKEN AUTHENTICATION PRODUCTS.CyberGuard offers a number of third-party
token authentication devices, including those offered through alliances with
Symantec Corporation and RSA Security, Inc., among others. Token authentication
devices provide an alternative to the use of static passwords for user
authentication, resulting in reduced likelihood of system penetration through
the reuse of an old password.

ANTI-VIRUS.F-Secure Anti-VirusTM for Firewalls, Windows version, is a
CVP (Content Vectoring Protocol) server that provides a means for detection and
disinfection of viruses and malicious code before they traverse the CyberGuard
appliance. Key features of this product that enhance protection and improve
performance include the use of multiple scanning engines, caching of recent
scan results, automatic database updates, and transparency to end users.

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CENTRALIZED MONITORING AND REPORTING.In 2001, the Company introduced an
advanced reporting function in conjunction with Soft-ex, Inc. The product,
which is private-labeled CSMART (Centralized Solution for Monitoring,
Auditing, Reporting and Tracking), allows businesses to implement an Internet
usage monitoring and control methodology similar to communications
accounting. CyberGuards CSMART is a simple, enterprise-wide solution that
provides information that enables network administrators to decide what is
excessive or inappropriate Internet use, establish acceptable boundaries for
Internet activity, and plan for and allocate costs. This allows companies to
take full advantage of Internet benefits while minimizing risks.

SERVICES

CyberGuard offers a range of services to customers who have its appliances
and to customers who require consulting or professional services. In January
2001, Information Securitymagazine published the results of a survey of more
than 2,000 readers. Among companies grouped by size, CyberGuard scored highest
overall in customer satisfaction. Among the largest companies, that is, those
with more than 50,000 employees, CyberGuard received a perfect score of 5.
Among government users, CyberGuard received the highest overall score.

SUPPORT SERVICES.CyberGuard believes that service can be a key
differentiator for the Company. Our worldwide customer support center provides
help on the phone and online around the clock. Support staff are highly
trained and qualified, level-2 experienced security professionals. Many of
them currently hold CISSP certification, one of the highest levels of
certifications a security professional can achieve.

With the globalization of the economy and the connectivity made possible
by the Internet, many large organizations no longer operate regionally or
nationally. Instead those organizations have begun to operate globally, either
independently or as part of a large multinational corporate entity. CyberGuard
has a strategic agreement with a major international service provider to expand
its worldwide support services, adding onsite and hardware support around the
clock, around the globe, and in multiple languages.

TRAINING AND EDUCATION.The Company offers a variety of courses to help
customers make the most of their CyberGuard appliance product. The courses
include basic and advanced training and are offered at CyberGuards corporate
headquarters in Ft. Lauderdale, Florida; at its subsidiary headquarters in
London; and at various reseller locations. Training courses may also be
offered at customer locations as appropriate.

Additionally, the Company has developed modular CyberGuard sales
professional training designed to equip the sales forceboth internal and
channelto better sell CyberGuard products against its competition.

As customers and resellers become more knowledgeable about the product,
they also become better advocates for the technology and the CyberGuard
advantages. Since word of mouth is one of the most effective forms of
advertising, the Company believes that a successful strategy for growing the
Company must include an emphasis on education and training.

Recognizing that the educated consumer is the Companys most valued
customer, CyberGuard is developing a certification track for its suite of
network security solutions. The courses involved are the CSF (CyberGuard
Security Foundations), CFSA (CyberGuard Firewall Security Administrator), and
CFSO (CyberGuard Firewall Security Officer). These offerings will create a
Network Security Certification to rival Check Point, Cisco and SANs
certifications.

These programs will be available for instructor-led delivery by select
channel solution providers throughout the world and via an upcoming online
university enabling administrators to become certified without having to
physically attend a course.

PROFESSIONAL SERVICES.Leveraging its security expertise and experience,
CyberGuard markets several specific types of consulting services relating to,
among others, penetration testing; vulnerability assessment; Internet gateway
security and technical evaluation; system security; corporate data security
policies and management control; network security policy and management
control; Internet security policy and management controls; network security
analysis; and information security training.

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PRODUCT DEVELOPMENT

The following table shows the significant products and product
enhancements that the Company introduced during the last two quarters of fiscal
year 2002 and will introduce during the first two quarters of fiscal year 2003.

|                         |  |              |  |                                                                                                                                  
|------------------------ |  | ------------ |  | ---------------------------------------------------------------------------------------------------------------------------------
|PRODUCT                  |  | INTRODUCTION |  | DESCRIPTION                                                                                                                      
|                         |  |              |  |                                                                                                                                  
|FS Hardware Upgrade      |  | Q3 2002      |  | Transition from 1st generation hardware platform to 2nd                                                                          
|Firewall Software Update |  | Q4 2002      |  | GUI enhancement, Save and Restore performance
enhancement, and resolution of known issues                                        
|LX Introduction          |  | Q4 2002      |  | New set-top appliance designed for small- and medium-sized enterprises                                                           
|5.1                      |  | Q2 2003      |  | New software release for the appliance family
(LX/FS/KS/SL) that includes High Availability state
synchronization and PKI support

The expected dates of introduction in the above table are forward-looking
statements and are based on certain assumptions, including assumed levels of
staffing and capital resources and assumptions regarding contractual
arrangements with suppliers, customers or strategic allies, market conditions,
overall product development costs and related sales and marketing expenses, and
the nature of available competing and complementary technologies and products.
Should these assumptions change or prove to be inaccurate, or should the
Companys plans change due to certain unforeseen factors, the development of
such products may be delayed or discontinued.

Development of new products and features is performed by the Companys
internal engineering staff and through third-party licensing. The Company has
approximately 35 full-time employees and independent contractors devoted to
product development. The Company supplements the development staff from time to
time with contract engineers as needed to meet product demands in the market.

For the fiscal years ended June 30, 2002, June 30, 2001, and June 30,
2000, the Company spent approximately $4.7, $5.5 million, and $3.0 million,
respectively, on research and development, an equivalent of 21%, 22%, and 16%,
respectively, of total sales during such periods.

STRATEGIC ALLIANCES AND RELATIONSHIPS

CyberGuard has undertaken joint product offerings, particularly those
relating to encryption, token authentication, intrusion detection and virus
alliances for the purpose of reselling the Companys products with several
strategic partners. The Company has additional strategic resellers outside the
United Statesin Asia, the United Kingdom, Europe, Middle East and Latin
America.

CyberGuard continues to actively seek additional strategic alliances for
product development and sales and marketing purposes. The Company seeks such
alliances to continue efforts to develop additional products or enhancements to
its existing products.

CUSTOMERS AND MARKETS

CyberGuard has traditionally served very large commercial businesses for
which network security is a top priority, including government agencies,
utilities, financial institutions and a myriad of Global 2000 companies.
Today, CyberGuard customers include three Fortune 10 companies, multinational
corporations and other commercial enterprises, financial institutions, stock
exchanges, educational institutions, telecommunications companies, large
service providers and many Global 2000 companies.

In many instances, CyberGuard supplies its product to value-added
resellers (VARS), solution providers, distributors, business partners or
system integrators who ultimately sell to and support end users. In

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turn, the Company supports these reseller channels through training and
education, product collateral, marketing support, consulting and interaction
with CyberGuards direct sales force.

Current and prospective commercial customers include medium to large
domestic and multinational companies that routinely create and store
proprietary and/or highly sensitive information, which is accessible via
corporate networks including intranets and extranets. From a buyers
perspective, these customers have a higher level of security knowledge, are
educated about the importance of accreditation and are likely to consider
network security and network throughput performance as decisive factors in
their procurement decisions. The sophisticated customers that CyberGuard
products attract demand such features as full application proxies and the
capability for the firewall to dissect the packet at the application layer
before it is allowed to pass through. CyberGuard enjoys an advantage with this
group of network security purchasers.

Target markets for the Companys products include governments, financial
institutions, financial news services, insurance companies, health care
institutions, telecommunications companies and companies that market electronic
commerce applications to businesses and consumers. In addition, the Company
focuses its marketing efforts on specific vertical market sectors including
government, banking and finance, telecommunications and healthcare.

SALES, MARKETING AND DISTRIBUTION

The Company employs a worldwide sales force focused on driving sales
through our channel partners around the globe. CyberGuard has established a
range of channels to market its products in the United States and
internationally, including regional value-added distributors, VARs and systems
integrators.

CyberGuard employs three regional sales vice presidents who are
responsible, respectively, for North America, EMEA (Europe-Middle East- Africa)
and the Pacific Rim. Each regional vice president employs a team of regional
sales managers to promote channel sales through their channel partners and
direct customers in their respective regions. The sales force focuses its
sales and marketing efforts on customers and resellers in selected vertical
markets such as financial services, government, healthcare, insurance,
telecommunications and electronic commerce application providers. The Companys
sales team also includes a dedicated team of inside sales professionals as well
as technical support engineers who extend CyberGuards marketing and sales
efforts. The sales force also solicits prospective customers and provides
technical advice and support with respect to the Companys products.

Marketing activities include advertising, publishing technical and
educational articles in industry journals, participating in industry
tradeshows, product technology conferences, regional educational seminars,
direct mail, electronic mail, public and media relations, telemarketing,
on-going customer and third-party communication programs, sales training and
marketing on our Web site. As of June 30, 2002, the Company had 21 employees in
the Sales and Marketing organization. CyberGuard also generates interest in and
educates potential customers about computer and network security through
speaking engagements, contributed articles, media interviews and outreach to
industry analysts.

CyberGuard focuses its direct and indirect marketing efforts on commercial
businesses that the Company perceives to have a need for network security due
to the sensitive nature of data they collect or the potential negative impact
of computer hacking. CyberGuard addresses these markets with its direct sales
force and through indirect channels such as VARs and systems integrators who
already serve such markets. The Company also believes its products are
particularly well-suited to a spectrum of Web service providers including
internet service providers (ISP), application service providers (ASP),
managed service providers (MSP) and Internet-based retailers of subscription
products and services.

In 2001, the Company established a dedicated federal division to take
advantage of the opportunities in the government vertical market. The
specialized team focuses exclusively on meeting the needs and information
security requirements of the U.S. federal government. Outside sales efforts,
which are driven through a channel distribution model, are supported by a group
of dedicated inside sales and sales engineering professionals.

COMPETITION

The market for network security products is intensely competitive and
characterized by frequent technological change. CyberGuard believes that
competition in this market is likely to persist and intensify as demand for
network security products continues to increase.

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At the same time, the Company believes that it enjoys certain advantages
because of its high level of independently evaluated security; its firewall/VPN
appliance strategy that offers a trusted secure operating system, multilevel
security, performance and functionality; and a strong core of developers who
helped create the Companys original technology, which continues to earn
industry awards and certifications even as it evolves to meet new security
demands.

In market segments requiring the highest levels of network security,
CyberGuard competes with Secure Computing Corporation, which also offers a
firewall with a security-enhanced operating system. The Company also competes
with manufacturers such as Check Point Software Technologies Ltd., Cisco
Systems, Inc., and NetScreen. Many of these companies enjoy higher sales
volumes than CyberGuard due to their sales of lower-end firewalls and other
non-firewall products and applications.

These companies products may be considered to be alternatives to
CyberGuard. In addition, companies such as Hewlett-Packard and Sun
Microsystems, Inc. sell products with similar features and functions that could
be considered competitors of the Company. Certain companies, such as Microsoft,
now offer network-related security products that could eventually compete with
CyberGuards firewall products.

Many of CyberGuards current and potential competitors have greater name
recognition, larger installed customer bases and significantly greater
financial, technical and marketing resources. There can be no assurance that
CyberGuard can maintain its competitive position against current and potential
competitors, especially those with significantly greater financial, marketing,
service, support, technical and other competitive resources. Failure to keep
pace with rapid technology changes could result in the Companys products
becoming less valuable or obsolete. Certain of CyberGuards competitors may
determine, for strategic reasons, to consolidate, substantially lower the price
of their network security products, or bundle their products with other
products such as hardware products or other enterprise software products. The
trend toward enterprise-wide network management and security solutions may
result in a consolidation of the network management and security market  for
example, the recent acquisition of several specialized security companies by
Symantec  around a smaller number of vendors who are able to provide the
necessary software and support capabilities. In addition, current and potential
competitors have established or may establish financial or strategic
relationships among themselves with existing or potential customers, resellers
or other third parties.

CyberGuard believes that the principal competitive factors affecting the
market for computer and network security products include the products level
of security, performance and reliability, technical features including
interoperability and functionality, ease of use, capabilities, customer service
and support, integration of products, manageability of products, brand name
recognition, Company reputation, distribution channels and lower total cost of
ownership. Based on its understanding of the features of the products and
services offered by CyberGuards competitors, the Company believes that its
products currently compete favorably with respect to most of those factors.
Based on its experience and understanding of the existing network security
market, CyberGuard believes that potential purchasers of its security products
who do not differentiate between the level of security provided by competing
security products are as likely to base their purchasing decisions on price,
ease of use, or other considerations as they are to base such decisions on the
level of security provided. In circumstances where a potential purchasers
primary concern is the level of security provided by products being considered,
the Company believes that its products compete favorably. While CyberGuard
provides a low total cost of ownership product, it does not compete in the very
low-end space with a low cost product because it believes that that market is
highly commoditized and would affect the Companys margins negatively. The
Company has incorporated new ease-of-use features into its LX product line.

Additionally, CyberGuard believes that a key competitive factor in the
foreign network security market and certain domestic vertical markets is a
computer systems security rating by intelligence and other government agencies
such as the internationally recognized Common Criteria, NCSC and ITSEC. The
CyberGuard firewall is built on an integrated secure operating system and
secure networking software components that are certifiable to the B1 level by
the NCSC, rated E3 by ITSEC Certification testing in the United Kingdom and
Australia, and certified at the Common Criteria EAL4+ level, which is accepted
by 15 countries around the world. The Companys secure operating system has
also successfully completed evaluation by the ICSA, CheckMark and NSS
organizations.

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In order for the U.S. government to standardize information assurance
purchasing by government
agencies, NSTISSP 11, a National Information Assurance Acquisition Policy,
mandated that by July 1, 2002, the acquisition of all information assurance IT
products to be used on systems entering, processing, storing, displaying, or
transmitting national security information ... shall be limited only to those
which have been evaluated and validated in accordance with the criteria,
schemes, or programs specified. Listed first is the International Common
Criteria for Information Security Technology Evaluation Mutual Recognition
Arrangement. Richard Clarke, the Presidents advisor on cyber security, has
suggested that the requirement to purchase evaluated and validated
information security products may be extended to apply to commercial sector
information assurance purchases.

As a result of the policy, a number of competitive products have been or
are being evaluated. They include Borderware, Cisco PIX, Check Point, Secure
Computings Gauntlet and Sidewinder products, and Symantec Enterprise Firewall.
It is important to note that a vendor may choose which portions of its firewall
technology to have evaluated (as specified in the Security Target document as
the Target of Evaluation or TOE). When those elements of a firewall that are
outside the scope of the TOE are utilized, the firewall does not, in fact, have
an EAL4 level of certification. In each instance where TOEs are compared, the
number of features and functions in the CyberGuard firewall that are within the
scope of the EAL4 evaluation exceed those of competitive evaluated products.

In 2002, CyberGuard achieved the EAL4+ level of certification as a result
of its enrollment in the Common Criteria Assurance Maintenance program.
CyberGuard is the only firewall provider to be enrolled in an ongoing assurance
maintenance program, which is a process of ongoing evaluation to ensure that
upgrades and enhancements to the originally certified technology retain their
certification. It is customary for vendors to periodically release patches,
when a change is made to the product. When a change is made, the product is no
longer the same as the original product that was certified. Without the ongoing
evaluation that enrollment in assurance maintenance guarantees, a product that
has been patched or changed in any way loses its original certification.

Additionally, CyberGuard currently has a history of no CERT alerts or
publicly reported vulnerabilities. Over the past few years various security
vulnerabilities have been discovered in many of our competitors firewall
products. Many of these exploits have been publicly documented by highly
respected security organizations. Key organizations that track computer
security vulnerabilities include CERT (the Computer Emergency Response Center
at Carnegie Mellon) http://www.cert.org; CIAC (the Computer Incident Advisory
Capability at the US Department of Energy) http://www.ciac.org; BugTraq (a
moderated mailing list and vulnerability database published by
SecurityFocus.com) http://www.securityfocus.com; and X-Force (a Computer
Threats and Vulnerabilities Database maintained by Internet Security Systems)
http://xforce.iss.net. A central point for vulnerability searching is Mitre
Corporations Common Vulnerabilities and Exposures or CVE at
http://cve.mitre.org. Listing here usually indicates that a vendor acknowledges
awareness of reported problem. Each of these organizations distributes their
findings in the form of vulnerability reports, vendor notes, advisories and
incident reports. At this time we are aware of no documented vulnerability on
the CyberGuard firewall in any of these databases.

Patents and Proprietary Technology

The Company relies upon license agreements with customers; trademark,
copyright and trade secret laws; employee conflict of interest and third-party
non-disclosure agreements and other methods to protect the trade secrets,
proprietary know-how and other proprietary rights on which the Companys
business depends. There can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for any breach, or that
the Companys trade secrets will not otherwise become known to or independently
developed by competitors. The Company has no pending patent applications to
cover any aspects of its technology. The Company has received trademark
registration in the United States, Canada and numerous other countries for its
CyberGuard® firewall mark and its CyberGuard logo.

Various companies hold patents, copyrights, and other intellectual
property rights covering a variety of competing products and processes. We have
from time to time received, and may in the future receive, communications from
third parties claiming that we may be infringing certain of such parties
patents and/or other intellectual property rights. The Company may be unable
to avoid infringement of third party intellectual rights and may have to obtain
a license, defend an infringement action, or challenge the validity of another
partys intellectual property rights in court. Intellectual property
litigation is costly and time consuming, and

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the Company may be unable to prevail in any such litigation or devote
sufficient resources to even pursue such litigation. A license may be
unavailable on terms and conditions acceptable to the Company, if at all. If
the Company does not obtain a license under another partys intellectual
property rights and if it were found liable for infringement, the Company may
be liable for significant money damages, may encounter significant delays in
bringing products to market, or may be precluded from participating in the
manufacture, use, or sale of products requiring such licenses. Any allegation
of infringement, infringement claim or other litigation against or by us could
have a material adverse effect on our results of operations and financial
condition.

Government Regulation

The Companys security products are subject to export restrictions
administered by the U.S. Department of Commerce. Export controls on
cryptographic products permit the export of the Companys encryption products
outside the U.S. only with the required level of export license or through an
export license exception. Although to date the Company has been able to secure
all required U.S. export licenses and license exceptions, there can be no
assurance that the Company will continue to be able to secure such licenses or
exceptions in the future. The effect of these regulations is to create delays
in the introduction of the Companys products in international markets, and, in
some cases, to prohibit them altogether.

There are currently few laws or regulations directly applicable to access
to or commerce on the Internet. Additional laws and regulations covering issues
such as privacy, pricing and characteristics and quality of products and
services could be adopted with respect to the Internet. The adoption of
additional laws or regulations may decrease the growth of the Internet, which
could, in turn, decrease the demand for the Companys products and increase the
Companys cost of doing business or otherwise have an adverse effect on the
Companys business, operating results or financial condition.

Employees

On June 30, 2002, the Company employed 106 employees through its Fort
Lauderdale headquarters, and its field offices in the United States and abroad.
The Company also utilizes the services of four contract engineers on a
temporary basis. All employees and contract engineers are bound by agreements
containing confidentiality and conflict of interest provisions.

