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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

FOR ANNUAL AND TRANSITION REPORTS

PURSUANT TO SECTIONS 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended June 30, 2004

OR

Commission File Number 0-24544

CYBERGUARD CORPORATION

(Exact Name of Registrant as Specified in its Charter)

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

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

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

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

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

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

State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed fiscal quarter: $184,413,136

As of August 30, 2004, 30,386,934 shares of the Registrant’s Common Stock, par value $.01 per share were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Definitive Proxy Statement for the Registrant’s 2004 Annual Meeting of Shareholders (incorporated in Part III to the extent provided in Items 10, 11, 12, 13, and 14 hereof).

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Forward-Looking Statements

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PART I

ITEM 1. BUSINESS

Overview

We provide a broad portfolio of security products that deliver high performance, cost effective security for enterprises and government entities worldwide. Our products are designed to provide the strongest security and protection available along with robust centralized management. We offer a broad family of security appliance solutions and related software that include firewall, Virtual Private Networking (VPN), secure content management and security management technologies. Our appliances are built upon a highly secure operating system and proprietary software designed to identify network and application attacks and prevent them from reaching mission-critical resources. We believe that a key differentiator of our security products is our ability to inspect all the content that is traveling over the network for security threats, whether originating from within or outside an enterprise without impacting performance. We believe that our ability to inspect each packet of network traffic at the application layer provides some of the highest levels of protection.

The rise in vulnerabilities of security products potentially provides ways for hackers to compromise enterprises’ networks and applications. Our highly secure appliance combines multi-gigabit performance and centralized management and provides the Company a key differentiator with current and potential customers.

Our target customers are large enterprises, including Global 2000 companies, major financial institutions and government entities worldwide. Our appliances are sold to end-users directly and indirectly by a direct sales force and resellers in the United States and in over 30 foreign countries.

We were incorporated in 1994 in connection with a spin-off from Harris Corporation. At that time, we produced computers for the real-time computing market as well as our firewall product for the secure computing market. We changed our name from Harris Computer Systems Corporation in June 1996 following the sale of our real-time computer business.

Industry Background

Online security is of growing importance to today’s organizations, as businesses and governments become increasingly reliant on Internet-based technology to conduct day-to-day operations. The rapid adoption of the Internet has accelerated the distribution and sharing of data and applications, enabling organizations to adopt new electronic ways of doing business. In order to realize the benefits of the Internet, businesses must open their networks to business partners, customers and their mobile workforce, significantly increasing their vulnerability. The more organizations depend on the Internet to conduct business, the greater the risk of business interruption, negative publicity, theft of proprietary or private information, liability for damages to others, and other costly business losses.

Increase in Security Risks

The move to Internet-based business processes and communications has increased concern about network and application security. Security threats include:

In addition to many of the security risk that have been identified, many threats are yet unidentified and unknown.

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Increasing Sophistication and Frequency of Security Attacks

In recent years, the frequency and severity of attempted breaches of network security has been increasing. According to the 2003 CSI/FBI Computer Crime and Security Survey, 56% of the respondents reported unauthorized use of their networks or applications. Moreover, this survey found that only 30% of those who suffered serious attacks actually reported them to law enforcement.

Despite the investments that governments and enterprises have made to secure their organizations, vulnerabilities and security breaches are becoming more prevalent. In addition, attacks have become more sophisticated and severe. This is a consequence, in part, of the availability of tools and information outlining how to make these attacks, an increase in the number of connections that are vulnerable to attack, and an increase in the overall amount of confidential information accessible through or delivered over the Internet. In some instances, the vulnerabilities have been in the existing security infrastructure set in place to protect the networks and applications.

Organizations have deployed security solutions to protect various parts of their infrastructure, however attacks have continued to evolve to target those elements of the infrastructure that are the most vulnerable or most difficult to protect. Many of these new attacks directly targets applications, often attempting to exploit vulnerabilities inherent in the applications themselves or in the underlying communications protocols. According to the Gartner Group, a leading technology research firm, over 70% of attacks target the application layer. As applications have become more sophisticated, so have the attack capabilities that threaten them. Organizations are recognizing that defensive measures must be even more advanced to protect against application-level threats.

In addition to external threats, businesses are increasingly recognizing the multiple risks and costs associated with personal Internet and computer use in the workplace. More than 45% of businesses detected unauthorized access to corporate data by personnel within the firewall perimeter according to a 2003 FBI survey. The proliferation of blended viruses and the rapid increase in employee use of instant messaging, peer-to-peer file sharing, and email, has resulted in new conduits for malicious code that bypass traditional network security measures. To address these problems, organizations are recognizing the need to proactively manage employee use of the Internet and computing resources.

The CyberGuard Solution

We provide a broad portfolio of security products that deliver high performance, cost effective security for enterprises and government entities worldwide. Our products are designed to provide the strongest security and protection available along with robust centralized management. We offer a broad family of security appliance solutions and related software that include firewall, VPN, secure content management, and security management technologies.

We believe that a key differentiator of our security products is our ability to inspect all the content that is traveling over the network for security threats, whether originating from within or outside an enterprise without impacting performance. Unlike many of our competitors whose firewall products only inspect a portion of the packet’s content, our firewall technology is designed to look deeper into the packet, up to and including the application-level. By examining the network traffic at a more granular level, we are able to provide our customers with a higher level of security. Similarly, our secure content management solutions inspect network traffic originating from employees to ensure that the content that has been requested or is being sent complies with the security policies established by the organization.

Key benefits of our security products include:

Multi-level security. Our security appliances and related software offer multi-level security by combining our highly secure firewall technology with our deep-content inspection capabilities associated with our secure content management software. We believe that our multi-level approach provides our customers with the ability to insure the content traveling both from outside and from within the organization is free from security threats. Our firewall technologies combine a hybrid methodology of stateful packet inspection and application proxies to provide deeper inspection of every packet that traverses the firewall. The application proxies make decisions on the types of data and commands allowed by looking at the application layer of the packet. Our secure content management technologies help prevent vulnerabilities and threats originated by actions within the organization.

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High performance appliances. Our high performance security appliances and related software can be deployed in mission-critical environments such as data centers, corporate extranets, major e-commerce web sites and government networks. Using our high performance appliances, enterprises and government entities are able to deploy integrated security capabilities at up to 3.2 gigabits of throughput.

Ease of implementation and management. Our appliances and related software are designed to require minimal configuration so that they can be deployed quickly and cost-effectively in a network. Our appliances and related use industry standard protocols and management interfaces enable interoperability with a broad range of third-party products. Our products can be configured and managed remotely using industry standard interfaces, including a built in web-based user interface or a command line user interface. In addition, our solutions provide the ability to centrally manage and monitor security policies of our appliances and related software across the entire organization.

Low cost of ownership. Our appliances and related software are designed to minimize installation and maintenance costs of security, which allows our customers to limit the expenses of hiring IT personnel otherwise required to implement and maintain an effective security solution.

High reliability and availability. Our appliances support an optional high availability configuration that combines two appliances to operate as a single logical unit. If there is a disruption in network connectivity or if the primary appliance fails, the secondary appliance is designed to automatically take over to provide continuous network connectivity. All configuration changes are automatically synchronized between the appliances in the high availability pair. For critical connections, such as those to mission-critical government and e-commerce sites, this high availability configuration minimizes the risk of lost network connectivity

Strategy

Our mission is to be a leading supplier of high performance security solutions by delivering the best performing security appliances and related software in the world. We are positioning ourselves to realize this objective with a growth strategy that includes the following elements:

Extend our application and deep-content inspection security capabilities. We intend to enhance our application-level and content inspection technology through continued internal development. We believe we support one of the broadest sets of application proxies in the industry. We intend to introduce additional application proxies to support voice over Internet Protocol (VoIP) communications technology as well as key proxies for XML and SOAP applications. We intend to continue to enhance our support of our existing application proxies to accelerate the performance of our solutions.

