<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission file number 0-24544
CYBERGUARD CORPORATION
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(Exact name of Registrant as Specified in Its Charter)
FLORIDA 65-0510339
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(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2000 WEST COMMERCIAL BLVD., SUITE 200, FORT LAUDERDALE, FLORIDA 33309
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(Address of Principle Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code 954-958-3900
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Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
Indicate by check [X] whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports),
Yes [ ] No [X]
and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of September 7, 1999 9,094,027 shares of the Registrant's $0.01 par
value Common Stock were outstanding.
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PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CYBERGUARD CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
1998 1997, RESTATED 1998 1997, RESTATED
----------- -------------- ----------- --------------
<S> <C> <C> <C> <C>
Revenues:
Products $ 3,941 $ 3,862 $ 5,453 $ 7,648
Services 736 323 1,231 710
----------- ----------- ----------- -----------
Total revenues 4,677 4,185 6,684 8,358
Cost of revenues:
Products 1,197 1,611 2,052 3,132
Services 439 212 751 462
----------- ----------- ----------- -----------
Total cost of revenues 1,636 1,823 2,803 3,594
----------- ----------- ----------- -----------
Gross profit 3,041 2,362 3,881 4,764
Operating expenses:
Research and development 850 1,582 1,746 3,162
Selling, general and administrative 3,996 4,795 7,697 9,025
----------- ----------- ----------- -----------
Total operating expenses 4,846 6,377 9,443 12,187
----------- ----------- ----------- -----------
Operating loss (1,805) (4,015) (5,562) (7,423)
Other income (expense)
Interest, net (31) 112 (76) 236
Gain on sale of assets 1,820
Gain on sale of securities available
for sale 123 275
Other 7 (107) 74 (119)
----------- ----------- ----------- -----------
Total other income (expense) (24) 128 1,818 392
----------- ----------- ----------- -----------
Net loss $ (1,829) $ (3,887) $ (3,744) $ (7,031)
=========== =========== =========== ===========
Basic and fully-diluted loss per common share $ (0.20) $ (0.48) $ (0.42) $ (0.89)
=========== =========== =========== ===========
Weighted average number of common
shares outstanding 8,950,223 8,111,851 8,929,769 7,899,557
=========== =========== =========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements
2
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CYBERGUARD CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
(Dollars in thousands except share and per share data)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1998 1998
-------- --------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 1,563 $ 1,773
Restricted cash 908 650
Accounts and receivable, less allowance for uncollectible
accounts of $700 at December 31, 1998
and $450 at June 30, 1998 4,470 3,334
Inventories 872 916
Software development costs, net 134
Other current assets 380 166
Receivable from sale of Arca Systems 3,261
-------- --------
Total current assets 8,327 10,100
Property and equipment at cost, less accumulated
depreciation of $2,335 at December 31, 1998 and
$1,977 at June 30, 1998 1,512 1,761
Non-compete agreements, net 700 840
Goodwill, net 84 96
Other assets 150 279
-------- --------
Total assets $ 10,773 $ 13,076
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Line of credit and note payable $ 1,273 $ 2,198
Accounts payable 2,397 2,383
Deferred revenue 2,500 1,288
Accrued expenses and other liabilities 2,532 2,619
-------- --------
Total current liabilities 8,702 8,488
Convertible debenture, net 705
Shareholders' equity:
Common stock par value $0.01 authorized 20,000,000 shares
Issued and outstanding 8,975,732 at December 31, 1998
and 8,902,699 at June 30, 1998 90 89
Additional paid-in capital 73,560 72,999
Accumulated deficit (72,104) (68,360)
Accumulated other comprehensive income (180) (140)
-------- --------
Total shareholders' equity 1,366 4,588
-------- --------
Total liabilities and shareholders' equity $ 10,773 $ 13,076
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
3
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CYBERGUARD CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
1998 1997, RESTATED
----------- --------------
<S> <C> <C>
Cash flows from operating activities
Net loss $(3,744) $(7,031)
Adjustment to reconcile net loss to net cash
used by operating activities:
Depreciation 385 428
Amortization 158 428
Compensation and benefits 123 241
Provision for uncollectible accounts receivable 290 461
Provision for inventory reserve 20
Gain on sale of business assets (1,820)
Gain on sale of securities available for sale (275)
Changes in assets and liabilities
Accounts Receivable (1,426) 1,508
Other current assets (214) (340)
Inventories (1) 173
Accounts payable 14 424
Accrued expenses and other liabilities (86) (868)
Deferred revenue 1,212 (388)
Other, net 89 22
------- -------
Net cash used in operating activities (5,000) (5,217)
------- -------
Cash flows from investing activities
Additions to property and equipment, net (112) (527)
Proceeds from sale of Arca Systems 3,261
Software development costs & other assets (140) --
------- -------
Net cash provided (used) by investing activities 3,009 (527)
------- -------
Cash flows from financing activities