CyberGuards future success will depend in significant part on the continued
service of its key technical, sales and senior management personnel.
Competition for such personnel is intense and there can be no assurance that
CyberGuard can retain its key managerial, sales and technical employees, or
that it can attract, assimilate or retain other highly qualified technical,
sales and managerial personnel in the future. None of CyberGuards employees is
represented by a labor union. CyberGuard has not experienced any work stoppages
and considers its relations with its employees to be good.

ITEM 2. PROPERTIES

The Companys principal administrative, sales and marketing, development,
engineering, production and support facility is located in Fort Lauderdale,
Florida, and consists of approximately 26,000 square feet of leased office
space. The lease on the facility expires on June 30, 2004. The Company has the
right to sublease the premises. Additionally, the Company maintains a marketing
and sales office located in the United Kingdom, which also functions as the
administrative office for the Companys subsidiary, CyberGuard Europe Ltd.

The Company leases its office locations in the United States and abroad.
CyberGuard believes that its existing facilities are adequate for its current
needs and additional space will be available at current market rates as
required in the future.

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ITEM 3. LEGAL PROCEEDINGS

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.

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 notified its insurance carrier of the
existence of the lawsuit, and the carrier has sent the Company a reservation of
rights letter. 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. The Companys
consolidated financial statements do not include any adjustments related to
these matters.

The Company is aware that on January 30, 2002, the SEC filed an
enforcement action in the United States District Court, Southern District of
Florida against CyberGuards former Chief Executive Officer and Chairman of
CyberGuards Board of Directors, Robert L. Carberry; CyberGuards former Chief
Financial Officer and Vice President of North American Sales and current Vice
President of Business Development, Patrick O. Wheeler; and CyberGuards former
Controller, Steven S. Gallers, alleging violations of the anti-fraud provisions
of the Exchange Act and seeking permanent injunctions, civil monetary penalties
and bars against serving as officers and directors of a public company. SEC vs.
Wheeler et al., Case No. 02-60131-CIV-Graham.

17



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##### 



Mr. Carberry and Mr. Gallers entered into settlements with the SEC
whereby, without admitting or denying the allegations of the complaint, they
agreed to be permanently enjoined from future violations of the Exchange Act,
pay a $50,000 civil penalty each and, in the case of Mr. Gallers, be barred
from serving as officer or director of a public company. Mr. Wheeler continues
to defend against the lawsuit. The Company is unable to determine at this time
what impact the SEC proceedings against Mr. Wheeler will have on the Company.

On September 16, 1999, the Company filed a lawsuit against KPMG and August
A. Smith, the KPMG engagement partner. The lawsuit is pending in the Circuit
Court of the 17th Judicial Circuit in and for Broward County, Case No.
00-004102-CACE-14. On May 1, 2000, the Company filed the First Amended
Complaint, alleging that KPMG failed to properly audit the Companys financial
statements and provided inaccurate advice on accounting matters for fiscal
years 1996, 1997 and 1998. The action alleges professional malpractice, breach
of fiduciary duty, breach of contract and breach of implied duty of good faith,
and seeks damages in excess of $10 million. KPMG and Mr. Smith filed motions to
dismiss, which were denied. In August 2000, KPMG and Mr. Smith filed their
answers and KPMG filed counterclaims against the Company, alleging the
Companys breach of contract, negligent misrepresentation and abuse of process,
and seeking an unspecified amount of damages consisting of unpaid service fees
and legal fees and costs. The Company filed an answer to KPMGs counterclaims
and moved to dismiss KPMGs abuse of process counterclaim. On April 9, 2001,
the Court dismissed the abuse of process counterclaim with prejudice. The
parties are currently conducting discovery.

On November 2, 2001, the Company filed a lawsuit against a former customer
in the United States District Court of the Southern District of Florida,
alleging breach of contract, and seeking, among other remedies, damages of
approximately $4.2 million. On November 26, 2001, the customer filed an answer
and affirmative defenses. On or about January 15, 2002, the customer filed a
motion challenging the jurisdiction of the U.S. District Court, Southern
District of Florida. On or about March 27, 2002, the U.S. District Court for
the Southern District of Florida dismissed the action on jurisdictional
grounds. The Company continues to consider its alternatives with respect to
this litigation, including whether to re-file the action in a different
jurisdiction.

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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth
quarter of the fiscal year ended June 30, 2002.

18



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PART II

ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Companys Common Stock was traded on NASDAQ under the symbol CYBG
from June 1996 until October 2, 1998. From October 2, 1998 until January 13,
1999, the Companys stock symbol was changed to CYBGE due to the Company
being late in filing its Form 10-K for its fiscal year ended June 30, 1998. On
January 13, 1999, the Company was de-listed from the NASDAQ Stock Market
because the Company was delinquent in its filings under the Exchange Act. From
January 13, 1999 to March 18, 2002, the Companys securities were traded by
market makers through the pink sheets again under the symbol CYBG. On
March 19, 2002, the Company began trading on the OTC Bulletin Board under the
symbol CYBG. On June 11, 2002, the Companys Common Stock began trading on the
American Stock Exchange under the ticker symbol CFW.

The Company is current in its reporting responsibilities pursuant to the
Exchange Act.

There were
approximately 3,734 holders of record of Common Stock as of
September 26, 2002. The table below sets forth, for the quarters indicated, the high
and low sales prices for the Companys Common Stock as reported by NASDAQ and
the American Stock Exchange.

|                                 |  |            |       |     |  |   |      | 
|-------------------------------- |  | ---------- | ----- | --- |  | - | ---- | 
|                                 |  | BID PRICES
|                                 |  |           
|                                 |  | HIGH       |       | LOW
|                                 |  |            |       |    
|FISCAL YEAR 2000                 |  |            |       |     |  |   |      | 
|Quarter Ended September 30, 1999 |  | $          | 1.75  |     |  | $ | 1    | 
|Quarter Ended December 31, 1999  |  |            | 6.25  |     |  |   | 1.75 | 
|Quarter Ended March 31, 2000     |  |            | 15.88 |     |  |   | 4.25 | 
|Quarter Ended June 30, 2000      |  |            | 10.12 |     |  |   | 5.37 | 
|FISCAL YEAR 2001                 |  |            |       |     |  |   |      | 
|Quarter Ended September 30, 2000 |  | $          | 6.12  |     |  | $ | 3.41 | 
|Quarter Ended December 31, 2000  |  |            | 4.25  |     |  |   | .95  | 
|Quarter Ended March 31, 2001     |  |            | 5.79  |     |  |   | 1.59 | 
|Quarter Ended June 30, 2001      |  |            | 3.95  |     |  |   | 1.80 | 
|FISCAL YEAR 2002                 |  |            |       |     |  |   |      | 
|Quarter Ended September 30, 2001 |  | $          | 2.55  |     |  | $ | 1.30 | 
|Quarter Ended December 31, 2001  |  |            | 1.70  |     |  |   | 1.30 | 
|Quarter Ended March 31, 2002     |  |            | 4.35  |     |  |   | 1.65 | 
|Quarter Ended June 30, 2002      |  |            | 4.00  |     |  |   | 2.75 | 

The Company has never paid dividends on its Common Stock. The Company
intends to retain earnings, if any, to finance future operations and expansion
and therefore, does not anticipate paying any cash dividends in the foreseeable
future. Any future payment of dividends will depend upon the financial
condition, capital requirements and earnings of the Company, as well as upon
other factors that the Board of Directors may deem relevant.

19



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##### 



EQUITY COMPENSATION PLAN INFORMATION

|                                                           |       |                                                                                             |        |                                                                             |     |                                                                                                                                             |      |      |  |  |       |       | 
|---------------------------------------------------------- | ----- | ------------------------------------------------------------------------------------------- | ------ | --------------------------------------------------------------------------- | --- | ------------------------------------------------------------------------------------------------------------------------------------------- | ---- | ---- |  |  | ----- | ----- | 
|Plan Category                                              |       | Number of
Securities to be
issued upon
exercise of
outstanding options, warrants
and rights |        | Weighted-average
exercise price of
outstanding options, warrants
and rights |     | Number of securities
remaining available
for future issuance under equity
compensation plans (excluding
securities reflected in column (a))
|                                                           |       |                                                                                             |        |                                                                             |     |                                                                                                                                            
|                                                           |       |                                                                                             | (a)    |                                                                             | (b) |                                                                                                                                             | (c) 
|                                                          
|Equity compensation
plans approved by
security holders     |       |                                                                                             | 5,143  |                                                                             |     |                                                                                                                                             | 1.89 |      |  |  | 4,257 |      
|Equity compensation
plans not approved
by security holders |       |                                                                                             | 143(1) |                                                                             |     |                                                                                                                                             | 1.75 |      |  |  |      |      
|                                                           | Total |                                                                                             |        | 5,286                                                                       |     |                                                                                                                                             |      | 1.89 |  |  |       | 4,257 | 
|                                                           |       |                                                                                             |        |                                                                             |     |                                                                                                                                             |      |      |  |  |       |      

(1)  Represents a warrant to purchase 142,857 shares of the Companys Common
Stock granted to Scott Hammack, the Companys Chief Executive Officer, on
December 26, 2000 at the price of $1.75 per share. The warrant was granted to
Mr. Hammack in connection with his purchase of shares of Common Stock at market
value. The warrant expires on December 25, 2005.

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial data that
is qualified in its entirety by, and should be read in conjunction with
Managements Discussion and Analysis of Financial Conditions and Results of
Operations and the Companys consolidated financial statements and notes
thereto appearing elsewhere in this annual report. The financial data for the
fiscal years ended June 30, 2002, 2001 and 2000 have been derived from the
audited consolidated financial statements of the Company for such periods as
audited by Grant Thornton LLP. The financial data for the fiscal years ended
June 30, 1999, and June 30, 1998, have been derived from the audited
consolidated financial statements of the Company for such periods as audited by
PricewaterhouseCoopers, LLP.

20



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##### 



FIVE YEAR FINANCIAL SUMMARY
(in thousands, except per share data)

|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|----------------------------------------------------- |  | ------------------- | ------ | ---- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | - |  | - | ------- | -
|                                                      |  | Year ended June 30,
|                                                      |  |                    
|                                                      |  | 2002                |        | 2001 |  | 2000 |        | 1999 |  | 1998
|                                                      |  |                     |        |      |  |      |        |      |  |     
|Revenues                                              |  | $                   | 22,340 |      |  | $    | 24,406 |      |  | $    | 18,859 |   |  | $ | 13,873 |   |  | $ | 15,552  |  
|Cost of Goods Sold                                    |  |                     | 6,469  |      |  |      | 7,216  |      |  |      | 5,956  |   |  |   | 5,313  |   |  |   | 7,076   |  
|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|Gross Profit                                          |  |                     | 15,871 |      |  |      | 17,190 |      |  |      | 12,903 |   |  |   | 8,560  |   |  |   | 8,476   |  
|Research & Development                                |  |                     | 4,705  |      |  |      | 5,450  |      |  |      | 2,969  |   |  |   | 3,664  |   |  |   | 5,767   |  
|Selling, general & administrative                     |  |                     | 12,007 |      |  |      | 14,680 |      |  |      | 9,752  |   |  |   | 14,724 |   |  |   | 18,869  |  
|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|Operating income/(loss)                               |  |                     | (841   | )    |  |      | (2,940 | )    |  |      | 182    |   |  |   | (9,828 | ) |  |   | (16,160 | )
|Interest income/(expense), net                        |  |                     | 58     |      |  |      | (751   | )    |  |      | (1,066 | ) |  |   | (186   | ) |  |   | 399     |  
|Other income/(expense)                                |  |                     | 193    |      |  |      | (90    | )    |  |      | (92    | ) |  |   | 41     |   |  |   | 11      |  
|Loss on sale of securities
available for sale         |  |                     |       |      |  |      |       |      |  |      |       |   |  |   |       |   |  |   | (128    | )
|Gain/(loss) on sale of assets                         |  |                     | (18    | )    |  |      | (106   | )    |  |      |       |   |  |   | 1,858  |   |  |   | (2,386  | )
|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|Loss before cumulative change in
accounting principle |  | $                   | (608   | )    |  | $    | (3,887 | )    |  | $    | (976   | ) |  | $ | (8,115 | ) |  | $ | (18,264 | )
|Cumulative effect of change in
accounting principle   |  |                     |       |      |  |      | (129   | )    |  |      |       |   |  |   |       |   |  |   |        |  
|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|Net Loss                                              |  | $                   | (608   | )    |  | $    | (4,016 | )    |  | $    | (976   | ) |  | $ | (8,115 | ) |  | $ | (18,264 | )
|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|Diluted loss per share                                |  | $                   | (.03   | )    |  | $    | (0.30  | )    |  | $    | (0.10  | ) |  | $ | (0.90  | ) |  | $ | (2.17   | )
|Balance Sheet Data:                                   |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|Current Assets                                        |  | $                   | 12,605 |      |  | $    | 11,024 |      |  | $    | 8,325  |   |  | $ | 6,428  |   |  | $ | 10,100  |  
|Total assets                                          |  | $                   | 14,130 |      |  | $    | 13,099 |      |  | $    | 10,996 |   |  | $ | 8,277  |   |  | $ | 13,076  |  
|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|Long term obligations                                 |  |                     |       |      |  |      |       |      |  | $    | 5,095  |   |  | $ | 885    |   |  |   |        |  
|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  
|Stockholders Equity                                   |  | $                   | 6,956  |      |  | $    | 6,474  |      |  | $    | (1,952 | ) |  | $ | (2,685 | ) |  | $ | 4,588   |  
|                                                      |  |                     |        |      |  |      |        |      |  |      |        |   |  |   |        |   |  |   |         |  

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ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

Certain statements within this item and throughout this annual report on
Form 10K and the documents incorporated herein are Forward Looking Statements
as described in the Safe Harbor provision of the Private Securities
Litigation Reform Act of 1995. The statements involve a number of risks and
uncertainties and actual results could differ materially from those projected.
Please refer to the cautionary statement at the beginning of this annual
report.

CyberGuard is a leading provider of Internet security solutions designed
to protect enterprises that use the Internet for electronic commerce and secure
communications. Our award winning products and services include firewalls and
virtual private networks or VPNs for secure communications. Our core market
includes Fortune 1000 companies, major financial institutions and government
agencies worldwide.

The following information should be read in conjunction with the
Consolidated Financial Statements and the related Notes to Consolidated
Financial Statements. Except for historical information contained herein, the
matters discussed herein are forward-looking statements made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.

Results of Operations

CYBERGUARD CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |    |     |  
|--------------------------------------------------------------- | ----------------------------------- | ---------------------------- | -- | ---------------------------- | --- | ---- | --- | ---- | --- | - | -- | -- | --- | -
|                                                                |                                     |                              |    | Percentages of Total Revenue
|                                                                |                                     |                              |    | Year Ended June 30,         
|                                                                |                                     |                              |    |                             
|                                                                |                                     |                              |    | 2002                         |     | 2001 |     | 2000
|                                                                |                                     |                              |    |                              |     |      |     |     
|Revenues:                                                       |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|                                                                | Products                            |                              |    | 68                           | %   |      |     | 77   | %   |   |    | 79 | %  
|                                                                | Services                            |                              |    | 32                           | %   |      |     | 23   | %   |   |    | 21 | %  
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|                                                                |                                     | Total Revenues               |    |                              | 100 | %    |     |      | 100 | % |    |    | 100 | %
|Cost of Revenues:                                               |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|                                                                | Products                            |                              |    | 20                           | %   |      |     | 20   | %   |   |    | 20 | %  
|                                                                | Services                            |                              |    | 9                            | %   |      |     | 10   | %   |   |    | 12 | %  
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|                                                                |                                     | Total cost of revenues       |    |                              | 29  | %    |     |      | 30  | % |    |    | 32  | %
|Gross Profit                                                    |                                     |                              | 71 | %                            |     |      | 70  | %    |     |   | 68 | % 
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|Operating expenses:                                             |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|                                                                | Research and development            |                              |    | 21                           | %   |      |     | 22   | %   |   |    | 16 | %  
|                                                                | Selling, general and administrative |                              |    | 54                           | %   |      |     | 60   | %   |   |    | 52 | %  
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|                                                                |                                     | Total operating expenses     |    |                              | 75  | %    |     |      | 82  | % |    |    | 67  | %
|Operating income (loss)                                         |                                     |                              | -4 | %                            |     |      | -12 | %    |     |   | 1  | % 
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|Operating income (expense)                                      |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|Interest income (expense), net                                  |                                     |                              | 0  | %                            |     |      | -3  | %    |     |   | -6 | % 
|Gain (loss) on sale of assets                                   |                                     |                              | 0  | %                            |     |      | -1  | %    |     |   | 0  | % 
|Other income (expense)                                          |                                     |                              | 1  | %                            |     |      | 0   | %    |     |   | 0  | % 
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|                                                                |                                     | Total other income (expense) |    |                              | 1   | %    |     |      | -4  | % |    |    | -6  | %
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|Loss before cumulative effect of change in accounting principle |                                     |                              | -3 | %                            |     |      | -16 | %    |     |   | -5 | % 
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |   
|Cumulative effect of change in accounting principle             |                                     |                              | 0  |                              |     |      | -1  | %    |     |   | 0  | % 
|Net Loss                                                        |                                     |                              | -3 | %                            |     |      | -16 | %    |     |   | -5 | % 
|                                                                |                                     |                              |    |                              |     |      |     |      |     |   |    |    |    

22



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Fiscal Year Ended June 30, 2002 and 2001

Total revenues. Total revenues, which consist of product revenues and
service revenues, decreased from $24,406,000 in 2001 to $22,340,000 in 2002, a
decrease of 8%. The 8% decrease represents a decrease in product revenues of
19%, which was offset by an increase in services revenues of 25%. We believe
the decrease in product revenue can be attributed to slowing economic
conditions that resulted in a delay or deferral in customer spending, changes
in our sales and marketing organization and realignment of our direct sales to
a reseller/distributor model during the year. The changes in the sales and
marketing organization includes complete turnover of the employees in those
departments. Offsetting these events was the change in revenue recognition for
eleven (11) resellers from cash to accrual based on a reasonable
assurance of collectibility from evaluating their payment histories. The impact for fiscal 2002 was an
increase in revenue of approximately $1,100,000. The increase in service revenues is due to
the growing installed base and renewals of previous years maintenance
contracts.

We categorize our revenues into three (3) geographic regions, North
America, Europe/Middle East/Africa or EMEA, and Asia Pacific/Latin America.
Our revenues of North America, EMEA and Asia Pacific/Latin America as a
percentage of total revenues were approximately 42%, 35% and 23%, respectively,
in 2002 and 50%, 35% and 15% for 2001, respectively. Our total international
revenues, which are revenues for customers outside the United States, represent
approximately 58% of the total revenues in 2002 and 51% of revenues in 2001.

We anticipate the majority of our product revenues will be generated from
large enterprise customers and government entities, in both domestic and
international markets. During the fiscal year 2002 we established a federal
division with a team of security engineers and sales professionals who focus
solely on working with U.S. government agencies and the military. As a result
of this focus we are experiencing an increase in government business activity,
not only in the United States but around the world.

