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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, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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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 [X] No [ ]
and (2) has been subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of February 9, 2000, 9,294,711 shares of the Registrant's $0.01
par value Common Stock were outstanding.
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CYBERGUARD CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands except share and per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
-------------------------- -------------------------
Dec. 31, Dec. 31, Dec. 31, Dec. 31,
1999 1998 1999 1998
----------- ---------- ----------- -----------
<S> <C> <C> <C> <C>
Revenues:
Products $ 3,498 $ 3,941 $ 6,763 $ 5,453
Services 872 736 1,939 1,231
----------- ---------- ----------- -----------
Total revenues
4,370 4,677 8,702 6,684
Cost of revenues:
Products 849 1,197 1,387 2,052
Services 259 439 948 751
----------- ---------- ----------- -----------
Total cost of revenues 1,108 1,636 2,335 2,803
Gross profit 3,262 3,041 6,367 3,881
Operating expenses:
Research and development 707 850 1,552 1,746
Selling, general and administrative 2,407 3,996 4,896 7,697
----------- ---------- ----------- -----------
Total operating expenses 3,114 4,846 6,448 9,443
----------- ---------- ----------- -----------
Operating income (loss) 148 (1,805) (81) (5,562)
Other income (expense)
Interest expense, net (319) (31) (662) (76)
Gain on sale of assets 24 -- -- 1,820
Other income (expense) 85 7 98 74
----------- ---------- ----------- -----------
Total other income (expense) (210) (24) (564) 1,818
----------- ---------- ----------- -----------
Net income (loss) $ (62) $ (1,829) $ (645) $ (3,744)
=========== ========== =========== ===========
Basic and fully-diluted loss per common share $ (0.01) $ (0.20) $ (0.07) $ (0.42)
=========== ========== =========== ===========
Weighted average number of common shares outstanding 9,148,283 8,950,223 9,118,481 8,929,769
=========== ========== =========== ===========
</TABLE>
See accompanying notes to condensed consolidated financial statements
2
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CYBERGUARD CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Dec. 31, June 30,
1999 1999
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<S> <C> <C>
ASSETS
Cash and cash equivalents $ 2,927 $ 2,622
Restricted cash 650 908
Accounts receivable, less allowance for uncollectible accounts
of $141 at Dec. 31, 1999 and $407 at June 30, 1999 2,082 2,021
Inventories, net 119 210
Capitalized software, net 467 185
Other current assets 623 482
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Total current assets 6,868 6,428
Property and equipment at cost, less accumulated
depreciation of $890 at Dec. 31, 1999 and
$922 at June 30, 1999 1,096 1,154
Non-compete agreements, net 420 560
Other assets 160 135
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Total assets $ 8,544 $ 8,277
======== ========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Line of credit and note payable 1,670 2,054
Accounts payable 1,043 2,766
Deferred revenue 2,349 2,047
Accrued expenses and other liabilities 1,419 3,210
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Total current liabilities 6,481 10,077
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Note Payable 650 --
Convertible debenture, net 3,508 885
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Total liabilities 10,639 10,962
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Shareholders' deficit
Common stock par value $0.01 authorized 50,000,000 shares
issued and outstanding 9,202,377 at Dec. 31, 1999
and 9,064,756 at June 30, 1999 92 91
Additional paid-in capital 74,941 73,677
Accumulated deficit (77,119) (76,475)
Accumulated other comprehensive income (9) 22
-------- --------
Total shareholders' deficit (2,095) (2,685)
-------- --------
Total liabilities and shareholders' deficit $ 8,544 $ 8,277
======== ========
</TABLE>
See accompanying notes to condensed consolidated financial statements
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CYBERGUARD CORPORATION
CONDENSED CONSOLIDATED STATEMENT OF CASH FLOW
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six Months Ended
---------------------
Dec. 31, Dec. 31,
1999 1998
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<S> <C> <C>
Cash flows from operating activities
Net loss $ (645) $(3,744)
Adjustment to reconcile net loss to net cash
used by operating activities:
Depreciation 188 385
Amortization 244 158
Interest on retirement of convertible debt 240
Interest on new convertible debt 95
Compensation and benefits -- 123
Provision for uncollectible accounts receivable (266) 290
Provision for inventory reserve -- 20
Gain on sale of business assets -- (1,820)
Changes in assets and liabilities
Accounts receivable 205 (1,426)
Other current assets (141) (214)
Inventories 91 (1)
Accounts payable (1,723) 14
