UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2005

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________________ to ________________

Commission file number 0-24544

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.)
350 SW 12 th Avenue, Deerfield Beach, Florida		33442
(Address of Principal Executive Offices)		Zip Code)

Registrant’s Telephone Number, Including Area Code 954-375-3500

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

     Indicate by check whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),

Yes þ No o

and (2) has been subject to such filing requirements for the past 90 days.

Yes þ No o

Indicate by check mark whether the Registrant is an accelerated filer as defined in Rule 12b-2 of the Exchange Act.

Yes þ No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes   o   No    o

     As of October 31, 2005, 31,747,939 shares of the Registrant’s $0.01 par value Common Stock were outstanding.

 

 

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
Item 1. Financial Statements			1
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3. Quantitative and Qualitative Disclosures about Market Risk			20
Item 4. Controls and Procedures			20
PART II.* OTHER INFORMATION
Item 1. Legal Proceedings			21
Item 2. Changes in Securities and Use of Proceeds			21
Item 3. Defaults Upon Senior Securities			21
Item 4. Submission of Matters to a Vote of Security Holders			21
Item 5. Other Information			21
Item 6. Exhibits and Reports on Form 8-K			22
SIGNATURES
Section 302 Certification of CEO
Section 302 Certification of CFO
Section 906 Certification of CEO
Section 906 Certification of CFO

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

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

		(Unaudited)
		September 30,				June 30,
		2005				2005
ASSETS
Cash and cash equivalents		$	13,837			$	15,003
Restricted cash			243				298
Accounts receivable, less allowance for uncollectible accounts of $1,391at September 30, 2005 and $480 at June 30, 2005			20,251				19,456
Inventories, net			1,864				1,753
Other current assets			4,035				3,248
Total current assets			40,230				39,758
Property and equipment at cost, less accumulated depreciation of $5,904 at September 30, 2005 and $5,562 at June 30, 2005			3,225				3,366
Capitalized software, less accumulated amortization of $2,716 at September 30, 2005 and $2,547 at June 30, 2005			3,084				2,521
Intangible assets, less accumulated amortization of $7,696 at September 30, 2005 and $6,452 at June 30, 2005			19,072				20,316
Other assets			210				241
Goodwill			45,339				45,339
Deferred tax asset, net			3,864				3,864
Total assets		$	115,024			$	115,405
LIABILITIES AND SHAREHOLDERS’ EQUITY
Accounts payable		$	2,449			$	3,769
Deferred revenue, current portion			16,954				16,500
Note payable			488				974
Accrued expenses and other liabilities			7,734				8,813
Total current liabilities			27,625				30,056
Deferred tax liability			5,755				5,755
Deferred revenue, less current portion			6,257				6,310
Total long-term liabilities			12,012				12,065
Total liabilities			39,637				42,121
Commitments and Contingencies			—				—
Shareholders’ equity
Preferred stock par value $0.01; authorized 5,000 shares; none issued			—				—
Common stock par value $0.01; authorized 50,000 shares; issued and outstanding 31,390 at September 30, 2005 and 31,082 at June 30, 2005			314				311
Additional paid-in capital			152,683				150,995
Accumulated deficit			(77,670	)			(78,011	)
Accumulated other comprehensive income			60				(11	)
Total shareholders’ equity			75,387				73,284
Total liabilities and shareholders’ equity		$	115,024			$	115,405

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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

		Three Months Ended
		September 30,				September 30,
		2005				2004
Revenues
Products		$	12,170			$	12,475
Services			5,266				3,204
Total revenues			17,436				15,679
Cost of revenues
Products			3,835				4,155
Services			1,332				996
Total cost of revenues			5,167				5,151
Gross profit			12,269				10,528
Operating expenses
Research and development			2,146				2,589
Selling, general and administrative			9,608				8,064
Total operating expenses			11,754				10,653
Operating income / (loss)			515				(125	)
Other income
Interest income, net			59				46
Other (expense) / income			(120	)			8
Total other (expense) / income			(61	)			54
Income / (loss) before income taxes			454				(71	)
Income tax (expense) / benefit			(113	)			12
Net income / (loss)		$	341			$	(59	)
Basic (loss) earnings per common share		$	0.01			$	(0.00	)
Basic weighted average number of common shares outstanding			31,568				29,172
Diluted (loss) earnings per common share		$	0.01			$	(0.00	)
Diluted weighted average number of common shares outstanding			33,491				29,172

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

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

		Three Months Ended
		September 30,				September 30,
		2005				2004
Cash flows from operating activities:
Net income / (loss)		$	341			$	(59	)
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation			342				184
Amortization			1,414				1,178
Provision for inventory			—				127
Deferred tax benefit			—				(12	)
Provision for uncollectible accounts receivable			808				348
Stock based compensation expense			964				126
Changes in assets and liabilities
Increase in accounts receivable			(1,603	)			(2,140	)
(Increase) / decrease in other current assets			(777	)			8
Increase in inventories			(111	)			(507	)
Decrease / (increase) in other assets, net			21				(288	)
Decrease in accounts payable			(1,320	)			(239	)
(Decrease) / increase in accrued expenses and other liabilities			(1,080	)			1,287
Increase / (decrease) in deferred revenue			402				(128	)
Net cash used in operating activities			(599	)			(115	)
Cash flows used in investing activities
Decrease / (increase) in restricted cash			55				(3	)
Capitalized software costs			(732	)			—
Purchase of property & equipment			(201	)			(799	)
Net cash used in investing activities			(878	)			(802	)
Cash flows provided by financing activities:
Proceeds from stock options exercised			529				52
Payment on note			(486	)			—
Proceeds from warrants exercised			—				3,169
Proceeds from issuance of common stock in stock purchase plan			197				—
Net cash provided by financing activities			240				3,221
Effect of exchange rate changes on cash			71				(130	)
Net (decrease) / increase in cash			(1,166	)			2,174
Cash and cash equivalents at beginning of period			15,003				12,447
Cash and cash equivalents at end of period		$	13,837			$	14,621
Supplemental disclosure of cash flow information
Cash paid for interest		$	12			$	—
Cash paid for income taxes		$	—			$	—