Service Revenues. Service revenues consist primarily of maintenance
contracts for technical support of the CyberGuard firewall and VPN appliances.
Service revenues also included training, consulting and installation revenue.
The increase in service revenues is due to the greater number of installed
products in fiscal year 2002 resulting from the additional product sales as
well as service renewals for product sold in previous years. We expect the
lower product sales growth rate for fiscal year 2002 will result in a lower
service revenue growth rate in 2003 than that which was achieved in fiscal year
2002. As a percentage of total revenue, service revenue increased to 32% in
2002 from 23% in 2001.

Cost of Revenue and Gross Margin. Total cost of revenues, which includes
product and service cost, decreased from $7,216,000 in 2001 to $6,469,000 in
2002, a decrease of 10%. The decrease is primarily due to the reduced product
sales discussed above. As a percentage of total revenues, costs of revenues
was 29% for 2002 and 30% for 2001. Gross margin was 71% in 2002 and 70% in
2001. Gross margins are affected by a variety of factors including,
competition, the mix in average selling prices of products we currently offer,
new product introduction and enhancements, fluctuation in manufacturing volumes
and incremental cost of supporting the increased installed custom base.

Gross Profit for network security products was $10,766,000 or 71% for
fiscal year ended June 30, 2002 as compared to $13,756,000 or 74% in fiscal
year 2001. The reduction in gross margin was a result of a competitive
pressures resulting from the economic downturn during fiscal year 2002 as
well as the introduction of a lower margin product during fiscal year 2002.

Gross product for security related services was $5,105,000 or 72% for
fiscal year ended June 30 2002 as compared to $3,434,000 or 60% in fiscal year
2001. The increase in service related gross margin is a result of the increased
installed customer base during fiscal year 2002 while maintaining strict cost
controls for all service related cost.

Operating Expenses. For the year ended June 30, 2002, the Company
reported total operating expenses of $16,712,000 compared to $20,130,000 for
the year ended June 30, 2001, a reduction in operating expenses of $3,418,000.
As a percentage of total revenue, operating expenses decreased from 82% in 2001
to 75% in 2002. The overall decrease in operating expenses can be explained in
part by a reduction of the research and development expenses for the year ended
June 30, 2002, of $745,000 and a reduction in selling general and
administrative expenses of $2,673, 000.

Research and Development. Research and Development expenses include
salaries, non-capitalized equipment, software tools, and depreciation from
capital equipment. The decrease is in part the result of the

23



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##### 



reduction in headcount and the reduction in salaries specifically related
to special options program discussed in Footnote 8 of the Consolidated
Financial Statement. The initial estimated impact of the program was to reduce payroll
cost by approximately $287,000 annually. The special option salary reduction
will end in November 2002 and total salary expense for research and development
will increase by approximately $10,500 per month. As a percentage of total
revenue, research and development expense decreased to 21% in 2002 from 22% in
2001.

Selling, General and Administrative. Selling, general and administrative
expenses include salaries, commissions, human resource, finance, administrative
support functions, and legal and accounting professional services. Selling,
general and administrative expenses decreased by $2,673,000 to $12,007,000 in
2002 from $14,680,000 during 2001. The decrease reflects the Companys
continued focus on streamlining its operations and making cost effective
changes in the way we operate, a reduction in head count and a reduction in
salary expense related to a special option program discussed in Footnote 8 of
the Consolidated Financial Statement. The initial estimated impact was to reduce
selling, general and administrative expense by $362,569 annually. The special
option salary reduction will end in November 2002 and salary expense for
selling, general and administrative expense will increase by approximately
$14,075 per month. As a percentage of total revenue selling, general and
administrative expenses decreased by 6% to 54% for the year ended June 30, 2002
compared to 60% for the year ended June 30, 2001.

Net Interest (income/expenses). Net interest income was $58,000 for 2002,
compared to net interest expense of $751,000 for 2001. The decrease in
interest expense is attributable to the conversion of the convertible debt in
January of 2001 and the pay off of the revolving line of credit facility in
December 2001.

Other Income/Expenses. Other income was $193,000 for 2002 compared to
expenses of $90,000 for 2001. The change in other income is a result of
foreign currency translation gain of $203,000 in fiscal year 2002 compared to a
loss of $159,000 for fiscal year 2001.

Net Loss. For the year ended June 30, 2002, the Company incurred a net
loss of $608,000 versus a loss of $4,016,000 for the year ended June 30, 2001.
The improvement in the bottom line is the direct result of cost cutting
measures, including reduced head count, salary reduction, decrease interest and
operating efficiency, achieved during 2002.

Fiscal Year Ended June 30, 2001 and 2000

Net Revenues. Net Revenues for the year ended June 30, 2001 were
$24,406,000 compared to $18,859,000 for the year ended June 30, 2000. This
represents an increase of $5,547,000 or 29%. The increase in net revenues for
2001 is principally the result of increased sales of the Companys firewall
appliance products and the associated maintenance revenue.

International sales accounted for $12,326,000 or 51% of the total revenue
in 2001 as compared to $6,993,000 or 37% of the total revenue in 2000. This
represents an increase of $5,333,000 or 76%. North American sales accounted
for $12,080,000 in 2001 as compared to $11,866,000 in 2000, a difference of
$214,000 or 2%. The increase in international sales is mainly attributed to
the acceptance of the Companys products in the European and Asian markets.

CyberGuard provides its customer base with a service offering that
includes the installation of its firewall, customer support, including product
training and consulting. For the fiscal year ended June 30, 2001, the Company
reported service revenue for its security products of $5,721,000, an increase
of $1,850,000 or 48% compared to revenues of $3,871,000 for the year ended June
30, 2000. As a percentage of total security revenues, service revenues
accounted for 23% in 2001 as compared to 21% in 2000. The increase in net
revenues from services is attributable to a growing base of customers under
maintenance agreements (and the greater number of installed products).

Gross Profit. CyberGuards costs of sales includes license fees to third
parties, media, packaging costs, equipment costs, and maintenance costs. The
Companys overall gross profit increased by $4,287,000 or 33% from $12,903,000
for the year ended June 30, 2000, to $17,190,000 for the year ended June 30,
2001, as a direct result of the revenue growth.

Gross profit for network security products was $13,756,000 or 74% in 2001
as compared to $11,280,000 or 75% in 2000. The gross margin for security
product has remained relatively constant year over year.

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Gross profit for security-related services was $3,434,000 or 60% in 2001
compared to $1,623,000 or 42% in 2000, an increase of 18%. The increase in
service-related gross profit margin is the result of a greater number of
customers under firewall maintenance support contracts, while the costs of
supporting those contracts has remained relatively constant on a per unit
basis.

Operating Expenses. For the year ended June 30, 2001, the Company
reported total operating expenses of $20,130,000 compared to $12,721,000 for
the year ended June 30, 2000. The increase of $7,409,000 is attributable to a
$2,481,000 increase in research and development costs and a $4,928,000 increase
in selling, general and administrative costs. The increased research and
development expense is attributed to an increase in headcount and salary rates
and a decrease in the amount of capitalized software development costs year
over year of approximately $845,000. The increase in selling, general and
administrative costs is the result of several factors, including a significant
increase in marketing costs, an increase in compensation and related employee
costs, and one-time charges related to severance for former officers and a
product branding campaign.

Interest Expense. For the year ended June 30, 2001, the Company reported
net interest expense of $751,000 compared to $1,066,000 for the year ended June
30, 2000. The decrease of $315,000 is attributable to the conversion of
convertible debt and warrants during January 2001 and lower interest expense
related to the reduced balance on the revolving line of credit facility during
the year.

Cumulative Effect of a Change in Accounting Principle.For the year ended
June 30, 2001, the Company reported a cumulative effect of a change in
accounting principle of $129,000. This represents the implementation of EITF
00-27, Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios, which required the Company to use
an effective conversion price to determine the convertible debts beneficial
conversion feature.

Net Loss. For the year ended June 30, 2001, the Company incurred a net
loss of $4,016 compared to a net loss of $976,000 for the year ended June 30,
2000. The loss is a direct result of the increase in operating expenses.

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 deferred taxes. We based 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.
CyberGuard follows 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.
|
| | We generate revenues through:                                                                                                                                                                                                                                                                                                                                                                                                                                                                           



| |                                                                                                                         
| | ------------------------------------------------------------------------------------------------------------------------
| |      Sales of product and services subscriptions indirectly
through our reseller network at a discount from list price;
|
| |      
Sales of products and services subscriptions directly
to our end users.                                          

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| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Service revenues primarily include the annual fee for maintenance, which
is sold as part of our security solutions, and for subscription renewals
from our existing customers and end users. These services provide our
customers access to our worldwide support organization for product
updates, general security information and technical support.                                                                                                                                                                                                                                                                                                                                                              
|
| | We recognize revenues for product sales 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. While we
generally recognize product revenue on product shipment, we defer
revenues on product sales for value added resellers until the partners
demonstrate consistency of payment within terms and no product returns
for a three month period. Service revenues are recognized ratably on a
monthly basis over the service contract term.                                                                                                                                                            
|
| | 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                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|
| | The Company capitalizes costs related to the development of certain
software products 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.
|
| | 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 (FIFO) 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 deferred tax assets, that cannot be
currently recognized due to our cumulative losses and the uncertainty as
to future recoverability. 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.                                                                                                                                                             

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board approved the
issuance of SFAS No. 141, Business Combinations and SFAS 142, Goodwill and
Other Intangible Assets. The new standards require that all business
combinations initiated after June 30, 2001, must be accounted for under the
purchase method. In addition, all intangible assets acquired that are obtained
through contractual or legal right, or are capable of being separately sold,
transferred, licensed, rented or exchanged shall be recognized as an asset
apart from goodwill. Goodwill and intangibles with indefinite lives will no
longer be subject to amortization, but will be

26



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subject to an annual assessment for impairment by applying a fair value
based test. The Company does not expect that the application of the
provisions of SFAS No. 141 and SFAS No. 142 will have an impact on the
Companys operations.

In July 2001, the Financial Accounting Standards Board issued SFAS No.
143, Accounting for Asset Retirement Obligations, effective for fiscal years
beginning after June 15, 2002. SFAS No. 143 addresses the accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The Company does not expect
that the application of the provisions of SFAS No. 143 will have an impact on
the Companys operations.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. The
provisions of the statement are effective for financial statements issued for
fiscal years beginning after December 15, 2001, and are to be applied
prospectively. SFAS No. 144 clarifies the accounting for impairment of
long-lived assets to be disposed of, including the disposal of business
segments and major lines of business. The Company does not expect that the
application of the provisions of SFAS No. 144 will have an impact on the
Companys operations.

In November 2001, the Financial Accounting Standards Boards Emerging
Issues Task Force (EITF) issued EITF No. 01-9, Accounting for Consideration
Given by a Vendor to a Customer or a Reseller of the Vendors Products. The
EITF reconciled selected guidance provided in Issue Nos. 00-14, 00-22, and
00-25, addressing the income statement classification of certain promotional
payments. The Company does not expect that the application of the provisions
of EITF No. 01-9 will have a material impact on the Companys operations.

In July 2002, the FASB issued Statement 146, Accounting for Exit or
Disposal Activities. SFAS 146 nullifies EITF 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). The statement provides
guidance on the accounting and disclosure requirements for companies that incur
costs to exit an activity. SFAS146 is effective for exit or disposal activities
initiated after December 31, 2002. Early application is encouraged. Restatement
of previously issued financial statements is prohibited.

Liquidity and Capital Resources

At June 30, 2002, our principal source of liquidity was $6,166,000 of
cash, cash equivalents and short-term investments, which consists principally
of commercial paper, and U.S. Government securities. For the year ended June
30, 2002, our cash, cash equivalents and short-term investments increased by
$1,395,000 or 29% to $6,166,000 from $4,771,000 at June 30, 2001.

Cash provided by operating activities was $2,503,000 for the year ended
June 30, 2002. For fiscal year 2001 operating activities used $2,240,000 of
cash. The overall increase in cash provided by operating activities from 2001
to 2002 was $4,743,000. The increase in cash from operating activities is the
result of the smaller net loss adjusted for non-cash items, offset by various
changes in current asset and liability accounts.

Net cash used in investing activities was $975,000 in fiscal year 2002,
primarily as a result of the purchase of property and equipment of $805,000 and
capitalized software of $172,000. Net cash used in investing activities was
$1,290,000 for fiscal year ended June 30, 2001, primarily the result of the
purchase of property and equipment of $930,000 and capitalized software of
$360,000.

Net cash used in financing activities was $133,000 for the year ended June
30, 2002, and net cash provided by financing activities for fiscal year 2001
was $5,804,000. In fiscal year 2002 the cash used in financing activities was
primarily the net repayment under the revolving line of credit facility that
was repaid at December 31, 2001. That was partially offset by proceeds from
the sale of common stock of approximately $683,000 during fiscal year during
2002. For the year ended June 30, 2001, the cash provided by financing
activities was primarily the result of the proceeds from the exercise of
warrants and the issuance of convertible debt. That was partially offset by
net repayment under the revolving credit facility of $1,203,000. In addition,
proceeds from the sale of the Companys common stock generated approximately
$1,306,000 in fiscal year 2001.

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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 and expansion of sales and
marketing, the timing of introductions of new products and enhancement to
existing products, and market acceptance of our products.

We cannot assure you that the additional equity or that financing will be
available on acceptable terms or at all. We have no other agreements or
arrangements for third parties to provide us with sources of liquidity and
capital resources beyond twelve (12) months.

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FORWARD-LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTS

Certain statements contained in Managements Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this report
that are not related to historical results are forward-looking statements.
Actual results may differ materially from those projected or implied in the
forward-looking statements. Further, certain forward-looking statements are
based upon assumptions of future events, which may not prove to be accurate.
Subsequent written and oral forward-looking statements attributable to the
Company or to persons acting on its behalf are expressly qualified in their
entirety by the cautionary statements set forth below and elsewhere in this
report and in other reports filed by the Company with the Securities and
Exchange Commission.

We have incurred significant losses in the past and may not achieve or sustain
consistent profitability, which could result in the decline in the value of our
common stock.

We have difficulty predicting our future operating results or
profitability due to volatility in the general economic conditions in the
internet security market.

The overall weakness in the general economy and volatility on demand for
our security products are two of the many factors underlying our inability to
predict our revenues for a given period. We base our spending levels for
product development, sales and marketing, and other operating expenses largely
on expected future revenues. A large portion of our expenses are fixed for a
particular quarter or a year, and therefore we may be unable to decrease our
spending in time to compensate for any unexpected quarterly or annual
shortfalls in revenues. As a result, any shortfall in revenue could adversely
affect our operating results.

For the year ended June 30, 2002 we reported a net loss of $608,000, or
approximately 3% of our revenues. We do not know if we will be able to achieve
profitability in the future.

Average selling prices of our product may decrease, which may reduce our
gross margins. The average selling price for our products may decline as a
result of competitive pricing pressures, promotional programs and customers who
negotiate price reductions in exchange for long-term purchase commitments. The
pricing of products depends on specific features and functions of the product,
purchase volumes and the level of sales and services support. We expect
competition to increase in the future. As we experience pricing pressure, we
anticipate that the average selling price and gross margin per product will
decrease over product lifecycles. We cannot assure you that we will be
successful in developing and introducing on a timely basis new products with
enhanced features, or that these products, if introduced, will able us to
maintain our average selling price and gross margins at current levels. Our
gross margin has been and will continue to be affected by a variety of factors
including competition, the mix in average selling price of products, new
product introduction, enhancements and the cost of components and manufacturing
labor. We must manage each of these factors competitively for our gross
margins to remain at their current levels.

We outsource all of our hardware manufacturing and assembly primarily to
one third-party manufacturer and assembly house. We do not have a long term
manufacturing contract with this vendor. The manufacturer has produced our
products with the acceptable quality, quantity and cost in the past, but it may
be unable or unwilling to meet our future demands. Our operations could be
disrupted if we have to switch to a replacement vendor, and interruption of our
hardware supply for an extended period could result in a loss of customer
orders and revenue.

We provide forecasts of our demand to our primary contract manufacturer up
to three (3) months prior to scheduled delivery of product to our customers.
If we overestimate our requirements, our primary contract manufacturer may have
excess inventory which would increase our cost. If we underestimate our
requirements, our primary contract manufacturer may have an inadequate
component inventory, which could interrupt manufacturing of our products and
result in delayed shipments and reduced revenues. In addition, lead times for
materials and components that we order vary significantly and depend on factors
such as the specific supplier, contract terms and demand for each component at
a given time. We may also experience shortages of components from time to time,
which also could delay the manufacturing of our products.

If we are unable to meet our future capital requirements, our business
would be harmed.

Although we expect our cash on hand, cash equivalents and networking
capital to meet our working capital requirements for at least the next twelve
(12) months, we may decide at any time to raise additional

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capital to take advantage of available strategic opportunities or
attractive financing terms. If we issue equity securities, shareholders may
experience dilution or the new equity securities may have rights, preferences
or privileges senior to those of existing holders of common stock. If we
cannot raise funds, if needed, on acceptable terms, we may not be able to
develop or enhance our products, take advantage of future opportunities or
respond to competitive pressures or unanticipated requirements, which could
have a material adverse effect on our business, operating results and financial
conditions.

For the past 3 years we incurred net losses. As of June 30, 2002, we have
an accumulated deficit of approximately $82 million. We may not achieve or
sustain profitability in future periods. Moreover, we currently expect to
increase our operating expenses in connection with:



| |  |  | Expanding into new geographical markets               
| | - |  | ------------------------------------------------------
|
| |  |  | Expanding into new product markets                    
|
| |  |  | Continuing to develop our technology                  
|
| |  |  | Hiring additional personnel                           
|
| |  |  | Upgrading our information and internal control systems

If we are not able to achieve or sustain profitability in future quarters,
the trading price of our common stock could decline.

Our operating results fluctuate and can fall below expectations of analysts and
investors, resulting in a decline of our stock price.

We base our spending levels for Product Development, Sales & Marketing and
other operating expenses largely on our expected future revenues. Because our
expenses are largely fixed for a particular quarter or year we may be unable to
adjust our spending in time to compensate for any unexpected quarterly or
annual shortfall in revenues. A failure to adjust our spending in time also
could cause operating results to fall below the expectations of our investors
and result in declining stock prices.

Because many potential customers remain unaware of the need for Internet
security or may perceive it as costly and difficult to implement, our products
and services may not achieve market acceptance.

We believe that many potential customers are not fully aware of the need for
Internet security products and services. Historically, only enterprises having
substantial resources have developed or purchased Internet security solutions.
Also, there is a perception that Internet security is costly and difficult to
implement. We will therefore not succeed unless the market understands the need
for Internet security and we can convince our potential customers of our
ability to provide this security in a cost effective manner. Although we have
spent and will continue to spend considerable resources educating potential
customers about the need for Internet security and the benefits of our products
and services, our efforts may be unsuccessful.

Seasonality and concentration of revenues at the end of the quarter could cause
our revenues to fall below the expectation of analysts and investors, resulting
in a decline of our stock price.

The growth rate of our domestic and international sales has been and may
continue to be slower in the summer months, when businesses often defer
purchasing decisions. Also, as a result of customer buying patterns and the
efforts of our sales force to meet or exceed quarterly and year-end quotas,
historically we have earned a substantial portion of a quarters revenue during
its last month and more recently in the latter half of the last month. If
expected revenues at the end of any quarter are delayed, our revenues for that
quarter could fall below the expectations of the analysts and investors.

If third party channel partners fail to perform, our ability to sell our
products and services will be limited.