Accrued expenses and other liabilities (1,511) (86)
Deferred revenue 952 1,212
Other, net 78 89
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Net cash used by operating activities (2,193) (5,000)
Cash flows provided by (used in) investing activities
Capitalized software costs (350) (140)
Additions/deletions to Property & Equipment (130) (112)
Proceeds from sale of Arca Systems -- 3,261
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Net cash provided (used) by investing activities (480) 3,009
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Cash flows provided by (used in) financing activities
Proceeds from sale of business assets -- 1,820
Change in restricted cash 258 (258)
Issuance of new convertible debt 4,314 1,125
Retirement of existing convertible debt (1,125) --
Notes Payable (610) --
Repayments on revolving line of credit (55) (925)
Proceeds from sale of common stock 196 19
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Net cash provided from financing activities 2,978 1,781
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Net increase (decrease) in cash 305 (210)
Cash and cash equivalents at beginning of period 2,622 1,773
Cash and cash equivalents at end of period $ 2,927 $ 1,563
======= =======
Supplemental disclosure of cash flow information
Cash paid for interest 482 0
======= =======
Cash paid for income taxes -- --
Non-cash financing activities
Beneficial conversion feature on new convertible debt 952 --
======= =======
</TABLE>
See accompanying notes to condensed consolidated financial statements
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CYBERGUARD CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(UNAUDITED)
1. BASIS OF PRESENTATION
The Company has prepared the consolidated financial statements included herein,
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission with respect to Form 10-Q. Certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles have been condensed or omitted
pursuant to such rules and regulations, although the Company believes that the
disclosures made are adequate so as to make the information contained not
misleading. These interim financial statements and the notes should be read in
conjunction with the financial statements and the notes included in the
Company's 10-K for the year ended June 30, 1999. In the Company's opinion, all
adjustments (consisting only of normal recurring adjustments) necessary for fair
presentation of the information shown have been included. Generally accepted
accounting standards also requires management to make estimates and assumptions
that affect the reported amounts of assets, liabilities, revenues and expenses,
and disclose contingent assets and liabilities at the date of the financial
statements. 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 results of operations for the six months ended December 31, 1999 presented
are not necessarily indicative of the results of operations that may be expected
for the year ending June 30, 2000.
Basic loss per share is calculated by dividing net loss by the weighted average
number of common shares outstanding during the year. Diluted per share data
includes the dilutive effects of options, warrants and convertible securities.
Since the effects of the outstanding options, warrants and convertible
securities are anti-dilutive, they are not included in the calculation of
diluted loss per share.
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
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CYBERGUARD CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(UNAUDITED)
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 (the "Shareholder Litigation"). An amended consolidated
complaint was filed on August 23, 1999, after the filing of the Company's
restated financial results. On October 30, 1999, the Company filed a Motion to
Dismiss Plaintiffs' Amended Class Action Complaint.
The Company's obligation to indemnify its officers and directors under the
aforementioned lawsuit is insured to the extent of the limits of the applicable
insurance policies. The Company has notified its insurance carrier of the
existence of the 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, of 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
that the Company will be successful in defending the lawsuits or if
unsuccessful, 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, NA that
alleged breach of contract, tortious interference and fraud. Also in June 1999,
DST filed a lawsuit against the Company alleging fraud, negligent
misrepresentation, and unjust enrichment, with unspecified damages, and
rescission and reformation of contract. The Company and DST settled both actions
on October 27, 1999, with the Company receiving $135,000 from funds being held
in escrow and DST receiving a $60,000 non-interest-bearing promissory note with
a maturity date of October 26, 2000.
On September 16, 1999, the Company filed a lawsuit against KPMG Peat Marwick LLP
("KPMG") and August A. Smith, the KPMG engagement partner, Case No.