Maintain focus on customer service and support. We believe that one of our competitive advantages is our commitment to customer service and support. We intend to continue our focus on satisfying customer needs by providing customized solutions and offering our customers support in solving complex security-related problems. We believe that delivering excellent customer service also provides a source of additional sales leads for our products.

Further penetrate and expand our existing customer base. We intend to leverage our technology, product leadership and superior customer service to continue to drive sales to new customers and to further penetrate our existing customers. We have an established customer base of Global 2000 companies and government entities worldwide in which we have developed strong relationships. We intend to generate incremental sales from these relationships by penetrating areas within our existing customers that are not currently using our security solutions. Additionally, we intend to broaden our customer base through the expansion of our sales force and continued enhancement of our channel distribution network.

Heighten our brand awareness and strengthen distribution channels. We intend to continue to expand domestically and internationally through enhanced marketing programs and sales activities designed to strengthen our brand and distribution channels. As part of our education-oriented marketing strategy, we intend to continue to expand our brand-building activities, emphasizing the unique factors and technologies that differentiate us from the competition. Our growing network of value-added resellers and distributors provides us with a key instrument to access new markets and customers while further penetrating our existing customer base. We intend to grow our distribution channels by establishing additional relationships with value-added resellers, system integrators and distributors that sell security solutions to large enterprises and government entities.

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Extend our product offerings. We intend to leverage our strength to further extend our core technologies, enhance our existing products and continue to develop new complementary products. We also intend to continue broadening the capabilities of our central management solution called Global Command Center^™ designed to simplify management of multiple security appliances. We also intend to develop a security product that will offload heavy computational operations, such as complex cryptographic algorithms, at the central processing unit to enable faster performance.

Continue to grow our business organically as well as through strategic acquisitions. We are positioned to benefit from the projected growth in the industry and intend to grow organically by adding additional personnel, particularly in the sales and engineering areas. We also intend to pursue strategic acquisitions that provide additional technology expertise, complementary product offerings, additional geographic reach and new customer opportunities.

Products

Firewall/VPN Appliances

We offer a comprehensive line of premium firewall/VPN appliances that includes fourteen models designed to address the full spectrum of security requirements – from the most sophisticated enterprises and government agencies to the medium-sized businesses. Our firewall/VPN appliances are built on our custom, secure operating system and combine a hybrid methodology of stateful packet and application proxies technology to provide deeper inspection of every packet that traverses the network.

The strength of our firewall/VPN appliances has been certified in numerous independent evaluations. Our secure operating system and networking software are designed to meet the United States Trusted Computer System Evaluation Criteria/National Computer Security Center, or NCSC, criteria at a B1 level. Our firewall/VPN appliances achieved the Common Criteria EAL4+ certification. This certification meets the US National Security Agency benchmark for firewalls. Certain agencies of the U.S. government and large enterprises require the products they use to carry a certification of the product’s proven reliability.

Our firewall/VPN appliances are designed to offer network security solutions by providing the combination of high security, high performance and ease of use for global customers including major banks, financial institutions, corporations and government entities. We offer a number of security modules as part of our firewall/VPN appliances that are sold as customer-selected options. These options include: anti-virus, anti-span, SSL acceleration, web-content filtering, and intrusion detection.

Our appliances are comprised of specialized hardware platforms and secure operating systems. Our specialized hardware platform provide security, scalability and performance in any easy to use form factor.

The SG300 and SG500 appliances are specifically designed to increase security and reduce costs associated with small-medium sized businesses and enterprises or replicated sites. The SG300 and SG500 appliances are available at various sustained throughput rates ranging from 35Mbps to 140Mbps.

FS Series

The FS series appliances are specifically designed for networks with moderate bandwidth requirements within medium-sized organizations. At 250 to 500 Mbps performance and more than 550,000 simultaneous connections, the FS series provides throughput to meet the bandwidth requirements of many mid-sized networks.

KS Series

The FS series appliances are specifically designed for large organizations that require maximum throughput and security. The KS series appliances eliminate the performance barriers imposed by traditional firewalls and virtual private network encryption and have sustained throughput rates ranging from 1Gbps to 1.5Gbps.

SL Series

The SL series appliances are designed to be ultra-secure and deliver multi-gigabit throughput for any organization’s most demanding environments. The SL series appliances have sustained throughput rates of 1.5Gbps.

Our FS, KS and SL series appliances all carry the highest levels of independent, objective security certifications – Common Criteria EAL4+, ICSA, ITSEC E3, and VPNC.

Embedded Firewall/VPN Solutions

While perimeter firewalls are effective in stopping incursions from an external network, they cannot

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prevent attacks that originate within the protected network. Since up to 90% of network attacks originate within the organization, many organizations are complementing perimeter defenses with embedded firewalls that secure critical servers and host systems. By embedding access control technology within PCI cards, independent of the host operating system, the embedded firewall offers a scalable, tamper-resistant and non-by-passable security solution to secure access inside the corporate firewall. Administrators can define and implement access rules that restrict desktop users to specific servers or network resources based on their user profiles or group affiliations.

SG630 and SG635 Series

The SG630 and SG635 appliances are cost-effective firewall/VPN solutions packaged on a PCI card. By offloading all firewall and VPN processing from the host computer, the SG630 and SG635 ensure high performance and throughput with the convenience of remote management and simplified installation. The SG635 series includes an intrusion detection module.

Secure Content Management Software

We offer a comprehensive suite of secure content management products that enable organizations to manage and inspect Internet content to effectively protect their networks from security threats and annoyances. We combined our content security components into a single comprehensive solution. The integration of these components and the synergy of several individual technologies improve network performance and reduce administrative costs.

The following are key components of our secure content management software:

Webwasher URL Filter. Manages access to inappropriate or distracting Web content to minimize organization’s legal risks, increase network security and improve employee productivity.

Webwasher Anti-Virus. Provides in-depth protection against a multitude of blended threats at the corporate gateway while offering high performance through our innovative Antivirus technology.

Webwasher Anti-spam. Combines the strengths of multiple complementary spam detection methods for unmatched accuracy, delivering spam detection well in excess of 90% and a false-positive rate of less than 1%.

Webwasher Instant Message Filter. Detects, reports, and selectively blocks the unauthorized use of high-risk and evasive Peer-to-Peer file sharing (P2P) and Public Instant Messaging (IM) from enterprise networks.

Webwasher Content Protection. Ensures that your systems are protected against the myriad threats transported in Web and e-mail traffic. Content Protection screens the HTTP data stream, filtering out unwanted and potentially dangerous content. In addition, Content Protection filters out-going content (Web and e-mail) to stop leakage of confidential materials.

Webwasher SSL Scanner. Enables enterprises to apply their existing security and Internet usage policies to the HTTPS protocol.

Each of these secure content management modules can be deployed independently or combined as part of a more comprehensive solution.

Security Management Platform

Our security management solution, Global Command Center, is designed to enable large enterprises and government entities to implement and manage security policies easily and consistently across complex, geographically dispersed networks of firewalls/VPNs and other related security products. It is designed to allow security administrators to manage network security from a centrally-located position.