Proceeds from sale of business assets 1,820
Increase to restricted cash (258) (650)
Proceeds from convertible debenture 1,125
Proceeds from note payable 650
(Repayments) proceeds of revolving line of credit (925) 157
Proceeds from sale of common stock 19 5,488
Proceeds from sale of securities available for sale 1,416
------- -------
Net cash provided from financing activities 1,781 7,061
Net increase in cash (210) 1,317
Cash and cash equivalents at beginning of period 1,773 2,975
------- -------
Cash and cash equivalents at end of period $ 1,563 $ 4,292
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
4
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CYBERGUARD CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Unaudited)
1. BASIS OF PRESENTATION
The consolidated financial statements are prepared on the basis of generally
accepted accounting principles. The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements as well as the reported amounts of revenues and
expenses during the reported periods. Significant estimates include those made
for software development costs, reserve for inventories, the allowance for
uncollectible accounts, and contingencies. Actual results could differ from
those estimates.
The consolidated financial statements of CyberGuard Corporation and Subsidiaries
(the "Company") include the accounts of the Company and its subsidiaries over
which it maintains control. Majority owned subsidiaries where control is
temporary are carried on the cost basis. All significant intercompany balances
and transactions have been eliminated.
The Company's operating results and financial condition may be impacted by a
number of factors including, but not limited to the following, any of which
could cause actual results to vary materially from current and historical
results or the Company's anticipated future results. A portion of the Company's
revenue is derived from its international operations and sources. As a result,
the Company's operations and financial results have been affected by
international factors such as changes in foreign currency exchange rates or weak
economic conditions in the international markets in which the Company
distributes its products. The network security industry is highly competitive
and competition is expected to intensify. There are numerous companies competing
in segments of the market in which the Company does business. Competitors
include organizations significantly larger and with more development, marketing
and financial resources than the Company.
In addition, the Company is subject to risks and uncertainties which include,
but are not limited to the timely development of and acceptance of new products,
impact of competitive products, regulation, inventory obsolescence, the ultimate
outcome of certain litigation matters, and cash balances in excess of federally
insured limits.
2. LITIGATION
In August 1998, the Company and certain current and former officers and
directors were named as defendants in 25 shareholder lawsuits filed in the
United States District Court for the Southern District of Florida. All of the
lawsuits purport to be brought on behalf of a class of all persons who purchased
or otherwise acquired the Company's common stock during various periods from
October 7, 1997, through August 24, 1998. The lawsuits allege, among other
things, that as a result of accounting issues relating to the Company's revenue
recognition practices, defendants knowingly or recklessly caused the Company to
publish false and misleading financial statements which caused the Company's
common stock prices to rise artificially. One lawsuit also alleges violations of
common law. The plaintiffs are seeking an unspecified amount of damages,
interest, costs and attorney fees. These cases have been transferred and
consolidated into a single case for purposes of all pre-trial matters and trial.
Discovery has been stayed and the plaintiffs were ordered to file a single
amended consolidated complaint within 45 days of the filing on July 22, 1999, of
the Company's restated financial statements. An amended complaint has been
received after filing of the Company's restated financial results.
5
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CYBERGUARD CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Unaudited)
The Company's obligation to indemnify its officers and directors under the
aforementioned lawsuits is insured, to the extent of the limits of the
applicable insurance policies. The Company has notified its insurance carrier of
the existence of the lawsuits, and the carrier has sent the Company a
reservation of rights letter. The Company intends to vigorously defend these
actions, and believes that in the event that it is unsuccessful, insurance
coverage will be available to defray a portion, or substantially all, the
expense of defending and settling the lawsuits or paying a judgment. However,
the Company is unable to predict the ultimate outcome of the litigation. There
can be no assurance the Company will be successful in defending the lawsuits or
that if unsuccessful, that insurance will be available to pay all or any portion
of the expense of the lawsuits. If the Company is unsuccessful in defending the
lawsuits and the insurance coverage is unavailable or insufficient, the
resolution of the lawsuits could have a material adverse effect on the Company's
consolidated financial position, results of operations, and cash flows. The
Company's consolidated financial statements do not include any adjustments
related to these matters.