99-21700CA05, in the Circuit Court of the 11th Judicial Circuit in and for
Miami-Dade County. The Company alleges KPMG failed to properly audit the
Company's financial statements and provided inaccurate advice on accounting
matters for fiscal years 1997 and 1998 and on accounting treatment of certain
matters at the end of fiscal year 1996. The action alleges professional
malpractice, breach of fiduciary duty, breach of contract and trade libel and
seeks damages in excess of $10 million. On December 29, 1999, KPMG served the
Company with a Motion to Dismiss the Complaint for failure to state a cause of
action. Discovery is in its initial stage.
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. RELATED PARTY TRANSACTIONS
On August 26, 1999, certain directors, officers and employees invested in the
Company's convertible debenture offering, contributing a total of $614,000. The
interest rate on the convertible debt is 11.5% per annum. The debt can be
converted into approximately 614,000 shares of common stock at a
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CYBERGUARD CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1999
(UNAUDITED)
conversion price equal to $1.00 per share. In addition, the Company issued
approximately 614,000 warrants to purchase the Company's common stock at $2.00
per share. The warrants are exercisable any time before August 2004. The terms
of the debt agreement permit the conversion of the debt to common stock at a
discount to market. This discount is considered a beneficial conversion feature
and, at the date of issuance of the debt, is being recognized as interest
expense over the shortest possible conversion period. The convertible debt is
subordinated to the Company's senior debt.
On August 26, 1999, David R. Proctor, Chairman and Chief Executive Officer,
signed a promissory note in the amount of $100,000 to facilitate his
participation in the convertible debt offering. The interest rate on the note is
11.5% per annum. The promissory note is being repaid bi-weekly in lieu of
salary, including any bonus payments. The note is expected to be paid in full by
March 2000.
4. SUBSEQUENT EVENTS
On January 24, 2000, the Company entered into a Master Purchase and Sale
Agreement with a major web-hosting company, in which they have committed to
purchase a minimum of 500 units of the Company's KnightSTAR(TM) premium
appliance firewall solution. This agreement represents the single largest
commitment in the Company's history and will translate into a revenue stream of
approximately $6M over the next twelve months.
On January 25, 2000, the Company announced the launch of its premium appliance
firewall, KnightSTAR. Designed to meet the needs of the high-volume,
high-performance data centers, this high-end firewall product, with superior
security and performance, combines the functionality and price of a network
appliance as a bundled hardware and software package. This internet
infrastructure product is a fully integrated, high-density, pre-staged and ready
to operate firewall, which includes browser-based central and remote management
features, carries an ITSEC E-3 certification and is built to NSA B-2
specifications with its hardened UNIX-based operating system.
7
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company provides a full suite of products and services for the network
security industry. The products offered by the Company include the CyberGuard(R)
Firewall, proprietary and third-party technology (such as Virtual Private
Network, authentication, virus scanning, encryption, advanced reporting, high
availability and centralized management), and training, consulting, support
maintenance, and installation services.
RESULTS OF OPERATIONS
THE QUARTER ENDED DECEMBER 31, 1999 COMPARED TO THE QUARTER ENDED
DECEMBER 31, 1998
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, 1999, net revenues
decreased $0.3 million when compared to the quarter ended December 31, 1998. The
$4.4 million of revenue was comprised of $3.5 million from the sales of network
security products and $0.9 million from the sales of training, consulting,
support maintenance, and installation services. The $0.4 million decrease in
network security product revenue as compared to last year was offset somewhat by
a $0.1 million increase in service revenue as compared to last year. Both the
decrease in product revenue and the increase in service revenue, particularly
support maintenance revenue, are directly attributed to the marketplace's
concerns regarding the effects of Y2K.
GROSS PROFIT
Gross Profit as a percentage of revenues increased to 75% for the quarter ended
December 31, 1999 from 65% when compared to the quarter ended December 31, 1998.
The increase is attributable to the increased level of revenues relative to the
fixed cost components of cost of revenues, to the shift in product mix to
predominately software only sales, and to the absence of any former TradeWave
Division operations.
OPERATING EXPENSES, OTHER INCOME AND EXPENSE AND NET LOSS
Overall, operating expenses decreased $1.7 million for the quarter ended
December 31, 1999 to $3.1 million. This is due to decreased compensation and
related employee costs, reduced professional accounting and legal fees, and
better cost controls over outside consulting and other third party contracts.