Global Command Center allows administrators to define objects, such as a firewall or other security device, once, and then reuse those objects wherever they are needed. When security policies change, an administrator can modify the objects and implement the changes instantly throughout the enterprise. Specifically, Global Command Center is designed to enable customers to centrally monitor and audit security policies, back-up and restore security configurations, centrally manage software updates and licensing and simplify routine administrative tasks.

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Professional Services

Global education programs. Recognizing that the educated consumer is our most valued customer, we have developed a portfolio of certification courses for our suite of network security solutions. The courses include CyberGuard Firewall Security Administration, CyberGuard Firewall Security Officer, Global Command Center Administration, Virtual Private Network Administration, and High Availability Administration. Certification is achieved through successful completion of demonstration-based testing in the classroom and online testing at the end of the course. In addition, customized on-site seminars can be scheduled covering advanced security topics, including specific responses to the results of external and internal security assessments.

Customer Support

We believe that service is a key differentiator for us. Our worldwide customer support center provides 24-hour support via telephone and over the Internet through CyberGuard On-line. Our knowledgeable support team is versed in real-world enterprise environments, and they have each obtained certifications in networking, firewalls and security. Our support staff is composed of highly trained and qualified, level-2 experienced security professionals. In addition support staff has access to information and services. Our customers have access to security tips, technical services and incident placement through CyberGuard On-line.

Security Certifications

Our products continue to earn high level, independent security certifications and evaluations.

We maintain a commitment to be a leader in providing certified security solutions. Some examples of our security certifications include:

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Strategic Relationships

We have strategic alliances with third parties to ensure our customers have access to the most powerful and interoperable network security solutions available in the market today. By partnering with top performing providers as it relates to encryption, token authentication, virus detection and load balancing, CyberGuard is both internally innovative and uniquely positioned to service system integrators, solution providers, and end users as they make important infrastructure and network security decisions.

We outsource all of our hardware manufacturing and assembly primarily to two third-party manufacturers and assembly houses. We do not have written contracts with these manufacturers.

Customers and Markets

Traditionally, we have served the Global 2000 enterprise and national governments sectors, which typically have the most stringent requirements for network security. Our success in these sectors is the product of an unparalleled commitment to Common Criteria EAL4+ certification and maintenance assurance, as well as our status as the only firewall vender to have received “Orange Book” certification by the U.S. Federal Government. Widely regarded as the “most secure” solution as a result of this commitment to maintaining the highest level of certifications, demand for our products is especially prevalent in regulatory-driven environments, such as the financial services and utilities sectors.

The acquisition of SnapGear in November 2003 expanded our product portfolio to include a family of cost-effective firewall/VPN appliances aimed at the “edge” of the enterprise network. These SG-branded products are an excellent fit for small and mid-sized branch and remote offices, which comprise the largest and most lucrative segment of the firewall/VPN appliance marketplace. The SG product delivers on our commitment to offer a complete range of appliances to enterprise customers, who must provide consistent levels of security for their branch offices and remote employees.

In April 2004, we acquired Webwasher, a leading provider of enterprise-class Web and e-mail content security solutions. Webwasher’s Content Security Management suite provides a significant market differentiation for CyberGuard’s TSP solutions. Robust content security features, including an inherent ability to mitigate risk associated with malware, viruses, and worms, uniquely position CyberGuard to provide a cost-effective core-to-edge blended protection solution to the large enterprise market.

During our fiscal year ended June 30, 2004, we executed on a well defined growth strategy, acquiring strategic technologies and exploiting product synergies to expand our presence in global markets as a leading provider of information security solutions that scale from the core to the edge of the enterprise network. Looking toward the future, we believe that security infrastructure is in a transition period and that a number of enterprise pain points and business drivers have aligned to make CyberGuard a very attractive information security solutions provider to large enterprise organizations seeking to refresh or enhance their securing infrastructure.

Sales and Distribution

We sell our products primarily through a global network of value-added distributors, resellers and system integrators. The SG line can also be purchased directly on shopping sites such as Yahoo. When mandated by a specific enterprise customer or government agency, the channel is used for fulfillment purposes and we maintain a direct relationship with the customer.

A global sales force is responsible for acquiring and managing distribution partners. This indirect distribution strategy allows us to leverage the trusted relationships our partners have built with their customers to expand our range of prospects and accelerate the sales process. It also allows us to reduce our sales costs by reducing the number of direct sales professionals that would otherwise be required to achieve comparable market coverage. The ability of our partners to provide regional technical support reduces our need to provide direct support to customers, enabling us to provide high quality support services across the globe.

In July 2004, the “One Program” was introduced to standardize the channel program across the globe and to unify CyberGuard with its business partners. One is an innovative channel program due to its hard segmentation nature.

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Even the name was chosen to communicate our view that our sales organization and the channel is managed as “one” entity, not separate delivery vehicles. The program reflects this philosophy. The program has been constructed to aggressively engage, energize, and reward the channel. Only channel partners that actively engage will be accepted into the program. Our channel managers are tasked with actively managing the engagement process, responsible for developing a coordinated marketing plan within 30 days of the acceptance of a new partner. By focusing their efforts on assisting our preferred-tier partners in developing go-to-market plans linked to CyberGuard’s quarterly marketing plan, the channel manager will be intimately involved in creating end user demand. “One” delivers on our commitment to drive business through the channel.

We employ three Regional Vice Presidents (RVP) who are responsible respectively for our businesses in the Americas, EMEA (Europe, the Middle East and Africa), and the US Federal Government. Each RVP employs a team of sales managers who are responsible for generating business through partners in their region and via selected key account end-user customers. A team of Inside Sales Professionals (ISPs) supports the RVPs in developing new channel partner relationships and assisting their regional sales managers throughout the sales process. In addition, we field a team of global technical support professionals who provide pre- and post-sales technical support to our sales force and channel partners.

Marketing

In June 2004, a VP of Worldwide Marketing was hired to lead the company’s marketing, brand management, and product management efforts. With this hire, CyberGuard has embraced the concept that market focus and brand management are equally important success criteria. Enhancing brand equity is the top priority for the next twelve months. Our marketing team intends to accomplish this objective by creating a sense of community for our customers and partners. To accomplish this objective, we will create “club-like” programs and events that reward our best customers and partners. We will also use advertising to influence the emotions our customers feel about doing business with CyberGuard.

A second key objective for 2005 is the mapping of marketing and product management activities to the technology adoption lifecycle model of market development. Specifically, marketing programs will be devised to enable CyberGuard to develop the “early mainstream” application-layer security market. These activities will consist of establishing beachhead accounts and a customer reference base for the Company’s new products, which generally represent a set of discontinuous innovations to both our legacy products and the industry at large. By definition, a discontinuous innovation requires that a prospect change their current behavior in order to implement the new technology. Therefore, our marketing efforts will be focused on defining the specific value propositions and business models required to coerce that change in behavior.

The third key objective for 2005 is to enhance our market focus. The company has historically been sales-driven, prioritizing product development on the basis of customer demand rather than broad market assessment. In June of 2004, we created a Director of Product Management position. Core responsibilities of this position are market assessment, definition of product requirements, and management of product development schedules. Under this new structure, specific customer requirements will be evaluated in the context of the broader market opportunity.