The accompanying Notes to Condensed Consolidated Financial Statements are an integral part of these financial statements.

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2005
(Unaudited)
(Dollars in thousands, except per share data)

1. Business and Basis of Presentation

Business

     CyberGuard Corporation and its subsidiaries (“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 Global 2000 companies, major financial institutions, and government agencies worldwide). The Company’s products include firewall, VPN (Virtual Private Network), secure content management and security management technologies. Through a combination of proprietary technology and a highly secure operating system, 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 products and services are sold to end-users directly and indirectly by direct sales and resellers worldwide in over thirty countries.

Basis of Presentation

     CyberGuard has prepared the condensed consolidated financial statements included herein, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission with respect to Form 10-Q. All significant intercompany transactions and balances have been eliminated. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures made are adequate so as to make the information contained herein not misleading. These consolidated interim financial statements and the notes should be read in conjunction with the consolidated financial statements and the notes included in the Company’s 10-K for the year ended June 30, 2005 and the risk factors set forth in the Company’s annual report on Form 10-K, including, without limitation, risk related to the factors listed in Management’s Discussion and Analysis. In the Company’s opinion, all adjustments (consisting only of normal recurring adjustments) necessary for fair presentation of the information shown, have been included. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 consolidated financial statements, including revenue recognition, bad debt, software development costs, inventory valuation, and deferred tax valuation allowances. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The results of operations for the three months ended September 30, 2005 are not necessarily indicative of the results of operations that may be expected for the year ending June 30, 2006.

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2005
(Unaudited)
(Dollars in thousands, except per share data)

Revenue Recognition

     The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2 “Software Revenue Recognition”, Statement of Position (“SOP”) 98-9 “Modification of SOP 97-2” and Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition”. Revenue recognition in accordance with these pronouncements can be complex due to the nature and variability of the Company’s sales transactions. The Company’s revenue is primarily from the following sources:

	(i)		Product sales of firewall appliances and software licenses which include the sale of subscription licenses to resellers and end users;
	(ii)		Product sales with customer-specific acceptance provisions to original equipment manufacturer (OEM) customers; and
	(iii)		Service revenue which is primarily maintenance which provides for customer support.

     Revenues from product sales are recognized only when a contract or agreement has been executed, delivery of the appliance has occurred or for software licenses an authorization code or subscription activation has been delivered to the customer, the fee is fixed and determinable and we believe collection is probable. Product revenue is generally recognized on product shipment, provided that no significant obligations remain. There is no product right of return available to the customer. For software licenses, revenue is generally recognized on the delivery of the authorization code for perpetual licenses or upon the activation of subscription licenses. Subscription license revenue is recognized ratably over the life of the subscription. We defer revenues on product sales for new value added resellers where we are unable to determine the ability of the reseller to honor a commitment to make fixed or determinable payment. Revenue will be deferred until the resellers demonstrate consistency of payment within terms and there are no instances where we have to take back the product because of non-payment for a three-month period. Two resellers were reclassified from cash basis to accrual for the quarter ended September 30, 2005 and three resellers were reclassified for the quarter ended September 30, 2004. The impact of the reclassifications did not have a material effect on revenue in any of the periods.

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

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

Reclassifications

     Certain amounts in the September 30, 2004 and June 30, 2005 financial statements have been reclassified to conform to the September 30, 2005 presentation.

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2005
(Unaudited)
(Dollars in thousands, except per share data)

2. Earnings Per Share (“EPS”)

     Basic EPS is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur assuming stock options, warrants or other contracts to issue common stock were exercised, using the treasury stock method. When the effects of the outstanding stock options, warrants and/or convertible securities are anti-dilutive, they are not included in the calculation of diluted EPS.

		Three months				Three months
		ended				ended
		September 30,				September 30,
		2005				2004
Net Income/(Loss)		$	341			$	(59	)
Basic weighted average number of common shares outstanding			31,568				29,172
Dilutive effect of:
Employee stock options			1,698				—
Unearned restricted stock			—				—
Warrants			225				—
Diluted weighted average number of common shares outstanding			33,491				29,172
Earnings per share basic		$	0.01			$	0.00
Earnings per share diluted		$	0.01			$	0.00

3. Stock-Based Compensation

     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. On January 30, 2004, the Company registered an additional 3,000,000 shares under the 1998 plan.

     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 unless approved by the Board of Directors. 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 at that time, participated in this special option program where he elected to accept options in lieu of salary for a twelve months period.