We expect to sell most of our products and services through our channel
network partners and we expect our success to depend in large part on their
performance. Some of our channel partners have the ability to sell products and
services that are competitive with ours, to devote more resources to those
competitive products than we devote to ours and to cease selling our products
and services all together. If our third party channel partners fail to perform,
our ability to expand our business and increase sales will be limited.

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If we are unable to compete successfully in the highly competitive market for
Internet security products and services, our business will fail.

The market for Internet security products is intensely competitive and we
expect competition to intensify in the future. An increase in competitive
pressures in our market or failure to compete effectively may result in price
reduction, reduced gross margin and loss of market share. Currently the primary
competitors in our industry include CISCO Systems, Checkpoint Software and
Netscreen Technologies. Other competitors offering security products include
hardware and software vendors, such as Hewlett-Packard and Network Associates
Inc., operating systems vendors, such as Microsoft Corporation, Sun
Microsystems Inc. and a number of smaller companies. Many of our competitors
have longer operating histories, greater name recognition and larger customer
bases and a significantly greater financial, technical, marketing and other
resources than we do.

In addition, our current and potential competitors may establish
cooperative relationships among themselves or with third parties that may
further enhance their resources. As a result they may be able to adapt more
quickly to new technologies and customer needs, devote greater resources to the
promotion or sales of their products and services, initiate or withstand
substantial price competition, take advantage of acquisitions or other
opportunities more readily or develop and expand their product and services
offerings more quickly. In addition, our competitors may bundle products
competitive with ours along with other products that they may sell to our
current or potential customers. These customers may accept these bundled
products rather than separately purchase our products.

Failure to address strain on our resources caused by growth will result in our
inability to effectively manage our business.

Our current systems, management and resources will be inadequate if we
begin to grow at a significant rate. A rapid expansion of our business will
place a significant strain on our administrative, operational and financial
resources and will result in ever increasing responsibilities of our management
personnel. We will be unable to effectively manage our business if we are
unable to timely and successfully alleviate the strain on our business caused
by rapid growth.

We may be unable to adequately expand our operational systems to accommodate
growth, which can harm our ability to deliver our products and services.

Our operational systems have not been tested at customer volumes that may
be required in the future. We may encounter performance difficulty when
operating with a substantially greater number of customers. An inability to add
additional operating systems and personnel to handle increased demands may
cause unanticipated disruptions in our current process, slower response times
and poor customer service, including problems filling customer orders.

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

To succeed we must continually change and improve our products in response
to rapid technological developments and changes in operating systems, Internet
access and communications, application and network software, computer and
communication hardware, programming tools, computer language technology and
hacker techniques. We may be unable to successfully and timely develop these
new products and services or achieve and maintain market acceptance. The
development of new technology, advance products and services is a complex and
uncertain process requiring innovation and the ability to anticipate
technological and market trends. Because Internet security technology is
complex it can require long development and testing periods. Releasing new
products and services prematurely may result in quality problems, and releasing
them late may result in loss of customer confidence and market share. In the
past we have on occasion experienced delays in the scheduled introduction of
new and enhanced products and services, and we may experience delays in the
future. When we do introduce new or enhanced products and services, we may be
unable to manage the transition from the older products and services to
minimize disruptions to the customers ordering patterns, avoid excess
inventory of older products and deliver enough products and services to meet
customer demand.

We may be required to defend lawsuits or pay damages in connection with the
alleged or factual failure of our products and services.

Because our products provide Internet security and may protect valuable
information, we may face claims for product liability, tort or breach of
warranty relating to our products and services. Anyone that circumvents our
products security measures could misappropriate the confidential information
or other property of end-users using our products and services or interrupt
their operations. If that happens, affected

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end-users or channel partners may sue us. In addition, we may face
breaches caused by faulty installations and implementations of our products by
end-users or channel partners. Although we attempt to reduce the risk of loss
from claims through contractual or warranty disclaimers and liability
limitation provisions, these provisions may be unenforceable. Some courts, for
example, have found contractual limitations of liability in standard software
licenses to be unenforceable because the licensee does not sign them. Defending
a suit regardless of its merit could be costly and could divert managements
attention. Although we currently maintain business liability insurance, this
coverage may be inadequate or be unavailable in the future on acceptable terms,
if at all.

A breach in security could harm public perception of our products.

We will not succeed unless the market place is confident that we provide
effective Internet security protection. Even networks protected by our products
may be vulnerable to electronic break-ins and computer viruses. If an actual or
perceived breach of Internet security occurs in an end-user system, regardless
of whether the breach is attributable to us, the market perception of the
efficiency of our products and services could be harmed. This could cause us or
our channel partners to lose current and potential customers or cause us to
lose potential channel partners. Because the technology used by computer
hackers to access or sabotage networks changes frequently and generally is not
recognized until launched against the target, we may be unable to anticipate
these techniques.

If we are unable to prevent attacks on our internal network security system by
computer hackers, public perception of our products and services will be
harmed.

Because we provide Internet security, we are a significant target of
computer hackers. We have experienced attacks by computer hackers in the past
and expect the attacks to continue. If attacks on our internal network systems
are successful, public perceptions of our products and services will be harmed.

We may be unable to deliver our products and services if we cannot continue to
license third party technology that is important for the functionality of our
products.

Our success will depend in part on our continued ability to license
technology that is important for the functionality of our products. A
significant interruption in the supply of third party technology could delay
our development and sales until we can find, license and integrate equivalent
technology. This could damage our brand and result in loss of current and
potential customers. Although we believe we can find other sources for the
technology we license, alternative technology may be unavailable on acceptable
terms, if at all. We depend on our third party licenses to deliver reliable
quality, high quality products, develop new products on a timely and cost
effective basis and respond to evolving technology and changes in the industry
standards. We also depend on the continued compatibility of third party
software with future versions of our product.

We will be unable to deliver our products and services if component
manufacturers fail to supply component parts with acceptable quality, quantity
and cost.

We obtain the component parts for our hardware from a variety of
manufacturers. While our component vendors have produced parts for us in
acceptable quantities and with acceptable quality and cost in the past, they
may be unable to do so in the future. Companies in the electronic industry
regularly experience lower than required component allocations and this
industry is subject to frequent component shortfalls. Although we believe we
can find additional or replacement sources for our hardware components, our
operation could be disrupted if we have to add or switch to a replacement
vendor or if our components supply is interrupted for an extended period. This
could result in a loss of customer orders and revenue.

Declines in Demand for Products and Services.

If overall market demand for computers, servers and other computing
devices declines significantly, and consumer and corporate spending for such
products declines, our revenue growth will be adversely affected. Additionally,
the Companys revenues would be unfavorably impacted if customers reduce their
purchases of new software products or upgrades to existing products if such new
offerings are not perceived to add significant new functionality or other value
to prospective purchasers.

A reduction in the growth of internet usage and a softening demand for our
products and services caused by the ongoing economic downturn may result in
decreased revenue, earnings or growth rates and problems with our ability to
manage inventory levels and realize customer receivables. The global economy
has weakened and market conditions continue to be challenging. As a result,
individuals and companies are

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delaying or reducing expenditures, including those for information
technology. In addition, if our customers experience financial difficulties, we
could suffer losses associated with the outstanding portion of accounts
receivable. We have observed the effects of the global economic downturn in
many areas of our business. The downturn has contributed to the decline of
revenue by 8% during fiscal year 2002. Further delays or reductions in
information technology spending could have a material adverse effect on demand
for our products and services and consequently our results of operations,
prospects and stock price.

New Product Development Schedule.

The development of software products is a complex and time-consuming
process. New products and enhancements to existing products can require long
development and testing periods. Significant delays in new product releases or
significant problems in creating new products could negatively impact the
Companys revenues.

Business Conditions in Specific Industries.

We depend on the government, telecommunications, financial services,
computing and manufacturing industries for a significant portion of our
revenues. Significant reduction in technology capital spending in these
industries caused by adverse economic conditions, such as we experienced during
fiscal year 2002, may continue to result in decreased revenues and earnings.
Our revenues are dependent on the level of technology capital spending in the
United States and international economies. A number of companies announced
significant reductions and deferrals in capital spending. If capital spending
continues to decline in these industries over an extended period of time, our
business will continue to be adversely affected.

The stock prices of technology companies such as ours are highly volatile and
could drop unexpectedly.

The public markets have experienced volatility that has particularly affected
the market prices of securities of many technology companies for reasons that
have often been unrelated to operating results. During the course of the
preceding twelve months ended June 30, 2002, the market price of our common
stock traded within a range of $1.30 to $4.00 per share. This volatility may
adversely affect the market price of our common stock and our visibility and
credibility in the markets. We may need additional capital and our ability to
secure additional funding is uncertain.

Our future revenue may be insufficient to support the expense of our
operations and the expansion of our business. We may therefore need additional
equity or debt capital. We may seek additional funding through:



| |  |  | Public or private equity financing, which could result in significant dilution for shareholders.
| | - |  | ------------------------------------------------------------------------------------------------
|
| |  |  | Public or private debt financing and capital lease transactions.                                
|
| |  |  | Capital lease transactions.                                                                     

We believe that existing cash and equivalent balances will be sufficient
to meet our capital requirements for at least the next twelve months. Our
capital requirements will depend on several factors, however, including:



| |  |  | The rate of market acceptance of products and services.               
| | - |  | ----------------------------------------------------------------------
|
| |  |  | Our ability to expand our customer base.                              
|
| |  |  | The growth of our sales & marketing capabilities.                     
|
| |  |  | The cost of any acquisitions we may complete.                         
|
| |  |  | Financing may be unavailable to us when needed or on acceptable terms.

If we do not retain our key employees, our ability to execute our business plan
strategy will be impaired.

Our future success will depend on the efforts and ability of our senior
management and our key development, technical, operation, information systems,
customer support, and sales and marketing personnel, and on our ability to
retain them. These employees are not obligated to continue their employment
with us and may leave us at any time.

33



---



##### 



If we do not extend our international operations, the growth of our
business will be limited.

Our ability to grow depends in part on the expansion of our International
sales and operations, which are expected to continue to account for a
significant portion of our revenues.
Sales to customers outside the United States accounted for approximately 38% of
our revenues in fiscal year 2000, 51% in fiscal year 2001 and 58% in fiscal
year 2002. The failure of our channel partners to sell our products
internationally will limit our ability to increase our revenues. In addition,
our international sales are subject to the risks inherent in international
business activity, including:



| |  |  | Cost of customizing products for foreign countries.                                        
| | - |  | -------------------------------------------------------------------------------------------
|
| |  |  | Export and import restrictions such as those affecting encryption commodities and software.
|
| |  |  | Difficulties in acquiring and authenticating customers information.                       
|
| |  |  | Reduced protection of intellectual property rights and increased liability exposure.       
|
| |  |  | Regional economic and political conditions.                                                

A significant portion of our international sales currently are U.S. dollar
denominated. As a result, an increase in the value of the U.S. dollar relative
to foreign currencies may make our products less competitive in the
international markets.

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

Despite our efforts to protect our proprietary rights, unauthorized
parties may misappropriate or infringe on our trade secrets, copyrights,
trademarks, service marks and similar proprietary rights. We face additional
risk when conducting business in countries which have poorly developed or
inadequately enforced intellectual property laws. While we are unable to
determine the extent to which piracy of our software products exists we expect
piracy to be a continuing concern, particularly in international markets and as
a result of the growing use of the Internet.

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

In the future we may have to resort to litigation to protect our
intellectual property rights, to protect our trade secrets or to develop the
validity and scope of our proprietary rights of others. Any litigation,
regardless of its success, would be costly and require significant time and
attention of our key management and technical personnel. The litigation could
also force us to:



| |  |  | Stop or delay selling, incorporating or using products that
incorporate the challenged intellectual property;
| | - |  | -------------------------------------------------------------------------------------------------------------
|
| |  |  | Pay damages;                                                                                                 
|
| |  |  | Enter into licensing or royalty agreements, which may be unavailable under acceptable terms;                 
|
| |  |  | Redesign products and services that incorporate infringing technology.                                       

Although we have not been sued for intellectual property infringement, we
may face infringement claims from third parties in the future. The software
industry has seen frequent litigation over intellectual property rights, and we
expect that participants in the Internet security industry will be increasingly
subject to infringement claims as the number of products, services, and
competitors grow and functionality of the products and services overlap. We
cannot assure you that the steps taken by us will be adequate to deter
misappropriation of our proprietary rights or that third parties will not
independently develop substantially similar products, services and technology.
Furthermore, there can be no assurance that our products will not infringe upon
the intellectual property rights of third parties. We may not be able to avoid
infringement of third party intellectual property rights and may have to obtain
a license, defend an infringement action, or challenge the validity of the
intellectual property rights in court. Failure to obtain or maintain
intellectual property rights in our products, for any reason, could have a
material adverse effect on us.

Undetected product errors or defects could result in loss of revenues, market
acceptance and claims against us.

Our products and services may contain undetected errors or defects,
especially when first released. Despite extensive testing, some errors are
discovered only after a product has been installed and used by customers. Any
errors discovered after commercial release could result in loss of revenue or
claims against us or our channel partners.

34



---



##### 



Shareholder Litigation

The Company is currently defending a class action lawsuit relating to a
restatement of the Companys financial results. 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 judgment rendered against the Company. If the Company is
unsuccessful and insurance coverage is unavailable or insufficient, the
resolution of the lawsuit could have a material adverse impact on the Company.

Governmental controls over the export or import of encryption technology could
cause us to lose sales.

Any additional governmental regulations of imports or exports, or failure
to obtain required approval for our encryption technologies could adversely
affect our international and domestic sales. The United States and various
other countries have imposed controls, export license requirements and
restrictions on the import or export of some technologies, especially
encryption technology. In addition, from time to time governmental agencies
have proposed additional regulation over encryption technology, such as
requiring the escrow and governmental recovery of private encryption keys.
Additional regulation of encryption technology could delay or prevent the
acceptance and use of encryption products in public networks for secure
communications. This in turn could result in decreased demand for our products
and services. In addition, some foreign competitors are subject to less
stringent controls on exporting their encryption technologies. As a result,
they may be able to compete more effectively than we can in the U.S. and
international security markets.

Our business will suffer if we fail to comply with recent federal legislation
and proposed rules and regulations of the Securities and Exchange Commission
relating to corporate governance reform.

As a public company, we are subject to certain legislation and the rules and
regulations of the Securities and Exchange Commission or the Commission. On
July 30, 2002, President George W. Bush signed into law the Sarbanes-Oxley Act
of 2002, effecting tighter accounting controls, more stringent corporate
governance standards, and stricter penalties for securities fraud and other
violations of the securities laws. To implement this legislation, the
Commission has adopted and will continue to adopt new rules pertaining to,
among other things, audit committee requirements and additional disclosure and
reporting requirements. Our business and financial results could be materially
harmed by any failure by us to comply with any current or future rules or
regulations relating to the Sarbanes-Oxley Act or to any other federal
corporate reform measures.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Interest rate risk.We do not hold derivative financial instruments or
derivative equity securities. Financial investments, which potentially subject
the Company to a concentration of credit risk, principally consist of cash,
cash equivalents and trade receivables. The Company holds any excess cash in
short-term investments consisting of commercial paper. Concentration of credit
risk with respect to receivables is limited due to the Companys customer base
and historical collection rates.

Foreign currency risk.The majority of our sales and the majority of our
expenses are currently denominated in US dollars. As a result, we have not
experienced significant foreign exchange gains and losses except those
disclosed on F8 in the accompanying audited consolidated financial statements.
While we conducted some transactions in foreign currencies during 2001 and 2002
and expect to do so in the future, we do not anticipate the foreign currency
gains or losses will be material to CyberGuard. Although we have not engaged in
foreign currency hedging to date, we may do so in the future.

35



---



##### 



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

|                                                                                                                                                              |  |  |     | 
|------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  | --- | 
|The following items are attached and incorporated into this Item 8                                                                                            |  |  |     | 
|Report of Independent Certified Public Accountants                                                                                                            |  |  | F-1 | 
|Consolidated Balance Sheets as of June 30, 2002 and June 30, 2001                                                                                             |  |  | F-2 | 
|Consolidated Statements of Operations for years ended June 30, 2002, June 30, 2001, and
June 30, 2000                                                         |  |  | F-3 | 
|Consolidated Statements of Cash Flows for years ended June 30, 2002, June 30, 2001, and
June 30, 2000                                                         |  |  | F-4 | 
|Consolidated Statements of Changes in Shareholders Equity (Deficit) and Comprehensive
Income for years ended June 30, 2002, June 30, 2001, and June 30, 2000 |  |  | F-5 | 
|Notes to Consolidated Financial Statements                                                                                                                    |  |  | F-6 | 

36



---



##### 



REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

The Board of Directors and Shareholders of
CyberGuard Corporation and Subsidiaries

We have audited the accompanying consolidated balance sheets of CyberGuard
Corporation and Subsidiaries as of June 30, 2002 and 2001, and the related
consolidated statements of operations, stockholders equity and comprehensive
income, and cash flows for each of the three years ended June 30, 2002. These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of CyberGuard Corporation and
Subsidiaries as of June 30, 2002 and 2001, and the consolidated results of
their operations and their consolidated cash flows for each of the three years
ended June 30, 2002 in conformity with accounting principles generally accepted
in the United States of America.