We will continue to invest in tactical marketing programs that help us attain strategic objectives. These include:

Co-Op Marketing will also play an important role in extending our global reach. This program enables our channel partners to accrue credits based on a percentage of their product revenue, and then to use these credits to offset 50% or more of the costs for generating marketplace awareness and leads for CyberGuard and its products.

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As of June 30, 2004, we had 12 employees in our sales and marketing organization.

Competition

The market for security solutions is intensely competitive and characterized by rapid change and consolidation. We believe this level of competition is likely to persist and intensify given the escalating threats to global security and the growing sophistication of hackers and cyber-criminals.

We believe that the principal competitive factors affecting the market for computer and network security products include the product’s level of security, performance and reliability, technical features, including interoperability and functionality, ease of use, capabilities, customer services and support, integration of products, manageability of products, brand name recognition, reputation, distribution channels and lower total cost of ownership.

However, we believe that we possess a number of competitive advantages that provide opportunities for us to secure a significant share of the fastest growing market segments and profitably expand our business. These competitive advantages include:

With our broad range of firewall/VPN solutions, we compete with a number of established firewall/VPN providers, including Cisco Systems, Check Point^®, Secure Computing, Juniper Networks^®, Watchguard^®, Symantec^®, SonicWALL, and others. In selected markets, we may also compete with new and emerging competitors such as Fortinet^™, Tipping Point, and Radware.

In the content security sector, our chief competitors include Websense^®, SurfControl^®, Secure Computing (via its N2H2 acquisition), and Symantec.

Patents and Proprietary Technology

The Company relies upon license agreements with customers; trademark, copyright and trade secret laws; employee conflict of interest and third-party non-disclosure agreements and other methods to protect the trade secrets, proprietary know-how and other proprietary rights on which the Company’s business depends. There can be no assurance that these agreements will not be breached, that the Company will have adequate remedies for any

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breach, or that the Company’s trade secrets will not otherwise become known to or independently developed by competitors. The Company has some pending patent applications to cover certain aspects of its technology. The Company has received trademark registration in the United States, Canada and numerous other countries for its CyberGuard^® firewall mark and its CyberGuard logo.

Various companies hold patents, copyrights, and other intellectual property rights covering a variety of competing products and processes. We have from time to time received, and may in the future receive, communications from third parties claiming that we may be infringing certain of such parties’ patents and/or other intellectual property rights. The Company may be unable to avoid infringement of third party intellectual rights and may have to obtain a license, defend an infringement action, or challenge the validity of another party’s intellectual property rights in court. Intellectual property litigation is costly and time consuming, and the Company may be unable to prevail in any such litigation or devote sufficient resources to even pursue such litigation. A license may be unavailable on terms and conditions acceptable to the Company, if at all. If the Company does not obtain a license under another party’s intellectual property rights and if it were found liable for infringement, the Company may be liable for significant money damages, may encounter significant delays in bringing products to market, or may be precluded from participating in the manufacture, use, or sale of products requiring such licenses. Any allegation of infringement, infringement claim or other litigation against or by us could have a material adverse effect on our results of operations and financial condition.

Government Regulation

Our security products are subject to export restrictions administered by the U.S. Department of Commerce. Export controls on cryptographic products permit the export of encryption products outside the U.S. only with the required level of export license or through an export license exception. The effect of these regulations is to create delays in the introduction of the products in international markets, and, in some cases, to prohibit them altogether.

Employees

As of June 30, 2004, we employed approximately 280 full-time employees and 10 contract engineers. All of our employees and contract engineers are bound by agreements containing confidentiality and conflict of interest provisions.

Available Information

The Company’s Internet Web site address is www.cyberguard.com. The Company makes available free of charge through its Web site its periodic reports as soon as reasonably practicable after filing.

ITEM 2. PROPERTIES

Our corporate headquarters are located at 2000 West Commercial Blvd, Ft. Lauderdale, Florida. This facility has approximately 26,000 square feet and provides office space for our executive team, research and development, sales and worldwide customer support organizations. The lease expires in August 2004. In September 2004, we will be moving to a new 38,000 square foot facility, located at 350 S.W. 12^TH Avenue, Deerfield Beach, Florida. The lease expires in November 2014.

We lease facilities on a short-term basis in Maryland, North Carolina, Illinois, Australia, Japan, Dubai, United Kingdom and Germany for regional sales support.

ITEM 3. LEGAL PROCEEDINGS

On August 24, 1998, the Company announced, among other things, that due to a review of its revenue recognition practices relating to distributors and resellers, it would restate prior financial results. After the August 24, 1998 announcement, twenty-five purported class action lawsuits were filed by alleged shareholders against the Company and certain former officers and directors. Pursuant to an order issued by the Court, these actions have been consolidated into one action, styled Stephen Cheney, et al. v. CyberGuard Corporation, et al., Case No. 98-

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6879-CIV-Gold, in the United States District Court, Southern District of Florida. On August 23, 1999, the plaintiffs filed a Consolidated and Amended Class Action Complaint. This action seeks damages purportedly on behalf of all persons who purchased or otherwise acquired the Company’s common stock during various periods from November 7, 1996 through August 24, 1998. The complaint alleges, among other things, that as a result of accounting irregularities relating to the Company’s revenue recognition policies, the Company’s previously issued financial statements were materially false and misleading and that the defendants knowingly or recklessly published these financial statements which caused the Company’s common stock prices to rise artificially. The action alleges violations of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and SEC Rule 10b-5 promulgated thereunder and Section 20(a) of the Exchange Act. Subsequently, the defendants, including the Company, filed their respective motions to dismiss the Consolidated and Amended Class Action Complaint. On July 31, 2000, the Court issued a ruling denying the Company’s and Robert L. Carberry’s (the Company’s CEO from June 1996 through August 1998) motions to dismiss. The court granted the motions to dismiss with prejudice for defendants William D. Murray (the Company’s CFO from November 1997 through August 1998), Patrick O. Wheeler (the Company’s CFO from April 1996 through October 1997), C. Shelton James (the Company’s former Audit Committee Chairman), and KPMG Peat Marwick LLP (“KPMG”). On August 14, 2000, the plaintiffs filed a motion for reconsideration of that order. The Company filed an answer to the plaintiffs’ Consolidated and Amended Class Action Complaint on August 24, 2000. On March 20, 2001, the Court ruled on the plaintiffs’ motion for reconsideration that the previously dismissed defendants William D. Murray, Patrick O. Wheeler and C. Shelton James should not have been dismissed from the action and shall be defendants in this action under the control person liability claims under Section 20(a) of the Exchange Act, and that the plaintiffs may amend the Consolidated and Amended Class Action Complaint to bring claims against C. Shelton James under Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder. On April 5, 2001, the plaintiffs filed their Second Consolidated and Amended Class Action Complaint to include amended claims against C. Shelton James. On May 10, 2001, the Company filed an answer and affirmative defenses to plaintiffs’ Second Consolidated and Amended Class Action Complaint. On August 14, 2002, the Court granted the plaintiffs’ Motion for Class Certification and certified the class to include all investors who acquired the Company’s common stock between November 7, 1996 and August 24, 1998 and were damaged by the purchase of such stock.

In July 2003, the Company entered into a Memorandum of Understanding to settle this lawsuit. The settlement amount of $10 million required the Company to incur a one-time charge of $3.9 million in the fourth quarter of its fiscal year ending June 30, 2003 for the amount in excess of the insurance coverage and related costs. The Company paid its portion of the settlement amount in cash. On October 9, 2003, the Company and all other parties signed a Stipulation and Agreement of Settlement and filed a Joint Motion for Preliminary Approval of Settlement of the lawsuit. On November 6, 2003, a hearing was held on the joint motion. The court entered a preliminary order approving the settlement and scheduled a final fairness hearing for April 16, 2004.