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2005
(Unaudited)
(Dollars in thousands, except per share data)

     At September 30, 2005, the Company has two stock-based employee compensation plans as described above. Prior to July 1, 2005, the Company accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation. No stock-based employee compensation cost was recognized in the Statement of Operations for the three month period ended September 30, 2004 or for the year ended June 30, 2005, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective July 1, 2005, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-Based Payment, using the modified-prospective-transition method. Under that transition method, compensation cost recognized in the three month period ended September 30, 2005 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to July 1, 2005, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). Results for prior periods have not been restated.

     The fair value of each option award is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions amortized to expense over the options’ vesting periods for the three months ended September 30, 2005: risk-free interest rate was 3.88%; an expected dividend yield of 0%, the volatility factor of the expected market price of the Company’s common stock was 50.2%; and a weighted average expected life of the option of 5 years. Expected volatilities are based on implied volatilities from traded options on the Company’s stock, historical volatility of the Company’s stock, and other factors. The Company uses historical data to estimate option exercise and employee termination within the valuation model. The expected term of options granted represents the period of time that options granted are expected to be outstanding and is derived from the contractual terms of the options granted, the effects of employees’ expected exercises, post-vesting employment term behavior, and historical expected term data.

     The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

     As a result of adopting Statement 123(R) on July 1, 2005, the Company’s income before income taxes and net income for the three months ended September 30, 2005, are $817 and $846 lower, respectively, than if it had continued to account for share-based compensation under Opinion 25. Basic and diluted earnings per share for the three months ended September 30, 2005 would have been $.04 and $.03, respectively, if the Company had not adopted Statement 123(R), compared to reported basic and diluted earnings per share of $.01. The Company has not recognized any income tax benefit for share-based compensation arrangement due to the fact that the Company does not believe it is more likely than not it will recognize any deferred tax assets from such compensation cost recognized in the current period.

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

										Weighted
						Weighted				Average
						Average				Remaining				Aggregate
		Number of				Exercise				Contractual				Intrinsic
		Shares				Price				Term				Value
Options at July1, 2005			4,877,000			$	4.71
Granted			125,000			$	6.29
Exercised			(245,000	)		$	2.17
Forfeited or expired			(89,000	)		$	7.41
Shares under option at September 30, 2005			4,668,000			$	4.87				5.8			$	15,766
Vested or expected to vest at September 30, 2005			2,834,000			$	3.54				4.0			$	13,338
Option shares exercisable at September 30, 2005			2,834,000			$	3.54				4.0			$	13,338

     A summary of the Status of the Company’s nonvested shares as of September 30, 2005, and changes during the three months ended September 30, 2005 is presented below:

						Weighted
						Average
		Number of				Exercise
		Shares				Price
Nonvested at July1, 2005			1,941,000			$	6.83
Granted			125,000			$	6.29
Vested			(176,000	)		$	5.19
Forfeited			(56,000	)		$	7.58
Nonvested at September 30, 2005			1,834,000			$	6.93

     The weighted-average grant-date fair value of options granted during the three months ended September 30, 2005 was $3.37. The total intrinsic value of options exercised during the three months ended September 30, 2005, was $1,423.

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2005
(Unaudited)
(Dollars in thousands, except per share data)

     As of September 30, 2005, there was $3,557 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 3 years. The total fair value of shares vested during the three months ended September 30, 2005 was $749.

     The following table illustrates the effect on net income and earnings per share if the company had applied the fair value recognition provisions of Statement 123 to options granted under the company’s stock option plans in all periods presented. 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 amortized to expense over the options’ vesting periods for the three months ended September 30, 2004: risk-free interest rate was 4.27%; an expected dividend yield of 0%, the volatility factor of the expected market price of the Company’s common stock was 95%; and a weighted average expected life of the option of 5 years.

		Three
		Months
		Ended
		September 30,
		2004
Net loss, as reported		$	(59	)
Add: Stock-based employee compensation expense included in net income, net of related tax effects			—
Deduct: Total stock-based employee compensation expense determined under fair value based methods for all awards			(1,089	)
Pro forma net income / (loss)		$	(1,148	)
Earnings / (loss) per share:
Basic—as reported		$	0.00
Basic—pro forma		$	(0.04	)
Diluted—as reported		$	0.00
Diluted—pro forma		$	(0.04	)

4. Software Development Costs

     The Company capitalizes costs related to the development of certain software products on a product by product basis in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting For the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed” which requires capitalization to begin when technological feasibility has been established and ends when the product is available for general release to customers. Software development costs incurred prior to technological feasibility, defined by the Company as implementation of a beta project, are considered research and development costs and are expensed as incurred. Capitalized costs are amortized on a straight-line basis over two to five years based on the products’ estimated economic life.

     The amount amortized, is the greater of the two amounts calculated using the methods noted in SFAS 86. Amortization starts when the product is available for general release to customers. Unamortized capitalized software cost is evaluated at each balance sheet date and compared to the net realizable value. Any excess capitalized cost above net realizable value will be written off. No such impairment existed at September 30, 2005. The Company capitalized $732 and $0 in software development costs for the three months ended September 30, 2005 and 2004, respectively.