On April 30, 1999, the Company sold substantially all of the assets of its
TradeWave division to Digital Signature Trust Company ("DST"). In June 1999,
CyberGuard filed a lawsuit against DST and Zions First National Bank, N.A. that
alleged breach of contract, tortious interference and fraud. Also in June 1999,
DST filed a lawsuit against the Company alleging fraud, negligent
misrepresentation, unjust enrichment, with unspecified damages, and rescission
and reformation of contract. Both actions are currently tolled due to ongoing
negotiations towards settlement between the Company and DST.
In August 1998, the Securities and Exchange Commission (the "SEC") began an
informal investigation into certain accounting and financial reporting practices
of the Company and certain members of Company's management.
The Company is involved from time to time in other litigation on various matters
relating to the conduct of its business. The Company believes that these other
litigation matters, single or collective, will not have a material adverse
effect on its consolidated financial position, results of operations or cash
flows.
3. RESTATEMENT OF QUARTERLY AMOUNTS
Previously, CyberGuard Corporation had announced that due to a review of its
revenue recognition policy relating to distributors and resellers it would
restate results for the first three quarters of its fiscal year ended June 30,
1998. Subsequently, the Company determined that it would also restate its
results from fiscal year 1997. These restatement were filed in the Form 8K on
July 22, 1999, and included in the Form 10K filed on August 31, 1999.
Previously, the Company had reported revenues for fiscal year 1997 of $15,621
and a net loss of $12,490 or a loss per share of $1.76. For the first
three-quarters of fiscal 1998, the Company had previously reported revenue of
$15,069 and a net loss of $5,951 or $0.75 per share. As a result, the financial
information regarding the 1998 fiscal year presented in this Item 2 and
elsewhere in the Form 10-Q have been restated.
6
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CYBERGUARD CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998
(Unaudited)
4. SUBSEQUENT EVENTS
On January 11, 1999, the Company was delisted from the NASDAQ.
Effective May 1, 1999, the Company sold substantially all the assets of its
TradeWave division and the assumption of several capital and operating leases.
On July 22, 1999, the Company filed its audited June 30, 1998, and restated June
30, 1997, financial statements with the Securities and Exchange Commission.
On August 27, 1999, the Company increased the convertible debt to approximately
$4,300,000, including repaying the December 1998 transaction. The majority of
this increased amount was with the same debt holders as the December 17, 1998
transaction. The interest rate will be 11.5% per annum. The debt will be
convertible into approximately 4,300,000 shares of common stock at a conversion
price equal to $1.00 per share. In addition, the initial warrants from the
December 17, 1998 transaction will be cancelled, and the Company will issue
approximately 4,300,000 warrants to purchase the Company's common stock at $2.00
per share.
On August 31, 1999, the Company filed its June 30, 1999 Form 10K with the
Securities and Exchange Commission.
7
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CYBERGUARD CORPORATION
DECEMBER 31, 1998
(Dollars in millions, except share and per share data)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
As previously announced, due to a review of its revenue recognition policy
relating to distributors and resellers, the Company has restated the results for
the first three quarters of fiscal year ended June 30, 1998. As a result, the
financial information regarding the 1998 fiscal year presented in this Item 2
and elsewhere in the Form 10-Q have been restated.
THE QUARTER ENDED DECEMBER 31, 1998 COMPARED TO THE QUARTER ENDED DECEMBER 31,
1997
NET REVENUES
Net revenues consist primarily of network security products and services
including third party security products and service and support related to
security products. For the quarter ended December 31, 1998, net sales increased
by $0.5 million when compared to the quarter ended December 31, 1997. The $0.5
million net increase comprised an increase of $0.1 million in network security
product sales and an increase of $0.4 million in service revenues for the
current quarter. The $0.1 million or 2% increase in network security product
sales is the result of increased shipments of the Company's CyberGuard firewall
systems and the deferral of revenue for resellers and distributors in accordance
with its revenue recognition policy.
Revenues from training, consulting and support services related to firewall
products and certificate authority increased $0.4 million from $0.3 million for
the three months ended December 31, 1997 to $0.7 million for the three months
ended December 31, 1998. Support services for network security products
accounted for 15.7% of sales during the quarter ended December 31, 1998 as
compared to 9.3% for the quarter ended December 31, 1997.