On April 16, 2004, a fairness hearing was held before the magistrate judge. There were no objections raised to the proposed settlement. On April 19, 2004, the magistrate judge issued a Report and Recommendation to the district judge recommending that the settlement be approved. On May 7, 2004, the district judge entered an Order and Final Judgment approving the settlement. No one has appealed the Order and Final Judgment and the time for appeal has expired.

Certain shareholders, owning approximately 40,000 shares, who had opted out of the settlement, reconsidered their decision and opted back into the settlement. A settlement with these shareholders was approved by the district court on August 11, 2004. A shareholder who owns approximately 2,000 shares opted out of the settlement. To date, this shareholder has not

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asserted a claim against the Company. If such claim is asserted, the Company would have no insurance coverage available to defray the cost of defending or paying the claim.

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

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended June 30, 2004.

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PART II

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

On March 19, 2002, the Company began trading on the OTC Bulletin Board under the symbol CYBG. On June 11, 2002, the Company’s Common Stock began trading on the American Stock Exchange under the ticker symbol “CFW”. Finally, on July 8, 2003, the Company’s Common Stock ceased trading on the American Stock Exchange and commenced trading on the NASDAQ National Market under the symbol “CGFW.”

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

There were approximately 3,376 holders of record of Common Stock as of June 30, 2004. The table below sets forth, for the quarters indicated, the high and low sales prices for the Company’s Common Stock as reported by NASDAQ and the American Stock Exchange.

We have not paid cash dividends on our common stock in the past and do not anticipate paying cash dividends in the foreseeable future. We currently intend to retain all future earnings to finance the expansion of our business. Any future determination regarding cash dividend payments will be made by our Board of Directors and will depend on our earnings, capital requirements, financial condition and other factors deemed relevant by our Board of Directors.

We issued 1.7 million shares of unregistered common stock on November 26, 2003 in connection with the acquisition of SnapGear. A registration statement was filed on Form S3 (commission number 333-110960) to register these shares on February 11, 2004.

We issued 3.134 million shares of unregistered common stock on April 29, 2004 in connection with the acquisition of webwasher. A registration statement was filed on Form S3 (commission number 333-115537) to register these shares on July 22, 2004.

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The number of shares issuable upon exercise of the outstanding options granted to employees and non-employee directors, as well as the number of shares remaining available for future issuance, under our equity compensation plans as of June 30, 2004 are summarized in the following table:

EQUITY COMPENSATION PLAN INFORMATION

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth selected consolidated financial data that is qualified in its entirety by and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and notes thereto appearing elsewhere in this Form 10-K. The financial data for the fiscal years ended June 30, 2004, 2003, 2002, 2001 and 2000 have been derived from our audited consolidated financial statements for such periods as audited by Grant Thornton LLP.

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

This Annual Report on the 10-K, 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;

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

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Overview

We provide a broad portfolio of security products that deliver high performance, cost effective security for enterprises and government entities worldwide. Our products are designed to provide the strongest security and protection available along with robust centralized management. We offer a broad family of security appliance solutions and related software that include firewall, Virtual Private Networking (VPN), secure content management and security management technologies. Our appliances are built upon a highly secure operating system and proprietary software designed to identify network and application attacks and prevent them from reaching mission-critical resources. We believe that a key differentiator of our security products is our ability to inspect all the content that is traveling over the network for security threats, whether originating from within or outside an enterprise without impacting performance. We believe that our ability to inspect each packet of network traffic at the application layer provides some of the highest levels of protection.

The rise in vulnerabilities of security products potentially provides ways for hackers to compromise enterprises’ networks and applications. Our highly secure appliance combines multi-gigabit performance and centralized management and provides the Company a key differentiator with current and potential customers.

Our target customers are large enterprises, including Global 2000 companies, major financial institutions and government entities worldwide. Our appliances are sold to end-users directly and indirectly by a direct sales force and resellers in the United States and in over 30 foreign countries.

We were incorporated in 1994 in connection with a spin-off from Harris Corporation. At that time, we produced computers for the real-time computing market as well as our firewall for the secure computing market. We changed our name from Harris Computer Systems Corporation in June 1996 following the sale of our real-time computer business.

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”).

The consideration to SnapGear was approximately $16 million in cash and stock. The $16 million consideration consisted of: (a) approximately 1.7 million shares of the Company’s common stock valued at $14 million; and (b) cash of approximately $1.6 million. In addition, the stockholders of SnapGear are entitled to receive up to approximately 367,000 additional shares of the Company’s common stock valued at $3.2 million based on revenues of up to $15 million are attained in the 12 months post-closing.

SnapGear stockholders were granted certain registration rights pertaining to the common stock they received in the transaction. The Company’s general corporate funds were the source of the funds used to fund the cash portion of the purchase price.

SnapGear, a privately-held company founded in Australia, is a leading developer of embedded Linux security and offers a popular line of edge firewall/VPN security appliances for the small to medium enterprise markets. SnapGear offers a range of products that will allow the Company to broaden its product offering and compete in new market segments.

The acquisition was accounted for using the purchase method of accounting, as required by Statement of Financial Accounting Standard No. 141, “Business Combinations.” Under this method of accounting, the Company allocated the purchase price to the fair value of the assets

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acquired, including identified intangible assets. The allocation was based on management’s estimates, with assistance from an independent third party valuation firm. The purchase price allocated includes $800,000 of the $3.2 million contingent earnout based on the Company’s estimate of SnapGear achieving a revenue target of $12.5 million per the Agreement, during the twelve months ended November 30, 2004. The purchase price included closing costs of $346,000.

On April 29, 2004, CyberGuard Corporation (“Company”) completed the acquisition of German high-end content security vendor webwasher AG for $37.5 million, of which $8.1 million was paid in cash and the remainder was paid with 3.1 million shares of the Company’s common stock valued at $29.01 million. There is additional earnout potential of $10 million to be paid in stock subject to webwasher achieving revenue targets beginning at $16.6 million and up to $20.6 million and net income targets beginning at $1.0 million for the period beginning April 15, 2004 through June 30, 2005. Webwasher develops and markets standalone and integrated solutions for Internet content security and filtering, including URL filtering, e-mail and spam filtering, virus protection, SSL filtering, Instant Message/Peer-to-Peer blocking and Internet usage reporting.

The acquisition was accounted for using the purchase method of accounting, as required by Statement of Financial Accounting Standard No. 141, “Business Combinations.” Under this method of accounting, the Company allocated the purchase price to the fair value of the assets acquired, including identified intangible assets. The allocation was based on management’s estimates, with assistance from an independent third party valuation firm. The Company is in the process of finalizing the purchase price allocation and these are subject to change. The purchase price included closing costs of $433,000.

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Results of Operations

The following table sets forth certain of our consolidated statement of operations data as a

percentage of total revenues for the periods indicated.

Fiscal Year Ended June 30, 2004 compared to Fiscal Year Ended June 30, 2003

Total revenues. Total revenues, which consist of product sales and software maintenance and professional services revenues, increased from $32.9 million for fiscal year 2003 to $47.8 million in fiscal year 2004, or 45%. The increase in total revenues was driven by the increase in the number of products we currently offer, the continued focus on security by government and commercial enterprises world-wide, increased awareness of our product brand and new product offerings as a result of our acquisition of SnapGear in November 2003 and webwasher in April 2004.