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2005
(Unaudited)
(Dollars in thousands, except per share data)

5. Recent Accounting Pronouncements

     In November 2004, the FASB issued SFAS No. 151, “Inventory Costs, an amendment of Accounting Research Bulletin (“ARB”) No. 43, Chapter 4”. SFAS No. 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing”, to clarify the accounting of abnormal amounts of idle facility expense, freight, handling costs, and wasted material. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS No. 151 did not impact the Company’s consolidated financial position, results of operations or cash flows for the three months ended September 30, 2005.

     In December 2004, the FASB issued Staff Position No. 109-2 (“FSP No. 109-2”) “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004”, that provides guidance for implementing the repatriation of earnings provisions of the American Jobs Creation Act of 2004 (the “Jobs Act”) and the impact on the Company’s income tax and deferred tax liabilities. Even though the Jobs Act was enacted in October 2004, FSP No. 109-2 allows additional time beyond the period of enactment to allow the Company to evaluate the effects of the Jobs Act on the Company’s plan for reinvestment or repatriation of foreign earnings. The Company is in the process of analyzing the law in order to determine its effects, if any, on the Company’s consolidated financial position and results of operations.

     On December 16, 2004, the FASB issued Statement No. 123 (revised 2004), Share-Based Payment. Statement 123(R) requires us to measure all employee stock-based compensation awards using a fair value method and record such expense in our consolidated financial statements. In addition, the adoption of Statement 123(R) requires additional accounting related to the income tax effects and additional disclosure regarding the cash flow effects resulting from share-based payment arrangements. Statement 123(R) is effective for fiscal periods beginning after June 15, 2005 and, thus, is effective for us beginning with the first quarter of fiscal 2006. The results of the adoption of Statement 123(R) are reflected in our consolidated financial position, results of operations and cash flows.

     In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets—An Amendment of ABP Opinion No. 29, Accounting for Nonmonetary Transactions” (“SFAS No. 153”). SFAS No 153 eliminates the exception from fair value measurement for nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB Opinion No. 29, “Accounting for Nonmonetary Transactions”, and replaces it with an exception for exchanges that do not have commercial substance. SFAS No. 153 specifies that a nonmonetary exchange has commercial substance if future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 is effective for the fiscal periods beginning after June 15, 2005 and is required to be adopted by the Company beginning on July 1, 2005. The adoption of SFAS No. 153 did not impact the Company’s consolidated financial position, results of operations or cash flows for the three months ended September 30, 2005.

     In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“ SAB 107”), “Share-Based Payment,” which provides interpretive guidance related to the interaction between SFAS 123R and certain SEC rules and regulations, as well as provides the SEC staff’s views regarding the valuation of share-based payment arrangements. The Company has incorporated SAB 107 in our implementation and adoption of SFAS 123R.

     In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Corrections” (“SFAS No. 154”). SFAS No. 154 replaces APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements” and changes the requirements for the accounting for and reporting of a change in accounting principle. SFAS No. 154 also provides guidance on the accounting for and reporting of error corrections. This statement is applicable for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005.

7. Goodwill and Other Intangible Assets

     The Company accounts for goodwill and other intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”. SFAS No. 142 revised the standards of accounting for goodwill and indefinite-lived intangible assets by replacing the amortization of these assets with the requirement that they are reviewed annually for possible impairment, or more frequently if impairment indicators arise. This testing includes the determination of each reporting unit’s fair value using market multiples and discounted cash flows modeling. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered to be impaired and a second test is performed to measure the amount of the impairment loss, if any. No impairment indicators have been identified at September 30, 2005. Separable intangible assets that have finite lives continue to be amortized over their estimated useful lives. There were no changes in the carrying amount of goodwill for the three months ended September 30, 2005.

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2005
(Unaudited)
(Dollars in thousands, except per share data)

     The components of intangible assets are:

		September 30,				June 30,
		2005				2005
Unamortizable Trade Name		$	5,100			$	5,100
Amortizable:
Developed Technology			7,509				7,509
Customer Base			14,159				14,159
Total Gross Intangible Assets			26,768				26,768
Accumulated Amortization:
Developed Technology			(3,947	)			(3,400	)
Customer Base			(3,749	)			(3,052	)
Total Accumulated Amortization			(7,696	)			(6,452	)
Total Net Book Value		$	19,072			$	20,316

     Amortization expense is computed by the straight-line method using the estimated useful lives of the assets, which range from 2 ¹ /2 to 5 years. Amortization expense for the three months ended September 30, 2005 and 2004 amounted to $1,413 and $1,178, respectively. Estimated amortization expense of currently capitalized costs for the remainder of fiscal year 2006 and for succeeding fiscal years is as follows:

Fiscal year
2006 (remainder)		$	3,687
2007			4,289
2008			2,930
2009			2,423
2010			643
		$	13,972

8. Comprehensive Income

     Comprehensive income is defined as the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from non-owner sources, and is comprised of net income and “other comprehensive income”. The Company’s other comprehensive income is comprised exclusively of changes in the Company’s Cumulative Translation Adjustment (“CTA”) account.

     Comprehensive income, for the three months ended September 30, 2005 and 2004, was as follows:

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
September 30, 2005
(Unaudited)
(Dollars in thousands, except per share data)

		Three months				Three months
		ended				ended
		September 30,				September 30,
		2005				2004
Net income		$	341			$	(59	)
Change in CTA			71				(130	)
Total		$	412			$	(189	)

9. Segment Information

     The Company views its operations and manages its business as one segment, enterprise security solutions. Major foreign markets for our products and services include Europe, the Middle East, Japan, the Pacific Rim, and Latin America. In each market, we have independent channel partners who are responsible for marketing, selling and supporting our products and services to resellers and end-users within their defined territories. International sales accounted for 55% and 53% of total revenues for the three months ended September 30, 2005 and 2004, respectively.