/s/ Grant Thornton LLP

Ft. Lauderdale, Florida
August 16, 2002

F-1



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)

|                                                                                                                                   |                            |                                            |         |          |          |      |         |        |        | 
|---------------------------------------------------------------------------------------------------------------------------------- | -------------------------- | ------------------------------------------ | ------- | -------- | -------- | ---- | ------- | ------ | ------ | 
|                                                                                                                                   |                            |                                            |         | June 30, | June 30,
|                                                                                                                                   |                            |                                            |         | 2002     |          | 2001
|                                                                                                                                   |                            |                                            |         |          |          |     
|ASSETS                                                                                                                             |                            |                                            |         |          |          |      |         |       
|Cash and cash equivalents                                                                                                          |                            | $                                          | 6,166   |          |          | $    | 4,771   |       
|Restricted cash                                                                                                                    |                            |                                            | 44      |          |          |      | 780     |       
|Accounts receivable, less allowance for uncollectible accounts
of $109 at June 30, 2002 and $36 at June 30, 2001                   |                            |                                            | 5,152   |          |          |      | 4,147   |       
|Inventories, net                                                                                                                   |                            |                                            | 442     |          |          |      | 261     |       
|Other current assets                                                                                                               |                            |                                            | 801     |          |          |      | 1,065   |       
|                                                                                                                                   |                            |                                            |         |          |          |      |         |       
|                                                                                                                                   | Total current assets       |                                            |         | 12,605   |          |      |         | 11,024 |       
|Property and equipment at cost, less accumulated
depreciation of $2,335 at June 30, 2002 and
$1,869 at June 30, 2001               |                            |                                            | 1,212   |          |          |      | 1,244   |       
|Capitalized software, net                                                                                                          |                            |                                            | 219     |          |          |      | 741     |       
|Other assets                                                                                                                       |                            |                                            | 94      |          |          |      | 90      |       
|                                                                                                                                   |                            |                                            |         |          |          |      |         |       
|                                                                                                                                   |                            | Total assets                               |         | $        | 14,130   |      |         | $      | 13,099 | 
|                                                                                                                                   |                            |                                            |         |          |          |      |         |       
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                               |                            |                                            |         |          |          |      |         |       
|Line of credit & notes payable                                                                                                     |                            |                                            | 140     |          |          |      | 919     |       
|Accounts payable                                                                                                                   |                            |                                            | 778     |          |          |      | 967     |       
|Convertible debenture, net                                                                                                         |                            |                                            |        |          |          |      | 62      |       
|Deferred revenue                                                                                                                   |                            |                                            | 3,951   |          |          |      | 2,308   |       
|Accrued expenses and other liabilities                                                                                             |                            |                                            | 2,305   |          |          |      | 2,369   |       
|                                                                                                                                   |                            |                                            |         |          |          |      |         |       
|                                                                                                                                   | Total liabilities          |                                            | $       | 7,174    |          |      | $       | 6,625  |       
|                                                                                                                                   |                            |                                            |         |          |          |      |         |       
|Commitments and Contingencies                                                                                                      |                            |                                            |        |          |          |      |        |       
|                                                                                                                                  
|Shareholders equity                                                                                                               |                            |                                            |         |          |          |      |         |       
|Preferred Stock par value $0.01: authorized 5 shares; none issued                                                                  |                            |                                            |        |          |          |      |        |       
|Common stock par value $0.01; authorized 50,000 shares;
issued and outstanding 19,100 at June 30, 2002
and 18,429 at June 30, 2001 |                            |                                            | 191     |          |          |      | 184     |       
|Additional paid-in capital                                                                                                         |                            |                                            | 88,673  |          |          |      | 87,557  |       
|Accumulated deficit                                                                                                                |                            |                                            | (82,075 | )        |          |      | (81,467 | )     
|Accumulated other comprehensive income                                                                                             |                            |                                            | 167     |          |          |      | 200     |       
|                                                                                                                                   |                            |                                            |         |          |          |      |         |       
|                                                                                                                                   | Total shareholders equity |                                            |         | 6,956    |          |      |         | 6,474  |       
|                                                                                                                                   |                            |                                            |         |          |          |      |         |       
|                                                                                                                                   |                            | Total liabilities and shareholders equity |         | $        | 14,130   |      |         | $      | 13,099 | 
|                                                                                                                                   |                            |                                            |         |          |          |      |         |       

See accompanying notes to consolidated financial statements

F-2



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands, except per share data)

|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |        |  
|--------------------------------------------------------------- | ---------------------------- | - | ------------------- | ------ | -------- | - | -------- | ------ | - | - | ------ | ------ | -
|                                                                |                              |   | Twelve Months Ended
|                                                                |                              |   |                    
|                                                                |                              |   | June 30,            |        | June 30, |   | June 30,
|                                                                |                              |   | 2002                |        | 2001     |   | 2000    
|                                                                |                              |   |                     |        |          |   |         
|Revenues:                                                       |                              |   |                     |        |          |   |          |        |   |   |        |       
|Products                                                        |                              | $ | 15,215              |        |          | $ | 18,685   |        |   | $ | 14,988 |       
|Services                                                        |                              |   | 7,125               |        |          |   | 5,721    |        |   |   | 3,871  |       
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|                                                                | Total revenues               |   |                     | 22,340 |          |   |          | 24,406 |   |   |        | 18,859 |  
|                                                               
|Cost of revenues:                                               |                              |   |                     |        |          |   |          |        |   |   |        |       
|Products                                                        |                              |   | 4,449               |        |          |   | 4,929    |        |   |   | 3,708  |       
|Services                                                        |                              |   | 2,020               |        |          |   | 2,287    |        |   |   | 2,248  |       
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|                                                                | Total cost of revenues       |   |                     | 6,469  |          |   |          | 7,216  |   |   |        | 5,956  |  
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Gross profit                                                    |                              |   | 15,871              |        |          |   | 17,190   |        |   |   | 12,903 |       
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Operating expenses:                                             |                              |   |                     |        |          |   |          |        |   |   |        |       
|Research and development                                        |                              |   | 4,705               |        |          |   | 5,450    |        |   |   | 2,969  |       
|Selling, general and administrative                             |                              |   | 12,007              |        |          |   | 14,680   |        |   |   | 9,752  |       
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|                                                                | Total operating expenses     |   |                     | 16,712 |          |   |          | 20,130 |   |   |        | 12,721 |  
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Operating income (loss)                                         |                              |   | (841                | )      |          |   | (2,940   | )      |   |   | 182    |       
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Other income (expense)                                          |                              |   |                     |        |          |   |          |        |   |   |        |       
|Interest income/(expense), net                                  |                              |   | 58                  |        |          |   | (751     | )      |   |   | (1,066 | )     
|Loss on sale of assets                                          |                              |   | (18                 | )      |          |   | (106     | )      |   |   |       |       
|Other income (expense)                                          |                              |   | 193                 |        |          |   | (90      | )      |   |   | (92    | )     
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|                                                                | Total other income (expense) |   |                     | 233    |          |   |          | (947   | ) |   |        | (1,158 | )
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Loss before cumulative effect of
change in accounting principle |                              |   | (608                | )      |          |   | (3,887   | )      |   |   | (976   | )     
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Cumulative effect of change in accounting principle             |                              |   |                    |        |          |   | (129     | )      |   |   |       |       
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Net Loss                                                        |                              | $ | (608                | )      |          | $ | (4,016   | )      |   | $ | (976   | )     
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Basic and diluted loss per common share:                        |                              |   |                     |        |          |   |          |        |   |   |        |       
|Before cumulative effect of change in accounting principle      |                              | $ | (0.03               | )      |          | $ | (0.29    | )      |   | $ | (0.10  | )     
|Cumulative effect of change in accounting principle             |                              | $ |                    |        |          | $ | (0.01    | )      |   | $ |       |       
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Basic and diluted loss per common share                         |                              | $ | (0.03               | )      |          | $ | (0.30    | )      |   | $ | (0.10  | )     
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       
|Weighted average number of common shares outstanding            |                              |   | 18,779              |        |          |   | 13,188   |        |   |   | 9,318  |       
|                                                                |                              |   |                     |        |          |   |          |        |   |   |        |       

See accompanying notes to consolidated financial statements

F-3



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)

|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |        |  
|--------------------------------------------------------------------------- | --------------------------------------------------- | - | ------------------- | ----- | -------- | - | -------- | ------ | - | - | ------ | ------ | -
|                                                                            |                                                     |   | Twelve Months Ended
|                                                                            |                                                     |   |                    
|                                                                            |                                                     |   | June 30,            |       | June 30, |   | June 30,
|                                                                            |                                                     |   | 2002                |       | 2001     |   | 2000    
|                                                                            |                                                     |   |                     |       |          |   |         
|Cash flows from operating activities                                        |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Net loss                                                                    |                                                     | $ | (608                | )     |          | $ | (4,016   | )      |   | $ | (976   | )     
|Adjustments to reconcile net loss to net cash
used in operating activities: |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Depreciation                                                                |                                                     |   | 817                 |       |          |   | 670      |        |   |   | 494    |       
|Amortization                                                                |                                                     |   | 694                 |       |          |   | 1,101    |        |   |   | 531    |       
|Loss on disposal of fixed assets                                            |                                                     |   | 18                  |       |          |   | 134      |        |   |   | 21     |       
|Interest expense related to convertible debt                                |                                                     |   |                    |       |          |   | 534      |        |   |   | 803    |       
|Provision for uncollectible accounts receivable                             |                                                     |   | 73                  |       |          |   | (15      | )      |   |   | (355   | )     
|Provision for inventory reserve                                             |                                                     |   | (68                 | )     |          |   | (5       | )      |   |   | 35     |       
|Compensation expense related to stock options                               |                                                     |   | 156                 |       |          |   | 195      |        |   |   |       |       
|Non cash expense for company 401(k) match                                   |                                                     |   | 259                 |       |          |   | 222      |        |   |   | 72     |       
|Cumulative effect of change in accounting principle                         |                                                     |   |                    |       |          |   | 129      |        |   |   |       |       
|Translation adjustment                                                      |                                                     |   | (33                 | )     |          |   | 89       |        |   |   | 89     |       
|Changes in assets and liabilities:                                          |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Restricted cash                                                             |                                                     |   | 736                 |       |          |   | 20       |        |   |   | 108    |       
|Accounts receivable                                                         |                                                     |   | (1,078              | )     |          |   | (517     | )      |   |   | (1,239 | )     
|Other current assets                                                        |                                                     |   | 264                 |       |          |   | 130      |        |   |   | (776   | )     
|Inventories                                                                 |                                                     |   | (113                | )     |          |   | (130     | )      |   |   | 17     |       
|Accounts payable                                                            |                                                     |   | (189                | )     |          |   | (457     | )      |   |   | (1,342 | )     
|Accrued expenses and other liabilities                                      |                                                     |   | (64                 | )     |          |   | 428      |        |   |   | (988   | )     
|Deferred revenue                                                            |                                                     |   | 1,643               |       |          |   | (604     | )      |   |   | 867    |       
|Other, net                                                                  |                                                     |   | (4                  | )     |          |   | (148     | )      |   |   | (101   | )     
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|                                                                            | Net cash provided by (used in) operating activities |   |                     | 2,503 |          |   |          | (2,240 | ) |   |        | (2,740 | )
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Cash flows used in investing activities:                                    |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Capitalized software costs                                                  |                                                     |   | (172                | )     |          |   | (360     | )      |   |   | (1,205 | )     
|Purchases of property & equipment                                           |                                                     |   | (805                | )     |          |   | (930     | )      |   |   | (448   | )     
|Proceeds from sale of property & equipment                                  |                                                     |   | 2                   |       |          |   |         |        |   |   |       |       
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|                                                                            | Net cash used in investing activities               |   |                     | (975  | )        |   |          | (1,290 | ) |   |        | (1,653 | )
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Cash flows provided by (used in) financing activities:                      |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Issuance of convertible debt                                                |                                                     |   |                    |       |          |   | 1,000    |        |   |   | 4,313  |       
|Payment of convertible debt                                                 |                                                     |   | (37                 | )     |          |   |         |        |   |   | (1,125 | )     
|Proceeds from exercise of warrants                                          |                                                     |   |                    |       |          |   | 4,804    |        |   |   |       |       
|Borrowings under notes payable                                              |                                                     |   | 162                 |       |          |   | 310      |        |   |   | 741    |       
|Repayment of notes payable                                                  |                                                     |   | (178                | )     |          |   | (413     | )      |   |   | (761   | )     
|Net repayment under credit facility                                         |                                                     |   | (763                | )     |          |   | (1,203   | )      |   |   | (89    | )     
|Proceeds from stock options exercised                                       |                                                     |   | 523                 |       |          |   | 532      |        |   |   | 888    |       
|Proceeds from private placement of common stock                             |                                                     |   |                    |       |          |   | 500      |        |   |   |       |       
|Proceeds from sale of common stock in stock purchase plan                   |                                                     |   | 160                 |       |          |   | 274      |        |   |   | 301    |       
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|                                                                            | Net cash provided by (used in) financing activities |   |                     | (133  | )        |   |          | 5,804  |   |   |        | 4,268  |  
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Net increase (decrease) in cash                                             |                                                     |   | 1,395               |       |          |   | 2,274    |        |   |   | (125   | )     
|Cash and cash equivalents at beginning of period                            |                                                     |   | 4,771               |       |          |   | 2,497    |        |   |   | 2,622  |       
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Cash and cash equivalents at end of period                                  |                                                     | $ | 6,166               |       |          | $ | 4,771    |        |   | $ | 2,497  |       
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Supplemental disclosure of cash flow information:                           |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Cash paid for interest                                                      |                                                     | $ | 62                  |       |          | $ | 511      |        |   | $ | 608    |       
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       
|Cash paid for income taxes                                                  |                                                     |   |                    |       |          |   |         |        |   |   |       |       
|                                                                            |                                                     |   |                     |       |          |   |          |        |   |   |        |       

Supplemental disclosure of non-cash information

During fiscal year 2002, the Companys CEO, Scott Hammack, participated in a
specialoption program which required the Company to record compensation
expense of $91.

During fiscal year 2002, approximately $25 in convertible debt and interest on
the debt was
converted into approximately 25 shares of the Companys common
stock.

During fiscal year 2001, the expiration dates of approximately 141 options to
purchase
shares of the Companys common stock were extended, which required the
Company to
record $141 in compensation expense. In addition, 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 $65 in
compensation expense during fiscal year 2002and $54 in compensation expense in
fiscal year 2001.

During fiscal year 2001, the Company recorded $129 as a cumulative effect of a
change in
accounting principle associated with the recognition of the effective
conversion price related
to the convertible debt issued in August 1999.

During fiscal year 2001, approximately $5,892 in convertible debt and interest
on the debt was
converted into approximately 5,492 shares of the Companys
common stock.

During fiscal year 2001, the Company issued a $1,000 convertible debenture and
issued 334warrants valued at $40.

During fiscal year 2000, the Company issued a $4,300 convertible debenture and
issued 4,300warrants valued at $431.

See accompanying notes to consolidated financial statements

F-4



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITY (DEFICIT)
AND COMPREHENSIVE INCOME
(Amounts in thousands, except share data)

|                                                            |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  |             |     |   |  |   |        |  
|----------------------------------------------------------- |  | ------------ | ---------- | --------- |  | ------- | --- | ----------- |  | ------------- | ------ | ----- |  | ----- | ------- | - |  | ----------- | --- | - |  | - | ------ | -
|                                                            |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  | Accumulated |     |   |  |  
|                                                            |  |              |            |           |  | Common  |     | Additional  |  |               |        |       |  | Other |         |   |  |            
|                                                            |  | Common Stock |            | Stock     |  | Paid in |     | Accumulated |  | Comprehensive |        |       |  |      
|                                                            |  | Shares       |            | Par Value |  | Capital |     | Deficit     |  | Income        |        | Total
|                                                            |  |              |            |           |  |         |     |             |  |               |        |      
|Balance June 30, 1999                                       |  |              | 9,064,756  |           |  | $       | 91  |             |  | $             | 73,677 |       |  | $     | (76,475 | ) |  | $           | 22  |   |  | $ | (2,685 | )
|Net loss                                                    |  |              |            |           |  |         |     |             |  |               |        |       |  |       | (976    | ) |  |             |     |   |  |   | (976   | )
|Translation adjustment                                      |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  |             | 89  |   |  |   | 89     |  
|Issuance of common stock                                    |  |              | 734,565    |           |  |         | 7   |             |  |               | 1,182  |       |  |       |         |   |  |             |     |   |  |   | 1,189  |  
|Discount on warrants                                        |  |              |            |           |  |         |     |             |  |               | 431    |       |  |       |         |   |  |             |     |   |  |   | 431    |  
|                                                            |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  |             |     |   |  |   |        |  
|Balance June 30, 2000                                       |  |              | 9,799,321  |           |  | $       | 98  |             |  | $             | 75,290 |       |  | $     | (77,451 | ) |  | $           | 111 |   |  | $ | (1,952 | )
|                                                           
|Net loss                                                    |  |              |            |           |  |         |     |             |  |               |        |       |  |       | (4,016  | ) |  |             |     |   |  |   | (4,016 | )
|Translation adjustment                                      |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  |             | 89  |   |  |   | 89     |  
|Issuance of warrants related to debt conversion             |  |              |            |           |  |         |     |             |  |               | 73     |       |  |       |         |   |  |             |     |   |  |   | 73     |  
|Modification of stock options                               |  |              |            |           |  |         |     |             |  |               | 195    |       |  |       |         |   |  |             |     |   |  |   | 195    |  
|Cumulative change in accounting principle                   |  |              |            |           |  |         |     |             |  |               | 129    |       |  |       |         |   |  |             |     |   |  |   | 129    |  
|Issuance of common stock related to debt conversion         |  |              | 5,506,905  |           |  |         | 55  |             |  |               | 5,791  |       |  |       |         |   |  |             |     |   |  |   | 5,846  |  
|Issuance of common stock related to exercise of warrants    |  |              | 2,402,000  |           |  |         | 24  |             |  |               | 4,780  |       |  |       |         |   |  |             |     |   |  |   | 4,804  |  
|Issuance of common stock related to the exercise of options |  |              | 385,938    |           |  |         | 4   |             |  |               | 528    |       |  |       |         |   |  |             |     |   |  |   | 532    |  
|Issuance of common stock                                    |  |              | 334,408    |           |  |         | 3   |             |  |               | 771    |       |  |       |         |   |  |             |     |   |  |   | 774    |  
|                                                            |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  |             |     |   |  |   |        |  
|Balance June 30, 2001                                       |  |              | 18,428,572 |           |  | $       | 184 |             |  | $             | 87,557 |       |  | $     | (81,467 | ) |  | $           | 200 |   |  | $ | 6,474  |  
|                                                           
|Net loss                                                    |  |              |            |           |  |         |     |             |  |               |        |       |  |       | (608    | ) |  |             |     |   |  |   | (608   | )
|Translation adjustment                                      |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  |             | (33 | ) |  |   | (33    | )
|Modification of stock options                               |  |              |            |           |  |         |     |             |  |               | 156    |       |  |       |         |   |  |             |     |   |  |   | 156    |  
|Issuance of common stock related to debt conversion         |  |              | 24,835     |           |  |         | 0   |             |  |               | 25     |       |  |       |         |   |  |             |     |   |  |   | 25     |  
|Issuance of common stock related to the exercise of options |  |              | 418,400    |           |  |         | 4   |             |  |               | 519    |       |  |       |         |   |  |             |     |   |  |   | 523    |  
|Issuance of common stock related to benefit plans           |  |              | 227,875    |           |  |         | 3   |             |  |               | 416    |       |  |       |         |   |  |             |     |   |  |   | 419    |  
|                                                            |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  |             |     |   |  |   |        |  
|Balance June 30, 2002                                       |  |              | 19,099,682 |           |  | $       | 191 |             |  | $             | 88,673 |       |  | $     | (82,075 | ) |  | $           | 167 |   |  | $ | 6,956  |  
|                                                            |  |              |            |           |  |         |     |             |  |               |        |       |  |       |         |   |  |             |     |   |  |   |        |  

See accompanying notes to consolidated financial statements

F-5



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

(1) DESCRIPTION OF BUSINESS

CyberGuard Corporation (CyberGuard or the Company) is a leading
provider of network security solutions designed to protect enterprises that use
the Internet for electronic commerce and secure communication (customers
include Fortune 1000 companies, major financial institutions, and government
agencies worldwide). The Companys CyberGuard® appliance, which includes
firewall and VPN (Virtual Private Network), provides a level of security,
features and availability that the Company believes is not matched in the
industry. Through a combination of proprietary and third-party technology, the
Company provides a full suite of products and services that are designed to
protect the integrity of electronic data and customer applications from
unauthorized individuals and digital thieves.

The appliance is sold to end users directly and indirectly by direct sales
and resellers worldwide in over thirty countries.

(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Consolidation. The consolidated financial statements of
CyberGuard Corporation and its subsidiaries (CyberGuard Europe Ltd. and CYBG
Consultants, Inc. (the Company)) include the accounts of the Company and its
subsidiaries over which it maintains control. All significant inter-company
balances and transactions have been eliminated.

Use of Estimates.The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the 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 deferred taxes. We based 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 Companys operations and ability to grow may be affected by numerous
factors, including changes in customer requirements, new laws and governmental
regulations and policies, technological advances, entry of new competitors and
changes in the willingness of financial institutions and other lenders to
finance acquisitions and operations. The Company cannot predict which, if any,
of these or other factors might have a significant impact on the Companys
industry in the future, nor can it predict what impact, if any, the occurrence
of these or other events might have on the Companys operations.