We categorize our revenues into three geographic regions: North America; Europe and the Middle East, (“EMEA”); and Asia and the Pacific Rim, (“APAC”). Revenues in North America, EMEA

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and APAC as a percentage of total revenues were approximately 50%, 32% and 18%, respectively, in fiscal year 2004 and 2003. All regions experienced increased sales in fiscal year 2004 compared to fiscal year 2003. Our total international revenues, which are revenues for customers outside North America, represented approximately 50% of the total revenues in fiscal year 2004 and 2003.

No single customer or reseller accounted for more than 10% of our total revenue in fiscal year 2004 or 2003.

We expect revenues to increase in fiscal 2005 as a result of including the revenues of the acquired companies, SnapGear and webwasher, for a full twelve months.

Product revenues. Product revenues consist primarily of firewall and VPN security appliances. Product revenues increased from $22.6 million in fiscal year 2003 to $35.8 million in fiscal year 2004, or 58%. The increase in product revenues is primarily the result of increased brand awareness, channel growth, penetrating into new markets and new product offerings as a result of our acquisition of SnapGear in November 2003 and webwasher in April 2004. The majority of our product revenues for fiscal year 2004 were generated from large enterprise customers and government entities, in both domestic and international markets. An additional component of our product revenue in fiscal 2004 is OEM sales to large service providers and systems integrators resulting from our acquisition of SnapGear.

Service revenues. Service revenues consist primarily of maintenance contracts for technical support of our firewall/VPN appliances and content management solutions from the Webwasher acquisition. Also included in service revenues are revenues from professional services such as training, consulting and installation. Service revenues increased from $10.3 million in fiscal year 2003 to $12 million in fiscal year 2004 an increase of 16%. The increase in service revenues was due primarily to growth in annual maintenance/customer support revenues, which represents approximately 90% of total service revenues. This growth is due to the greater number of installed products during fiscal year 2004 resulting from additional product sales, as well as maintenance/customer support renewals for products sold in previous years. Revenues from training, consulting and installations made up the balance of the growth of service revenues from fiscal year 2003 to fiscal year 2004.

Cost of revenues and gross profit. Total cost of revenues, which includes products and services costs, increased from $8.6 million in fiscal year 2003 to $15.7 million in fiscal year 2004, or 83%. The increase was primarily due to the increased product sales and services revenues for fiscal year 2004. Total gross profit was 67% for fiscal year 2004 and 74% for fiscal year 2003. Gross profit is affected by a variety of factors including competition, the mix in average selling prices of products we currently offer, OEM sales, new product introduction and enhancements, fluctuation in manufacturing volumes and incremental cost of supporting the increased installed customer base. The reduction in product related gross profit was primarily the result of a change in the product mix as a result of the acquisition of SnapGear in November of 2003. The security solutions for the SG product range are used in regional, branch and small offices of small to medium-sized enterprises. These products fall into more of a commodity offering and margins are lower than the traditional Cyberguard offerings. In addition, the OEM component of revenues has margins, which are substantially lower than those products that are sold through channel relationships. The gross margin was also negatively impacted by the amortization of acquisition related charges which totaled 905,000 during 2004. Gross profit for services was $8.1 million, or 67%, for fiscal year 2004 as compared to $7.7 million, or 74%, for fiscal year 2003. The decrease in service related gross profit was a result of the increase in headcount of the support maintenance engineers.

Operating expenses. For fiscal year 2004, total operating expenses increased to $32.6 million as compared to $24.8 million for the fiscal year 2003, or 32%. As a percentage of total revenues, operating expenses decreased from 75% in fiscal year 2003 to 68% in fiscal year 2004. Included in the operating expenses for the year ended June 30, 2004 was a non-recurring charge of $4.4 million for a non-cash compensation charge related to the SnapGear acquisition and $844,000 of acquisition related amortization of intangibles. Excluding the non-cash compensation charge and the amortization of acquisition related

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intangibles, operating costs were $28.2 million, or 59% of total revenue. The increase in total operating expenses in fiscal year 2004 from fiscal year 2003, excluding acquisition related amortization and other non-recurring charges from both years, was $6.7 million, or 32%. The overall increase in operating expenses is due primarily to the increase in development costs of $1.5 million, and an increase in selling, general and administrative expenses of $5.3 million. The increase in both operating expense categories is as a result of the acquisitions made during the current year. Operating expenses are expected to increase in fiscal 2005 as a result of including the operating expenses of the acquired companies for a full twelve months. For a reconciliation of the Company’s operating expenses under generally accepted accounting principles, please see the table below under the heading “Non-GAAP Financial Information”.

Research and development expenses. Research and development expenses includes salaries, non-capitalized equipment, software tools and facilities related costs. For fiscal year 2004, total research and development expenses increased to $7.4 million from $5.9 million for fiscal year 2003, or 25%. Sixty five percent of the increase is the result of additional development associated with the acquisitions during the year and the balance is due to the increase in headcount of the existing development organization. As a percentage of total revenue, research and development expenses decreased to 16% in fiscal year 2004 compared to 18% for fiscal year 2003 due primarily to the growth in revenues during the year and the increase in capitalization of software development costs during fiscal 2004 of $1.6 million relating to the latest release of the software, compared to $179,000 of software development costs that were capitalized during fiscal 2003. Research and development expenses are expected to increase in fiscal 2005 as a result of including the research and development expenses of the acquired companies for a full twelve months.

Selling, general and administrative expenses. Selling, general and administrative expenses include salaries, commissions, human resources, finance, administrative support functions, and legal and accounting professional services. Selling general and administrative expenses increased by $5.8 million or 39% to $20.8 million for fiscal year 2004 from $14.9million for fiscal year 2003. The increase was due to labor related expenses, including increases in bonuses, commissions as a result of including the costs of the acquired companies as well as option related payroll costs incurred. The increase also includes an increase in amortization of acquisition related charges of $540,000. As a percentage of total revenue, selling, general and administrative expenses decreased to 43% for fiscal year 2004 compared to 45% for fiscal year 2003.

Selling, general and administrative expenses are expected to increase in fiscal 2005 as a result of including selling, general and administrative expenses of the acquired companies for a full twelve months.

Compensation expense related to restricted stock. The restricted stock compensation balance of $4.4 million recorded in connection with the acquisition of SnapGear, represented the portion of the purchase consideration linked to continued employment of certain key employees of SnapGear. This amount was written off as a one-time non-cash charge during fiscal year 2004 as a result of the Company’s election to remove the employment requirement from the restricted stock agreement. The restricted stock agreement still requires release of stock to these employees from escrow over a two year period beginning November 26, 2004.

Net interest income. Net interest income was $148,000 for fiscal year 2004 compared to net interest income of $111,000 for fiscal year 2003. The increase in net interest income was primarily the result of the significant increase in cash balances for fiscal year 2004 versus fiscal year 2003.

Other income. Other income was $376,000 for fiscal year 2004 versus $205,000 for fiscal year 2003. Other income represents foreign currency gains for fiscal year 2004 and 2003.

Income tax benefit. We provide a deferred tax valuation allowance for the portion of our deferred tax assets which is not more likely than not, to be recognized due to our cumulative losses and the uncertainty as to future recoverability. We recorded an income tax benefit of $1.7 million as of June 30, 2004, as a result of the reversal of a portion of the deferred tax asset valuation allowance. The reversal of

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the allowance was made because we believe 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 of additional reduction or increase of the valuation allowance that should be made, if any. This will be based on our estimate and conclusions regarding the ultimate realization of the deferred tax assets, including but not limited to, our recent positive financial results as well as projected earnings over a 9 quarter period. The impact of further reductions of the deferred tax valuation allowance will be to record a tax benefit, which will increase net income in the period this determination is made.