Additionally, the Company reduced its provision for uncollectible accounts by
$106,000, reflecting a better than estimated realization of accounts receivable.
Other Income and Expense increased $0.2 million for the quarter ended December
31, 1999 to ($0.2) million. This is the related to an increase in interest
expense of $0.2 million associated with the issuance of the new convertible
debt.
The net loss for the quarter ended December 31, 1999 was $62,000 compared to
$1.8 million for the quarter ended December 31, 1998. The Company did not
provide for income taxes due to the significant net operating loss carryforwards
available.
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THE SIX-MONTH PERIOD ENDED DECEMBER 31, 1999 COMPARED TO THE SIX-MONTH PERIOD
ENDED DECEMBER 31, 1998
NET REVENUES
For the six-month period ended December 31, 1999, net revenues increased by
approximately $2.0 million to $8.7 million when compared to the six-month period
ended December 31, 1998 of $6.7 million. Product revenue increased 24%, or $1.3
million, and service revenue increased 58%, or $0.7 million, over the same
period last year. The increase in both product and service revenue is directly
attributed to the return of consumer confidence in the Company's management,
products, and future.
GROSS PROFIT
Gross Profit as a percentage of revenues increased to 73% for the six-month
period ended December 31, 1999 from 58% when compared to the six-month period
ended December 31, 1998. The increase is attributable to the increased level of
revenues relative to the fixed cost components of cost of revenues, to the shift
in product mix to predominately software only sales, and to the absence of any
former TradeWave Division operations.
OPERATING EXPENSES, OTHER INCOME AND EXPENSE AND NET LOSS
Overall, operating expenses decreased $3.0 million for the six-month period
ended December 31, 1999 to $6.4 million. The $2.8 million decrease in selling,
general and administrative expenses was the result of significant staffing
reductions and an overall reduction in discretionary spending. Additionally, the
Company reduced its provision for uncollectible accounts by $266,000 reflecting
a better than estimated realization of accounts receivable for the six-month
period.
Other Income and Expense changed by $2.4 million for the six-month period ended
December 31, 1999 to ($0.6) million. The change relates to the increase in
interest expense of $0.6 million associated with the issuance of the new
convertible debt and a non-recurring, one-time gain of $1.8 million realized
from the sale of the Company's Arca division in 1998.
The net loss for the six-month period ended December 31, 1999 was $0.6 million
compared to $3.7 million for the six-month period ended December 31, 1998. The
Company did not provide for income taxes due to the significant net operating
loss carryforwards available.
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 the net losses
from operations, the research and development of its products, and the capital
expenditures for property, equipment and software. For the quarter ended
December 31, 1999, the Company incurred a net loss of approximately $62,000 on
revenues of approximately $4.4 million. For the quarter ended December 31, 1998,
the Company incurred a net loss of approximately $1.8 million on revenues of
approximately $4.7 million. For the six-month period ended December 31, 1999,
the Company incurred a net loss of approximately $0.6 million on revenues of
approximately $8.7 million. For the six-month period ended December 31, 1998,
the Company incurred a net loss of approximately $3.7 million on revenues of
$6.7 million.
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At December 31, 1999, the Company had cash and cash equivalents on hand of $2.9
million representing an increase of $0.3 million from $2.6 million as of June
30, 1999. Accounts payable and accrued liabilities decreased by $3.2 million,
accounts receivable increased $.06 million, property and equipment decreased
$0.06 million, and inventory levels decreased by $0.09 million compared to June
30, 1999.
The Company's principal sources of liquidity at December 31, 1999, consisted of
cash, accounts receivable, a revolving line of credit with Coast Business
Credit, and vendor trade credit. The revolving line of credit with Coast
Business Credit is based on available eligible account receivables and
inventory. The line of credit decreased $.4 million, from $2.1 million to $1.7
million compared to June 30, 1999.