Cash Equivalents and Restricted Cash.The Company considers all
investments purchased with an original maturity of three months or less at the
time of purchase to be cash equivalents. Restricted cash is unavailable to the
Company until certain contractual terms and conditions are met. At June 30,
2002, the Company has $1,019 of cash in a UK bank.

Restricted cash as of June 30, consists of the following:

|                                                                 |  |      |    |      |  |   |     | 
|---------------------------------------------------------------- |  | ---- | -- | ---- |  | - | --- | 
|                                                                 |  | 2002 |    | 2001
|                                                                 |  |      |    |     
|Cash held on behalf of employees for purchase of company stock   |  | $    | 33 |      |  | $ | 103 | 
|Cash held on behalf of employees for flexible reimbursement plan |  |      | 11 |      |  |   | 2   | 
|Certificate of deposit as collateral on a lease                  |  |      |   |      |  |   | 25  | 
|Escrow on line of credit facility                                |  |      |   |      |  |   | 650 | 
|                                                                 |  |      |    |      |  |   |     | 
|                                                                 |  | $    | 44 |      |  | $ | 780 | 
|                                                                 |  |      |    |      |  |   |     | 

F-6



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

Inventories.Inventories consist primarily of component parts and
computer hardware and are carried at the lower of cost, determined by the
First-In-First-Out (FIFO) 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.

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.

Property and Equipment.Property and equipment are stated at cost, less
accumulated depreciation. Depreciation is computed by the straight-line method
using the estimated useful lives of the assets, which range from 2 to 5 years.
Maintenance and repairs are charged to expense as incurred. Upon sale,
retirement or other disposition of these assets, the cost and the related
accumulated depreciation are removed from the respective accounts and any gain
or loss on the disposition is included in the consolidated statement of
operations.

Impairment of Long Lived Assets.The Company evaluates the recoverability
of all its long-lived assets, including intangibles. If the sum of the
undiscounted future cash flows is less than the carrying amount of the asset,
an impairment loss is recognized as the amount by which the carrying amount of
the asset exceeds its fair value. Effective July 1, 2002, impairment of
goodwill and other long-lived assets will be assessed according to new
accounting guidelines (see footnote 13).

Software Development Costs.The Company capitalizes costs related to the
development of certain software products 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.

During fiscal year 2002, the Company capitalized software development
costs of $172 and associated amortization of $694. During 2001, the Company
capitalized software development costs of $360 and associated amortization of
$761. During 2000, the Company capitalized software development costs of $1,205
and associated amortization of $247.

Revenue Recognition.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
probable. While we generally recognize product revenue on product shipment, we
defer revenues on product sales for value added resellers until the partners
demonstrate consistency of payment within terms and no product returns for a
three month period. Service revenues are recognized ratably on a monthly basis
over the service contract term. Service revenues primarily include the annual
fee for maintenance, which is sold as part of our security solutions, and for
subscription renewals from our existing customers and end users. These
services provide our customers access to our worldwide support organization for
product updates, general security information and technical support.

F-7



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

During fiscal year 2002, the revenue recognition for four resellers in
Asia and seven resellers in Europe, was changed from cash basis to accrual,
based on a reasonable assurance of collectibility from evaluating their payment
histories. The impact was to increase revenue by approximately $1,100 in fiscal
year 2002. Revenue on post-contract customer support is deferred and amortized
by the straight-line method over the term of the contracts. The Company also
provides professional support services, 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.

Deferred Revenue. Deferred revenue represents amounts billed or payments
received in advance of maintenance services to be rendered over a certain
period of time, and are recognized ratably over the service term.

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

Advertising Expense.The Company expenses advertising and promotional
costs as incurred. Advertising expense for the years ended June 30, 2002, 2001
and 2000 was $872, $1,475 and $569, respectively

Income Taxes. The provision for income taxes and corresponding balance
sheet accounts are determined in accordance with Statement of Financial
Accounting Standards No. 109, Accounting for Income Taxes (SFAS No. 109).
Under SFAS No. 109, deferred tax liabilities and assets are determined based on
the temporary differences between the bases of certain assets and liabilities
for income tax and financial reporting purposes. The deferred tax assets and
liabilities are classified according to the financial statement classification
of the assets and liabilities generating the differences. The Company provides
a valuation allowance for deferred tax assets, which cannot be currently
recognized due to the Companys cumulative losses and the uncertainty as to
future recoverability. The Company has considered future taxable income and
ongoing prudent and feasible tax planning strategies in assessing the need for
the valuation allowance. In the event the Company was to determine that it
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.

Foreign Currency Translation.The Companys foreign operations utilize the
local foreign currency as the functional currency. The results of operations
and cash flows for the foreign operations are translated at an average exchange
rate for the period, and the assets and liabilities of the foreign operations
are translated at the exchange rate at the end of the period. Translation
adjustments are included in stockholders equity (deficit). Transaction gains
or losses are included in determining net income / (loss) for the period.
During fiscal year 2002, 2001, and 2000, the Company recognized a transaction
gain of $203, a transaction loss of $159, and a transaction loss of $172
respectively, reported as other income / (expense).

Accounting for Stock Options.Options granted under the Companys Stock
Option Plans are accounted for under APB 25, Accounting for Stock Issued to
Employees, and related interpretations. The Company also makes additional
pro-forma disclosures in accordance with Statement of Financial Accounting
Standards (SFAS) 123.

Net Loss Per Share.Basic income (loss) per share excludes dilution and is
computed by dividing income (loss) available to common shareholders by the
weighted-average number of common shares outstanding for the period. Diluted
net income (loss) per share reflects the potential dilution that could occur if
securities, stock options, warrants or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the entity. Potential common
stock in the form of options totaling 5,143,000 and warrants totaling 2,388,000
that have an effect on diluted net loss per share calculations, due to their
anti-dilutive effects, are excluded.

F-8



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

(3) PROPERTY AND EQUIPMENT

Property and equipment consists of the following:

|                                    |          |   |               |       |               |   |        |       | 
|----------------------------------- | -------- | - | ------------- | ----- | ------------- | - | ------ | ----- | 
|                                    |          |   | June 30, 2002 |       | June 30, 2001
|                                    |          |   |               |       |              
|Property and equipment              |          | $ | 3,126         |       |               | $ | 2,706  |      
|Purchased software for internal use |          |   | 387           |       |               |   | 373    |      
|Leasehold improvement               |          |   | 34            |       |               |   | 34     |      
|                                    |          |   |               |       |               |   |        |      
|                                    | Subtotal |   |               | 3,547 |               |   |        | 3,113 | 
|                                    |          |   |               |       |               |   |        |      
|Less: accumulated depreciation      |          |   | (2,335        | )     |               |   | (1,869 | )    
|                                    |          |   |               |       |               |   |        |      
|Property and equipment, net         |          | $ | 1,212         |       |               | $ | 1,244  |      
|                                    |          |   |               |       |               |   |        |      

(4) ACCRUED EXPENSES AND OTHER LIABILITIES

Accrued expenses and other liabilities consists of the following:

|                                       |  |          |       |          |  |   |       | 
|-------------------------------------- |  | -------- | ----- | -------- |  | - | ----- | 
|                                       |  | June 30, |       | June 30,
|                                       |  | 2002     |       | 2001    
|                                       |  |          |       |         
|Salaries, wages and other compensation |  | $        | 1,355 |          |  | $ | 1,570 | 
|Other payables                         |  |          | 950   |          |  |   | 799   | 
|                                       |  |          |       |          |  |   |       | 
|                                       |  | $        | 2,305 |          |  | $ | 2,369 | 
|                                       |  |          |       |          |  |   |       | 

(5) LINE OF CREDIT AND NOTES PAYABLE

On December 30, 1997, the Company entered into an asset-based revolving
line of credit of approximately $3,350 and a $650 Term Note Agreement with a
financing company. Interest was charged at the prime rate plus 2%. At June 30,
2001, the interest rate on the revolving line of credit was 9%. The credit
facility was collateralized by all of the tangible assets and intellectual
property of the Company. Availability under the revolving credit facility was
limited to 80% of eligible accounts receivable and 30% of qualified inventory
up to a maximum availability of $300 on eligible inventory. The amount of
availability on the revolving line of credit at June 30, 2001 was $988. The
original term note was for a period of three years and payable in thirty-nine
monthly installments. In December 1999, the Company re-negotiated the terms of
the credit facility, which extended the term of the note until December 30,
2001. At June 30, 2001, the Company presented the $650 cash compensating
balance equal to the amount of the term loan as restricted cash. As of June 30,
2001, there was approximately $113 outstanding under the revolving line of
credit agreement. The loan and revolving line of credit were repaid on December
31, 2001.

The Company has entered into an insurance premium financing agreement. At
June 30, 2002 the total amount outstanding was $140 and the interest rate was
5.26%. At June 30, 2001, the amount outstanding was $156 and the interest rate
was 8.11%.

(6) CONVERTIBLE DEBENTURE

On December 17, 1998, the Company executed an agreement to issue $1,125 of
Convertible Debt (Debt) with an investment company. The Debt was interest
bearing at a rate of prime plus 2% and

F-9



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

was payable quarterly. The Debt was
convertible into 750,000 shares of common stock at a conversion price equal to
$1.50 per share. The Debt was convertible, at the debt holders option, after
February 1, 2000. In addition, the Company issued the debt holders warrants to
purchase 500,000 shares of the Companys common stock at $2.00 per share. The
warrants were exercisable at any time before June 2001. The terms of the Debt
and warrant agreement that permitted the conversion of the Debt and warrants to
common stock at a discount to market, was considered a beneficial conversion
feature. The beneficial conversion feature at the date of issuance of the Debt
was recognized as interest expense over the shortest possible conversion
period. The convertible debt was secured by a second lien on the Companys
assets and properties and was subordinated to the Companys senior debt.

On August 26, 1999, the Company increased the convertible debt to
approximately $4,300 including repaying the December 1998 issuance. This
increased amount was principally with the same debt holders as the December
1998 transaction, with certain company officers, directors and employees also
participating.The debt was interest bearing at a rate of 11.5% per annum with
a maturity of June 30, 2002. Interest was payable quarterly, except for
interest accruing from the date of issuance through July 1, 2000, which was
added to the principal amount of the note. The number of shares of common
stock into which the debt may be converted was equal to the principal amount of
the note, plus the accrued interest, divided by the conversion price of $1.00
per share. In addition, the warrants from the December 17, 1998 transaction
were cancelled, and the Company issued approximately 4,300,000 warrants to
purchase the Companys common stock at $2.00 per share and have a term of five
years. The warrants were valued at $431 and this amount was recognized as
interest expense over the debt conversion period. Certain debt holders, holding
$25 in convertible debt, elected to convert the debt during fiscal 2002 into
24,835 shares of common stock. Holders of the remaining $38 convertible debt
were repaid during fiscal 2002.

As of September 30, 1999, the Company had recorded a beneficial conversion
feature attributable to the convertible debt of $1,078. This feature was being
amortized over the term of the debt. A report subsequently issued by a national
valuation firm indicated the fair value of the Companys common stock was below
the conversion price at the date of the transaction and therefore, no such
beneficial conversion feature existed. The Company reversed the charge of $317
in the fourth quarter of fiscal year 2000 that had been charged as interest
expense. The effect on the prior quarterly results was immaterial.

On December 29, 2000, the Company completed an additional $1 million
financing transaction as an add-on to the August 1999 financing agreement. The
additional note was convertible into the Companys common stock at $1.51 per
share and carried a warrant to purchase an additional 333,877 shares of the
Companys common stock at $2.51 per share.

At the November 2000 meeting, The Emerging Issues Task Force (EITF)
reached a consensus opinion on Issue 00-27 regarding the Application of EITF
Issue 98-5, Convertible Securities with Beneficial Conversion Features or
Contingently Adjustable Conversion Ratios, to Certain Convertible
Instruments. The consensus opinion required the Company to use an effective
conversion price to determine a convertible instruments beneficial conversion
feature. The change was effective retroactively to transactions for which a
commitment date occurred prior to November 16, 2000. As a result, in December
2000, the Company recognized approximately $129 as a cumulative effect of a
change in accounting principle associated with the convertible debt issued in
August 1999. During December 2000, the Company also recognized $33 in interest
expense associated with the convertible debt issued in December 2000.

On January 24, 2001, approximately $5,700 of convertible debt and the
interest accrued on that debt was converted into approximately 5,300,000 shares
of common stock at prices between $1.00 and $1.51 per share, by the investment
company, current directors and certain former officers. Approximately $130 of
the value of the warrants associated with this debt conversion was amortized
into interest expense.

F-10



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

During January 2001, warrants for the purchase of approximately 2,400,000
shares of the Companys common stock were exercised at $2.00 per share for a
total of approximately $4,800 in cash. The value of the warrants decreased by
$127 as a result of this exercise.

On May 31, 2001, approximately $192 of convertible debt and the interest
accrued on that debt was converted into approximately 192,000 shares of common
stock at $1.00 per share. Approximately $7 of the value of the warrants
associated with this debt conversion was amortized into interest expense.

The number of warrants outstanding on the convertible debt as of June 30,
2002 and 2001 was 2,245,361 and are exercisable at prices ranging from $2.00 to
$2.50, and expire in August 2004. The book value of the warrants as of June
30, 2002 and 2001 was $0 and $2, respectively. During 2002 and 2001, $2 and
$209 of the book value of the warrants was amortized to interest expense. As of
June 30, 2002 all convertible debt has either been repaid or converted into
common stock of the Company.

(7) INCOME TAXES

The significant components of the Companys net deferred income tax assets
(liabilities) are as follows:

|                                    |  |          |         |          |  |          |         |   |  |   |         |  
|----------------------------------- |  | -------- | ------- | -------- |  | -------- | ------- | - |  | - | ------- | -
|                                    |  | June 30, |         | June 30, |  | June 30,
|Deferred tax assets and liabilities |  | 2002     |         | 2001     |  | 2000    
|                                    |  |          |         |          |  |         
|Accrued expenses                    |  | $        | 443     |          |  | $        | 339     |   |  | $ | 243     |  
|Depreciation and amortization       |  |          | 545     |          |  |          | 313     |   |  |   | (290    | )
|Net operating loss carryforwards    |  |          | 25,029  |          |  |          | 24,210  |   |  |   | 22,843  |  
|Capital loss carryforwards          |  |          | 2,855   |          |  |          | 2,024   |   |  |   | 2,024   |  
|Other deferred tax assets           |  |          | 39      |          |  |          | 517     |   |  |   | 522     |  
|Valuation allowance                 |  |          | (28,911 | )        |  |          | (27,403 | ) |  |   | (25,342 | )
|                                    |  |          |         |          |  |          |         |   |  |   |         |  
|Net deferred income tax liability   |  |          |        |          |  |          |        |   |  |   |        |  
|                                    |  |          |         |          |  |          |         |   |  |   |         |  

A reconciliation of the effective income tax rate and the statutory United
States income tax rate follows:

|                               |  |               |       |               |  |  |       |   
|------------------------------ |  | ------------- | ----- | ------------- |  |  | ----- | --
|                               |  | Year ended    |       | Year ended   
|                               |  | June 30, 2002 |       | June 30, 2001
|                               |  |               |       |              
|Statutory U.S. income tax rate |  |               | (34.0 | )%            |  |  | (34.0 | )%
|State taxes                    |  |               | (3.0  | )%            |  |  | (3.0  | )%
|Other                          |  |               | (2.5  | )%            |  |  | 0.0   | % 
|Interest on convertible debt   |  |               | 21.7  | %             |  |  | 4.4   | % 
|Valuation Allowance            |  |               | 17.8  | %             |  |  | 32.6  | % 
|                               |  |               |       |               |  |  |       |   
|Effective income tax rate      |  |               | 0.0   | %             |  |  | 0.0   | % 
|                               |  |               |       |               |  |  |       |   

As of June 30, 2002, the Company had U.S. net operating loss carryforwards
for federal income tax purposes of approximately $67,438. The Companys net
operating loss carryforwards begin to expire in 2010. Under the Tax Reform Act
of 1986, the amounts of, and the benefits from, net operating loss
carryforwards may be impaired or limited due to a change of ownership control
as defined by the Internal Revenue Code. In addition, the Company has U.S. net
capital loss carryforwards of approximately $5,394. The Company may utilize the
U.S. capital loss carryforwards only to the extent it generates future capital
gains. As of June 30, 2002, the Company had U.K. net operating loss
carryforwards of $250, which do not expire under U.K. tax laws. As of June 30,
2002 and 2001, a valuation allowance has been established against the net
deferred tax asset since the Company believes it is more likely than not that
the tax asset will not be realized.

F-11



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

(8) SHAREHOLDERS EQUITY

Common Stock-The Company has authorized 50,000,000 shares of CyberGuard
common stock, each share having a par value of $0.01 per share.

Preferred Stock -The Company has authorized 5,000 shares of CyberGuard
preferred stock, each share having a par value of $0.01 per share. No
preferred shares are outstanding.

Stockholder Protection Rights Agreement-In September 1994, the Company
approved a Stockholder Protection Rights Agreement. The agreement states that
each share of the Companys common stock has attached to it one right. Each
right entitles its registered holder to purchase from the Company after the
Separation Time, as hereinafter defined, one-hundredth of a share of
Participating Preferred Stock, par value $0.01 per share, for an amount
calculated in accordance with the Preferred Stock Agreement. The rights will
not trade separately from the common stock unless and until the Separation
Time. The Separation Time is defined as the earlier of the tenth business day
after the date on which any person commences a tender or exchange offer which,
if consummated, would result in an acquisition, and the first date of public
announcement by the Company of such offering. In the event of any voluntary or
involuntary liquidation of the Company, the holders of the Preferred Stock
shall be paid an amount as calculated in accordance with the Preferred Stock
Agreement.

Stock Option Plans-Effective October 8, 1994, the Company adopted an
Incentive Stock Option Plan. On February 4, 1996, the Board of Directors
approved an amendment to the plan to reserve 2,025,000 shares of common stock
for grant, and effective October 28, 1997 increased the reserve to 2,400,000
shares. Effective September 4, 1998, the Company adopted an Employee Stock
Option Plan. The Board of Directors approved an initial reserve of 1,400,000
shares of common stock for grant, and effective August 10, 1999 increased the
reserve to 2,500,000 shares. On March 9, 2001, the Company registered an
additional 2,000,000 shares and on November 21, 2001, an additional 2,500,000
shares, totaling 7,000,000 shares under the 1998 plan. The options vest over a
three-year period and have a term of five years.

Both plans permit the issuance of stock options; stock appreciation
rights, performance awards, restricted stock and/or other stock based awards to
directors and salaried employees. The option price shall be determined by the
Board of Directors effective on the Grant Date. The option price shall not be
less than 100% of the Fair Market Value of a share of common stock on the Grant
Date. If Incentive Stock Options are granted to a participant who on the Grant
Date is a ten-percent holder, such price shall not be less than one hundred and
ten percent of the Fair Market Value of a share of common stock on the Grant
Date. Vesting of these options occurs based on years of service. Generally it
begins at 33% after one year, 66% after two years, and 100% after the third
year of service. All options become immediately exercisable upon the occurrence
of a Change in Control of the Company.