GROSS PROFIT
Gross profit increased from $2.4 million as restated, to $3.0 million, and as a
percent of sales, increased 8% from 57%, as restated, to 65% for the quarter
ended December 31, 1998. The increase is a result of increased service revenues
and declining Nighthawk(TM) hardware sales which a change in the product mix
impacted the overall gross profit margin.
OPERATING EXPENSES AND NET LOSS
Overall operating expense decreased by $1.5 million for the quarter ended
December 31, 1998 to $4.8 million from restated operating expenses of $6.3
million. This is due to decreased research and development expenditures of $0.7
million and a decrease of $0.8 million in sales, marketing and general and
administrative expenses. The previously reported operating expenses for the
quarter ended December 31, 1997 was $5.8 million. The adjustment of $0.6 million
was primarily due to the amortization of the capitalized software, compensation
expense accruals, and other general and administrative accruals. The selling
costs decreased relative to the decrease in sales revenue.
The net loss for the quarter ended December 31, 1998, was $1.9 million compared
to $3.9 million for the quarter ended December 31, 1997.
8
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CYBERGUARD CORPORATION
DECEMBER 31, 1998
(Dollars in millions, except share and per share data)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1998 COMPARED TO THE SIX-MONTH PERIOD
ENDED DECEMBER 31, 1997
NET REVENUES
For the six-month period ended December 31, 1998, net revenues increased by
approximately $1.7 million to $6.6 million when compared to the six-month period
ended December 31, 1997 of $8.4 million, as restated. The restatement for the
six-month period ended December 31, 1997 was $1.6 million. The $1.7 million
increase represents a decrease of $2.2 million in revenues from the sale of
network security products and $0.5 million increase in service-related revenues.
The $2.2 million (or 28.0%) decrease in network security product revenues is the
result of decreased shipments of the Company's CyberGuard firewall product.
Revenues from services related to firewall products and certificate authority
increased from $0.7 million for the six months ended December 31, 1997 to $1.2
million for the six months ended December 31, 1998. This increase in
service-related revenues is due to the greater number of installed units and to
the increased need for customer training and consulting services. Support
services for network security products accounted for 18% of sales during the six
months ended December 31, 1998 as compared to 8.5% for the quarter ended
December 31, 1997.
GROSS PROFIT
The Company's gross profit as a percent of sales increased to 58% from 57.0% for
the six months ended December 31, 1998 compared to the corresponding period in
the previous year. The increase is a result of increased "software-only" sales,
for six months ended December 31, 1998. In addition, the Company experienced
cost reductions with the shipping of the Intel based product as compared to
products sold during the previous year that combined the Company's firewall
software with the Company's proprietary Nighthawk platform.
OPERATING EXPENSES AND NET LOSS
The Company's overall operating expenses decreased by $2.7 million for the
six-month period ended December 31, 1998 to $9.4 million. This is due to a
decrease of $1.4 million for research and development expenditures compared to
the same period in the prior year and a decrease of $1.3 million in selling,
general and administrative expenses over those in the same period of the prior
year. Previously reported operating expenses for the six month period ended
December 31, 1997 was $11.2 million. This adjustment of $1.0 million was
primarily due to the amortization of adjusted capitalized software.
The net loss for the six-month period ended December 31, 1998 decreased by $3.2
million from $7.0 million for the six-month period ended December 31, 1997, as
restated, to $3.8 million.
9
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CYBERGUARD CORPORATION
DECEMBER 31, 1998
(Dollars in millions, except share and per share data)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
LIQUIDITY AND CAPITAL RESOURCES
The Company has experienced losses since its inception as a network security
company. The Company's historical uses of cash have been to fund net losses from
operations, establish inventory stocking levels, and fund capital expenditures
for property, equipment and software. For the fiscal year ended June 30, 1997,
the Company incurred a net loss of approximately $17.4 million on revenues of
approximately $14.2 million. For the fiscal year ended June 30, 1998, the
Company incurred a net loss of approximately $18.3 million on revenues of
approximately $15.6 million. For the fiscal year ended June 30, 1999, the
Company incurred a net loss of approximately $8.1 million on revenues of
approximately $13.9 million. The consolidated financial statements have been
prepared on a going concern basis which contemplates the realization of assets
and the satisfaction of liabilities in normal course of business. In addition,
violations of covenants in debt agreements have resulted in classification of
all of its debt as current as of June 30, 1998. Management's financing plans
include the sale of certain assets and the issuance of debt, as well as the
potential issuance of equity securities. Accordingly, management believes that
the Company's consolidated financial statements are appropriately prepared on a
going concern basis.