10. Plan of merger

     On August 18, 2005, CyberGuard announced that it has entered into an Agreement and Plan of Merger dated as of August 17, 2005 (the “Merger Agreement”) with Secure Computing Corporation, a Delaware corporation (“Secure”) and Bailey Acquisition Corp., a Delaware corporation and a wholly-owned subsidiary of Secure (“Merger Sub”), providing for the merger of CyberGuard with and into Merger Sub (the “Merger”), with Merger Sub surviving the Merger as a wholly-owned subsidiary of Secure. At the effective time and as a result of the Merger, each share of CyberGuard common stock issued and outstanding immediately prior to the effective time of the Merger shall be automatically converted into the right to receive $2.73 and 0.50 shares of Secure common stock as set forth in the Merger Agreement.

11. Commitments and Contingencies

     Employment Agreements. The Company has entered into employment agreements with certain key employees. These agreements provide for severance and other benefits if the Company, for any reason other than cause, as defined by the agreements, terminates these employees. The aggregate amount of severance for these employees would be $877.

     The Company is subject to legal proceedings, products liability claims and other claims that arise in the ordinary course of its business. In the opinion of management, the amount of ultimate liability, if any, in excess of applicable insurance coverage, is not likely to have a material effect on the financial condition, results of operations or liquidity of the Company. However, as the outcome of litigation or other claims is difficult to predict, significant changes in the estimated exposures could occur.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This Quarterly Report on Form 10-Q, including this Management’s Discussion and Analysis of the Financial Condition and Results of Operations, contains forwarding-looking statements, as described in the “safe harbor” provision of the Private Securities Litigation Reform act of 1995. These statements involve a number of risks and uncertainties and actual results could differ materially from those projected. These forward-looking statements regarding future events and future results of CyberGuard Corporation are based on current expectation, estimates, forecast, and projections about the industry in which we operate and the beliefs and assumptions of our management. Words such as “expects,” “anticipates,” “target,” “goal,” “project,” “intend,” “plans,” “believes,” “seeks,” “estimates,” variations of such words, and similar expressions are intended to identify such forward-looking statements. Statements regarding future growth, future products and product development, including the anticipated dates for introducing such products, future prospects, trends in our business, 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, future acquisitions, and increases in our sales force, as well as all other statements contained in this report that are not purely historical, are forward-looking statements. Readers are cautioned that these forward-looking statements are predictions and are subject to risk, uncertainties, and assumptions that are difficult to predict. Therefore, actual results may vary materially and adversely from those expressed in any forward-looking statement. Readers are referred to the cautionary statements and important risk factors discussed elsewhere in this report and in our other reports and filings with the SEC. 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 future 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 governmental regulation and effects of changes in regulation; uncertainties associated with product performance liability; risks associated with growth and expansion; global economic conditions; 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; and the ability of the Company to integrate successfully any businesses it acquires. We undertake no obligation to revise or update publicly any forward-looking statements for any reason.

     The risks and uncertainties described below are not the only ones facing our company. Additional risks and uncertainties not presently known to us or that we currently consider immaterial may also impair our operations. If any of the following risks, or any additional risks and uncertainties, were to materialize, our business, financial condition or results of operations could be materially adversely affected. Were that to occur, the trading price of our common stock could decline.

     Factors that could cause actual results to differ materially include the following:

	•		Intense competition both domestically and internationally
	•		Decrease in profit margins
	•		Inventory risk due to shifts in market demands
	•		Dependence on information systems
	•		Upgrading our information and internal control systems

	•		Credit exposure due to the deterioration of the financial condition of our customers
	•		Inability to obtain required capital
	•		Fluctuations in interest rates
	•		Potential adverse effects of acquisitions
	•		Foreign currency exchange rates and exposure to foreign markets
	•		The impact of changes of income tax and other regulatory legislation
	•		Changes in accounting rules
	•		Product supply and availability
	•		Changes in vendor terms and conditions
	•		Changes in general economic conditions
	•		Exposure to natural disaster, war and terrorism
	•		Volatility of common stock
	•		Accuracy of forecast data
	•		Expansion into new geographic markets
	•		Expansion into new product markets
	•		The ability to sustain profitability in the future
	•		Seasonality and concentration of revenues at the end of the quarter
	•		Dependence on third party channel partners to distribute products
	•		Decrease in the price of our products
	•		Dependence on one primary manufacturer and assembly house
	•		Resource constraints caused by growth
	•		Changes in technology and industry standards could affect our products and services
	•		Litigation in connection with the alleged or actual failure of our products and services
	•		A breach in security could harm public perception of our products
	•		Cost of customizing products for foreign countries
	•		Export and import restrictions, including those affecting encryption commodities and software
	•		Regional economic and political conditions
	•		Intellectual property claims and litigation
	•		Governmental controls over the export or import of encryption technology
	•		Changes in federal regulations and future rules of the Securities and Exchange Commission
	•		Lack of resources compared to our competitors
	•		Limited products or product types
	•		Downturns in the technology sector in the US and key foreign economies
	•		Fluctuations in quarterly operating results

     Additional discussion of these and other factors affecting our business and prospects is contained in our periodic filings with the SEC, copies which can be obtained at the Investor Relations section of our website at www.cyberguard.com.