Net income and earnings per share. As a result of the factors described above, net income decreased to $1.7 million in fiscal 2004, or $0.06 per diluted share, compared to a net income of $4.1 million, or $0.16 per diluted share for the fiscal year 2003. The acquisition related charges described above, had the impact of reducing our earnings by $6.1 million during fiscal year 2004. Acquisition related charges and the class action settlement had the impact of reducing our earnings by $4.4 million, during fiscal year 2003.

Non-GAAP Financial Information

The following reconciliation details the adjustments between the results calculated using generally accepted accounting principals (GAAP) and the same results excluding acquisition related and non-recurring charges. The non-GAAP information is included herein in order to provide investors a more complete understanding of the underlying operational results and trends, which should only be read in conjunction with the results reported in accordance with GAAP. (Amounts in thousands except per share amounts)

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Fiscal Year Ended June 30, 2003 Compared to Fiscal Year Ended June 30, 2002

Total revenues. Total revenues, which consist of product sales and software maintenance and professional services revenues, increased from $22.3 million for fiscal year 2002 to $33.0 million in fiscal year 2003, or 48%. The increase in total revenues was driven by increased demands for our products due to an increased focus on security by government and commercial enterprises and increased awareness of our product brand.

We categorize our revenues into three geographic regions: North America; EMEA; and APAC. Revenues in North America, EMEA and APAC as a percentage of total revenues were approximately 50%, 32% and 18%, respectively, in fiscal year 2003 and 42%, 35% and 23%, respectively, in fiscal year 2002. All regions experienced increased sales in fiscal year 2003 compared to fiscal year 2002. Our total international revenues, which are revenues for customers outside North America, represented approximately 50% of the total revenues in fiscal year 2003 and 58% of total revenues in fiscal year 2002.

No single customer or reseller accounted for more than 10% of our total revenue in fiscal year 2003. During 2002, one customer represented 11% of consolidated revenues. This customer represented 3% of consolidated revenues in 2003.

Product revenues. Product revenues consist primarily of firewall and VPN security appliances. Product revenues increased from $15.2 million in fiscal year 2002 to $22.6 million in fiscal year 2003, or 49%. The increase in product revenues is primarily the result of increased brand awareness, channel growth and penetration into new markets. The majority of our product revenues for fiscal year 2003 were generated from large enterprise customers and government entities, in both domestic and international markets. Our federal division consists of a team of security engineers and sales professionals who focus solely on working with various U.S. government agencies and departments. As a result of this focus we have experienced an increase in government business activity, not only in the U.S. but also around the world.

Service revenues. Service revenues consist of maintenance contracts for technical support of our firewall/VPN appliances and professional services such as training, consulting and installation. Service revenues increased from $7.1 million in fiscal year 2002 to $10.3 million in fiscal year 2003. The increase in service revenues was due primarily to growth in annual maintenance/customer support revenues, which represents approximately 91% of total service revenues. This growth is due to the greater number of installed products during fiscal year 2003 resulting from additional product sales, as well as maintenance/customer support renewals for products sold in previous years. Revenues from training, consulting and installations were not a significant factor in the growth of service revenues from fiscal year 2002 to fiscal year 2003.

Cost of revenues and gross profit. Total cost of revenues, which includes products and services costs, increased from $7.2 million in fiscal year 2002 to $8.6 million in fiscal year 2003, or 20%. The increase was primarily due to the increased product sales and services revenues for fiscal year 2003. Total gross profit was 74% for fiscal year 2003 and 68% for fiscal year 2002. Gross profit is affected by a variety of factors including competition, the mix in average selling prices of products we currently offer, new product introduction and enhancements, fluctuation in manufacturing volumes and incremental cost of supporting the increased installed customer base. Gross profit for products was $16.7 million, or 74%, for fiscal year 2003 as compared to $10.1 million, or 66%, for fiscal year 2002. The increase in product related gross profit was a result of new hardware platforms adopted during fiscal year 2003, resulting in lower cost of hardware for our appliances. Gross profit for services was $7.7 million, or 74%, for fiscal year 2003 as compared to $5.1 million, or 72%, for fiscal year 2002. The increase in service related gross profit was a result of the increased installed customer base during fiscal year 2003 and strict cost controls for all service related costs.

Operating expenses. For fiscal year 2003, total operating expenses increased to $24.8 million as compared to $16.0 million for the fiscal year 2002, or 55%. As a percentage of total revenues, operating expenses increased from 72% in fiscal year 2002 to 75% in fiscal year 2003. Included in operating expense for fiscal year 2003, was the settlement of a class action lawsuit in the amount of $3.9 million, which represents our portion of the class action litigation settlement. Excluding the one-time charge for this settlement, operating costs were $20.9 million, or 63% of total revenue. The increase in total

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operating expenses in fiscal year 2003 from fiscal year 2002, excluding the one-time charge, was $4.9 million, or 30%. The overall increase in operating expenses is due primarily to the increase in development costs of $1.2 million, and an increase in selling, general and administrative expenses of $3.7 million. The non-GAAP information is included herein in order to provide investors a more complete understanding of the underlying operational results and trends and comparison of results from period to period. The non-GAAP information should only be read in conjunction with the results reported in accordance with GAAP.

Research and development expenses. Research and development expenses includes salaries, non-capitalized equipment, software tools and facilities related costs. For fiscal year 2003, total research and development expenses increased to $5.9 million from $4.7 million for fiscal year 2002, or 26%. The increase is primarily the result of the acquisition of the NetOctave, Inc. assets in the third quarter of fiscal year 2003 and additional development employees hired during the year. As a percentage of total revenue, research and development expenses decreased to 18% in fiscal year 2003 compared to 21% for fiscal year 2002.

Selling, general and administrative expenses. Selling, general and administrative expenses include salaries, commissions, human resources, finance, administrative support functions, and legal and accounting professional services. Selling general and administrative expenses increased by $3.6 million or 32% to $14.9 million for fiscal year 2003 from $11.3 million for fiscal year 2002. The increase is due to an increase of approximately $2.7 million of labor related expenses, including increases in bonuses, commissions and option related payroll costs. In addition, we recorded amortization expense of $305,000 related to the NetOctave, Inc. acquisition transaction as well as $122,000 of additional depreciation expense for assets acquired in that transaction. As a percentage of total revenue, selling, general and administrative expenses decreased to 45% for fiscal year 2003 compared to 51% for fiscal year 2002.

Class action settlement. In June 2003, we received an offer to settle an outstanding class action lawsuit for $10.0 million. In July 2003, the Company entered into a Memorandum of Understanding to settle this lawsuit. The settlement amount of $10 million required the Company to incur a one-time charge of $3.9 million in the fourth quarter of its fiscal year ending June 30, 2003 for the amount in excess of the insurance coverage and related costs. The Company’s portion of the settlement amount was paid by the Company in cash.

Net interest income. Net interest income was $111,000 for fiscal year 2003 compared to net interest income of $58,000 for fiscal year 2002. The increase in net interest income was primarily the result of the significant increase in cash balances for fiscal year 2003 versus fiscal year 2002.