10
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CYBERGUARD CORPORATION
DECEMBER 31, 1998
(Dollars in millions, except share and per share data)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company and certain former officers and directors were named in twenty-five
shareholder lawsuits. The plaintiffs sued for unspecified compensatory damages,
legal fees, and litigation costs. The Company is unable to predict the ultimate
outcome or potential financial impact of this litigation.
The consolidated financial statements do not include any adjustments relating to
the realization of assets and the recognition and satisfaction of liabilities
that might be necessary as a result of the matters described in this Item 2 or
Part II Item 1 of this report. At December 31, 1998, the Company had cash and
cash equivalents on hand of $1.53 million representing an decrease of $0.25
million from $1.77 million as of June 30, 1998. Accounts receivable increased by
$1.3 million as a result of increased quarter to quarter sales. Inventory levels
remained relatively even. The Company received $3.3 million from the receivable
due on Arca sale. Property and equipment additions amounted to $0.1 million for
the quarter ended December 31, 1998, consisting primarily of development
computers, and demonstration equipment.
The Company's principal sources of liquidity at December 31, 1998, consisted of
cash, accounts receivable, the revolving line of credit with Coast Business
Credit, vendor trade credit and the convertible debt closed during December. The
revolving line of credit with Coast Business Credit is based on available
eligible accounts receivable and inventory and decreased $0.9 million for the
three months ended December 31, 1998 from $2.2 million to $1.3 million.
The Company uses the U.S. Dollar as its reporting currency for financial
statement purposes. The Company conducts business in numerous countries around
the world through its international subsidiary which uses local currency to
denominate their transactions, and is, therefore, subject to certain risks
associated with fluctuating foreign currencies. The resulting changes in the
financial statements do not indicate any underlying changes in the financial
position of the international subsidiary, but merely reflect the adjustment in
the carrying value of the net assets of this subsidiary at the current U.S.
dollar exchange rate. Due to the long-term nature of the Company's investment in
this subsidiary, the translation adjustments resulting from these exchange rate
fluctuations are excluded from the results of operations and recorded in a
separate component of consolidated stockholders' equity. The $0.04 million
decrease for the quarter ended December 31, 1998, is a result of the weakening
of the dollar since June 30, 1998. The Company monitors its currency exposure
but does not hedge its translation exposure due to the high economic costs of
such a program and the long-term nature of its investment in its European
subsidiary.
Based upon information currently available to the Company, including the
Company's current level of sales, its margins on sales, its expected levels of
expense, opportunities for selling additional network security products and the
availability of additional equity and debt financing, the Company believes that
it has an opportunity to execute on its business plans and achieve
profitability. There can be no assurance, however, that the Company will be able
to execute on its business plans, or that it will not be required to obtain
additional financing or capital infusions. There can be no assurance that the
Company will be able to secure additional financing or that such additional
financing will be on terms and conditions acceptable to the Company. Any
additional financing may involve dilution of the interests of the Company's then
existing shareholders. The future liquidity of the Company will be affected by
numerous factors, including sales volumes, gross margins, the levels of selling,
general and administrative expenses, levels of required capital expenditures and
access to external sources of financing. Management believes that upon execution
of its business plan which includes tactics to achieve operating efficiencies,
use of availability under its current line of credit, and the issuance of
convertible debt, that it will enable it to continue as a going concern. Other
recent and possible future events that could also materially impact the
Company's ability to successfully execute on its business plans are described in
Information Relating to Forward Looking Statements of this Report on Form 10-Q.
11
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CYBERGUARD CORPORATION
DECEMBER 31, 1998
(Dollars in millions, except share and per share data)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
RISK RELATED TO YEAR 2000 PROBLEM
The Year 2000 problem stems from the use of a two-digit date to represent the
year (e.g., 85 = 1985) in computer software and firmware. As a result, many
currently installed computer systems are not capable of distinguishing dates
beginning with the year 2000 from dates prior to the year 2000. As a result,
computer systems or applications used by many companies in a wide variety of
industries may experience operating difficulties unless the systems or
applications are modified to process adequately information related to the date
change. Significant uncertainty exists in the software and other industries
concerning the scope and magnitude of problems associated with the century
change. To the extent Year 2000 issues cause significant delays in or
cancellation of decisions to purchase products or product support, due to the
reallocation of resources to address Year 2000 issues or otherwise, the
Company's business could be materially adversely affected.
