UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission file number 0-24544

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

     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

          As of April 29, 2005, 30,735,957 shares of the Registrant’s $0.01 par value Common Stock were outstanding.

TABLE OF CONTENTS

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

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

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

1

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

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

2

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

3

In connection with the acquisition of SnapGear, 1,651 shares valued at $14,414 were issued and a contingent purchase consideration of $800 was accrued for during the quarter ended December 31, 2003.

During the quarter ended December 31, 2004, 342 shares valued at $2,137 (which includes the $800 of contingent consideration previously recorded), were issued based on the attainment of revenues during the 12 months following the acquisition.

4

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 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. 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, 2004 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 nine months ended March 31, 2005 are not necessarily indicative of the results of operations that may be expected for the year ending June 30, 2005.

Revenue Recognition

5

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

     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. No resellers were reclassified from cash basis to accrual for the quarter ended March 31, 2005 and three resellers were reclassified for the quarter ended March 31, 2004. For the nine-months ended March 31, 2005, three resellers were reclassified from cash basis to accrual, based on a reasonable assurance of collectibility from evaluating their payment history and no product returns. Eight resellers were reclassified for the nine-months ended March 31, 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 March 31, 2004 and June 30, 2004 financial statements have been reclassified to conform to the March 31, 2005 presentation.

6

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 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.

3. Stock-Based Compensation

     The Company has adopted the disclosure provisions of Statement of Financial Accounting Standard (“SFAS”) No. 148, “Accounting for Stock Based Compensation – Transition and Disclosure,” which amended SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS No. 148 allows for continued use of recognition and measurement principles of Accounting Principles Board (“APB”) Opinion No. 25 and related interpretations in accounting for stock based compensation. 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. For the three and nine months ended March 31, 2005 there was no stock based compensation included in net income for the issuance of options during the period. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions to stock-based compensation. Such disclosure is not necessarily indicative of the

7

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

fair value of stock options that could be granted by the Company in future periods or of the value of all options currently outstanding.

     The fair value method for these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for the three and nine month period ended March 31, 2005 and 2004: risk-free interest rates were 4.00% and 2.13%; the volatility factor of the expected market price of the Company’s common stock was 92% and 89%, and the weighted average expected life of the option was 6 years and 3 years for each period, respectively. No dividend yield was used as the Company does not currently pay dividends.

     Results may vary depending on the assumptions applied within the Black-Scholes option-pricing model.

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 Company changed the amortization period for certain software development costs during the quarter ended December 31, 2004 from two to five years as a result of the actual lives of historical products exceeding previous estimates. This change in estimate resulted in amortization expense being $240 lower than what

8

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

would previously have been recorded in the nine months ended March 31, 2005. 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 March 31, 2005. The Company capitalized $507 and $632 in software development costs for the three months ended March 31, 2005 and 2004, respectively. The Company capitalized $860 and $1,139 in software development costs for the nine months ended March 31, 2005 and 2004, respectively.

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 and earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. The provisions of SFAS No. 151 are to be applied prospectively. The Company has not determined the impact, if any, that the adoption of SFAS No. 151 may have on the Company’s future consolidated financial position and results of operations.

     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) which 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) will require 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, will be effective for us beginning with the first quarter of fiscal 2006. The adoption of Statement 123(R) could have a material impact on 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

9

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

on July 1, 2005.The Company is currently evaluating the effect that the adoption of SFAS No. 153 will have, if any, on its consolidated results of operations and financial position.

     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 is currently assessing the impact of SAB 107 on our implementation and adoption of SFAS 123R.

6. Acquisitions

     On November 26, 2003, the Company completed the acquisition of SnapGear, Inc., a Delaware corporation (“SnapGear”), pursuant to an Agreement and Plan of Merger dated November 12, 2003 (“Agreement”). On April 29, 2004, the Company completed the acquisition of German high-end content security vendor webwasher AG (“webwasher”).