Other income. Other income was $205,000 for fiscal year 2003 versus $193,000 for fiscal year 2002. The decrease is the result of less foreign currency gains for fiscal year 2003 compared to fiscal year 2002.

Income tax benefit. We provide a valuation allowance for the portion of our deferred tax assets, which we cannot determine, is more likely than not to be recognized due to our cumulative losses and the uncertainty as to future recoverability. We recorded an income tax benefit of $4.2 million as of June 30, 2003, primarily as a result of the reversal of a portion of the deferred tax asset valuation allowance. The reversal of the allowance was made because we believe it is more likely than not that this portion of the deferred tax asset will be realized. The computation of our deferred tax asset and valuation allowance is based on taxable income we expect to earn over the next two years which will include the utilization of previously accumulated net operating tax losses. We will continue to evaluate each quarter the amount, if any, of additional reduction of the valuation allowance that should be made. This will be based on our estimate and conclusions regarding the ultimate realization of the deferred tax asset, including but not limited to, our 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.

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Net income (loss). For fiscal year 2003 we recorded net income of $4.1 million compared to a net loss of $608,000 for the fiscal year 2002. This improvement is the direct result of the increase in revenues for fiscal year 2003 versus fiscal year 2002 and a continued focus on maintaining appropriate cost controls and operating efficiencies.

Liquidity and Capital Resources

At June 30, 2004, our principal source of liquidity was $12.4 million of cash and cash equivalents on hand, which consist principally of commercial paper and U.S. government securities. For the fiscal year 2004, our cash and cash equivalents and short-term investments increased by $300,000 to $12.4 million from $12.1 million at June 30, 2003.

Cash provided by operating activities was $4.8 million for the fiscal year 2004. For fiscal year 2003 cash provided by operating activities was $5.1 million. The decrease is primarily the result of the class action payout, off-set by various changes in current asset and liability accounts.

Net cash used in investing activities was $10.1 million in fiscal year 2004, primarily as a result of the acquisition of webwasher expenditure of $8.1 million and investments in capitalized software of $1.6 million. Net cash used in investing activities was $1.5 million in fiscal year 2003, primarily as a result of the purchase of property and equipment of $666,000, an increase in restricted cash of $335,000, capitalized software of $179,000 and the cash portion of the acquisition of the NetOctave, Inc. assets of $300,000. Net cash provided by financing activities was $5.8 million for fiscal year 2004 and $2.4 million for fiscal year 2003. In fiscal year 2004, the cash provided by financing activities was primarily the proceeds from stock options exercised and warrants converted.

At June 30, 2004, our contractual obligations were as follows:

Additional information regarding our financial commitments as of June 30, 2004 is contained in Note 9 to the financial statements. The Company had no off-balance sheet arrangements as of June 30, 2004. Currently, we have no agreements or arrangements for third parties to provide us with sources of liquidity and capital resources. We believe our existing cash; cash equivalents and short-term investments will be sufficient to meet our cash requirements at least through the next twelve months. Our future capital requirements will depend on many factors, including our rate of revenue growth, acquisitions, the timing and extent of spending on support, product development efforts and expansion of sales and marketing, the timing of introductions of new products and enhancement to existing products, and market acceptance of our products. We 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. There can be no assurance, however, that the assumptions upon which we base our future working capital and capital expenditure requirements will prove to be correct. If these assumptions are not correct, we may be required to raise additional capital through loans or the issuance of debt or equity securities. To the extent we raise additional capital by issuing equity securities or obtaining borrowings convertible into equity, ownership dilution to existing shareholders will result, and future investors may be granted rights superior to those of existing shareholders. Moreover, additional capital may be unavailable to us on acceptable terms, or may not be available at all.

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Critical Accounting Policies

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

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

Revenue Recognition— The Company recognizes revenue in accordance with Statement of Position (“SOP”) 97-2 “Software Revenue Recognition” 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:

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; this includes the transfer of both title and risk of loss, provided that no significant obligations remain. There is no product right of return available to the customer. For software licenses, revenue is generally recognized on the delivery of the authorization code for perpetual licenses or upon activation of the 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. For the year ended June 30, 2004, twenty one resellers were reclassified from cash basis to accrual, based on a reasonable assurance of collectibility from evaluating their payment history and no product returns. The impact of the reclassifications did not have a material effect on revenue.

The Company recognizes revenue from product sales with customer-specific acceptance provisions when such specifications have been met and the title and risks and rewards of ownership transfer to the customer.

The Company recognizes revenue from product sales to one customer on a bill and hold

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basis in accordance with the criteria established by SAB 104 for such transactions. Revenue is recognized after the risk of ownership has passed to the customer and when there are no remaining performance obligations on the part of the Company. This applies to revenue generated from a customer of the SnapGear subsidiary.

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.

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 performs its test of goodwill on an annual basis on the anniversary date of recording goodwill to determine if impairment has occurred. Testing would be done on a more frequent basis, if impairment indicators arise. No impairment has been identified or recorded during fiscal 2004 as goodwill was recorded for the first time in November 2003 in connection with the SnapGear acquisition and in April 2004 in connection with the webwasher acquisition.

Intangibles – Intangible assets are primarily an allocation of a portion of the purchase price in connection with the SnapGear and webwasher acquisitions to the following separate and identifiable intangible assets: Developed Technology, Trade Name and Customer Base. Intangible assets are stated at cost, less accumulated amortization. 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. Trade Name was determined to have an indefinite life and is not being amortized but is subject to impairment testing.

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

Inventory Valuation. Inventories consist primarily of component parts and computer hardware and are carried at the lower of cost, determined by the First-In-First-Out method, or market. We write our

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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 more likely than not to be recognized due to the Company’s cumulative losses and the uncertainty as to future recoverability. Any reversal of the 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 nine quarters 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 nine quarters. 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.

Recent Accounting Pronouncements

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

SFAS No. 150 does not apply to features embedded in a financial instrument that is not a derivative in its entirety. Most of the guidance in SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective for our first quarter of fiscal 2004. The adoption of SFAS No. 150 did not have an impact on our consolidated financial position or results of operations during the period.

In January 2003, the FASB issued FASB Interpretation 46 (FIN 46), Consolidation of Variable Interest Entities. FIN 46 clarifies the application of Accounting Research Bulletin 51, Consolidated Financial Statements, for certain entities that do not have sufficient equity at risk

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for the entity to finance its activities without additional subordinated financial support from other parties or in which equity investors do not have the characteristics of a controlling financial interest (“variable interest entities”). Variable interest entities within the scope of FIN 46 will be required to be consolidated by their primary beneficiary. The primary beneficiary of a variable interest entity is determined to be the party that absorbs a majority of the entity’s expected losses, receives a majority of its expected returns, or both. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period beginning after June 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. At June 30, 2004 we were not a party to transactions contemplated under FIN 46.

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

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

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

Foreign currency risk. The majority of our sales and the majority of our expenses are currently denominated in US dollars. As a result, we have not experienced material foreign currency exchange gains and losses except those disclosed on page F11 in the accompanying audited consolidated financial statements. As a large international organization, however, we face exposure to adverse movements in foreign currency exchange rates. With our acquisition of WebWasher AG and our sales performance this past year in Europe, the percentage of our business with exposure to currency risk is increasing. These exposures may change over time as business practices evolve and could have a material impact on our financial results in the future. Although we have not engaged in foreign currency hedging to date, we may do so in the future.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following items are attached and incorporated into this Item 8.

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

None

ITEM 9A. CONTROLS AND PROCEDURES