The Company recognizes the need to ensure its operations will not be adversely
impacted by Year 2000 issues. The Company has put into place a Year 2000 risk
management initiative. This initiative's scope covers both the Company's
information technology (IT) systems and non-IT systems and addresses all areas
of the Year 2000 issues as defined by the Information Technology Association of
America (ITAA).
Based on the ongoing assessment relative to the Company's current software
service offerings, the Company believes that the current versions of its
products are Year 2000 compliant. The Company has reviewed, and continues to
review, internal management information and other systems in order to identify
and to further modify those products, services or systems that may not be Year
2000 compliant. Based on the Company's assessment to date, the Company believes
that internal management information and other systems are either Year 2000
compliant or will not require substantial effort or cost to make them Year 2000
compliant.
The Company's Year 2000 initiative also addresses vendor relationships (both IT
and non-IT) and their readiness/preparedness relating to Year 2000 issues. IT
vendors include software providers, hardware providers, service providers,
off-the-shelf software publishers and IT consultants. Non-IT providers include
electric power suppliers, vendors of uninterruptable power supplies and
generators, telecommunications service and equipment providers, business
partners, facilities maintainers and other non-IT service contractors. In the
event that third parties cannot provide the Company with products, services or
systems that are Year 2000 compliant on a timely basis, the Company's business
could be materially adversely affected. To date, the Company has not discovered
nor does it anticipate any material Year 2000 issues with vendors and service
providers. Evaluation of vendor Year 2000 preparedness is an on-going process.
As the Company's Year 2000 evaluation does not evaluate its vendors' vendors nor
its vendors' customer base viability issues, the Company may be required to
develop contingency plans to address specific vendor/service provider concerns.
Many of the Company's customers maintain their Internet operations on servers,
which may be impacted by Year 2000 complications. The failure of the Company's
customers to ensure that their servers are Year 2000 compliant could have a
material adverse effect on the Company's customers, which in turn could have a
material adverse affect on the Company's business, if the Company's customers
are forced to cease or interrupt Internet operations or experience malfunctions
related to their equipment.
While the Company believes its Year 2000 initiative is appropriate given its
available resources, there can be no assurance that the Company will identify
and remedy all Year 2000 problems in a timely fashion, that any remedial efforts
in this regard will not involve significant time and expense, or that such
problems will not have a material adverse affect on the Company's business. The
Company has been addressing these matters on an ongoing basis for the past two
years and has incurred minimal cost to date, due to the dynamic nature of the
development process.
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CYBERGUARD CORPORATION
DECEMBER 31, 1998
(Dollars in millions, except share and per share data)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INFORMATION RELATING TO FORWARD LOOKING STATEMENTS
Statements regarding future products, future prospects, future profitability,
business plans and strategies, future revenues and revenue sources, future
liquidity and capital resources, computer network security market directions,
future acceptance of the Company's products, possible growth in markets, as well
as all other statements contained in this Report on Form 10-Q that are not
purely historical are forward-looking statements.
These statements are based upon assumptions and analyses made by the Company in
light of current conditions, future developments and other factors the Company
believes are appropriate in the circumstances, or information obtained from
third parties and are subject to a number of assumptions, risks and
uncertainties. Readers are cautioned that forward-looking statements are not
guarantees of future performance and that the actual results might differ
materially from those suggested or projected in the forward-looking statements.