CRITICAL ACCOUNTING POLICIES

     Our discussion and analysis of financial conditions and results of operations is based on our condensed 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 tax valuation allowances. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

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

     Revenue Recognition— The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2 “Software Revenue Recognition”, Statement of Position (“SOP”) 98-9 “Modification of SOP 97-2” and Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition”. Revenue recognition in accordance with these pronouncements can be complex due to the nature and variability of the Company’s sales transactions. The Company’s revenue is primarily from the following sources:

	(i)		Product sales of firewall appliances and software licenses which include the sale of subscription licenses to resellers and end users;
	(ii)		Product sales with customer-specific acceptance provisions to original equipment manufacturer (OEM) customers; and
	(iii)		Service revenue which is primarily maintenance which provides for customer support.

     Revenues from product sales are recognized only when a contract or agreement has been executed, delivery of the appliance has occurred or for software licenses an authorization code or subscription activation has been delivered to the customer, the fee is fixed and determinable and we believe collection is probable. Product revenue is generally recognized on product shipment, provided that no significant obligations remain. There is no product right of return available to the customer. For software licenses, revenue is generally recognized on the delivery of the authorization code for perpetual licenses or upon the activation of subscription licenses. Subscription license revenue is recognized ratably over the life of the subscription. We defer revenues on product sales for new value added resellers where we are unable to determine the ability of the reseller to honor a commitment to make fixed or determinable payment. Revenue will be deferred until the resellers demonstrate consistency of payment within terms and there are no instances where we have to take back the product because of non-payment for a three-month period. Two resellers were reclassified from cash basis to accrual for the quarter ended September 30, 2005 and three resellers were reclassified for the quarter ended September 30, 2004. The impact of the reclassifications did not have a material effect on revenue in any of the periods.

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

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

     Stock-Based Compensation. At September 30, 2005, the company has a stock-based employee compensation plan. Prior to July 1, 2005, the Company accounted for those plans under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by FASB Statement No. 123, Accounting for Stock-Based Compensation. No stock-based employee compensation cost was recognized in the Statement of Operations for the three month period ended September 30, 2004 or for the year ended June 30, 2005, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective July 1, 2005, the Company adopted the fair value recognition provisions of FASB Statement No. 123(R), Share-Based Payment, using the modified-prospective-transition method. Under that transition method, compensation cost recognized in the three month period ended September 30, 2005 includes: (a) compensation cost for all share-based payments granted prior to, but not yet vested as of July 1, 2005, based on the grant date fair value estimated in accordance with the original provisions of Statement 123, and (b) compensation cost for all share-based payments granted subsequent to July 1, 2005, based on the grant-date fair value estimated in accordance with the provisions of Statement 123(R). Results for prior periods have not been restated. 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: risk-free interest rate was 4.27%; an expected dividend yield of 0%, the volatility factor of the expected market price of the Company’s common stock was 95%; and a weighted average expected life of the option of 5 years. The expected term of options granted represents the period of time that options granted are to be outstanding and is derived from the contractual terms of the options granted, the effects of employees’ expected exercises, post-vesting employment term behavior, and historical expected term data. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

     As a result of adopting Statement 123(R) on July 1, 2005, the Company’s income before income taxes and net income for the three months ended September 30, 2005, are $817 and $846 lower, respectively, than if it had continued to account for share-based compensation under Opinion 25. Basic and diluted earnings per share for the three months ended September 30, 2005 would have been $.04 and $.03, respectively, if the Company had not adopted Statement 123(R), compared to reported basic and diluted earnings per share of $.01.

     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.

     Goodwill — In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” the Company will perform its test of goodwill on an annual basis to determine if impairment has occurred. Testing will be done on a more frequent basis if impairment indicators arise. Any impairment would be charged to expense in the period identified. No impairment indicators have been identified during the three months ended September 30, 2005.

     Intangible Assets — Intangible assets are primarily an allocation of a portion of the purchase price in connection with the SnapGear and Webwasher acquisitions and to the acquisition of certain assets of Zix Corporation to the following separate and identifiable intangible assets: Developed Technology, Trade Name and Customer Base. Amortization is computed by the straight-line method using the estimated useful lives of the assets, which range from 2 1/2 to 5 years.

     Software Development Costs — The Company capitalizes costs related to the development of certain software products on a product by product basis in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 86, “Accounting For the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed” which requires capitalization to begin when technological feasibility has been established and ends when the product is available for general release to customers. Software development costs incurred prior to technological feasibility, defined by implementation of a beta project, are considered research and development costs and are expensed as incurred. Capitalized costs are amortized on a straight-line method over two to five years, based on the products’ estimated economic life. The Company changed the amortization period for certain software development costs during the previous quarter from two to five years as a result of the actual lives of historical products exceeding previous estimates. The amount amortized, is the greater of the two amounts calculated using the methods noted in SFAS 86. Amortization starts when the product is available for general release to customers. Unamortized capitalized software cost is evaluated at each balance sheet date and compared to the net realizable value. Any excess capitalized cost above net realizable value will be written off. No such impairment existed at September 30, 2005. The Company capitalized $732 and $0 in software development costs for the three months ended September 30, 2005 and 2004, respectively.