     The following unaudited pro-forma financial information was prepared in accordance with SFAS No. 141 and assumes the acquisitions occurred at the beginning of the periods presented. The unaudited pro forma financial information is provided for informational purposes only. These pro-forma results are based upon the respective historical financial statements of the respective companies, and do not incorporate, nor do they assume, any benefits from cost savings or synergies of operations of the combined company. Unaudited pro-forma results of operations are presented after giving effect to certain adjustments for acquisition related amortization expense on intangibles resulting from the acquisitions of $818 and $2,855 for the three and nine months ended March 31, 2004. The unaudited combined results of continuing operations are as follows:

10

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

     On March 11, 2005, the Company completed the acquisition of certain assets of Zix Corporation, a Texas corporation. The Company paid Zix Corporation $2,126 in cash, executed a promissory note for $1,500 and acquired the following assets and liabilities. The terms of this note require the Company to make three equal payments to Zix Corporation of $500 each on June 15, September 15, and 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 March 31, 2005. Separable intangible assets that have finite lives continue to be amortized over their estimated useful lives.

The changes in the carrying amount of goodwill for the three and nine months ended March 31, 2005 are as follows:

11

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

The adjustment to previously recorded purchase price in the quarter ended December 31, 2004 relates to the achievement of revenue targets, as specified in the SnapGear Agreement and Plan of Merger. The earnout period for the attainment of revenue targets, ended on November 30, 2004.

     The components of intangible assets are:

     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 March 31, 2005 and 2004 amounted to $1,083 and $451, respectively. Amortization expense for the nine months ended March 31, 2005 and 2004 amounted to $3,190 and $820, respectively. Estimated amortization expense of currently capitalized costs for the remainder of fiscal year 2005 and the next five fiscal years thereafter is as follows:

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 and nine months ended March 31, 2005 and 2004, was as follows:

12

CYBERGUARD CORPORATION
Notes to Condensed Consolidated Financial Statements
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

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, 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 62% and 44% of total revenues for the three months ended March 31, 2005 and 2004, respectively. International sales accounted for 57% and 49% of total revenues for the nine months ended March 31, 2005 and 2004, respectively.

10. Commitments and Contingencies

     The Company expects to spend approximately $1,500 for the implementation of new financial software over the next year.

     The Company is involved from time to time, in the ordinary course of its business, in various litigation matters 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.

13

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

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

14

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

	•	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

15

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

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. No resellers were reclassified from cash basis to accrual for the quarter ended March 31, 2005 and three resellers were reclassified for the quarter ended March 31, 2004. For the nine-months ended March 31, 2005, three resellers were reclassified from cash basis to accrual, based on a reasonable assurance of collectibility from evaluating their payment history and no product returns. Eight resellers were reclassified for the nine-months ended March 31, 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.

16

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

     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 nine months ended March 31, 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 March 31, 2005. The Company capitalized $507 and $632 in software development costs for the three months ended March 31, 2005 and 2004, respectively. The Company capitalized $860 and $1,139 in software development costs for the nine months ended March 31, 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

17

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

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 March 31, 2005 compared to the quarter ended March 31, 2004

Total Revenues

     Total revenues consist of product sales and maintenance and professional services related to the sale of products. For the quarter ended March 31, 2005, total revenues increased by $3,668 to $16,704 compared to $13,036 for the quarter ended March 31, 2004. The increase was comprised of an increase in product sales of $2,532 and an increase in services of $1,136. International revenue represented approximately 62% of total revenues for the three months ended March 31, 2005 and 44% of total revenues for the three months ended March 31, 2004. The increase in product revenue is primarily the result of the inclusion of revenue from the webwasher acquisition for a full quarter in the current year. The increase in product and service revenue is the result of an increase in the number of units and products shipped and not from an increase in product prices. The increase in international sales from 44% to 62% is primarily the result of the inclusion of webwasher revenues, who for the quarter ended March 31, 2005, derived 78% of their total revenue from international customers.

     Network security product revenue accounted for 76% of revenue during the quarter ended March 31, 2005 compared to 78% of revenues during the quarter ended March 31, 2004. Revenues are expected to increase in the fourth quarter of this year compared to last year in part due to of the inclusion of the results of the webwasher acquisition for a full quarter. Additionally, the Company expects that the incorporation of the customer base acquired from Zix Corporation into webwasher will favorably impact revenues in the fourth quarter of this year.