On August 26, 1999, the Company entered into a financing transaction with
Fernwood Partners II, LLC ("Fernwood") and certain officers, directors and
employees of the Company, through which the Company obtained a total amount of
$4,313,484 (the "Fernwood Financing"). In the Fernwood Financing, Fernwood
provided $3,699,484 and certain directors, executive officers and employees of
the Company provided $614,000. All of the financing consisted of promissory
notes convertible into the Company's Common Stock at $1.00 per share and
warrants to purchase an equivalent number of shares of the Company's Common
Stock at $2.00 per share. The terms of the debt agreement permit the conversion
of the debt to common stock at a discount to market. This discount is considered
a beneficial conversion feature. The beneficial conversion feature at the date
of issuance of the debt of $1,069,621 is being recognized as interest expense
over the thirty-four month conversion period. The Fernwood Financing bears
interest at a rate of 11.5% per annum and is secured by a lien on all of the
Company's assets. Part of the proceeds from this financing was used to repay a
$1,125,000 loan and accrued interest to Fernwood Partners, LLC, a limited
liability company that provided financing to the Company in December 1998.
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 that uses the local currency to
denominate its transactions. Therefore, the Company is 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. There was no significant change for the
quarter ended December 31, 1999. 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.
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.
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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
in the long term. 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. 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.
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. It was thought that
many currently installed computer systems were not capable of distinguishing
dates beginning with the year 2000 from dates prior to the year 2000. Computer
systems or applications used by many companies in a wide variety of industries
could experience operating difficulties unless the systems or applications were
modified to adequately process information related to the date change. A degree
of uncertainty still exists in the software and other industries concerning the
scope and magnitude of problems associated with the century change. Many
industry experts believe that the extent of Year 2000 issues may not be realized
until after March 31, 2001.
While the Company believes its Year 2000 risk management initiative's scope
covered both the Company's information technology (IT) systems and non-IT
systems and addressed all areas of the Year 2000 issues as defined by the
Information Technology Association of America (ITAA), and to date there have
been no Year 2000 issues detected, there can be no assurance that the Company
has identified and remedied all Year 2000 problems, and that such problems will
not have a material adverse affect on the Company's business.
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-
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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 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 the 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). The Company is now current in its filings
with the SEC. 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 at sufficient
volume and prices to become profitable on a consistent basis. The velocity of
technological change has accelerated and the Company believes that it is
important to its future that it keeps pace with these changes. The Company
believes that competition will continue to intensify in the rapidly evolving
markets in which the Company is involved, and that the continued development of
technologically advanced products will be necessary to keep its products
current. The Company believes that its ability to generate adequate cash flow
from operations will be critical to its future.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES CONCERNING MARKET RISK
We have limited exposure to financial market risks, including changes in
interest rates. The fair value of our 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 our
investment portfolio. A fluctuation in interest rates would not significantly
affect interest expense on debt obligations since a significant portion of the
debt obligation is at a fixed rate of interest.
12
<PAGE> 13
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 was filed on August 23, 1999, after
the filing of the Company's restated financial results. On October 30, 1999, the
Company filed a Motion to Dismiss Plaintiffs' Amended Class Action Complaint.
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, NA 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. The Company and DST settled both actions on October 27, 1999, with the
Company receiving $135,000 from funds being held in escrow and DST receiving a
$60,000 non-interest-bearing promissory note with a maturity date of October
26, 2000.
On September 16, 1999, the Company filed a lawsuit against KPMG Peat Marwick LLP
("KPMG") and August A. Smith, the KPMG engagement partner, Case No.
99-21700CA05, in the Circuit Court of the 11th Judicial Circuit in and for
Miami-Dade County. The Company alleges KPMG failed to properly audit the
Company's financial statements and provided inaccurate advice on accounting
matters for fiscal years 1997 and 1998 and on accounting treatment of certain
matters at the end of fiscal year 1996. The action alleges professional
malpractice, breach of fiduciary duty, breach of contract and trade libel and
seeks damages in excess of $10 million. On December 29, 1999, KPMG served the
Company with a Motion to Dismiss the Complaint for failure to state a cause of
action. Discovery is in its initial stage.
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 its officers, directors and employees. In September 1999, the
Company was notified that the SEC had begun a formal investigation into certain
accounting and financial reporting practices of the Company and its officers,
directors and employees.
The Company is unable to predict the ultimate outcome of the litigation and
investigation described above in this Part II, Item 1. The resolution of such
matters could have a material adverse affect on the
13
<PAGE> 14
Company's results of operations and financial position. The Company's financial
statements do not include any adjustments related to these matters.