Accordingly, there can be no assurance that the forward-looking statements will
occur, or that results will not vary significantly from those described in the
forward-looking statements. Some of the factors that might cause future actual
events to differ from those predicted or assumed include: future advances in
technologies and computer security; the Company's history of significant annual
operating losses and the financing of these losses through the sale of assets
and newly issued Company securities; risks related to the early stage of the
Company's existence and its products' development; the Company's history of
losses; 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;
risks relating to the year 2000 problem; risk and expense of government
regulation and effects on changes in regulation; the limited experience of the
Company in marketing its products; uncertainties associated with product
performance liability; risks associated with growth and expansion; risks
associated with obtaining patent and intellectual property right protection;
uncertainties in availability of expansion capital in the future and other risks
associated with capital markets. In addition, certain recent events that have
occurred also are factors that might cause future actual events to differ from
those predicted or assumed, including: the resignation of KPMG Peat Marwick LLP
as the Company's independent accountant and the subsequent engagement of
PricewaterhouseCoopers LLP as the Company's independent accountant; the impact
of the restatement of financial results for the Company's fiscal year ended June
30, 1997, and quarters ended September 30, 1997, December 31, 1997, and March
31, 1998; the completion of the numerous organizational changes and the assembly
of a new management team for CyberGuard; the outcome of a purported class action
lawsuit against the Company and certain current and former officers and
directors relating to the restatement of financial results for the fiscal
periods noted above and an SEC investigation regarding these matters; the
delisting of the Company from the NASDAQ National Market; and the Company's past
delinquency in filing reports that were required to be filed under the
Securities Exchange Act of 1934 (which, among other things, restricts the
Company from being able to use Form S-3, a simplified method of registering
securities for sale with the Securities and Exchange Commission). In addition,
the forward-looking statements herein involve assumptions, risks and
uncertainties, including, but not limited to economic, competitive, operational,
management, governmental, regulatory, litigation and technological factors
affecting the Company's operations, liquidity, capital resources, markets,
strategies, products, prices and other factors discussed elsewhere herein and in
the other documents filed by the Company with the Securities and Exchange
Commission. Many of the foregoing factors are beyond the Company's control.
The Company's future success is based largely on its ability to develop and sell
increasingly technologically advanced network security solutions in sufficient
volume and at sufficient prices to become profitable on a consistent basis. In
addition, the network security market is characterized by extremely rapid
technological change, requiring rapid product in production. The velocity of
technological change has accelerated and the Company believes that it is
important to its future that it keeps pace with these changes. The Company
believes that competition will continue to intensify in the rapidly evolving
markets in which the Company is involved,
13
<PAGE> 14
CYBERGUARD CORPORATION
DECEMBER 31, 1998
(Dollars in millions, except share and per share data)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
and that the continued development of technologically advanced products will be
necessary to keep its products current. The Company believes that its ability to
generate adequate cash flow from operations will be critical to its future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has limited exposure to financial market risks, including changes in
interest rates. The fair value of the investment portfolio or related income
would not be significantly impacted by a 100 basis point increase or decrease in
interest rates due mainly to the short-term nature of the major portion of the
investment portfolio. An increase or decrease in interest rates would not
significantly increase or decrease interest expense on debt obligations due to
relative nature of the debt obligations to the current assets borrowed against.
PART II OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
On August 24, 1998, the Company announced, among other things, that due to a
review of its revenue recognition policies 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 current and former officers and
directors. Each of these lawsuits was filed in the United States District Court
for the Southern District of Florida. These actions seek damages purportedly on
behalf of all persons who purchased or otherwise acquired the Company's common
stock during various periods from October 7, 1997 through August 24, 1998. The
complaints allege, 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 actions allege violations of Section 10(b) of the Securities
Exchange Act of 1934 (the "Exchange Act") and SEC Rule 10b-5 promulgated
thereunder and Section 20(a) of the Exchange Act. One action also alleges
violations of common law. Pursuant to an order issued by the Court, these
actions have been consolidated into one action, styled STEPHEN CHENEY, ET AL. V.
CYBERGUARD CORPORATION, ROBERT L. CARBERRY AND WILLIAM D. MURRAY, Case No.
98-6879-CIV-Gold, in the United States District Court, Southern District of
Florida. An amended consolidated complaint is expected within 45 days after the
filing of the Company's restated financial results. The Company is unable to
predict the ultimate outcome of the litigation and investigation described above
in this Item 1. The resolution of such matters could have a material adverse
affect on the Company's results of operations and financial position. The
Company's financial statements do not include any adjustments related to these
matters.
On April 30, 1999, the Company sold substantially all of the assets of its
TradeWave division to Digital Signature Trust Company ("DST"). In June 1999,
CyberGuard filed a lawsuit against DST and Zions First National Bank, N.A. in
state court in Austin, Texas. The action was removed to United States District
Court, Western District of Texas, Case No. 99-CA-431-JN. The Company alleged
breach of contract, tortious interference and fraud. Also in June 1999, DST
filed a lawsuit against the Company in United States District Court, District of
Utah, Case No. 99CV 0417G, alleging fraud, negligent misrepresentation, unjust
enrichment, with unspecified damages, and rescission and reformation of
contract. Both actions are currently tolled due to ongoing negotiations towards
settlement between the Company and DST.