During October 2001, certain officers and employees elected to participate
in a special stock option program offered by the Company through a Stock Option
Plan. Officers could elect a base salary reduction ranging from 10.01% to 100%
and employees could elect a base salary reduction ranging from .01% to 100%.
This base salary reduction entitled them to receive a specified number of stock
options, as defined in the program agreement, to purchase shares of the
Companys common stock at the then current market price of $1.30 per share.
Approximately 1,751,000 stock options, with a one-year vesting period that will
expire in 10 years from the grant date were issued related to this program. The
Companys CEO participated in this special option program where he elected to
accept options in lieu of salary for a twelve months period. The company was
required to record compensation expense of $91 through June 30, 2002.

In September 1998, the Company elected to have non-qualified stock options
for key executives as part of their compensation plan. The Board of Directors
has the authority to determine who may be granted options, the period of
exercise, the option price at the date of grant, and any other restrictions, if
applicable. For the fiscal years ended June 30, 2002 and 2001, the Company
granted 274,000 and 1,929,000 options, respectively, under this election, which
vest over a three-year period.

F-12



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock volatility.
Because the Companys employee stock options have characteristics significantly
different from those of traded options, and because changes in subjective input
assumptions can materially affect the fair value estimate, in managements
opinion, the existing models do not necessarily provide a reliable single
measure of the fair value of its employee stock options.

The adoption of SFAS No. 123 under the fair value based method would have
increased compensation expense by $2,506, $2,560, and $3,397 for the years
ended June 30, 2002, 2001, and 2000, respectively. The effect of SFAS No. 123
under the fair value based method would have affected net loss and loss per
share as follows:

|                                  |  |            |        |            |  |            |        |   |  |   |        |  
|--------------------------------- |  | ---------- | ------ | ---------- |  | ---------- | ------ | - |  | - | ------ | -
|                                  |  | Year ended |        | Year Ended |  | Year Ended
|                                  |  | June 30,   |        | June 30,   |  | June 30,  
|                                  |  | 2002       |        | 2001       |  | 2000      
|                                  |  |            |        |            |  |           
|Net loss                          |  | $          | (608   | )          |  | $          | (4,016 | ) |  | $ | (976   | )
|                                  |  |            |        |            |  |            |        |   |  |   |        |  
|Pro-Forma                         |  | $          | (3,114 | )          |  | $          | (6,576 | ) |  | $ | (4,373 | )
|                                  |  |            |        |            |  |            |        |   |  |   |        |  
|Loss per common share as reported |  | $          | (0.03  | )          |  | $          | (0.30  | ) |  | $ | (0.10  | )
|                                  |  |            |        |            |  |            |        |   |  |   |        |  
|Pro-Forma                         |  | $          | (0.17  | )          |  | $          | (0.50  | ) |  | $ | (0.47  | )
|                                  |  |            |        |            |  |            |        |   |  |   |        |  

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 2002, 2001, and 2000, respectively: risk-free interest
rates were 5.31%, 6.0%, and 5.11%, expected dividend yield of 0%, volatility
factors of the expected market price of the Companys common stock were 115.0%,
121.0%, and 116.3%, and a weighted average expected life of the option of 3, 3,
and 3 years, respectively.

The above pro-forma disclosures may not be representative of the effects
on reported net earnings for future years as certain options vest over several
years and the Company may continue to grant options to employees.

F-13



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

Information relating to the Companys stock option plans is as follows:

|                                           |  |           |           |                  |  |   |      | 
|------------------------------------------ |  | --------- | --------- | ---------------- |  | - | ---- | 
|                                           |  | Number of |           | Weighted Average
|                                           |  | Shares    |           | Exercise Price  
|                                           |  |           |           |                 
|Options at June 30, 1999                   |  |           | 3,061,000 |                  |  | $ | 1.91 | 
|Granted                                    |  |           | 1,094,000 |                  |  | $ | 3.94 | 
|Exercised                                  |  |           | (640,000  | )                |  | $ | 1.41 | 
|Forfeited                                  |  |           | (539,000  | )                |  | $ | 1.79 | 
|                                           |  |           |           |                  |  |   |      | 
|Shares under option at June 30, 2000       |  |           | 2,977,000 |                  |  | $ | 2.65 | 
|                                           |  |           |           |                  |  |   |      | 
|Shares exercisable at June 30, 2000        |  |           | 1,703,000 |                  |  | $ | 2.05 | 
|                                           |  |           |           |                  |  |   |      | 
|Options at June 30, 2000                   |  |           | 2,977,000 |                  |  | $ | 2.70 | 
|Granted                                    |  |           | 1,929,000 |                  |  | $ | 1.98 | 
|Exercised                                  |  |           | (386,000  | )                |  | $ | 1.38 | 
|Forfeited                                  |  |           | (654,000  | )                |  | $ | 4.66 | 
|                                           |  |           |           |                  |  |   |      | 
|Shares under option at June 30, 2001       |  |           | 3,866,000 |                  |  | $ | 2.15 | 
|                                           |  |           |           |                  |  |   |      | 
|Option shares exercisable at June 30, 2001 |  |           | 1,993,000 |                  |  | $ | 1.83 | 
|                                           |  |           |           |                  |  |   |      | 
|Options at June 30, 2001                   |  |           | 3,866,000 |                  |  | $ | 2.15 | 
|Granted                                    |  |           | 2,025,000 |                  |  | $ | 1.41 | 
|Exercised                                  |  |           | (418,000  | )                |  | $ | 1.25 | 
|Forfeited                                  |  |           | (330,000  | )                |  | $ | 2.77 | 
|Shares under option at June 30, 2002       |  |           | 5,143,000 |                  |  | $ | 1.89 | 
|                                           |  |           |           |                  |  |   |      | 
|Option shares exercisable at June 30, 2002 |  |           | 3,327,000 |                  |  | $ | 1.84 | 
|                                           |  |           |           |                  |  |   |      | 

The following information applies to options outstanding as of June 30,
2002:

|                |  |                     |           |                     |  |                  |     |                    |  |                |      |  |  |                  |           |  |  |   |      | 
|--------------- |  | ------------------- | --------- | ------------------- |  | ---------------- | --- | ------------------ |  | -------------- | ---- |  |  | ---------------- | --------- |  |  | - | ---- | 
|                |  | Options Outstanding |           | Options Exercisable
|                |  |                     |           |                    
|Actual Range of |  |                     |           |                     |  | Weighted-Average |     |                    |  |                |      |  |  |                  |           |  |  |  
|Exercise Prices |  |                     |           |                     |  | Remaining        |     | Weighted-Average   |  |                |      |  |  | Weighted-Average
|Increment       |  | Number Outstanding  |           | Contractual Life    |  | Exercise Price   |     | Number Exercisable |  | Exercise Price
|                |  |                     |           |                     |  |                  |     |                    |  |               
|$0.75 - 1.13    |  |                     | 374,000   |                     |  |                  | 1.4 |                    |  | $              | 1.02 |  |  |                  | 374,000   |  |  | $ | 1.02 | 
|$1.25 - 1.70    |  |                     | 3,802,000 |                     |  |                  | 6.4 |                    |  | $              | 1.37 |  |  |                  | 2,396,000 |  |  | $ | 1.35 | 
|$2.00 - 3.00    |  |                     | 223,000   |                     |  |                  | 7.3 |                    |  | $              | 2.61 |  |  |                  | 137,000   |  |  | $ | 2.51 | 
|$3.09 - 4.35    |  |                     | 452,000   |                     |  |                  | 5.6 |                    |  | $              | 3.71 |  |  |                  | 211,000   |  |  | $ | 3.80 | 
|$5.00 - 7.38    |  |                     | 292,000   |                     |  |                  | 4.6 |                    |  | $              | 6.40 |  |  |                  | 209,000   |  |  | $ | 6.41 | 
|                |  |                     |           |                     |  |                  |     |                    |  |                |      |  |  |                  |           |  |  |   |      | 
|$0.75 - 7.38    |  |                     | 5,143,000 |                     |  |                  | 5.9 |                    |  | $              | 1.89 |  |  |                  | 3,327,000 |  |  | $ | 1.84 | 
|                |  |                     |           |                     |  |                  |     |                    |  |                |      |  |  |                  |           |  |  |   |      | 

In November 2000, the Company resolved that the former Chief Executive
Officer (CEO) and then current Chairman of the Boards stock options would
vest in full upon his retirement date, and the options would remain exercisable
through February 28, 2003 or the options expiration date, whichever comes
first. The former CEO waived the extended exercise period and therefore, the
Company recorded no compensation expense related to this modification.

In November 2000, the Company extended the expiration dates of
approximately 129,000 options to purchase shares of the Companys common stock.
As a result of this modification, the Company recorded approximately $68 in
compensation expense.

F-14



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

In January 2001, the Company resolved that the former Chief Financial
Officers (CFO) stock options would vest in full upon his retirement date,
and the options would remain exercisable through June 30, 2003 or the options
expiration date, whichever comes first. As a result of this modification, the
Company recorded approximately $73 in compensation expense.

During the third quarter of 2001, under market priced options were issued
to the Companys President, which resulted in compensation expense of $43. The
Company also issued under market priced options to two employees, which
resulted in compensation expense of $65 in fiscal 2002 and $11 in fiscal 2001.

On March 9, 2001, the Company filed a Registration Statement on Form S-8
with the Securities and Exchange Commission to register 2 million additional
shares of the Companys common stock for issuance pursuant to the exercise of
options to be granted under the Companys Amended and Restated Employee Stock
Option Plan.

On October 24, 2001, the Board of Directors of the Company resolved that
upon Mr. David Proctors resignation as Chairman of the Board effective
November 15, 2001, additional vesting of 16,667 options to purchase the
Companys common stock granted on April 26, 2000, with the options remaining
exercisable through May 15, 2002. There was no accounting effect as a result
of this resolution.

On November 21, 2001, the Company filed a Registration Statement on Form
S-8 with the Securities and Exchange Commission to register 2,500,000
additional shares of the Companys common stock for issuance pursuant to the
Companys Second Amended and Restated Employee Stock Option
Plan.

On July 19,
2002, the Company filed an amendment to its Registration Statement on Form S-8
with the Securities and Exchange Commission to reflect the amendment and
restatement of the Harris Computer Systems Corporation Employee Savings Plan as
the CyberGuard Corporation Retirement Savings Plan.

Related Party Equity Transactions-During January 2001, the Companys CEO
invested $500 to purchase at the market value approximately 143,000 shares of
common stock at $1.75 share and approximately 62,000 shares of common stock at
$4.00 per share. In conjunction with the purchase of the approximately 143,000
shares of common stock, the CEO was granted an equal number of warrants to
purchase the Companys common stock at $1.75 per share. The warrants are
exercisable any time before December 25, 2005.

(9) COMMITMENTS AND CONTINGENCIES

Employment Agreements. The Company has entered into employment agreements
with certain key employees. These agreements provided for severance and other
benefits if the Company for any reason other than cause terminates these
employees.

Lease Commitments.Rent expense was approximately $643 for the year ended
June 30, 2002, $631 for the year ended June 30, 2001, and approximately $697
for the year ended June 30, 2000.

Total future minimum rental commitments under non-cancelable operating
leases, primarily for buildings and equipment, for the years following June 30,
2002 are as follows:

|      |  |        |       | 
|----- |  | ------ | ----- | 
|YEAR  |  | AMOUNT
|      |  |       
|2003  |  | $      | 514   | 
|2004  |  |        | 508   | 
|2005  |  |        | 42    | 
|      |  |        |       | 
|Total |  | $      | 1,064 | 
|      |  |        |       | 

F-15



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

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.

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 notified its insurance carrier of the
existence of the lawsuit, and the carrier has sent the Company a reservation of
rights letter. 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. The Companys
consolidated financial statements do not include any adjustments related to
these matters.

The Company is aware that on January 30, 2002 the SEC filed an enforcement
action in the United States District Court, Southern District of Florida
against CyberGuards former Chief Executive Officer and Chairman of
CyberGuards Board of Directors, Robert L. Carberry; CyberGuards former Chief
Financial Officer and Vice President of North American Sales and current Vice
President of Business Development, Patrick O. Wheeler; and CyberGuards former
Controller, Steven S. Gallers, alleging violations of the anti-fraud provisions
of the Exchange Act and seeking permanent injunctions, civil

F-16



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

monetary penalties and bars against serving as officers and directors of a public company.
SEC vs.
Wheeler et al., Case No. 02-60131-CIV-Graham. Mr. Carberry and Mr. Gallers
entered into settlements with the SEC whereby, without admitting or denying the
allegations of the complaint, they agreed to be permanently enjoined from
future violations of the Exchange Act, pay a $50,000 civil penalty each and, in
the case of Mr. Gallers, be barred from serving as officer or director of a
public company. Mr. Wheeler continues to defend against the lawsuit. The
Company is unable to determine at this time what impact the SEC proceedings
against Mr. Wheeler will have on the Company.

On September 16, 1999, the Company filed a lawsuit against KPMG and August A.
Smith, the KPMG engagement partner. The lawsuit is pending in the Circuit Court
of the 17th Judicial Circuit in and for Broward County, Case No.
00-004102-CACE-14. On May 1, 2000, the Company filed the First Amended
Complaint, alleging that KPMG failed to properly audit the Companys financial
statements and provided inaccurate advice on accounting matters for fiscal
years 1996, 1997 and 1998. The action alleges professional malpractice, breach
of fiduciary duty, breach of contract and breach of implied duty of good faith,
and seeks damages in excess of $10 million. KPMG and Mr. Smith filed motions to
dismiss, which were denied. In August 2000, KPMG and Mr. Smith filed their
answers and KPMG filed counterclaims against the Company, alleging the
Companys breach of contract, negligent misrepresentation and abuse of process,
and seeking an unspecified amount of damages consisting of unpaid service fees
and legal fees and costs. The Company filed an answer to KPMGs counterclaims
and moved to dismiss KPMGs abuse of process counterclaim. On April 9, 2001,
the Court dismissed the abuse of process counterclaim with prejudice. The
parties are currently conducting discovery.

On November 2, 2001, the Company filed a lawsuit against a former customer in
the United States District Court of the Southern District of Florida, alleging
breach of contract, and seeking, among other remedies, damages of approximately
$4.2 million. On November 26, 2001, the customer filed an answer and
affirmative defenses. On or about January 15, 2002, the customer filed a motion
challenging the jurisdiction of the U.S. District Court, Southern District of
Florida. On or about March 27, 2002, the U.S. District Court for the Southern
District of Florida dismissed the action on jurisdictional grounds. The Company
continues to consider its alternatives with respect to this litigation,
including whether to re-file the action in a different jurisdiction.

The Company is involved from time to time in other litigation on various
matters 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.

(10) FINANCIAL INSTRUMENTS AND CONCENTRATIONS OF CREDIT RISK

Financial instruments, which potentially subject the Company to a
concentration of credit risk principally, consist of cash, cash equivalents and
trade receivables. The Company holds any excess cash in short-term investments
consisting of commercial paper. The carrying value of these financial
instruments approximates fair value.

The Company does not require collateral or other security on its trade
receivables. During 2002, one customer represented 11% of consolidated
revenues. During 2001, one customer represented 16% and one distributor
represented 12% of consolidated revenues. During 2000, one customer represented
28% of consolidated revenues.

During 2002, 2001 and 2000, one supplier who is our hardware manufacturer
and assembly provider, represented 21%, 20% and 17% respectively of
consolidated purchases. At June 30, 2002, 2001 and 2000, this supplier
represented 39%, 43% and 21% respectively of consolidated accounts payable.

F-17



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

(11) EMPLOYEE BENEFIT PLANS

The Company has a 401(k) Savings Plan (the Plan) which covers the
eligible employees of the Company. An employee is eligible to participate in
the Plan on the date of hire. The amount of profit-sharing contributions made
by the Company into the Plan is discretionary. Each participant may contribute
up to 19% of compensation into the Plan. The Company makes a matching
contribution on behalf of each participant for the first 6% of their individual
contribution. These contributions are made in the form of cash and common stock
of the Company. Participants profit sharing and matching contribution vests
over a three-year period. For the years ended June 30, 2002, 2001, and 2000, the
Company recorded compensation expense of $259, $222, and $72 respectively, for
the Company matches to the Plan.

The Company has an Employee Stock Purchase Plan (ESPP), which covers the
eligible employees of the Company. The ESPP allows an employee to purchase
common stock of the Company at a 15% discount on the lower of the beginning or
ending offering date. An employee is eligible to participate in the ESPP
beginning on the offering date (defined as January 1 and July 1) following
their hire date. Each participant may contribute the lesser of 10% of eligible
compensation or $25,000 per calendar year. During 2002 and 2001, 114,000 and
54,000 shares respectively, were issued in connection with this plan.

(12) GEOGRAPHIC INFORMATION

A summary of the Companys revenues* by geographic area is summarized
below:

|              |  |                     |        |      |  |      |        |  |  |   |        | 
|------------- |  | ------------------- | ------ | ---- |  | ---- | ------ |  |  | - | ------ | 
|              |  | Year Ended June 30,
|              |  |                    
|              |  | 2002                |        | 2001 |  | 2000
|              |  |                     |        |      |  |     
|North America |  | $                   | 9,339  |      |  | $    | 12,080 |  |  | $ | 11,866 | 
|Europe        |  |                     | 7,761  |      |  |      | 8,553  |  |  |   | 4,974  | 
|Asia          |  |                     | 4,976  |      |  |      | 3,773  |  |  |   | 2,019  | 
|Latin America |  |                     | 264    |      |  |      |       |  |  |   |       | 
|              |  |                     |        |      |  |      |        |  |  |   |        | 
|              |  | $                   | 22,340 |      |  | $    | 24,406 |  |  | $ | 18,859 | 
|              |  |                     |        |      |  |      |        |  |  |   |        | 



|* |  | Revenues are attributed to countries based on location of customer.
|- |  | -------------------------------------------------------------------

A summary of the Companys long-lived assets is summarized below:

|              |  |                     |       |      |  |      |       |  |  |   |       | 
|------------- |  | ------------------- | ----- | ---- |  | ---- | ----- |  |  | - | ----- | 
|              |  | Year Ended June 30,
|              |  |                    
|              |  | 2002                |       | 2000 |  | 2000
|              |  |                     |       |      |  |     
|United States |  | $                   | 1,121 |      |  | $    | 1,190 |  |  | $ | 1,048 | 
|Europe        |  |                     | 91    |      |  |      | 54    |  |  |   | 38    | 
|Asia          |  |                     |      |      |  |      |      |  |  |   |      | 
|              |  |                     |       |      |  |      |       |  |  |   |       | 
|              |  | $                   | 1,212 |      |  | $    | 1,244 |  |  | $ | 1,086 | 
|              |  |                     |       |      |  |      |       |  |  |   |       | 

(13) NEW ACCOUNTING PRONOUNCEMENTS

In June 2001, the Financial Accounting Standards Board approved the
issuance of SFAS No. 141, Business Combinations and SFAS 142, Goodwill and
Other Intangible Assets. The new standards require that all business
combinations initiated after June 30, 2001 must be accounted for under the
purchase method. In addition, all intangible assets acquired that are obtained
through contractual or legal right, or are capable of being separately sold,
transferred, licensed, rented or exchanged shall be recognized as an asset

F-18



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

apart from goodwill. Goodwill and intangibles with indefinite lives will no
longer be subject to amortization, but will be subject to an annual assessment
for impairment by applying a fair value based test. As the Company has no
goodwill or other intangibles generated as a result of a business combination,
the adoption of these Standards is not expected to have an impact on the
Companys operations.