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. The debt was convertible into 750,000 shares of Company common
stock at a conversion price equal to $1.50 per share. In addition, the Company
issued the debt holders 500,000 warrants to purchase the Company's common stock
at $2.00.
On August 26, 1999, the Company closed an offering of convertible debt in the
approximate amount of $4,300,000, from which the prior $1,125,000 convertible
debt was repaid. The majority of the new debt is with the same debt holders as
the previous transaction. The interest rate is 11.5% per annum. The debt can be
converted, at the debt holder's option, into approximately 4,300,000 shares of
common stock at a conversion price equal to $1.00 per share. In addition, the
warrants from the December 1998 transaction were cancelled and the Company
issued approximately 4,300,000 warrants to purchase the Company's common stock
at $2.00 per share. The warrants are exercisable at any time before August 2004.
The terms of the debt agreement permit the conversion of the debt to Company
common stock at a discount to market. This discount is considered a beneficial
conversion feature and, at the date of issuance of the debt, is being recognized
as interest expense over the shortest possible conversion period. The
convertible debt is subordinated to the Company's senior debt.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On December 8, 1999, the Company held its Annual Meeting of Shareholders at the
Marriott by Courtyard at Cypress Creek, in Fort Lauderdale, Florida. David L.
Manning and David R. Proctor were nominated as members to the Board of Directors
for a period of two years and William G. Scott was nominated as a member to the
Board of Directors for a period of three years. Mr. Manning received 8,190,291
votes in favor of his appointment, while 134,023 shareholders withheld, Mr.
Proctor received 8,192,149 votes in favor of his appointment, while 132,165
shareholders withheld, and Mr. Scott received 8,202,310 votes in favor of his
appointment, while 122,004 shareholders withheld. C. Shelton James and Richard
P. Rifenburgh continue on in their current capacity as Board members.
Two other matters were brought for vote during the annual meeting: an amendment
to CyberGuard's Amended and Restated Articles of Incorporation to increase the
number of shares of Common Stock authorized for issuance from 20,000,000 to
50,000,000 shares, and the ratification of Grant Thornton LLP as the Company's
independent public accountants for the fiscal year ending June 30, 2000. The
amendment to increase the number of shares of Common Stock authorized was passed
with 7,742,841 votes in favor, 532,655 votes against and 48,817 abstentions. The
ratification of Grant Thornton LLP was passed with 8,223,033 votes in favor,
66,194 votes against, and 35,087 abstentions.
14
<PAGE> 15
ITEM 5. OTHER INFORMATION
None
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
EXHIBIT NR. EXHIBIT DESCRIPTION
----------- -------------------
27.1 -- Financial Data Schedule
-----------------
(b) Reports filed on Form 8-K during the quarter ended December 31, 1999: On
October 15, 1999 - Changes in Registrant's Certifying Accountant
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: February 14, 2000 CYBERGUARD CORPORATION
By: /s/ David R. 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, 1999 AND CONSOLIDATED
STATEMENTS OF OPERATION FOR THE SIX MONTHS ENDED DECEMBER 31, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> JUN-30-2000
<PERIOD-START> JUL-01-1999
<PERIOD-END> DEC-31-1999
<CASH> 3,577
<SECURITIES> 0
<RECEIVABLES> 2,223
<ALLOWANCES> 141
<INVENTORY> 119
<CURRENT-ASSETS> 6,868
<PP&E> 1,986
<DEPRECIATION> 890
<TOTAL-ASSETS> 8,544
<CURRENT-LIABILITIES> 6,482
<BONDS> 0
0
0
<COMMON> 92
<OTHER-SE> (2,096)
<TOTAL-LIABILITY-AND-EQUITY> 8,544
<SALES> 6,763
<TOTAL-REVENUES> 8,702
<CGS> 1,387
<TOTAL-COSTS> 2,335
<OTHER-EXPENSES> 6,448
<LOSS-PROVISION> (266)
<INTEREST-EXPENSE> 335
<INCOME-PRETAX> (645)
<INCOME-TAX> 0
<INCOME-CONTINUING> (645)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (645)
<EPS-BASIC> (0.07)
<EPS-DILUTED> (0.07)
</TABLE>