     Inventory Valuation — Inventories consist primarily of component parts and computer hardware and are carried at the lower of cost, determined by the First-In-First-Out method, or market. We write our inventories down to estimated market value based on assumptions of our future demand, based on projected product releases and market conditions. Variation in market trends, customer preferences, introduction of new products (replacing existing products) or technological advances could, however, significantly affect these estimates and result in additional inventory write-downs. Evaluation inventory older than six-months is transferred to fixed assets and depreciated over 12 months.

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

Recent Accounting Pronouncements and Legislation

     See Note 5 of Notes to Condensed Consolidated Financial Statements for the discussion on recent accounting pronouncements and legislation.

Results of Operations

The quarter ended September 30, 2005 compared to the quarter ended September 30, 2004

Total Revenues

     Total revenues consist of product sales and maintenance and professional services related to the sale of products. For the quarter ended September 30, 2005, total revenues increased by $1,757 to $17,436 compared to $15,679 for the quarter ended September 30, 2004. The change was comprised of a decrease in product sales of $305 and an increase in services of $2,062. International revenue represented approximately 55% of total revenues for the three months ended September 30, 2005 and 53% of total revenues for the three months ended September 30, 2004. The increase in international sales from 53% to 55% is primarily the result of increased service revenue in Europe associated with the Company’s Webwasher product line.

     Network security product revenue accounted for 70% of revenue during the quarter ended September 30, 2005 compared to 80% of revenues during the quarter ended September 30, 2004.

     Service revenue includes maintenance contracts related to new product sales, renewal maintenance contracts for products previously deployed, training and consulting services. Support services for network security products accounted for 30% of revenues during the quarter ended September 30, 2005, compared to 20% of revenues during the quarter ended September 30, 2004. The increase service revenue was primarily due to an increase in consulting contracts, service contracts in Europe, and an increase in service revenues resulting from the acquisition of certain assets of Zix Corporation.

Gross Profit

     Gross profit as a percentage of revenues was 70% for the quarter ended September 30, 2005 and 67% for the quarter ended September 30, 2004. The increase in the gross profit percentage is due to increased margins in the Company’s OEM business in the current quarter and the release of new higher margin products. Margins also benefited from a higher percentage of service revenue, which has a fixed cost of sales.

     The Company’s gross margin has been, and will continue to be, affected by a variety of factors including, competition, the product mix and average selling prices of products, new product introductions and enhancements, and the fluctuations in manufacturing volumes. We must continue to manage each of these factors effectively for our gross margins to move back toward prior levels.

Operating Expenses and Net Income

     Research and development expense includes salaries, non-capitalized equipment, software, software tools, and depreciation from capital equipment. Research and development expense decreased by $443 to $2,146 for the quarter ended September 30, 2005, compared to $2,589 for the quarter ended September 30, 2004. This decrease is the result of the capitalization of $732 in software development costs. As a percentage of total revenue, gross research and development expense was 12% and 17% for the quarters ended September 30, 2005 and 2004, respectively.

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

     Selling, general and administrative expense includes salaries, commissions, costs associated with the executive, human resource, finance and administrative support functions, legal and accounting professional services, and depreciation and amortization expense. Selling, general and administrative expense increased by $1,544 to $9,608 for the quarter ended September 30, 2005, from $8,064 for the quarter ended September 30, 2004.

     The increase in selling, general and administrative expenses for the quarter ended September 30, 2005, is primarily attributable to increases in reserves for doubtful accounts and payroll related expenses. Stock compensation costs associated with the implementation of SFAS 123(R) accounted for 30% of the increase. Amortization and depreciation expense accounted for 26% of the increase, primarily due to increased amortization expenses associated with the acquisition of certain assets from Zix Corporation in the third quarter of fiscal 2005. The increase in reserves for doubtful accounts was responsible for 30% of the increase in selling, general and administrative expense for the quarter when compared to the prior year.

     The Company recorded an income tax expense of $113 as of September 30, 2005 and an income tax benefit of $12 as of September 30, 2004.

     As a result of the factors described above, net income for the quarter ended September 30, 2005 was $341 or $0.01 per diluted share compared to a net loss of $59 or $0.00 per diluted share for the quarter ended September 30, 2004.

Liquidity and Capital Resources

     The following table summarizes the Company’s consolidated statements of cash flows for the first three months of fiscal 2006 and 2005:

		For the three months ended
		September 30,
		2005				2004
Net cash flow (used in) provided by:
Operating activities		$	(599	)		$	(115	)
Investing activities			(878	)			(802	)
Financing activities			240				3,221
Effect of exchange rate changes on cash			71				(130	)
Net (decrease) / increase in cash		$	(1,166	)		$	2,174

     Cash flow used in operating activities in the three months ended September 30, 2005 was ($599). The Company reported net income of $341 for the three-month period ended September 30, 2005. In addition, the Company reported adjustments to reconcile net income of $3,528 for the three months ended September 30, 2005. The primary components of these adjustments for the three months ended September 30, 2005 were amortization expense of $1,414, depreciation expense of $342, a provision for uncollectible accounts receivable of $808 and stock based compensation expense of $964. The primary change in assets and liabilities that negatively impacted cash flow from operating activities was a $1,603 increase in accounts receivable, a decrease of $1,320 in accounts payable and a $1,080 decrease in accrued expenses and other liabilities.