In July 2001, the Financial Accounting Standards Board issued SFAS No.
143, Accounting for Asset Retirement Obligations, effective for fiscal years
beginning after June 15, 2002. SFAS No. 143 addresses the accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs. The Company does not expect
that the application of the provisions of SFAS No. 143 will have an impact on
the Companys operations.

In August 2001, the Financial Accounting Standards Board issued SFAS No.
144, Accounting for the Impairment or Disposal of Long-Lived Assets. The
provisions of the statement are effective for financial statements issued for
fiscal years beginning after December 15, 2001 and are to be applied
prospectively. SFAS No. 144 clarifies the accounting for impairment of
long-lived assets to be disposed of, including the disposal of business
segments and major lines of business. The Company does not expect that the
application of the provisions of SFAS No. 144 will have an impact on the
Companys operations.

In November 2001, the Financial Accounting Standards Boards Emerging
Issues Task Force (EITF) issued EITF No. 01-9, Accounting for Consideration
Given by a Vendor to a Customer or a Reseller of the Vendors Products. The
EITF reconciled selected guidance provided in Issue Nos. 00-14, 00-22, and
00-25, addressing the income statement classification of certain promotional
payments. Primarily effective in 2002, the Company does not expect that the
application of the provisions of EITF No. 01-9 will have a material impact on
the Companys operations.

In July 2002, the FASB issued Statement 146, Accounting for Exit or
Disposal Activities. SFAS 146 nullifies EITF 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring). The statement provides
guidance on the accounting and disclosure requirements for companies that incur
costs to exit an activity. SFAS146 is effective for exit or disposal activities
initiated after December 31, 2002. Early application is encouraged. Restatement
of previously issued financial statements is prohibited.

(14) QUARTERLY FINANCIAL INFORMATION (UNAUDITED)

Selected unaudited quarterly results for the fiscal year ended June 30,
2002 and 2001 were as follows:

Fiscal Year 2002

|                                            |  |       |        |      |  |         |       |         |  |         |       |         |  |   |       |  |  |   |       |  
|------------------------------------------- |  | ----- | ------ | ---- |  | ------- | ----- | ------- |  | ------- | ----- | ------- |  | - | ----- |  |  | - | ----- | -
|                                            |  |       |        |      |  | Jun 30, |       | Mar 31, |  | Dec 31, |       | Sep 30,
|                                            |  | Total |        | 2002 |  | 2002    |       | 2001    |  | 2001   
|                                            |  |       |        |      |  |         |       |         |  |        
|Revenues                                    |  | $     | 22,340 |      |  | $       | 5,720 |         |  | $       | 6,291 |         |  | $ | 5,753 |  |  | $ | 4,576 |  
|Gross profit                                |  |       | 15,871 |      |  |         | 3,949 |         |  |         | 4,403 |         |  |   | 4,130 |  |  |   | 3,389 |  
|Operating (loss) / income                   |  |       | (841   | )    |  |         | (131  | )       |  |         | 85    |         |  |   | 141   |  |  |   | (936  | )
|                                            |  |       |        |      |  |         |       |         |  |         |       |         |  |   |       |  |  |   |       |  
|Net (loss) / income                         |  | $     | (608   | )    |  | $       | 109   |         |  | $       | 81    |         |  | $ | 110   |  |  | $ | (908  | )
|                                            |  |       |        |      |  |         |       |         |  |         |       |         |  |   |       |  |  |   |       |  
|Basic and diluted (loss)
/ income per share |  | $     | (0.03  | )    |  | $       | 0.00  |         |  | $       | 0.00  |         |  | $ | 0.01  |  |  | $ | (0.05 | )
|                                            |  |       |        |      |  |         |       |         |  |         |       |         |  |   |       |  |  |   |       |  

F-19



---



##### 



CYBERGUARD CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Amounts in thousands, except share and
per share data)

Fiscal Year 2001

|                                                                                |  |       |         |      |  |         |        |         |  |         |        |         |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------- |  | ----- | ------- | ---- |  | ------- | ------ | ------- |  | ------- | ------ | ------- |  | - | ------ | - |  | - | ------- | -
|                                                                                |  |       |         |      |  | Jun 30, |        | Mar 31, |  | Dec 31, |        | Sep 30,
|                                                                                |  | Total |         | 2001 |  | 2001    |        | 2000    |  | 2000   
|                                                                                |  |       |         |      |  |         |        |         |  |        
|Revenues                                                                        |  | $     | 24,406  |      |  | $       | 6,374  |         |  | $       | 7,635  |         |  | $ | 6,349  |   |  | $ | 4,048   |  
|Gross profit                                                                    |  |       | 17,190  |      |  |         | 4,530  |         |  |         | 5,333  |         |  |   | 4,459  |   |  |   | 2,868   |  
|Operating loss                                                                  |  |       | (2,940  | )    |  |         | (534   | )       |  |         | (548   | )       |  |   | (183   | ) |  |   | (1,675  | )
|Loss before cumulative effect of change
in accounting principle                 |  |       | ($3,887 | )    |  |         | ($655  | )       |  |         | ($888  | )       |  |   | ($485  | ) |  |   | ($1,859 | )
|Cumulative effect of change in accounting
principle                             |  |       | (129    | )    |  |         |       |         |  |         |       |         |  |   | (129   | ) |  |   |        |  
|                                                                                |  |       |         |      |  |         |        |         |  |         |        |         |  |   |        |   |  |   |         |  
|Net loss                                                                        |  |       | ($4,016 | )    |  |         | ($655  | )       |  |         | ($888  | )       |  |   | ($614  | ) |  |   | ($1,859 | )
|                                                                                |  |       |         |      |  |         |        |         |  |         |        |         |  |   |        |   |  |   |         |  
|Basic loss per share before cumulative
effect of change in accounting principle |  |       | ($0.29  | )    |  |         | ($0.04 | )       |  |         | ($0.06 | )       |  |   | ($0.05 | ) |  |   | ($0.19  | )
|Cumulative effect of change in accounting
principle                             |  |       | ($0.01  | )    |  |         | ($0.00 | )       |  |         | ($0.00 | )       |  |   | ($0.01 | ) |  |   | ($0.00  | )
|                                                                                |  |       |         |      |  |         |        |         |  |         |        |         |  |   |        |   |  |   |         |  
|Diluted loss per share                                                          |  |       | ($0.30  | )    |  |         | ($0.04 | )       |  |         | ($0.06 | )       |  |   | ($0.06 | ) |  |   | ($0.19  | )
|                                                                                |  |       |         |      |  |         |        |         |  |         |        |         |  |   |        |   |  |   |         |  

F-20



---



##### 



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES

None

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated herein by reference
to the Companys Proxy Statement for the 2002 Annual Meeting of Shareholders to
be filed within 120 days from June 30, 2002, the end of the Companys fiscal
year.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated herein by reference
to the Companys Proxy Statement for the 2002 Annual Meeting of Shareholders to
be filed within 120 days from June 30, 2002, the end of the Companys fiscal
year.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this Item is incorporated herein by reference
to the Companys Proxy Statement for the 2002 Annual Meeting of Shareholders to
be filed within 120 days from June 30, 2002, the end of the Companys fiscal
year.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated herein by reference
to the Companys Proxy Statement for the 2002 Annual Meeting of Shareholders to
be filed within 120 days from June 30, 2002, the end of the Companys fiscal
year.

38



---



##### 



PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K



|(a) |  | Financial Statements. The Financial Statements filed as part of this
Report are listed separately in the Index to Financial Statements
beginning on page F-1 of this Report.                                         
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|(b) |  | Reports on Form 8-K.During the fourth quarter of the fiscal year 2002
the Company filed a report on Form 8-K on June 7, 2002 regarding the
listing of the Companys securities on the American Stock Exchange (AMEX).
|   
|(c) |  | Exhibits. The following exhibits are included in this Report:                                                                                                                                                        

|        |  |   |  |                                                                                                                        
|------- |  | - |  | -----------------------------------------------------------------------------------------------------------------------
|Exhibit |  |   |  |                                                                                                                        
|No.     |  |   |  | Exhibit Description                                                                                                    
|        |  |   |  |                                                                                                                        
|2.01    |  |  |  | Restated Purchase and Sale Agreement between Concurrent Computer Corporation and the Company dated May
23, 1996(1)     
|3.01    |  |  |  | Articles of Incorporation of the Company, as amended June 26, 1996(8)                                                  
|3.02    |  |  |  | Articles of Amendment to the Amended and Restated Articles of Incorporation of the
Company (13)                        
|3.03    |  |  |  | Restated Bylaws of the Company(3)                                                                                      
|4.01    |  |  |  | Form of Common Stock Certificate(4)                                                                                    
|4.02    |  |  |  | Form of Stockholder Rights Plan(2)                                                                                     
|4.03    |  |  |  | Form of Share Holding Agreement between Concurrent Computer
Corporation and the Company(4)                             
|10.01   |  |  |  | Employee Stock Incentive Plan(6)                                                                                       
|10.02   |  |  |  | Amendment to Employee Stock Incentive Plan(7)                                                                          
|10.03   |  |  |  | Amendment to Employee Stock Incentive Plan dated March 20, 1998(15)                                                    
|10.04   |  |  |  | Amended and Restated Employee Stock Option Plan dated September 4, 1998, as
amended through March 2, 2001(16)          
|10.05   |  |  |  | Forms of Stock Option Agreements(15)                                                                                   
|10.06   |  |  |  | Retirement Savings Plan, as amended and restated on July 1, 2002(5)                                                    
|10.07   |  |  |  | Employment Agreement Amendment dated October 1, 2001 between the Company
and Scott Hammack(12)                         
|10.08   |  |  |  | Employment Agreement Amendment dated October 1, 2001 between the Company
and Patrick Clawson(12)                       
|10.09   |  |  |  | Employment Agreement Amendment dated October 1, 2001 between the Company
and Michael Matte(12)                         
|10.10   |  |  |  | Employment Agreement Amendment dated October 1, 2001 between the Company
and Michael Wittig(12)                        
|10.11   |  |  |  | Employment Agreement Amendment dated October 1, 2001 between the Company
and Adriana Kovalovska(12)                    
|10.12   |  |  |  | Second Amended and Restated Employee Stock Option Plan dated September 4,
1998, as amended through October 16, 2001(14)
|10.13   |  |  |  | Employment Agreement dated September 30, 1998 between the Company and
Michael Wittig(15)                               
|10.14   |  |  |  | Amendment to Employment Agreement between the Company and Mike Wittig,
dated December 13, 2000(17)                     
|10.15   |  |  |  | Agreement between the Company and Scott J. Hammack, dated December 26,
2000(17)                                        
|10.16   |  |  |  | Employment Agreement between the Company and Scott J. Hammack, dated January
2, 2001(17)                               
|10.17   |  |  |  | Agreement between the Company and Scott J. Hammack, dated January 17, 2001(17)                                         
|10.18   |  |  |  | Employment Agreement between the Company and Patrick J. Clawson, dated January
18, 2001(17)                            

39



---



##### 



|        |  |   |  |                                                                                                                                                                                                                                                                                                                               
|------- |  | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |   |  |                                                                                                                                                                                                                                                                                                                               
|No.     |  |   |  | Exhibit Description                                                                                                                                                                                                                                                                                                           
|        |  |   |  |                                                                                                                                                                                                                                                                                                                               
|10.19   |  |  |  | Employment Agreement dated February 13, 2001 between the Company and Michael
Matte(18)                                                                                                                                                                                                                                        
|10.20   |  |  |  | Employment Agreement dated April 18, 2001 between the Company and Adriana
Kovalovska(9)                                                                                                                                                                                                                                       
|10.21   |  |  |  | Loan and Security Agreement dated December 29, 1997 between the
Company, TradeWave Corporation and Coast Business Credit(11)                                                                                                                                                                                                  
|10.22   |  |  |  | Amendment Nr. 1 to Loan and Security Agreement dated December 29,
1997 between the Company, TradeWave Corporation and Coast Business
Credit(11)                                                                                                                                                                               
|10.23   |  |  |  | Amendment Nr. 2 to Loan and Security Agreement dated October 6, 1999 between the
Company and Coast Business Credit(3)                                                                                                                                                                                                         
|10.24   |  |  |  | Loan Documents dated December 17, 1998 between the Company and Fernwood
Partners, LLC(15)                                                                                                                                                                                                                                     
|10.25   |  |  |  | Loan Agreements dated August 26, 1999, between (i) the Company and
Fernwood Partners II, LLC; (ii) the Company and certain officers,
directors and employees of the Company; and (iii) the Company and David R.
Proctor(3)                                                                                                    
|10.26   |  |  |  | Amendment No. 1 to Loan Agreement, dated December 29, 2000 between
the Company and Fernwood Partners II, LLC(17)                                                                                                                                                                                                              
|10.27   |  |  |  | Agreements dated January 24, 2001 relating to the conversion of
promissory notes and exercise of warrants issued under (i) the Loan
Agreement, as amended, between the Company and Fernwood Partners II, LLC,
and (ii) the Loan Agreement between the Company and certain officers,
directors and employees of the Company(17)
|10.28   |  |  |  | Private Securities Subscription Agreement dated May 15, 1997 between the Company
and Capital Ventures International(10)                                                                                                                                                                                                       
|10.29   |  |  |  | Registration Rights Agreement dated May 15, 1997 between the Company and
Capital Ventures International(10)                                                                                                                                                                                                                   
|10.30   |  |  |  | Manufacturers Representative Agreement between Marketlink Technologies,
LLC and the Company, as amended through July 11, 2001(9)                                                                                                                                                                                             
|21.01   |  |  |  | List of subsidiaries of the Company(9)                                                                                                                                                                                                                                                                                        
|23.01   |  |  |  | Consent of Grant Thornton LLP, Independent Certified Public Accountants                                                                                                                                                                                                                                                       
|99.01   |  |  |  | Certification by Scott Hammack, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                            
|99.02   |  |  |  | Certification by Michael D. Matte, Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                                                                                                                          



---

|(1)  |  | Incorporated herein by reference to Annex A of the Registrants
Definitive Proxy Statement as filed on May 24, 1996.                                              
|---- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(2)  |  | Incorporated herein by reference to Post-Effective Amendment No. 1 to the
Companys Registration Statement on Form 10, dated September 29, 1994,
File No. 0-24544.
|    
|(3)  |  | Incorporated herein by reference to the Companys Quarterly Report on
Form 10-Q filed on November 12, 1999.                                                       
|    
|(4)  |  | Incorporated herein by reference to the Companys Registration Statement
on Form S-3 dated May 23, 1996 (File No. 333-04407).                                     
|    
|(5)  |  | Incorporated herein by reference to the Companys Registration Statement
on Form S-8 (Commission File Number 333-58262), filed on July 19, 2002.                  
|    
|(6)  |  | Incorporated herein by reference from Exhibit 4.1 to the Companys
Registration Statement on Form S-8 (Commission File Number 33-88448) filed
on January 13, 1995.
|    
|(7)  |  | Incorporated herein by reference to Annex E of the Registrants
Definitive Proxy Statement as filed on May 24, 1996.                                              
|    
|(8)  |  | Incorporated herein by reference to the Companys Annual Report on Form
10-K for fiscal year ended June 30, 1996.                                                 
|    
|(9)  |  | Incorporated herein by reference to the Companys Annual Report on 10-K
for fiscal year ended June 30, 2001.                                                      
|    
|(10) |  | Incorporated herein by reference to the Companys Registration Statement
on Form S-3 (Commission File Number 333-28693) filed on June 12, 1997.                   

40



---



##### 



|(11) |  | Incorporated herein by reference to the Companys Quarterly Report on
Form 10-Q filed on February 13, 1998.                                         
|---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(12) |  | Incorporated herein by reference to the Companys Quarterly Report on
Form 10-Q filed on February 5, 2002.                                          
|    
|(13) |  | Incorporated herein by reference to the Companys Annual Report on 10-K
for fiscal year ended June 30, 2000.                                        
|    
|(14) |  | Incorporated herein by reference to the Companys Registration Statement
on Form S-8 (Commission File Number 333-73852), filed on November 21,
2001.
|    
|(15) |  | Incorporated herein by reference to the Companys Annual Report on 10-K
for fiscal year ended June 30, 1999.                                        
|    
|(16) |  | Incorporated herein by reference to the Companys Registration Statement
on Form S-8 (Commission File Number 333-56768), filed on March 9, 2001.    
|    
|(17) |  | Incorporated herein by reference to the Companys Quarterly Report on
Form 10-Q filed on February 14, 2001.                                         
|    
|(18) |  | Incorporated herein by reference to the Companys Quarterly Report on
Form 10-Q filed on May 14, 2001.                                              

41



---



##### 



SIGNATURES

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

|                   |  |     |  |                                                   
|------------------ |  | --- |  | --------------------------------------------------
|September 27, 2002 |  |     |  | CYBERGUARD CORPORATION                            
|                  
|                   |  | By: |  | /s/ SCOTT J. HAMMACK                              
|                   |  |     |  |                                                   
|                   |  |     |  | Scott Hammack
Chairman and Chief Executive Officer

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

|                                           |  |                                                                                |  |                   
|------------------------------------------ |  | ------------------------------------------------------------------------------ |  | ------------------
|SIGNATURE                                  |  | TITLE                                                                          |  | DATE              
|                                           |  |                                                                                |  |                   
|/s/ SCOTT J. HAMMACKScott Hammack          |  | Chairman and Chief Executive Officer
(Principal Executive Officer)             |  | September 27, 2002
|                                          
|/s/ MICHAEL D. MATTEMichael D. Matte       |  | Chief Financial Officer
(Principal Financial
and Principal Accounting Officer) |  | September 27, 2002
|                                          
|/s/ PATRICK CLAWSONPatrick Clawson         |  | President
(Principal Executive Officer)                                        |  | September 27, 2002
|                                          
|/s/ DANIEL J. MOENDaniel J. Moen           |  | Director                                                                       |  | September 27, 2002
|                                          
|/s/ DAVID L. MANNINGDavid L. Manning       |  | Director                                                                       |  | September 27, 2002
|                                          
|/s/ WILLIAM G. SCOTTWilliam G. Scott       |  | Director                                                                       |  | September 27, 2002
|                                          
|/s/ JOHN V. TIBERI, JR.John V. Tiberi, Jr. |  | Director                                                                       |  | September 27, 2002
|                                          
|/s/ WILLIAM D. RUBINWilliam D. Rubin       |  | Director                                                                       |  | September 27, 2002
|                                          
|/s/ RICHARD L. SCOTTRichard L. Scott       |  | Director                                                                       |  | September 27, 2002

42



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##### 



CERTIFICATIONS

I, Scott J. Hammack, certify that:

1.     I have reviewed this annual report on Form 10-K for CyberGuard Corporation;

2.     Based on my knowledge, the report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by the report; and

3.     Based on my knowledge, the financial statements, and other financial
information included in the report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in the report.

Date: September 27, 2002

/S/ SCOTT J. HAMMACK

Scott J. Hammack
Chief Executive Officer



I, Michael D. Matte, certify that:

1.     I have reviewed this annual report on Form 10-K for CyberGuard Corporation;

2.     Based on my knowledge, the report does not contain any untrue statement of a
material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not
misleading with respect to the period covered by the report; and

3.     Based on my knowledge, the financial statements, and other financial
information included in the report, fairly present in all material respects the
financial condition, results of operations and cash flows of the registrant as
of, and for, the periods presented in the report.

Date: September 27, 2002

/S/ MICHAEL D. MATTE

Michael D. Matte
Chief Financial Officer

43