     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 24% of revenues during the quarter ended March 31, 2005, compared to 22% of revenues during the quarter ended March 31, 2004. Approximately 9% of SnapGear

18

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

and webwasher total sales were service revenue. The increase in service revenue when compared to the prior year is the result of the inclusion of the results of webwasher.

Gross Profit

     Gross profit as a percentage of revenues was 68% for the quarter ended March 31, 2005 and 65% for the quarter ended March 31, 2004. The increase in the gross profit percentage is due, in part, to a decrease in the Company’s OEM business in the current quarter, which have lower gross margins than the Company’s other product lines.

     The higher gross margin is the direct result of the inclusion of the webwasher product range, which have higher gross margins than the CyberGuard and SnapGear product ranges.

     The gross margin was positively impacted during the current quarter by 1 percentage point as a result of management’s change in estimate for the remaining useful life of certain capitalized software costs. These costs are now amortized to cost of goods sold over a five year period to better reflect the useful life of the software, where they were previously amortized over a two year period.

     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 increased by $692 to $2,406 for the quarter ended March 31, 2005, compared to $1,714 for the quarter ended March 31, 2004. The increase is net of research and development costs capitalized during the quarter ended March 31, 2005 of $507 compared to $632 of research and development costs capitalized during the quarter ended March 31, 2004. The net increase in cost is the result of the acquisition of webwasher which accounted for $440 of the increase. As a percentage of total revenue, gross research and development expense was 17% for the quarters ended March 31, 2005 and 2004.

     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 $2,758 to $8,190 for the quarter ended March 31, 2005, from $5,432 for the quarter ended March 31, 2004.

     The increase in selling, general and administrative expenses for the quarter ended March 31, 2005, is in part attributable to increases in headcount across all functional areas as a result of the webwasher acquisition. The additional payroll related costs as a result of the additional headcount described above, accounted for 70% of the increase. Amortization and depreciation expense accounted for 12% of the increase in selling, general and administrative expense for the quarter when compared to the prior year, primarily as a result of the webwasher acquisition and related amortization of acquisition related intangible assets. The remaining portion of the increase was primarily due to an increase in professional services related to Sarbanes-Oxley 404 compliance and an increase in marketing expenses.

19

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

     The Company recorded an income tax expense of $84 as of March 31, 2005, and an income tax benefit of $481 as of March 31, 2004.

     As a result of the factors described above, net income for the quarter ended March 31, 2005 was $473 or $0.01 per diluted share compared to a net loss of $2,109 or $0.09 per diluted share for the quarter ended March 31, 2004. The net loss in the March 31, 2004 quarter included a charge of $4,113 related to the acquisition of SnapGear.

The nine-month period ended March 31, 2005 compared to the nine-month period ended March 31, 2004

Total Revenues

     Total revenues consist of product sales and maintenance and professional services related to the sale of products. For the nine-month period ended March 31, 2005, total revenues increased by $15,596 to $48,888 compared to $33,292 for the nine-month period ended March 31, 2004. The increase was comprised of an increase in product sales of $13,810 and an increase in services of $1,786. International revenue represented approximately 57% of total revenues for the nine months ended March 31, 2005 and 49% of total revenues for the nine months ended March 31, 2004. The increase in product revenue is primarily the result of inclusion of revenue from the SnapGear and webwasher acquisitions for the full period in the current year. The increase in product and service revenue is the result of an increase in the number of units and products shipped and not from an increase in product prices. The increase in international sales from 49% to 57% is primarily the result of the inclusion of webwasher revenues, who for the nine-month period ended March 31, 2005, derived 76% of their total revenue from international customers.

     Network security product revenue accounted for 78% of revenue during the nine months ended March 31, 2005 compared to 74% of revenues during the same period in the prior year. The increase in the contribution of product revenue as a percentage of total revenue is a result of the inclusion of the results of SnapGear and webwasher, both of which derive their revenues primarily from the sale of product. Revenues are expected to increase for the full year compared to last year as a result of the acquisitions. Additionally, the Company expects that the incorporation of the customer base acquired from Zix Corporation into webwasher will favorably impact revenues in the fourth quarter of this year.