     Net cash used in investing activities during the three-month period ended September 30, 2005 of $878 related primarily to capitalized software costs and the purchase of property and equipment.

     Cash provided by financing activities of $240 during the three-month period ended September 30, 2005 reflects the proceeds from stock options exercised net of the payment made on the short term note.

     For the three months ended September 30, 2005 and 2004, the effect of exchange rate changes on cash were $71 and ($130), respectively.

     At September 30, 2005, the Company had cash and cash equivalents on hand of $13,837 representing an decrease of $1,166 from $15,003 as of June 30, 2005. The Company’s principal sources of liquidity at September 30, 2005, consisted of cash, accounts receivable, and vendor trade credit.

     We believe our existing cash, cash equivalents and short-term investments will be sufficient to meet our operating cash requirements through at least the next twelve months, except for acquisition related needs. Our future capital requirements will depend on many factors, including our rate of revenue growth, the timing and extent of spending on support, product development efforts, expansion of sales and marketing, the timing of introductions of new products and enhancement to existing products, and market acceptance of our products. Other recent and possible future events that

could also materially impact the Company’s ability to successfully execute on its business plans are described in Information Relating to Forward Looking Statements of this Item on Form 10-Q. Other than as described above, we are not aware of any known demands, commitments, events or uncertainties that will result or that are reasonably likely to result in our liquidity increasing or decreasing in a material way.

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

Information Relating to Forward Looking Statements

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

     Forward-looking statements are based upon assumptions and analyses made by the Company in light of current conditions, future developments and other factors the Company believes are appropriate in the circumstances, or information obtained from third parties and are subject to a number of assumptions, risks and uncertainties. Readers are cautioned that forward-looking statements are not guarantees of future performance and that the actual results might differ materially from those suggested or projected in the forward-looking statements. Accordingly, there can be no assurance that the forward-looking statements will occur or that results will not vary significantly from those described in the forward-looking statements. Some of the factors that might cause future actual events to differ from those predicted or assumed include: future advances in technologies and computer security; the Company’s history of annual net operating losses and the financing of these losses through the sale of assets and newly issued Company securities; the Company’s ability to execute on its business plans; the Company’s ability to effectively integrate newly acquired operations; 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; the completion of the numerous organizational changes and the assembly of a new management team for the Company; global economic conditions, overall network security spending, risks associated with obtaining and maintaining patent and intellectual property right protection, uncertainties in availability of expansion capital in the future and other risks associated with capital markets. 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. Copies of these filings can be obtained at the Investor Relations section of our website at www.cyberguard.com. We provide our annual and quarterly reports free of charge on www.cyberguard.com, as soon as reasonably practicable after they are electronically filed, or furnished to the SEC. Many of the foregoing factors are beyond the Company’s control.

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

Item 3. Quantitative and Qualitative Disclosures Concerning Market Risk

     We have limited exposure to financial market risks, including changes in interest rates. The fair value of our investments or related income would not be significantly impacted by a 100 basis point increase or decrease in interest rates due mainly to the short-term nature of the major portion of our investments.

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

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

Item 4. Controls and Procedures

     The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the specified time periods. As of the end of the period covered by this report, the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) evaluated, with the participation of CyberGuard’s management, the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15(d)-15(e) under the Exchange Act). Based on the evaluation, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were effective. There were no changes in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15-d-15(f) under the Exchange Act) during the last fiscal quarter covered by this report that has materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

     A significant deficiency has been identified relating to the recording of our quarterly income tax provision. This deficiency has been discussed and considered in detail among management, the Audit Committee and our independent auditors. Despite the issue identified, management believes that the Company’s financial statements and related disclosures as filed to date present fairly, in all material respects, our financial condition and results of operations.

Limitations on the Effectiveness of Controls

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

     The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) is recorded, processed, summarized and reported within the specified time periods. In designing and evaluating our disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of a simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

     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 litigation matters will not have a material adverse effect on its consolidated financial position, results of operations or cash flows.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None

Item 3. Defaults upon Senior Securities

None

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

None

Item 6. Exhibits and Reports on Form 8-K

     (a) Exhibits:

Exhibit No.		Exhibit Description
31.01		Certification by Patrick J. Clawson, Chief Executive Officer, pursuant to Exchange Act Rules 13a-14 and 15d-15.
31.02		Certification by Michael D. Matte, Chief Financial Officer, pursuant to Exchange Act Rules 13a-14 and 15d-15.
32.01		Certification by Patrick J. Clawson, Chief Executive Officer, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.02		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.

(b) Reports filed on Form 8-K during the quarter ended September 30, 2005:

During the quarter ended September 30, 2005, the Company filed 4 Current Reports on Form 8-K. On July 6, 2005, Item 1.01 in connection with entering into a material licensing agreement was filed. On August 18, 2005, Items 2.02 and 9.01 in connection with the results of operations for the fourth quarter and fiscal year ended June 30, 2005 were filed. On August 19, 2005, Items 1.01 and 9.01 were filed in connection with the announcement of the Company entering into an Agreement and Plan of Merger dated as of August 17, 2005 with Secure Computing Corporation and Bailey Acquisition Corp. After the end of the quarter ended September 30, 2005, on October 6, 2005, Item 5.02 was filed in connection with the departure of the Company’s Chief Operating Officer, effective as of September 30, 2005.

SIGNATURES

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