In August 1998, the Securities and Exchange Commission (the "SEC") began an
informal investigation into certain accounting and financial reporting practices
of the Company and certain members of Company's management.
14
<PAGE> 15
CYBERGUARD CORPORATION
DECEMBER 31, 1998
(Dollars in millions, except share and per share data)
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
On December 17, 1998, the Company executed an agreement to issue $1,125,000 of
Convertible Debt ("Debt"). The Debt bears interest at prime plus 200 basis
points and is payable quarterly. The Debt is convertible into 750,000 shares of
common stock at a conversion price equal to $1.50 per share. The Debt is
convertible, at the debt holders option, after February 1, 2000. In addition,
the Company issued the debt holders 500,000 warrants to purchase the Company's
common stock at $2.00. The warrants are exercisable at any time before June,
2001. The terms of the Debt and warrant agreement, which permit the conversion
of the Debt and warrants to common stock at a discount to market, is considered
a beneficial conversion feature. The beneficial conversion feature at the date
of issuance of the Debt will be recognized as interest expense over the shortest
possible conversion period. The convertible debt is subordinated to the
Company's senior debt.
On August 27, 1999, the Company increased the convertible debt to approximately
$4,300,000, including repaying the December 1998 transaction. The majority of
this increased amount was with the same debt holders as the December 17, 1998
transaction. The interest rate will be 11.5% per annum. The debt will be
convertible into approximately 4,300,000 shares of common stock at a conversion
price equal to $1.00 per share. In addition, the initial warrants from the
December 17, 1998 transaction will be cancelled, and the Company will issue
approximately 4,300,000 warrants to purchase the Company's common stock at $2.00
per share.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
During December 1998, the Company's senior creditor, Coast, notified the Company
of the following events of default under the loan agreement: decline in
revenues, significant decline in the market value of the Company's stock, and
the shareholder lawsuits. Coast agreed to continue to make advances to the
Company but did not waive any of their rights under the default provision, Coast
may elect to cease funding and demand payment. The Company reclassified the
three-year note to current due to the technical default. In addition, pursuant
to the loan agreement, the default interest rate was adjusted to prime plus 5%.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NONE
ITEM 5 - OTHER INFORMATION
During September 1998, the Company re-priced all of the outstanding stock
options to employees to its then current fair market value per share of $1.125.
In addition, during fiscal year 1999 the Company issued officers and employees
approximately 1,110,936 new options at an exercise price of $1.31 per share.
ITEM 6. EXHIBITS AND REPORTS OF FORM 8-K
(a) Exhibits:
27 Financial Data Schedule
(b) Reports filed on Form 8-K during the quarter ended
December 31, 1998
NONE
15
<PAGE> 16
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: September 7, 1999 CYBERGUARD CORPORATION
By: /s/ David Proctor
--------------------------------------------
Chairman and Chief Executive Officer
By: /s/ Terrence A. Zielinski
--------------------------------------------
Vice President of Finance and Chief
Financial Officer (Principal Financial and
Accounting Officer)
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S CONSOLIDATED BALANCE SHEET AT DECEMBER 31, 1998 AND CONSOLIDATED
STATEMENTS OF OPERATIONS FOR THE SIX MONTHS ENDED DECEMBER 31, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-1999
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 2,471
<SECURITIES> 0
<RECEIVABLES> 5,171
<ALLOWANCES> 700
<INVENTORY> 872
<CURRENT-ASSETS> 83,276
<PP&E> 3,874
<DEPRECIATION> 2,335
<TOTAL-ASSETS> 10,773
<CURRENT-LIABILITIES> 8,702
<BONDS> 705
0
0
<COMMON> 90
<OTHER-SE> 1,276
<TOTAL-LIABILITY-AND-EQUITY> 10,773
<SALES> 5,453
<TOTAL-REVENUES> 6,684
<CGS> 2,052
<TOTAL-COSTS> 2,803
<OTHER-EXPENSES> 9,153
<LOSS-PROVISION> 290
<INTEREST-EXPENSE> 76
<INCOME-PRETAX> (3,744)
<INCOME-TAX> 0
<INCOME-CONTINUING> (3,744)
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<NET-INCOME> (3,744)
<EPS-BASIC> (0.42)
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