     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 22% of revenues during the nine-month period ended March 31, 2005, compared to 26% of revenues during the same period in 2004. The decrease in service revenue as a percentage of total revenue corresponds to the growth in product revenue related to product sales from the acquisition of SnapGear and webwasher. Approximately 6 % of SnapGear and webwasher total sales were service revenue. The increase in services revenue when compared to the prior year is the result of the inclusion of the results of SnapGear and webwasher.

Gross Profit

     Gross profit as a percentage of revenues was 68% for the nine-month period ended March 31, 2005 and 69% for the nine-month period ended March 31, 2004.

     The lower gross margin is the direct result of the inclusion of the SnapGear product range in the current year, which tend to have lower gross margins than the CyberGuard product range due to the significant OEM revenue in the first and second quarter of the current fiscal year. OEM refers to

20

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

contracts the Company has with large individual customers to manufacture a custom firewall appliance. These relationships normally result in lower product margins.

     The gross margin was positively impacted during the nine months ended March 31, 2005 by 1 percentage point as a result of management’s change in estimate for the remaining useful life of certain capitalized software costs. These costs are now amortized to cost of goods sold over a five year period, where they were previously amortized over a two year period.

     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 increased by $2,401 to $7,510 compared to $5,109 for the nine-month period ended March 31, 2005 and 2004. The increase is net of research and development costs capitalized during the nine-month period ended March 31, 2005 of $860 compared to $1,139 of research and development costs capitalized during the nine-month period ended March 31, 2004. The net increase in cost is the result of the acquisition of SnapGear and webwasher with SnapGear accounting for $1,427 and webwasher accounting for $1,085 of the increase. As a percentage of total revenue, gross research and development expense was 17% and 18% for the nine-month periods ended March 31, 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 $10,589 to $24,442 for the nine-month period ended March 31, 2005, from $13,853 for the nine-month period ended March 31, 2004.

     The increase in selling, general and administrative expenses for the nine-month period ended March 31, 2005, is in part attributable to increases in headcount across all functional areas as a result of the SnapGear and webwasher acquisitions. The additional payroll related costs as a result of the additional headcount described above, accounted for 62% of the increase. An increase in marketing expense accounted for 13% of the increase and an increase in professional fees, primarily related to Sarbanes-Oxley 404 compliance, accounted for 9% of the increase. Amortization and depreciation expense accounted for 10% of the increase in selling, general and administrative expense for the quarter when compared to the prior year, primarily as a result of the SnapGear and webwasher acquisitions and related amortization of acquisition related intangible assets. Additionally, an increase in the allowance for doubtful accounts accounted for 5% of the increase.

     The Company recorded an income tax expense of $123 as of March 31, 2005, and an income tax benefit of $1,348 as of March 31, 2004.

     As a result of the factors described above, net income for the nine-month period ended March 31, 2005 was $1,225 or $0.04 per diluted share compared to net income of $1,395 or $0.05 per diluted for the nine-month period ended March 31, 2004.

21

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

Liquidity and Capital Resources

     The following table summarizes the Company’s consolidated statements of cash flows for the first nine months of fiscal 2005 and 2004:

     Cash flow provided by operating activities in the nine months ended March 31, 2005 was $2,224. The Company reported net income of $1,225 for the nine-month period ended March 31, 2005. In addition, the Company reported adjustments to reconcile net income of $5,680 for the nine months ended March 31, 2005. The primary components of these adjustments for the nine months ended March 31, 2005 were amortization expense of $3,441 primarily attributable to the Snapgear and webwasher acquisitions, depreciation expense of $836, a provision for uncollectible accounts receivable of $703 and stock based compensation expense of $573. The primary change in assets and liabilities that negatively impacted cash flow from operating activities was a $7,500 increase in accounts receivable offset by an increase in deferred revenue of $3,208. The increase in accounts receivable is as a result of the concentration of revenue at the end of the quarter as well as a slower collection cycle with certain large customers.

     Net cash used in investing activities during the nine-month period ended March 31, 2005 of $4,779 related primarily to the acquisition of certain assets of Zix Corporation and the purchase of property and equipment.

     Cash provided by financing activities of $3,550 during the nine-month period ended March 31, 2005 reflects the proceeds from stock options exercised and the proceeds from stock purchase warrants exercised.

     For the nine months ended March 31, 2005 and 2004, the effect of exchange rate changes on cash were ($560) and $12, respectively.

     At March 31, 2005, the Company had cash and cash equivalents on hand of $12,882 representing an increase of $435 from $12,447 as of June 30, 2004. The Company’s principal sources of liquidity at March 31, 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. The Company purchased an enterprise software solution the cost of which is approximately $1,500 over the next twelve months. 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

22

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

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

23

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

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.

Non-GAAP Financial Information

     The following table details the difference between results calculated using Generally Accepted Accounting Principles (“GAAP”) and the same results reported excluding certain charges (“non-GAAP information”). The non-GAAP information is included with the intention of providing investors a more complete understanding of our underlying operational results and trends, but should only be used in conjunction with results reported in accordance with GAAP. The Company believes that the non-GAAP disclosures set forth below provide useful information to show the effect on net income when all acquisition-related costs are excluded.

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

24

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

25

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

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

Evaluation of Disclosure Controls and Procedures

     The Company maintains disclosure controls and procedures designed to ensure that information required to be disclosed in reports filed under the Securities Exchange Act of 1934, as amended, (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.

     The Company is currently in the process of completing its documentation, evaluation and testing of internal controls over financial reporting, as required by the Sarbanes-Oxley Act of 2002. The Company has engaged extensive outside resources to assist with activities related to Section 404 of Sarbanes-Oxley Act. As part of this evaluation, we have identified certain deficiencies in the design and / or operating effectiveness of internal controls. During the current quarter the Company identified a cost that should have been recorded in the prior quarter and subsequently restated the December 31, 2004 10 Q. While the error did result in a restatement, it was the Company’s control system that identified the error that led to the subsequent restatement. The Company believes while the control that detected this error was operating effectively, the control was not operating with enough frequency to detect the error.

26

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

Accordingly, the Company believes a material weakness in the design of its internal control system existed at December 31, 2004. The Company considers the error that resulted in the restatement of the December 31, 2004 quarterly results to be an isolated event. During the current quarter, management corrected the design of its internal control system by increasing the frequency of the control that detected the error. Further, management has implemented additional controls to identify and correct any potential reoccurrence of such an error. These matters have been discussed with the Company’s audit committee and independent auditors and the Company is in the process of making necessary improvements to enhance the reliability of its internal controls over financial reporting. The Company has not fully completed its evaluation and testing nor have all the control enhancements been completed. Although we do not foresee being unable to complete our evaluation and remediation activities, there can be no assurances that all such control deficiencies will be fully remediated and successfully tested prior to June 30, 2005.

     The Company is in the process of upgrading its computer systems used for operations at the corporate location as well as all subsidiaries. The upgrade process will take place over the next several quarters. As we believe is the case in most system changes, the implementation of these systems will necessitate changes in operating policies and procedures and the related internal controls and their method of application. Thus far throughout this implementation, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

     As of the end of the period covered by this report, the Company’s Chief Executive Officer and Chief Financial Officer evaluated, with the participation of the Company’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 Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

Litigation

     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. Changes in Securities and Use of Proceeds

     None

Item 3. Defaults upon Senior Securities

     None

Item 4. Other Information

27

CYBERGUARD CORPORATION
March 31, 2005
(Unaudited)
(Dollars in thousands, except per share data)

     None.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits:

(b) Reports filed on Form 8-K during the quarter ended March 31, 2005:

During the quarter ended March 31, 2005, the Company filed 2 Current Reports on Form 8-K. On January 25, 2005, Items 2.02 and 9.01 in connection with the results of operations for the second quarter of fiscal 2005 were filed. On March 15, 2005, Items 8.01 and 9.01 were filed in connection with the acquisition of certain assets of Zix Corporation.

28

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.

29